Basic Personal Finance Book

Companies Make Big Money Off People Who Don’t Pay Attention

October 10, 2018lencabLeave a comment

You hear a lot of people moaning that the rich get rich on the backs of the poor. A more plausible source of riches comes from people who don’t pay attention. This is a frequent warning I give to students, especially when talking about banking and ATM machines. (A couple years ago, I learned that companies like McDonalds pay employees with prepaid debit cards if they don’t have bank accounts for direct deposit, and I was shocked to learn that kids were paying $4 fees to cash $20 paychecks.)

Today I added several more data points to support the “riches from the ignorant” hypothesis. I had my car serviced; just an oil and filter change and tire rotation. (Yes, I can do it myself, but I had a coupon that got it all done for under $30, with tax.) The service scammer (she claimed “advisor”) told me the technician recommended several things: a fuel injector cleaning, a coolant flush, a brake fluid flush, and a wheel alignment “because you have some feathering on the outside of the front tires.” The total bill would be $670. Surprisingly, they didn’t recommend an engine air filter change since the manufacturer’s recommended service calls for it at my mileage.

It was easy to spot the scam and decline all the services because I’m familiar with the manufacturer’s service schedule, which I always review before doing anything to the car. The manufacturer recommended interval for a coolant flush is 6 years or 120K miles, but it’s a very high profit service with low materials cost and very little required labor, so dealers push it as often as they can, especially at the change of seasons to “winterize” or “prepare for summer heat.”

The fuel injector service is also a scam because the service manual does not mention a requirement for such a service… ever… at any mileage. Other dealers offer an “induction system cleaning” which basically means cleaning all the plumbing from the intake up to the cylinders… yes, plumbing that’s kept clean by an engine air filter (and up to the air filter is supposed to be cleaned when the filter is replaced). If it’s not in the manufacturer’s recommended maintenance, don’t pay someone to do it.

The alignment claim could be legitimate, if you haven’t already identified a scammer. In my case, I had just had the front suspension bushings replaced under warranty so an alignment had been done less than 5K miles before. Also, I knew I was getting close on my tires so I looked at them carefully before dropping the car off. The wear on each tire was perfectly even.

At a previous visit to this same dealership, the service scammer brought me a dirty engine air filter and suggested I replace it. I thought it odd that my filter could be that dirty because I only had 15K miles at the time and the manual calls for replacements every 35K miles. As usual, I declined. When I got home, I popped the hood and looked at my filter. It was spotless, and it wasn’t even the same size as the one the scammer showed me.

Dealerships aren’t the only scammers out there. On the way back, I stopped for gas and the pump defaulted to premium even though I pushed the button for regular. I’ve seen that happen at this particular gas station before and I wonder how many people don’t notice and pay the extra $5+ for a fill up (figuring $0.50/gal and 10 gal of gas).

This isn’t exactly a new idea. The phrase “a fool and his money are soon parted” dates back to 1587 (Dr. John bridge, Defence of the Government of the Church of England). This is your reminder to not be a fool with your money.

Financial Discipline Begins with Personal Discipline

August 25, 2017August 25, 2017lencabLeave a comment

You’ve heard the saying, you can’t love others until you first love yourself. The same can be said of your personal finance: You can’t have financial discipline if you don’t have personal discipline.

A new study by CareerBuilder shows that 78% of Americans live paycheck to paycheck. Their survey of 3,462 full-time workers and 2,369 full-time employers showed people struggle to make ends meet even at higher wages. People earning over $100,000 (9%) were living paycheck to paycheck; 28% of those making $50K to $99K do too.

The big problem is behaviors that lead to debt. 71% of those surveyed had some kind of debt and 56% said they would never pay off their debts. The same percentage (56%) save less than $100 per month.

Brittany Jones-Cooper at Yahoo Finance reported on the survey and interviewed a financial planner. He said the first step is to look at non-monetary factors like shopping and drinking in bars to “relieve stress.” The Yahoo story offers a bulleted list of ideas to consider, but it boils down to take personal responsibility. For the most part people don’t live paycheck to paycheck because someone else is not paying them enough. It’s because they are spending too much.

The solution is to create a budget to understand where your money is going. Then develop a plan to cut back the bad habits. You need to have personal discipline to stick to that plan. In time, you’ll learn to live within your means and save at least 10% of your income for the future. It’s all covered in Chapter 3 of Basic Personal Finance.

