You may have seen this piece in the news last week: Ronald Nelson, a Tennessee high school student, was accepted to all eight Ivy League universities. And he turned them all down, deciding on the University of Alabama instead. His reasoning? He didn’t want to take on the burden of college debt as an undergrad. While the Ivy League schools had offered him some level of financial aid, the University of Alabama offered Nelson a full ride—and he decided to jump at the opportunity.
As interviewers commented over the weekend, Nelson’s decision is stunning to many. It shines a spotlight on the exorbitant cost of college tuition in the US, which continues to rise faster than inflation. But his decision also says a lot about this young man’s understanding of money. When he looked at the long term, he took into account his plans to attend medical school, and the additional cost of his education down the road. He took the emotion out of the decision (I can’t even imagine the pressure he felt to say yes to Stanford, John Hopkins, NYU, among others) and focused on his ultimate goal: starting his career with as little debt as possible.
The story speaks to the need for families and individuals of every age to understand “good debt” versus “bad debt,” and the importance of balancing the expected return on an investment with the burden of the debt itself.
The upside of debt
While even the word “debt” can cause most of us to cringe, there really is such as thing as good debt. Good debt helps build wealth—not deplete it—and works over time to help you increase your net worth. Of course, no investment comes with a guarantee, but these top three examples most often result in asset growth, at least over the long term:
- College Education: It’s no mystery that greater education leads to greater earnings potential, which is why investing in higher education is generally considered good debt. But as tuition costs continue to outpace inflation, college-bound students may be wise to take a lesson from Ronald Nelson. He is still working toward his goal of medical school, but he’s accomplishing that goal at a much lower cost than if he’d chosen one of the Ivy Leagues.
- Real Estate: Buying a home is often the primary goal for 20- and 30-somethings. And while such an investment doesn’t always pay off (talk to anyone who found themselves “underwater” after the last housing crash), in most cases, owning a home for 15-30 years results in a significant profit.
- Investing: Again, long-term is the key. Sure, some people get lucky on a short-term stock purchase that they happen to buy low and sell high, but the more trusted approach to building wealth is investing over many years in a market that, at least to date, has consistently gone up over time. Yes, bear markets happen, but so do bull markets, and the bulls seem to always win in the end.
Dow Jones Industrial Average - 1900-Present
The downside of debt
While there are no guarantees on the return of good debt, bad debt has no upside. Yes, there are certain living expenses we all must make—including some of the big-ticket items listed below—but the key is to manage that debt as much as possible. Be rational, not emotional, and make choices that reflect your own budget (even your neighbors may not really be able to afford that luxury car, even if it’s sitting in their garage!). Here are some examples of bad debt:
- Credit Cards: While it’s important to build your credit over time—and using credit cards is often the primary vehicle for this goal—living beyond your means and increasing your credit card debt may very well be the worst possible “bad debt.” Beware of “no interest” cards that falsely allow you to view credit as “free money.” While compound interest is good for investors, it is exponentially bad to debtors.
- Cars: Yes, most of us need a car (especially in Southern California!). But remember, you are not what you drive. Cars are both a necessity and a major acquisition. Try to keep emotion out of the decision and do your homework. Remember that driving your own car for just one more year can be a profitable decision.
- Stuff: Items like furniture, clothing, and appliances may be necessities, but that doesn’t mean you should take on debt to pay for them. Making a budget and sticking to it, or saving up for that beautiful new sofa instead of financing it, can keep your level of bad debt to a minimum.
Ultimately, managing debt is a balancing game, and I expect every one of us could learn a lesson from Ronald Nelson. He took a close look at his long-term goals and opted for the road less traveled, all in an effort to manage his debt. I have to wonder how his peers who are busy taking out huge loans to pay the cost of an Ivy League tuition are going to fare in comparison down the road. My guess: Ronald Nelson is going to excel at more than just medicine in years to come.