Advanced Personal Finance

Am I the only person who gets tired of reading about the latte factor or how if you save and invest the $0.75 you spend a day on a USAToday in 50 years you’ll have $17 zillion? (For those who don’t know, the ‘latte factor’ as espoused by David Bach is the idea that if you save the money you normally spend on a cup of coffee per day and invest it instead, you’ll have a big pile of money some day.) I must see at least one article a week along these lines.

Man, I get it. And so does everyone else. If you’re an adult and don’t know that saving and investing money today will result in more money a long time from now, I can’t help you. No one can.

“But people aren’t doing it. They’re not saving. They’re still spending money on those little things and giving up all that money in the future,” someone will always say.

To which I’d say, “Yeah. So what. It’s not that much money, that’s why people don’t do it.”

You’re forever reading an example that goes something like this (the numbers are real):

“If you normally spend $8 on a sandwich and chips for lunch every workday and instead save that money and invest it in a low-fee mutual fund returning 10%, in 40 years you’ll have $967,867. You’d be a millionaire! You should totally start packing your lunch and retire on that money!”

What this little example leaves out is inflation and taxes. That nearly million dollar pile will be worth substantially less than a million dollars right now. Actually, it will only be worth about $83,000 (if inflation is 3.5% and fees are 0.5%). Not so impressive any more is it?

(click to enlarge image) courtesy gafri.com

My point is that it’s misleading to use the tired old ’save a little bit and eventually you’ll have a lot’ line. You’re not going to save for a house down payment or retirement by not buying a cup of coffee every day. Sorry to have to point this out, but if you want a lot of money at retirement, you have to save a lot of money right now.

As one Ernest Haskins once said, “Save a little money each month and at the end of the year you’ll be surprised at how little you have.”

photo courtesy wikimedia.org

Share This

Money, Matter, and More Musings is hosting the Carnival of Personal Finance this week.

He’s grouped the articles by category and provided a table of contents for us (88 entries this week). There are also fun money facts sprinkled throughout. Pretty cool.

Here are a couple of notable posts from the Carnival:

Remember that scene from Ferris Bueller’s day off when the maitre de says, “I weep for the future.” Well, Clever Dude had a similar moment with his cousins when he had a money talk with them.

I got a lot out of a post by SVB at The Digerati Life. She’s getting her thoughts together about making a career change in her life. I think such thoughts are pretty common (at least I’ve thought about it).

Share This

The U.S. dollar recently touched an all-time low against the euro. Part of the reason is because the financial markets anticipate a rate cut from the Federal Reserve’s Open Market Committee. That may not seem entirely clear, though. Why does a Fed rate cut drive down the dollar? (For a great explanation of how a Fed rate cut affects the stock market, see Jim’s recent post at Blueprint for Financial Prosperity.)

Interest rates down - Dollar down

As interest rates fall, borrowing becomes cheaper. Correspondingly, lending becomes less attractive. The U.S. is the world’s biggest debtor nation, meaning lots of other countries have loaned us money. When we pay back those loans with interest, we do so in U.S. dollars.

What all this means is that investors overseas have lots of dollars in their hands. When a rate cut occurs, investors holding U.S. dollars see lower returns. When your bank offers a savings account interest rate lower than someone else’s, what do you do? You move your money to the other bank. Same thing here. Investors dump dollars in favor of some other currency. That drives down the value of the dollar relative to those other currencies.

Here’s a look at what the euro/dollar relationship looks like right now:

What a weak dollar means to you

A weak dollar has several different effects, among them:

• Traveling overseas sucks for Americans because it costs much more. Conversely, anyone from another country vacationing in America loves it because their currency buys so many more dollars.
• Because oil is priced in dollars, the price of a barrel goes up. This is part of the reason oil has hit a record high recently.
• Overseas investments by Americans are more profitable. This is especially important for people who have a portion of their 401(k) or other investments in global mutual funds.
• American businesses that do much of their business overseas will be more profitable.

Share This

Coming out of college with student loan debt is practically a given. Repaying that debt can be a challenge since typical loans for professional and graduate-level degrees can reach six digits. Even for graduates with a smaller number, repayment can be tough given all the other costs a new graduate is likely to encounter right out of school.