How’s Your Financial Wisdom?

August 7, 2017lencabLeave a comment

After my last post on baby boomers failing their retirement planning, you might have some smug thoughts that you’re doing much better than them. Here’s a little test, thanks to The Atlantic:

Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After five years, how much do you think you would have in the account if you left the money to grow? A) more than $102; B) exactly $102; C) less than $102; D) do not know; refuse to answer.
Imagine that the interest rate on your savings account is 1 percent per year and inflation is 2 percent per year. After one year, would you be able to buy A) more than, B) exactly the same as, or C) less than today with the money in this account?; D) do not know; refuse to answer.
Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.” A) true; B) false; C) do not know; refuse to answer.

The correct answers are 1-A; 2-C; and 3-B.

Based on a survey by economists Annamaria Lusardi and Olivia Mitchell, only 30 percent of Americans answered all three questions correctly. Their findings are published by American Economic Association (subscription required).

The Atlantic author warns that financial ignorance becomes more devastating in a modern economy. Fortunately, the study authors found that basic financial education can boost someone’s economic situation (by 82% of initial wealth for people with low levels of formal education and 56% for college graduates).

If you’re reading a personal finance blog (or read my book), you probably did pretty well on the test. Try to share your financial knowledge with someone you know who needs the help. They might not even know it. Start with the quiz.

Get Your Kids Ready For College

July 10, 2017lencab2 Comments

A new study in England shows incoming college students are woefully unprepared, both for the “reality of life” and for school. Two news articles (Daily Mail and BBC) are based on a Higher Education Policy Institute (HEPI) study of 2,000 incoming university students (incorrectly labeled as millennials by Daily Mail). The study found 61% of respondents are anxious about heading to college, and 27% have panic attacks.

Parents really need to prepare their kids for the realities of college academics. The study says almost half (46%) expect more one-on-one support in college than in high school. A large majority (78%) expect career-planning support. These kids are in for a rude awakening. While students are the stated reason for a university’s existence, many schools receive far more money from research grants, athletic events, and alumni donations than they do from tuition. That means students and their education are rarely the primary focus of a university. The study also says 60% of students expect to spend more time in class in college than in high school. They do not grasp how little time they’ll actually be in class and that they are responsible for their own learning. Professors will not handhold them and “teach the tests” (unlike high schools that have standardized tests linked to teacher pay, for better or worse). The standard rule of thumb is that students should expect to spend at least three hours studying for each one hour in class. I can tell you, from experience, that most students do not follow that advice. Maybe if they’re told to expect to do that work beforehand, they will… call me an optimist.

Since this is a finance blog, I’d like to focus on the fact that more than half the respondents admitted they don’t know how to pay a bill. Over half said they don’t understand student finances, and many underestimate essential expenses. Less than half recognize that rent is likely to be their biggest expense after tuition. Some thought “nights out” or “student societies” would be their biggest expense. Ironically, 78% expect to get more financial advice from their university than they did in high school.

What can you do? If you have or know someone about to start college, take the time to give them some advice on what to expect, both in terms of academics and student life. On the financial side, make sure they know what things cost and how much they have available to them (i.e., make a budget). I’m biased, but I think they should read Basic Personal Finance and realize that a student loan should be treated as an investment (i.e., don’t get one if your degree won’t increase your lifetime earnings).

Retirement Mistakes Before Retirement

June 14, 2017June 15, 2017lencabLeave a comment

Here’s an article from Yahoo! Finance that points out retirement mistakes many people make well before they get to retirement:

Not starting early
Not having a Roth IRA
Raiding your retirement account
Cashing out your 401(k)

The article quotes a lot from CPA and “retirement expert” Ed Slott. He points out that starting early and maximizing your Roth IRA every year (age 25 to 65) is basically all you need to do to have a million dollar nest egg. If you wait and start 5 years later, you’ll have $200K less in your nest egg.

Mistake #4 is a big one for people who switch jobs. If your next employer doesn’t have a 401(k) plan, or you prefer to manage the money yourself, you can open a 401(k) rollover account. Simply cashing out your 401(k) will incur a 10% penalty, plus a one-time bill for all the taxes owed. Worse, you’ll be giving up the benefit of future tax-deferred earnings.

