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Author Archives: Robert Weagley

Doggone Expensive

I was sitting in my office thinking about what I could write as a financial tip of the week. It is spring. Many students are graduating and some are receiving graduation presents.  Some are presents that students buy for themselves.  Just yesterday, I visited with my friend’s daughter and three of her friends.  Between them, they had three dogs – two are puppies and the “old” one is turning a year old next month.  The dogs are great fun and the most recent acquisition is a Chesapeake Bay retriever puppy who will be trained to hunt for his owner. I truly understand this, as I purchased a golden retriever for myself, as a present for my successful matriculation form Mizzou 42 years ago.  Her name was Jessica and her photograph still adorns my office, as her love filled my heart during many a day.  She lived with me in Arkansas, Missouri, Nova Scotia, California, and New York, before returning to Missouri shortly before her untimely death.  To her credit, she not only swam in both the Atlantic and Pacific, but she also paddled in the Great Lakes, the Great Salt Lake, and many rivers while perched within my canoe. Truly, Jessica was loved by many who agreed that she should have been awarded a degree from Cornell, when I received mine, as she went to campus most days with me to her be adored by others. Moreover, she costs me a lot of money in care and attention and money was scarce while I was in school!  So, in case you’re thinking about getting a dog, consider what a doggone dog costs, before you make a commitment to join your life with that of your new best friend.

To begin, and shortly after the puppy has licked your face multiple times, there are initial costs.  If you are purchasing a pedigree dog, depending on the breed and local market, a dog can cost from $200 to close to $2,000.  (Don’t make fun of that high figure.  That is about what my son, the finance professor, and his wife spent on their dog, a Golden Doodle, during my son’s last year of graduate school!)

Other than acquisition costs, you may choose (or be required) to have the pet neutered.  This may cost you $200-$400. An initial medical exam will typically be $60-$80, a collar with a walking leash $25-$30, a training leash is another $15, a shipping/travel/sleeping crate will come in under $100, and the cost of signing up for a training class $150. (The training class is for you.  It keeps you disciplined to work with your dog so you can be proud of her when she is the star of the class.)  Taken together, the initial costs, at the low-end, is $750 upward to over $2,500.  The following site estimates the first year costs of owning a dog: http://www.thesimpledollar.com/pet-cost-calculator/ .

Next, the dog will live with you for twelve to fifteen years!  These years cost money, in addition to the one-time costs. Annual costs for food for a dog will range from $120 – $360 per year, depending on the size of the dog and the quality of the diet. Annual medical exams, vaccinations, and emergency visits to the veterinarian will run from $200 to some unbelievably large number if your dog is an extreme health risk and requires surgery or overnight stays in the doggie hospital.  Of course, you will want your dog to look good and to have some dog toys.  If you only buy 3 tennis balls a month from Amazon, they will cost you $45 for the year and monthly grooming could run to $200 for the year.  Doggy treats, depending on your preferred doggy diet, will cost at least $5 per month or $60 a year.  If you chose to purchase pet insurance that will be over $200 per year and, of course, we’ll throw in another $50 per year to cover miscellaneous expenses like repairing your friend’s door when your lovelorn puppy decides to scratch her way back to your welcoming arms when you leave her there, while you go to the movie. Of course, you can’t go on vacation without taking the dog.  If you do, you will need from $40 to $100 per day in kennel expenses.  In addition, many landlords will not allow pets.  If they do, they might require a second month’s rent as a dog damage deposit. (It always took me a while longer to find a place to live that allowed pets.)

Given the above and one week of kennel, a dog has an annual cost of from $755 to $1,465, perhaps much more. If we assume you will own the dog for 12 years, when you decide to buy that dog, you’ve made an immediate financial commitment of from $8,300 (for the economy model) to over $16,000 (for a dog tinged in gold with health issues).  Of course, at the end of the dog’s life, there may be heroic measures you wish to purchase to keep your friend at your side.  You may even consider going into debt. I recommend that you consider what actions you will take, should this occur, before it occurs! This eventuality puts additional pressure on your emergency fund.

