Category Archives: Personal Finance

An Interview with Adam Carroll about America’s Student Loan Debt Crisis

I recently had a chance to interview Adam Carroll about America’s looming student loan debt crisis (it’s already here). If you’re not familar with Adam’s work, he is a professional speaker, has published multiple books and is a self-described financial literacy junkie.

I recently found Adam through one of his recent projects – Broke Busted & Disgusted, a documentary about the evergrowing student loan debt crisis and the impacts on the millennial generation and beyond. If you have an hour, I highly recommend checking out the movie.

I’m honored today to be joined by Adam.

TFG: What initially sparked your interest in personal finance literacy and specifically the increasingly important issue of student loan debt?

Adam: My interest in financial literacy was sparked by a mentor I met in my very early 20’s. He recommended several books to me and I took him up on every one of them. This guy was a multi-millionaire with a wealth of experience and I was going to do whatever he told me to do. The student loan issue became a passion of mine after presenting to hundreds of colleges and universities where students had no idea how much they’d borrowed or how much their payments were going to be. I felt like something had to be done and a documentary on the topic seemed like a logical step in the right direction!

TFG: I loved the term that one union worker in the film alluded to, “learn as you earn.” When I was in high school, I remember tons of pamphlets & fliers about going to college, but not so much when it came to trade schools & apprenticeships. What can we do to make sure young people aren’t feeling pressured into feeling like they HAVE to go to college to be successful in life?

Adam: This is such an important question. First off, parents need to realize that the economics of college have changed dramatically. It’s not possible to work to pay your way through school like many of them probably did. 75% of today’s full-time students work over 30 hours a week in addition to full class loads and STILL borrow to make ends meet. We have to change the societal norm that EVERY 18 year old should be in a four year school. Whether students pursue an apprenticeship, a 2 year program, a certificate, a gap year, or just plain old work experience, we have to celebrate the fact that they’re making decisions that will ultimately lead them down whatever path was meant for them.

TFG: Can you envision an America where financial literacy classes are required for college curriculum, or better yet high school and junior high?

Adam: Not only can I imagine it, I dream about it in technicolor. In my mind I can see exactly how to get young people super enthused to learn about money and being money savvy. Several schools in my area are using various methods to make this a reality and the results are astoundingly successful. The challenge today is getting the Department of Education, both locally and nationally to understand that teaching money should be one of the TOP priorities. Our country is dependent on the next generation being financially viable. Millions of 20-somethings that are hundreds of billions in debt is NOT the answer.

TFG: The film showed a graphic that 48% of students expected their parents to help with loan payments after graduation, but only 16% of parents expected to help with payments. It seems like there is a breakdown of communication in families across the country. What can they do to fix this?

Adam: Well, first and foremost, families need to be having the college conversation much earlier than they do currently. I’d venture to guess that the majority of families start thinking about and discussing paying for college right before a student enrolls. At that point the financial aid office is doing the majority of the educating, and as helpful as they are, families are leaving those appointments having signed up for a decade or more of debt repayments. Parents and kids need to have very honest conversations about what’s possible and what isn’t. At 18, these kids don’t know what’s good for them or not — tens of thousands of dollars in debt isn’t.

TFG: Student debt hit $1 trillion in the United States in March 2012, was around $1.3 trillion in 2015, and according to the student loan debt clock is rapidly approaching $1.4 trillion. Do you envision the student debt problem ballooning to the point where it could negatively impact the real estate market over a long period of time?

Adam: I think we’re there. In the coming months and years, we’ll see student debt borrowers not qualify for mortgages, car loans, and in some cases an apartment due to non-payment of student debt. When 1 in 4 loans are predicted to be in default in 2016 (according to the Congressional Budget Office), this will absolutely bleed over into our general economy. As of right now, we have no idea what kind of ramifications and repercussions could be felt.

TFG: College tuitions continue to skyrocket at record levels year over year. How do you feel about the government backing all student loans, including the private loans that banks give to students?

Adam: I’m diametrically opposed to the government backing student loans as if there is a big checkbook in the sky to guarantee all of these. In my opinion, if you are pursuing an education degree that will pay around $40,000 a year, you shouldn’t be able to borrow more than a certain amount (like around your annual starting salary). Right now there are Russian Literature majors graduating from private schools with well over $100k in governmentally guaranteed loans. How is it we can’t seem to set the ridiculousness in this situation?