I recently learned about a repayment option that I didn’t know about. It’s called ‘Income Contingent Repayment’ (ICR) and is great for individuals who have a large amount of debt relative to their expected income. I should note right up front that ICR can only be used on federal guaranteed loans to the student. Parental loans and loans from private lenders do not qualify.

First, let me recap the more common ways to pay off student loans - there are three besides ICR.

• Standard repayment - the total amount borrowed is amortized over ten years with a fixed payment each month. Minimum monthly payment is $50.

• Extended repayment - the total amount borrowed is amortized over a 12 to 30 year period with a fixed payment each month. The length of repayment depends on total amount borrowed.

• Graduated repayment - the payment on this plan is lower at the beginning of repayment and gradually increases throughout the 12 to 30 year repayment period. The increases come every two years.

Income contingent repayment is different in that payments are based on a combination of total amount owed and the borrowers income. The term can reach 25 years (and typically will). Your monthly payment changes each year and is calculated based on your IRS adjusted gross income.

There’s one other awesome feature to ICR. If, at the end of 25 years, you haven’t paid the balance in full, the government writes off any remaining debt. The down side to that is, as the law is currently written, you’d owe tax on the amount forgiven. It sure beats paying the entire amount, though. Plus, that tax payment will occur 25 years in the future.

The ICR is ideal for someone whose profession requires a lot of expensive schooling but whose expected income is low. So if that’s you, check out the income contingent repayment plan.

Share This

I just read a really interesting post by David at My Two Dollars. His post, “Which Jones family are you trying to keep up with?” struck a chord with me. I’ve been thinking and reading about consumption and psychology for a while now and I’m going to run with a bit of what David touched on.

Is TV making you spend?

David’s thesis as I read it is that people would be better off if, when comparing their lives to those around them, they did so with open eyes. He says that people are too susceptible to the effects of advertising and television. If they looked at their neighbors, they’d see people much like them in terms of lifestyle.

I have to disagree. I think that the media (e.g. advertising and TV) play a relatively small part in people’s consumption behavior. Certainly people do respond to advertising, but I don’t believe to the degree David seems to think.

Looking one rung up on the consumption ladder

No, I think the real cause of conspicuous consumption is that people do exactly what David advocates - look at those around them. The difference is that people compare themselves to others just one step higher on the consumption ladder. Instead of seeing the other Toyotas on their street (to take an analogy from David’s post), they see the one BMW. Instead of comparing their vacation to other people in their office who also went to Six Flags, they compare it to the one person who went to Italy.

It’s this kind of comparison that drives conspicuous consumption ever higher. When people look at their house, they don’t compare it to their old one bedroom apartment. They compare it to the 3,000 square foot McMansion they pass dropping their kid off at school. And the owner of the 3,000 square foot McMansion? He’s looking at the 4,000 square foot estate on 3 acres down the road.

I’m not going to make a judgment on whether a 3,000 square foot house is necessary. I’ll only mention that since the 1950s, the median U.S. home has doubled in size, while the median family has shrunk in size by close to 50%. Does a modern person take up that much more space? Yes, we’re fatter as a nation, but not that much fatter.

We’re all moving together

The real problem with this conspicuous consumption pattern of comparing ourselves to those just a little higher on the ladder is that we’re all moving up the ladder at more or less the same pace. The additional consumption isn’t getting anyone anywhere. People’s expectations have simply shifted. A perfectly good working refrigerator isn’t good enough anymore. It has to be a gigantic stainless steel one.

In the process of this expectation shift, though, we’ve spent a lot of money. Real money that could have been better used. Not only that, but people aren’t happier with their abundant lives.

So where does this leave us? I’d like to say that we can make a difference one person at a time. I’d like to say we’d be happier if we were all just thankful for what we have. I’d like to say you could just get off the consumption treadmill.

But the truth is, I can’t say those things because they’re not true. The plain fact is, what you do affects me. And when you spend half a million dollars to buy a four bedroom house in my town, that’s what I’ll also have to pay for a similar house. When you buy a two ton SUV, if I don’t want to lose badly in a crash with you, I also have to drive a two ton SUV.

To reduce conspicuous consumption, we have to do what economists like to say. We have to get the incentives right. I’m not sure of the details, but there’s a real need to limit consumption for its own sake. Making it worthwhile for all Americans to save would do us a world of good.

And it would reduce your mortgage payment, too.

Share This