Finally, I wouldn’t give anything in exchange for those years I had with Jessica. Many called her my first wife, as she went many places with me and always helped me meet people and make friends. A dog adds much to life, but a dog is a huge commitment and a large expense.  The total commitment to training, caring, and loving a pet is a big decision.  It is a decision to spend thousands of dollars which cannot be spent on tickets to events, cars, houses, books, food, or anything else you might want. Yet, coming home to that wagging tail and those “so happy to see you” eyes can be worth every penny it costs. Just make sure that those wags fit in with your vision of financial success, before you visit the breeder or your local Humane Society.

Investments 101 (a review)

The stock market has shown itself to be very volatile in 2015. So volatile, that many have left the market, some see it as a time to look for buying opportunities, others worry about a return to the great recession, and we long-term investors are doing our best to tune the noise out and to keep our faith in the future of the world’s economies.
We’ve all heard reasons for the markets retreat in 2016.  If not, here is a sampling, along with my commentary.

  1. The Chinese economy is tanking – Yes, the Shanghai index peaked last June 12 and the index is down 48% since that date.  Yet, the index remains up 31% over the past two years.  As for the Chinese economy, they do have some problems and the largest is a rate of growth that has decreased to 6.9% – a rate that most countries would love to have!
  2. The Federal Reserve Bank is raising interest rates – Really?  Who did this surprise?  Most people have asked, “Why did it take so long to happen?”  Even so, the economy is showing some weaknesses, particularly given world dynamics.
  3. The price of oil crashed – All commodities have fallen since 2011, although several have shown robust growth in 2016.  Gold, for example, has led other investments for this calendar year, with a 15.7% return.  It remains, however, about 26% below its most recent peak in 2010. Just yesterday, I noticed that gasoline is about 14% more expensive than a week ago and today’s price is still relatively inexpensive.  We have to go back to 2004 to see prices like we see today. This should be good for the consumer which is good for the economy – except if you are a producer of oil.
  4. The strong dollar – I don’t think a strong dollar can decrease the value of the stock market. In fact, we know that citizens of other countries, when they perceive weaknesses in their economies, move money to the United States and they purchase our securities.  This one is hard to judge.
  5. Trump and Sanders – This might have some veracity. I don’t think that most of the investing public, either domestic or international, predicted that these two candidates would be doing as well as they are.  With ideas ranging from protectionist trade and forced deportation to free medical care and university education, these ideas have the heads of members of the status quo spinning.  Markets don’t like uncertainty.
  6. The Cubs might actually make it to the World Series – No one has actually said this has caused the market to be down. I just thought I’d throw it in the mix of wild ideas.

One thing is certain.  The market will survive and it never hurts to review what we know, in order to help us reach financial success.

Below is a graph of returns for stocks as measured by the S&P 500 (blue), 10-year Treasury bonds (green), and Treasury Bills (red) from 1994 through 2015.  During this time period, the S&P500 had an average annual return of 10.7% with a standard deviation of 18.7%, 10-year Treasury bonds saw a 5.9% average annual return and a 9.7% standard deviation, and T-Bills a 2.6% annual return and a 2.2% standard deviation.  It is clear that if we wanted to reduce the risk in our portfolio, we would simply buy T-bills and be content with the relatively flat line for the twenty years.  While that may make one sleep better in the near term, it is likely that one may not eat well in the long term, for taxes and inflation will greatly reduce the return.  So, what can we do to reduce the volatility?  The answer, as always, is diversification.

Investment returns 1994-2014

When we invest 60% of our portfolio in the S&P500 and 40% in ten-year Treasury bonds, it reduces our return by 17.8% (from 10.7% to 8.8%) , while the riskiness of the portfolio is reduced by 43.9% (from 18.7% to 10.6%).  Over these twenty years, by replacing 25% of 10-year Treasury bonds with Treasury-bills, the return is driven down to 8.4% with very little, if any reduction in risk. This can be seen in the following chart where the blue line is 100% invested in the S&P 500, the red line is for the 60%/40% portfolio, and the green line the portfolio of 60%/30%/10% which includes 10% Treasury-bills.  As can be seen both of the latter two lines are very similar but they do remove variation in the annual returns of the S&P 500.