If you’re unsure what this all means, check out Basic Personal Finance. You can read the first chapter, which lists the 10 rules of thumb for financial success, for free on Amazon. Chapter 6 shows an example of how tax-deferred investments outperform similar investments in taxable accounts.

Retirement Plan Math

June 13, 2017June 13, 2017lencabLeave a comment

A few days ago, I posted the two basic steps of retirement planning.

Step 1: Figure out what quality of life you want during retirement (i.e., how much you want to live on each year). This will determine the size of the nest egg you need to have ready when you retire.

Step 2: Figure out how much you need to start saving now to get there.

Of course, those makes sense to me, but my inner math teacher feels compelled to elaborate for those who need it (even if they won’t ask for it). The calculation for step 1 is a present value formula for an annuity payment. In this case, the payment (PMT) is the amount you want to draw from your portfolio each year in retirement. The present value (PV) is the amount of the portfolio when you retire. (That could be confusing because it’s a present value, but we’re talking about future money; we’ll deal with that later.) You have to specify a real return for the portfolio (r) and the number of years you want to draw this benefit (n). So, if you start with PV in your portfolio at retirement, you can draw PMT from the portfolio each year for n years until you run out of money. You can solve this with the following formula:

Eqn09

If you’re scared of math, you can solve it in Excel: =PV(rate, nper, -pmt). Because Excel looks at time-value-of-money equations as cash flows, enter your PMT value as a negative number. If you don’t, you’ll get the same absolute value, but PV will be negative… no big deal.

For Step 2, you set that present value to a future value (FV), because that’s what you want your portfolio to be in the future. Now use the future value annuity formula and solve for the payment (PMT), which is the amount you need to invest each year (at a real return, r, for n years) to reach that FV. The formula is:

Eqn12

Again, Excel makes it easy: =PMT(rate, nper, pv, -fv). In this case, add a present value (pv) if you already have some savings started.

Note that the second r and n are not the same as the previous formula. This time n is the number of years you have to save for retirement. The previous n was the number of years you plan to draw on your savings during retirement. Similarly, the r in the PMT formula is the real return you expect to earn while you save for retirement. The r in the PV formula is the real return you expect to earn during retirement (which will probably be lower, assuming safer investments).

This (and lots more financial math) is covered in Basic Personal Finance, but now you have the two most important formulas. You can complicate this by simulating returns to add some realism, or you can simply pad your numbers by using a smaller r in either or both formulas. You can also use a larger n and/or larger PMT in the first formula to pad your nest egg.

Retirement Planning Includes Plans During Retirement

June 9, 2017June 9, 2017lencabLeave a comment

CNBC ran a story last week pointing out an obvious part of retirement planning that they think people don’t consider: “make sure you don’t run out of money.”

They start with the 4 percent rule recommended by “many investors”-only draw 4% of your total portfolio value in any given year. That way, you’re basically living on the gains, and your portfolio remains intact (assuming a 4% real return). Research by Wade Pfau suggests that the 4% rule may be optimistic if people transition their portfolios to safer investments after retirement, hence earning less than a 4% return.

The story then quotes certified financial planners who state more obvious points, that you should consider three things when planning your retirement spending goals:

Life expectancy
Social Security benefits
Taxes

I’ll start with the last one. You have to consider the required minimum distributions from your retirement plans. Try to balance your tax-deferred (traditional IRA & 401(k)s) and tax-free (Roth) distributions to minimize your taxes. Avoid unnecessary portfolio reallocations, which could increase your tax burden for taxable accounts (i.e., don’t use actively managed mutual funds).

When looking at Social Security benefits (for those retired or retiring soon who will actually have them), consider your objectives. Do you want to maximize your total benefits, or do you want to maximize your monthly benefit? For the former, take your benefits as early as possible. If quality of life is more important, and you don’t need the money right away, waiting to draw social security will increase your monthly payments. (I’ll follow up with a post on this soon.)

Life expectancy is a somber topic, but you really do have to consider how long you might be around to make sure you have enough to support yourself in retirement. If you don’t want to put a specific number to it, pick something far into the future (say 100 years old… or 40 years of retirement). Use that number when planning your nest egg requirement. Other alternatives are to plan on smaller returns than you think you’ll get and/or using random returns and simulating your retirement, as shown in my book and discussed in a previous post.

