Can someone explain the reasoning behind this?

[jdc]

Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.

This quote is from http://forum.mrmoneymustache.com/investor-alley/investment-order-65299/.

Does this mean that if the 10 year Treasury note yield is 2%, then any debts 7% or great should be paid, but debts less than that deferred?

What is the reasoning for this?

Thanks!

[acepedro45]

It is a slightly convoluted way to say, "You should pay off high interest debt." Instead of arbitrarily defining high interest as a fixed number like "Over 7%" the poster tried to index it to the 10-year Treasury rate. That way, if the interest rate situation should change suddenly, the poster's advice will still be valid.

Right now the ten-year Treasury rate is around 2.5%, so the OP would advise paying down any debt that's over 7.5%.

Looking back at the original post, the writer is trying to give a list of priorities to invest, starting with the juiciest (401k match and paying off high interest debt) and working down to the less attractive. The idea is if you don't have enough money to do ALL the things he recommends, work your way down his list to get the most bang for your buck.

If you have debt that's at 6%, the OP would advise you to max your HSA and Roth before you pay your debt off.

[Fire2025]

Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.

This quote is from http://forum.mrmoneymustache.com/investor-alley/investment-order-65299/.

Does this mean that if the 10 year Treasury note yield is 2%, then any debts 7% or great should be paid, but debts less than that deferred?

What is the reasoning for this?

Thanks!

I don't think the option is to pay or defer.  The option is to pay off quickly or save first and pay off slowly.

[jdc]

Thank you for the replies! Is the reason that it is tied to the treasury rate because the treasury rate is reflective of the inflation rate? Something else?

[ShoulderThingThatGoesUp]

Yes, it's a good measure for what high interest is.

[skuzuker28]

Don't want to derail the OPs thread, but I have a follow-up question along similar lines: does the recommendation change based on whether the debt in question is fixed vs. variable rate?  While presumably the changes would correlate with the treasury rate pretty closely, wouldn't a variable rate note present increased risk from economic conditions (like stagflation) that could change the payoff recommendation?

[MDM]

Don't want to derail the OPs thread, but I have a follow-up question along similar lines: does the recommendation change based on whether the debt in question is fixed vs. variable rate?  While presumably the changes would correlate with the treasury rate pretty closely, wouldn't a variable rate note present increased risk from economic conditions (like stagflation) that could change the payoff recommendation?

In short, no.

Determining the "correct" investment order requires making some assumptions about the returns one will get (or interest one will pay) in non-fixed-rate situations.  One should at least be consistent regarding the conclusions drawn from assumptions made, but the assumptions themselves are not provably correct except in hindsight.

There is also a risk continuum.  One should not refrain from doing X simply because X is riskier than doing Y.  In general, the riskier the investment the greater the potential return.  Of course, that doesn't mean one should go to the extreme of betting the house on the next lottery drawing.  At some point the risk really is too high.

For a variable rate loan, make your best guess for what the rate will be over time.  Then proceed according to your guess.  You will find that you were either correct or incorrect - good luck!