Portfolio returns 1994-2014

What does this do to us over the longer-term?  The answer can be seen in the table below, where we assume that $5,000 is deposited to an account at the beginning of the year for both 30 and 40 years.  As can be seen had one been invested in 100% of the S&P500 for every year, instead of the 60%/40%/10% portfolio, their wealth at the end of 20 years would have been 22% greater ($737,708 compared to $603,039).  Due to compounding, this increases over 40 years to 33% greater future value ($1,823,347 compared to $1,370,886).  Clearly, discipline is good if one can handle the inevitable ups and downs.  Most of us cannot.

Interest/Year 8.964% 8.274% 7.925%
Payment/Year $5,000 $5,000 $5,000
Number of Years 30 30 30
Future Value $737,708 $644,997 $603,039
Number of Years 40 40 40
Future Value $1,823,347 $1,507,715 $1,370,886

Another reason to support being well diversified is the following “periodic table” of investment returns.  For each year the category with the greatest return is listed at the top, while the one with the lowest return is at the bottom.  One glance will tell you that there is not one category that is at the top, or the bottom, each and every year. Moreover at the beginning of the year we never know which category will be at the top at the end of the year. You will see that it is rare that any category of investment has the same placement in two consecutive years. In fact, it occurs only 12 times in the 100 year-pairs below.

periodic table of investment returns

So, what do we do?  One needs to have a plan to remain well diversified with a riskier mix of investments the further in the future the money is needed.  Short-term goals will be funded with cash type investments, intermediate term goals with a balanced approach, and long-run goals with a more aggressive approach. At least once per year, the investor should rebalance their portfolio to assure that the mix they wish to have is truly the mix they have.  This will naturally force one to sell those categories that have performed well and to buy those which have not.  To repeat a recent Financial Tip, this assures that you will sell high and buy low – as opposed to the other way around.

A New Student Loan REPAYE-ment Plan

You would be forgiven if you missed the news about a new Federal Student Loan repayment plan that went into effect mid-December last year.  After all, for some that time is finals week, others it’s Christmas break, there is shopping and family gatherings and all sorts of other things begging for our attention.  Hopefully, nearly a month and a half into 2016, you are back into the normal groove and feeling receptive toward some newish and potentially helpful student loan news.

December 17th 2015 was the date that a new repayment plan went into effect for federal student loan borrowers.  The new plan is called REPAYE, and can be considered a close relative to the existing PAYE income driven payment plan.  Each plan share similarities, but also have major differences which should be taken into consideration when trying to decide between the two.
Pay as You Earn vs. Revised Pay as You Earn
Let’s begin with the similarities.  They are both income driven plans, meaning, your income and household size are used to determine how much you will have to pay each month.  Income is evaluated on a yearly basis to determine if a new payment amount should be used.

They can be used to repay Direct Subsidized & Unsubsidized, Direct PLUS loans made to students, and Direct Consolidation Loans that do not contain PLUS loans to parents.  If you’re not sure what type of loans you have, visit www.NSLDS.ed.gov, select the “Financial Aid Review”, and login to review what types of loans you have.

If the loans are not repaid in the maximum repayment periods, a borrower may be held liable for the tax consequences of unpaid debt due to loan forgiveness, but both repayment plans are eligible for use when working towards the 10 year Public Service Loan Forgiveness (PSLF) plan.

Now let’s explore the differences between the two.
Firstly, the REPAYE plan does not require a financial hardship.  Anyone can apply and take advantage of the benefits.  Borrowers also do not have to be “new borrowers”, a classification based on the date the first Direct loans were received.  It doesn’t matter when your loans were received, you are eligible for the REPAYE plan.