TFG: What are your thoughts on programs like Pay as You Earn & Income-Based Repayment? Do you feel these are sustainable government programs or band-aids for our student loan debt problem?

Adam: I think they are helpful to a certain extent, like a tourniquet is helpful when you’ve cut your hand off (TFG here – love this, ha). There is talk, at length, of making college more affordable but the way we do it is by spreading the payments out over 25 years. While we may make it more “affordable”, it actually makes it more expensive. I think the Department of Education has a vested interest in making sure that colleges and universities have a steady stream of applicants and students. Their loans make it exceptionally easy to pursue a degree, even if it’s not the best possible scenario for the student.

TFG: I think it’s fairly reasonable to say the system is at least somewhat broken. Imagine you are emperor of the student  loan debt crisis and can make any changes you’d like. How do you handle getting the situation under control?

Adam: I, as emperor of the student loan debt crisis, do hereby declare that for starters we are going to reduce the interest rate charged on student loans because it’s insane that the government will lend banks money at .25% while it lends students money at 6.8% or higher. I also declare that you can no longer borrow unlimited funds for college, but instead it’s based on an equation that will ultimately keep you from borrowing too much relative to your earning power. If you borrow more than the governmentally guaranteed amounts (relative to income) then the risk that’s assumed by lenders is their own. Any of these amounts may be bankrupted as the free market will regulate accordingly. Interest rates will be high on these loans, as they should be. So borrow accordingly…

TFG: Now onto something a little more fun: Monopoly! I loved your idea of playing the game with your kids as a social experiment with real cold hard cash. Do you have any other innovative financial literacy ideas for parents with young kids?

Adam: My kids are investing in the stock market on a monthly basis and we make a bit of a game of it. They like to see which companies are paying dividends, which companies have a high EPS, which ones are tanking and why. It’s exceptionally rewarding to see them take an interest in it. We also require that our children have an emergency savings account. By the time they were 5 they had to have at least $300 in their account. By the age of 7 it was $400, and by 9 they have to have $500. My 8 year old currently has the most at over $900 in his emergency fund. He likes to see his bank statement when it comes each month. Anything he thinks he’d like to save at this point I’m encouraging him to put towards his investment account. Right now he’s buying Microsoft stock because he loves Minecraft!

TFG: Thanks so much for stopping by! I really enjoyed the film and I will have to check out your book, Winning The Money Game.
Adam: Thanks for having me! I encourage you to check out my other book as well: 30 Days To $1K. It’s a chapter a day book for a month that will help you put away at least $1,000 in an emergency fund.

 

TFG, here back at you. Big thanks to Adam for taking some time and providing his insight on the student loan debt crisis! I’m curious to hear other opinions on our current student loan debt situation in America and methods to fixing it. For me, Adam’s words hit home. I think one of the biggest fundamental problems is that 18 year-olds are given a “blank check” to borrow as much money as they need to obtain their education. We have to be smarter than this.

Why Market Volatility Is Good For Our Future Financial Independence

My goal is to prove to you, the skeptical reader, why sometimes market volatility is a good thing for us. Like so many others in the financial blogosphere, I am addicted to spreadsheets.

Let me preface this by saying, this is not to say you should be 100% allocated into equities. But like I mentioned to Financial Samurai, I believe too many of us Gen Yers are way too risk adverse when it comes to investing our money for the long-term. The point is that you should have a predetermined investing strategy and desired asset allocation. Market movement and sentiment should not change this. Market volatility should not change this. It’s times like this that help new investors learn their spot on the risk continuum. But it’s also headlines like this that are the equivalent of financial porn. And they are out there almost every day, many times on major media sites. Ignore the noise and stay the course.

Now that I’m off my soapbox about creating a plan and coming up with an asset allocation, I wanted to look at a hypothetical portfolio with different growth rates throughout time. I spend quite a bit of time forecasting out net worth, retirement planning, other financial nerd stuff, etc. Until recently, I have always assumed a constant growth rate. But what happens if instead of assuming constant growth, we assume cyclical bear/bull markets that might be more realistic based on history. I was suprised by the results.

Here are my base assumptions:

  • Freddy the Finance Nerd is 27 years old
  • He earns $60k salary and expects to average a 3% raise throughout his career
  • Even though he slightly wants to blow all his money on hookers and coke (see what I did there), he instead is committed to contributing 10% of his lifetime salary into a 401k plan. His employer will match at 5%.
  • He holds his 10% contribution constant throughout all his working years (this is an important assumption!)