One thing the article didn’t point out is that all the “help” these professional financial advisors give you will cost you 2-3% of your portfolio value every year. That’s the real reason you won’t be able to draw 4% for yourself. It doesn’t take a PhD in finance, or even a CFP, to plan for your retirement. It’s fairly basic:

Figure out what quality of life you want during retirement (i.e., how much you want to live on each year). This will determine the size of the nest egg you need to have ready when you retire.
Figure out how much you need to start saving now to get there.

Take the time to study the basics and make a plan. You can enjoy spending/saving that 2-3% fee on yourself instead of paying for advice you can easily get on your own.

Consider Income When Considering Career

June 6, 2017June 7, 2017lencabLeave a comment

In an earlier post, I referenced an article that discussed Bloomberg’s Shift: The Commission on Work, Workers, and Technology. That’s Bloomberg-as in Michael Bloomberg, the former mayor of New York City. I was shocked at the credit given to the capitalist economic system. From the report: “Today, the poorest Americans have higher living standards-and live healthier, longer lives-than the richest Americans in the 19th century.” It goes on to praise technological advances because increased productivity is the only real way to advance our quality of life. Unfortunately, advancement also means some workers are rendered obsolete. The point of the study was to address the state of workers in the near future (10-20 years). The commission had 100 members in 5 cities create 44 scenarios, which were whittled to 4 scenarios to analyze. More importantly, they surveyed workers about their jobs, satisfaction and expectations.

The conclusions and comments aren’t all that productive. The report seems to mostly provide the opportunity for the members to virtue signal (i.e., talk how much they care about workers). That said, some of the survey results are interesting:

1) There’s the disturbing part about unexpected expenses: 28% said they would have to worry about a $10 unexpected expense. That what my previous post was about.

2) The amazing result, to me, was the response to “What matters most to you about work?” While the report highlights the desire for stability (a top 3 response for every income bracket), a higher response was “Doing things I enjoy”… #1 for all income brackets except $50K-$75K, which had it at #2 (behind stability).

While everyone wants to do things they enjoy, they have to figure out how to get paid for it. Basic Personal Finance points out that work is called work because, for the most part, people don’t want to do it. Picking an occupation is about finding a good or service that you can provide that people are willing to pay for. It is important to consider future job prospects when you decide to invest in yourself through any kind of education or training. Studying a subject that you like but with little prospect of a job (either from no demand or abundance of supply) is not a good investment. Going into an industry on the verge of automation (e.g., truck driving) is also not a good investment.

Make Your Own Savings Plan

June 1, 2017June 1, 2017lencabLeave a comment

We’re definitely in a period of “fake news.” Two stories on Yahoo make me think April Fool’s Day was postponed to May this year. The first story claims millennials save for financial freedom rather than to leave the workforce and retire. It cites a Merrill Edge study that claims the 18-34 age group is saving more money than any other age group. That’s hard to believe, given a Consumerist article two weeks ago that said nearly half of Americans are not able to cope with a $100 surprise expense. CNBC has run several stories on a March 2016 Economic Policy Institute report that shows median savings are pathetically low: only $480 for ages 32-37.

From the Merrill Edge study, “average income they say they’re saving per year”:

Millennials: 19%
Gen X:             14%
Boomers:        14%
Seniors:           12%

I started to question those numbers, but then realized it’s self-reported. (Re-read that quote above the numbers.) Digging through the article, it says millennials are more likely to spend money on travel, dining, and fitness than to put it into savings.

Sadly, the only thing in the article that rang true was this line: “they’re not thinking about retirement as a phase of life”

Curiously, another article about millennial savings by the same Yahoo author claims millennials are “more eager to pay their own way at younger ages than when baby boomers think they should.” That one claims a Bankrate survey. The funny thing is the conclusion: “The dream of financial independence and the reality of their current financial situation continues to be at odds for many millennials.” Don’t forget, this is the same author that just claimed millennials save more than other generations.

The take away (besides don’t print fake news): don’t make your decisions based on what other people are doing (or claim to be doing). Figure out what quality of life you want during retirement (i.e., how much you want to live on each year), and then figure out how much you need to start saving now to get there. My book helps you figure out how to do that. The important part is to start now. Compound interest isn’t something you get back later.

LenCabrera.com

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