Undergraduate and Graduate borrowers also get different maximum repayment periods.  Undergraduate, like with the PAYE plan, can take as long as 20 years to repay the loans.  Graduate borrowers however, get an additional 5 years, bringing the maximum repayment period up to 25 years.  As mentioned before, failure to pay off the loans in the maximum repayment periods will result in loan “forgiveness”, and taxation on the forgiven amount.

In the REPAYE plan, the “amount of your payment is 10% of your discretionary income” (see below for an explanation of discretionary income).  This is different from the PAYE plan, where the “maximum amount of your payment is 10% of your discretionary income”.  You may have noticed the lack of the word “maximum” in the REPAYE plan description.  Good on you, because that’s one of the key differences between these two plans.  Under the older PAYE plan your payments are capped, and you would never have a payment larger than the amount of a payment for the 10 year Standard Repayment Plan, no matter how much your income increased.  Under the REPAYE plan, there is no such cap.  Meaning, if your income increases significantly over the life of the loan (20-25 years), your payments will continue to grow.  The upside to that is, as you approach the end of the repayment period, you will likely have less debt to be forgiven than under the PAYE plan, and therefore a smaller tax liability.

Another difference, and arguably a disadvantage for married borrowers, is that REPAYE considers spousal income regardless if taxes are filed jointly or separately.  Since spousal income is always taken into consideration, this could increase a borrowers overall discretionary income, increasing the monthly payment amount.

And there you have it, a brief breakdown of the new REPAYE Federal Student Loan Repayment Plan, and how it differs from its cousin the PAYE plan.  I would encourage you to continue reading below for a quick breakdown on how discretionary income is calculated.  For more information about Income Driven Plans, please visit:
https://studentaid.ed.gov/sa/repay-loans/understand/plans

https://studentaid.ed.gov/sa/sites/default/files/income-driven-repayment-q-and-a.pdf
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What is discretionary income you ask?  It’s your Adjusted Gross Income (AGI – Found on your 1040 tax form) minus, 1.5 times the Federal Poverty Level for your Household size.

Household Size Poverty Level
1 $11,880
2 $16,020
3 $20,160
4 $24,300

Source: https://aspe.hhs.gov/poverty-guidelines

So, if your AGI is $18,000, and you are a single person without dependents (household size of 1), your discretionary income formula looks like this:
18,000 – 1.5*(11,880) = 18,000 – 17,820 = $180 discretionary income
Which makes for a very small monthly payment because, 10% of $180 is $18, and your monthly payment is $18/12 = $1.50.  Yes, one dollar and fifty cents is your estimated monthly payment, under the REPAYE plan with $18,000 annual AGI and a household size of one.
Something to consider about a payment this small is that interest will continue to accumulate as you go through the life of the loan, meaning the balance owed will increase significantly over what was originally borrowed.  If the loan can’t be repaid within the maximum allotted time, the tax liability due to loan forgiveness could be substantial.

The End to Beginning

I can’t believe how fast time flies.  Here we are at the end of another year, which coincides for a brief moment with the beginning of the New Year.  As such it is time to take stock of where we are financially.

Taxes:

  • If you’ve some capital gains in your portfolio, look for some capital losses to offset those gains and remove them from income taxation. You may deduct an additional $3,000 in losses (above your capital gains) from your ordinary income.
  • Americans are addicted to income tax refunds. Like other addictions, you need to control your impulse to loan Uncle Sam money for the year while not charging him interest.  Seriously, if you have a substantial refund coming each year, reduce your withholdings by filing a revised W-4 with your employer.  If you’ve changed your family structure; divorce, marriage, or children, a tax estimator like this one from the IRS:  https://apps.irs.gov/app/withholdingcalculator/ may help.
  • On the other hand, if you’ve underpaid your taxes and think you’ll owe taxes, prepay additional taxes to avoid being charged a penalty. The final date for prepayment is January 15, 2016.
  • If your income is dropping next year, move as many deductions as you can legally move to this year. On the other hand, if you expect next year’s income to exceed this years, you will benefit from moving deductions to next year.
  • If you have a flexible spending plan for child care and/or medical care expenses and have over $500 in these plans that is not carried forward by your employer, spend the balance on qualified expenses. For a list of allowable expenses read https://www.irs.gov/pub/irs-pdf/p502.pdf
  • If a favorite charity accepts gifts of appreciated securities, such as stocks, donate some from those which have appreciated. You receive the entire deduction for the full market value on the day of the gift and you do not have to pay taxes on the gains.  If your favorite charity does not accept the gift of securities, set up a donor advised fund which allows you to deduct the gift and you can decide on the beneficiary later.  Charitable gifts from an IRA of those 70-1/2, in lieu of taking distributions from the IRA, is no longer allowed under most cases.