In this example, we will look at 5 different scenarios for the upcoming 33 year outlook. Each of the 4 scenarios with growth will average 7% return annually.

  1. No Growth: 0% return
  2. Constant Growth: 7% annual return
  3. Bear 5, Bull 5: -5% return for 5 years, 19% return for 5 years and so on – last 3 years assumed 7% return
  4. Super Bear 5, Bull 5: -11% return for 5 years, 25% return for 5 years and so on – last 3 years assumed 7% return
  5. Bear 7, Bull 7: -5% return for 7 years, 19% return for 7 years and so on – last 5 years assumed 7% return

The results can be found below.

Screen Shot 2016-01-21 at 6.41.45 PM

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Maybe you’re surprised, maybe you’re not. I was. But it makes sense. All 3 scenarios with bear/bull markets (cyclical) outpace the constant growth scenario. I also realize that time doesn’t stop when we turn 60 and we likely have 2-3 MORE decades in the market after that.

The no growth and constant growth are pretty straightforward. Over his working lifetime, Freddy & his employer have contributed about $450k to his 401K plan, which grows to about $1.5M with a consistent 7% annual growth rate.

But with the cyclical market scenarios, something remarkable happens. For 5-7 year stretches throughout his career, Freddy is able to effectively purchase more shares of whatever mutual fund or index fund because the market is going down, down, down. By staying the course, Freddy is effectively dollar cost averaging during the down times and gets the benefit of amazing returns during the up times. This translates into a 33-55% increase in Freddy’s 401K account (depending on which cyclical scenario we are looking at)  after 33 years compared to the constant growth rate scenario.

This only works if Freddy is consistently contributing money into his 401K. If he tries to time the market and decreases his 401k contribution during perceived bad times and increase during perceived good times, he could end up just about anywhere on this graph.

I’m not saying that I guarantee an average 7% return, but if it happens I sure as hell want it to happen in peaks & valleys instead of at a constant rate over time.

Being in my 20’s I have to remember that market volatility will be present throughout my accumulation phase. A down market (*cough*2016*cough*) means cheaper shares and at the end of the day, that’s what we are accumulating – numbers of shares.

I can understand as someone gets into their 40’s, there might be some resistance to this idea of thinking hoping for MORE market volatility. I would still argue that if you are resistant to the level of risk associated with increased market volatility, you should be changing your asset allocation to lower risk investments. This is, of course, because higher 401K balances raise the stakes and the magnitude of risk.

In your 20’s and 30’s, my argument would be that market volatility is a good thing for our accumulation and our path towards financial independence because of the decades that we have on our side.

At the end of day, my sentiment has less than 0% impact on the movement of the market and . So in that case, go down ms. market and get me some cheaper shares these next couple years!

So what do you think readers? Is market volatility good or bad? Have I gone absolutely crazy? Shoot some holes in my theory.

 

Should I Buy or Lease a Car? – The Long-Term Solution

If you hate reading, found this through google and just want an answer to this question: DON’T LEASE!

For everyone else:

Over the years, I’ve seen numerous blog posts and webpages asking the age old question, “Should I Buy or Lease a Car?” One thing that I haven’t seen is the long-term analysis of this question. Usually the tools focus on a singular decision, but the reality is that life is about a long-term string of choices. Below serves as a guide for a long-term scenario to this common question.

The Scenario:

In our fictional scenario, we will assume we are sitting in the magical year of 2016. We just graduated from college at 22 years old, got a spankin’ brand new job, and we need a car to make that hour long commute in. Three options are presented to us for acquiring said car. We can:

  1. Buy Car (Cash)
  2. Buy Car (Loan Financing)
  3. Lease Car

Because we are looking at the long-term implications of this decision, we will also assume that once we go down one of  the 3 yellow brick roads, we stick with the same acquisition method for the next 48 years (until we are 70 years old). Obviously, our method of obtaining a car could change over time, but in effort for a meaningful comparison, we will stick with this simple assumption. Below are some of our additional base assumptions:

  • Purchase Price of Car in 2016: $33,560 (this is average – people are cray cray…)
  • Annual Depreciation Rate: 17%
  • Inflation Rate: 2.5%
  • Interest Rate: 4.5%
  • Both Buying Methods: New Car every 7 years
  • Lease Method: New Car every 3 years

So just a couple of notes on these assumptions. I know cars don’t straight line depreciate, but this gets us down to about 57% of purchase price after 3 years. This is probably pretty realistic for most cars. You may be thinking the interest rate assumption is too high, but remember we are looking at a long-term case here. Though car loans today are lower than 4.5% for prime borrowers, they will likely increase over time (since we are in a historically low interest rate environment). I believe this assumption is actually quite conservative, as over the next 50 years I would expect this average rate to be more in the mid-to-high single digits (I don’t know why I typed this – no one knows where interest rates will be 50 years from today).

