James d. Gwartney

ELEMENT 4.5
Avoid credit-card debt and consider purchasing used items.

---

230
high interest rates being charged on the unpaid balance.
It is common for people to pay interest charges of 15 to 18 percent on their credit card
debt. This is far higher than most people, even successful investors, can earn on their savings
and investments. As we shall see in later elements, you can become wealthy earning 7 percent
per year on your investments. Unfortunately, high interest rates on outstanding debt will have
the opposite impact. Paying 15 to 18 percent on your credit card debt can drive even a person
with a good income into poverty.
Consider the example of Sean, a young professional who decides to take a few days
relaxing in the South of France. The trip costs Sean €1,500, which he puts on his credit card.
But instead of paying the full amount at the end of the month, Sean pays only the minimum,
and he keeps doing so for the next ten years, when the bill is finally paid off. How much did
Sean pay for his trip, assuming an 18 percent interest rate on his credit card? He pays €26.63
per month for 120 months, or a total of €3,195.40. So Sean pays his credit card company more
than he paid for the air travel, hotel, food, and entertainment.
Sean could have taken the trip for a whole lot less by planning ahead and starting to
make payments to himself before the trip, instead of making payments to the credit card
company after the trip. By saving €75 a month at 5 percent per year in compound interest (we
will discuss compound interest in Element 7) for twenty months, Sean could have had
€1,560.89 for the trip, and not the €3,195.40 he ended up paying (including interest) for the
same trip (but taken earlier) on the credit card. In other words, by saving and planning to make
his trip, instead of running up credit card debt to pay for it, Sean could take two trips for less
than what he ended up paying for one on credit.
In some cases, you may already have a sizeable credit card bill. It would have been
better if you had avoided that debt, but it does provide an opportunity for you to get a very
high return. Everything you save to pay down a credit card debt effectively earns an interest
rate of 18 percent, or whatever you are paying on the debt.
Look at it this way. If you put a euro in an investment that is paying 18 percent rather
than spend that euro, then one year from now you have added €1.18 to your net worth. If you
save a euro to pay off your credit card debt, then one year from now it has also added €1.18 to
your net worth. Your debt will be that much lower—first, from the amount you saved that

---

231
reduced your debt initially and, second, from the 18 cents you would have otherwise owed in
interest.
Even if your credit card rate is less than 18 percent, it is still much higher than what
you will consistently earn on any other savings program you will ever have, unless you are
extraordinarily lucky or a spectacular investor. Of course you may not feel as though your
savings are really earning 18 percent, since the money isn’t actually being paid into your
investment accounts. But it amounts to the same thing. The very first thing anyone who has a
credit card debt and is serious about achieving financial success should do is pay that debt off,
from savings if necessary.