Investments:

  • Be cautions when buying mutual funds in December. Many funds make their annual distributions to shareholders in December and this flow of money is taxable in the year they are paid.  Thus, some of the money you’ve already been taxed on will be taxed again and the value of the mutual fund will fall by the amount of the distribution.
  • Rebalance your portfolio to assure that it reflects the diversification you want. You may have to sell some securities that have appreciated (taxable event) while others may have gone down in value.  This forces you, in a small way, to sell high and buy low.  Proper diversification is important for long-run investment success, but rebalancing too often can lead to greater costs of investing which removes some of the benefits of rebalancing.
  • Calculate your net worth to see if the difference between you assets and debts is greater than it was the year before. If you did not do this last year, you will not know.  Yet doing this year after year is a great way to keep score in your financial life, as we want to see your net worth grow by at least the rate of inflation each year.
  • Review your savings. Are you saving enough money for your goals; retirement, education, second home, vacation, and etc.?  This year the market has been relatively flat for the year with the SP500 standing at 2058 in January and 2052 at the time of this writing. If this indicates that you need to add to savings to reach your goals, add to your savings.

Debts:

  • Which of your debts have the greatest interest rate (APR)? Add to your monthly payment to the one with the greatest APR until it is paid off. Then, pay more to the next highest APR loan.  Keep doing this until all your loans are repaid with the exception of, possibly, your mortgage.  Yet even a modest mortgage interest rate represents money that you’re paying out instead of taking in.   In the process do NOT skip payments on any loan for it will reduce your credit rating.
  • If you’ve many debts with some at high rates, it may pay to consolidate them into a home equity loan since rates are relatively low. You must have home equity to do this. (That is, you must be a home owner with a home worth substantially more than the mortgage.)  In this way, the interest you pay may be reduced and is tax deductible, in most cases.

 

Much of the above is common sense and has been repeated in other weekly Tips.  It is good, however, to ask ourselves the question of what we can do differently to improve our lives, beginning with our finances. That said, we might find that we are successful in our financial lives but lacking in our personal lives.  Money is not everything, yet it is a long way ahead of what comes after it.  Be a good shepherd of your money and remember to be grateful for the gifts you’ve been given. The writer William Arthur Ward once said, “Feeling gratitude and not expressing it is like wrapping a present and not giving it.”  So, wrap your presents to give to others.  As a gift to yourself, freely give your thanks for those you love and believe that they love you.  Be grateful for your financial success and celebrate the diversity of our great nation.

– Rob Weagley

Race and Wealth: Results from the Great Recession

By now, most readers are aware of what has transpired on the MIZZOU campus this week.  We have been deeply involved in issues related to race.  Many people have been effected by the events and, as is often the case, some people have achieved their goals, some are tired, some are angry, and others have lost their job.  One thing you may have forgotten is that we had our Personal Finance Symposium last Wednesday and one of the papers presented was entitled Why Didn’t Higher Education Protect Hispanic and Black Wealth, by William Emmons, PhD, of the Federal Reserve Bank of St. Louis.  It seems timely to provide you, our readers, with some bullets from his presentation.  It will be clear that both human and financial capital could do much to lessen the divide separating us from one another.

We all know that education can be a great equalizer but is it sufficient for equal outcomes?  To begin, we will focus on median level of income and net-worth, by education and race.  The following table is instructive.
Case Study: Large Racial/Ethnic Income/Wealth Gaps Even Among College Grads.