For both buying methods, we will assume that we get a new car every 7 years and also that we will take out a 6 year loan on the car for the financing method (DAYUM – that’s a long time). Not unrealistic, since amazingly the average car loan is up to a whooping 67 months. Crazy. At the end of the 7 years, we will also assume we use all the proceeds from the sale of our current vehicle towards the purchase of our next vehicle.

On the leasing side, it was interesting to research all the pieces of the math puzzle that make up a lease. If you’re not familiar with a car lease, here is usually how it works:

You make a down payment on the car (usually 10% of purchase price). The remaining value is something called the capitalized cost. At the end of the lease (3 years in this case) you have an assumed residual value based on depreciation rates (remember this is 17% annual depr. rate).  The other important piece of information in this calculation is this weird term called “the money factor”. It sounds like a fun game show, but later you’ll see how this kills you slowly over time and is not a fun game show.

Money Factor = Interest Rate / 2400      or in our case      4.5/2400 = .001875

So with this information we can now see our total cash outflows on each 3 year car lease:

  1. 10% down payment of car price
  2. Monthly Depreciation Cost (we are paying for the depreciation that is used up in our 3 year lease)
  3. Monthly Interest Cost (which equals [(Capitalized Cost + Residual Value) x Money Factor]/12)
  4. Monthly Sales Tax Cost (assume 7% because the seller has to pay taxes & stuff)

Now the craziest part of this whole calculation is #3 because you are paying interest on not only the capitalized cost, or the 90% value of the car you haven’t paid for upfront but also the residual value of the car after 3 years, remember this was 57% based on our assumptions from above. So think about that with me – you are paying interest based on: 147% (90% + 57%) of the value of the car, even though you are also paying 10% downpayment. Ouch.

Now for the results:

Screen Shot 2015-11-11 at 10.33.58 PM

A lot of numbers to decipher through, but not surprisingly buying your cars for the next 48 years in cash is the cheapest method in terms of total cash spent. The only difference between the financing vs. cash method is the interest that you pay. Since we are financing each of our cars over 6 years, instead of paying for them up front in cash, the bank wants to be compensated via a healthy interest cost. Okay, makes sense.

But let’s now turn our focus on the total cash spent in the lease column. This column consists of three portions of cost. 1) the principal cost (10% down payments every 3 years) 2) the interest cost (remember that high multiple of car value you are paying – 147%) and 3) depreciation / other cost (the value of the car you use up in your lease + local sales tax). Hopefully you notice the total cash spent in the column is significantly higher. But I think it’s hard to quantify or really see the simplified meaning of this comparison in the above table. So consider the following:

Screen Shot 2015-11-11 at 10.45.45 PM

Over the next 48 years, in each buy method you will drive 7 total cars for 7 years each (7x cars driven multiple). In the lease method, since you are leasing a new car every 3 years you will drive a total of 16 cars (16x). But when we look at the cost of each method in something called the equivalent cars paid multiple – the results are STAGGERING. Over the same 48 year method, we are paying for an additional 5.7 cars or an additional $180K total cash spent by leasing cars vs. buying our vehicles in cash. By the way, we aren’t leasing anything that’s a nicer car, the base assumption was with the same purchase price!

So what’s the point & why the difference?

Some others disagree, but I still would argue it’s best to buy vehicles in cash (and for way less than $33,560 – by the way), but the point is even over a 48 year timeframe financing your cars isn’t too big of a deal (especially in a low interest environment). You are basically paying for an extra car over your lifetime (7.9x vs. 7.0x). Not ideal, but not a life-changer either, and not everyone has the circumstances to buy cars in cash. But by consistently leasing a car, you are committing financial suicide. It hurts big time because in a car lease you are paying for the depreciation of a car but you don’t get any of the benefit (because you don’t own it!) and you are paying massive interest costs (though they disguise it well).

On my local radio, when I hear a leasing commercial that says, “Lease your car, but drive it like you own it” it makes me want to punch my radio dial in the face. Ha, yeah right. Don’t do it. Don’t lease.