Case Study: Large Racial/Ethnic Income/Wealth Gaps Even Among College Grads.

Median Family Income in 2013  
Four Year College Graduates Non-College Graduates Median College Income as a Multiple of Median Non-College Income
All Families $87,250 $36,523 2.4
White $94,351 $41,474 2.3
Asian $92,931 $32,668 2.8
Hispanic $68,379 $30,436 2.2
Black $52,147 $26,581 2.0
Median Family Net-Worth in 2013  
Four Year College Graduates Non-College Graduates Median College Wealth as a Multiple of Median Non-College Wealth
All Families $273,586 $43,625 6.3
White $359,928 $80,692 4.5
Asian $259,637 $25,632 9.8
Hispanic $49,606 $12,160 4.1
Black $32,780  $9,006 3.6

The importance of education is clear. Regardless of race, those with four years of college have greater income and net-worth, than do those with only a high school education.  The impact of education appears to be greatest for Asian and White households, when compared to Hispanic and Black households. What is striking is the lower median income and, in particular, net-worth, for Hispanic and Black compared to White and Asian households.  One should note that in 2013, all college graduates (39% of the population) actually owned 75% of all the wealth. This leaves 25% of the wealth for the other 61% of the population.

Moreover, it should be noted that for those with some college or a college degree, between 1989 and 2013, their net worth increased by 7% for those with an associate’s or bachelor’s degree and 23% for those with a graduate or professional degree.  For those with only a high-school education, median net-worth fell by 31%, while it fell by 61% for those with less than a high school education.  Clearly, education matters when it comes to saving and investing.

During the Great Recession, however, the resiliency (or, lack of resiliency) of net-worth by race is striking.  We see in the picture below that for all households, except college educated Asians, net-worth

graph

Change in Median Real Net Worth between 2007 and 2013

fell between 2007 (before the recession) and 2013 (after the recession).  What is striking is for both Asians and Whites, net-worth for the college educated recovered more than it did for the non-college educated.  For Hispanic and Black college educated households the opposite held true.  For these races, the college educated Blacks and Hispanics a 71.9% and 59.7% decrease, respectively, in their median net-worth was found.  Similar results are found over the period 1992 and 2013 (not shown), where Hispanic and Black college educated households saw their median real net-worth decrease, 27.4% and 55.6%, respectively.  Meanwhile, White and Asian households saw their net-worth increase by 86.4% and 89.6%, respectively.  What are some possible explanations?

  • Whites and Asians had more favorable short-term income trends, if college educated.  Black, college-educated had their median income fall by 21.3% during the recession, while it was only 5.9% for White households.
  • Blacks and Hispanics had a larger proportion of their net-worth in owned housing which took a large hit in the recession.
  • College educated Blacks and Hispanics entered the recession with greater debt-to-income ratios (Whites, 102.2%; Asians, 86.5%; Hispanics, 134.5%, and Blacks, 164.7%).  Thus, their greater borrowing may have forced them to spend existing savings and wealth.
  • A larger share of Black and Hispanic college graduates are female and they face greater barriers in the labor market.
  • Hispanic and Black college graduates are less likely to graduate from a highly selective college.
  • A smaller proportion of Hispanic and Black college graduates receive a post-graduate degree.

The above is just a snapshot taken from the Survey of Consumer Finances, perhaps the best data set for these analyses in the world.  It is clear, however, that there are links between Black and Hispanic college graduation and wealth accumulation that we do not understand.  Thus, the implication is that more research needs to be done. This is especially true when there are such large differences in earnings and wealth accumulation between Blacks/Hispanics and Whites/Asians.  These differences will continue to lead to greater and greater gulfs between populations and, while your race does not predetermine your income and wealth, the widening of that gulf makes financial success an ever elusive goal for subpopulations in the United States.

For more information see:  https://www.stlouisfed.org/publications/in-the-balance/issue12-2015/why-didnt-higher-education-protect-hispanic-and-black-wealth