Saving vs. Borrowing for Your Cars

Over each Memorial Day weekend, our family always celebrates two birthdays – our eldest son’s (25 May) and our daughter’s (26 May) – and our anniversary (26 May). As you can see, as academics, we always tried to plan things to coincide with the end of the academic year and we were lucky to be relatively successful in this pursuit. (Our youngest son was born on 10 June!)

Regardless, it is always a great weekend with some BBQ, music, laughs, and thoughts about the future. Our oldest graduated from university this spring and is headed off to graduate school. Consequently, this past weekend, our thoughts turned to his transportation situation. As you can guess, he has heard the mantra, “Don’t borrow money to purchase a depreciating asset”, for much of his life. Well, he is a finance major and this weekend, we “ran the numbers” on my mantra. What did we find?

First, our assumptions were as follows. We looked at both the cost of borrowing from a bank for a car purchase and the alternative of saving for a later purchase in a money market account. The rates were posted on a nationwide bank’s website as 5.19% and 3.75%, respectively. We assumed a new car costing $25,000 with a rate of purchase price inflation of 3%, while we assume a 10.91% annual rate of depreciation for an owned vehicle, resulting in the car being worth half its purchase price in 6 years. Every six years, for forty-eight years, the car was replaced with a similar car, less the trade-in, residual value. What did we find?

To begin, the $25,000 car purchased with debt would require payments of $404.83 each month for 48 months at an interest rate of 5.19%. On the other hand, one could keep driving their jalopy and save to purchase a new car in six years. An inflation adjusted goal of $29,851 is the cost of the car in six years. At a savings interest rate of 3.75%, a deposit of $370.35 per month would be required – a monthly savings of $34.48 over purchasing the car with debt. Similar calculations are done for each of the eight, six year periods and then the present value of the savings over one’s life of car ownership is calculated.

If one uses the 3.75% as the rate at which one earns on their savings, the present value is equivalent to an immediate increase in your expected wealth of $19,683 or a future increase in your wealth, at the end of the forty-eight years, of $118,740. Not bad but, on the other hand, if you invest these monthly savings in an account, say your 401k or 403b retirement account, and earn 7% on your savings, the present value of the savings falls to an immediate increase in your expected wealth of $7,874, while the future value rises to $224,490. At 10%, the long-run average for equity investments, the future value is $529,122! WOW!

Bottom Line? Mantra prevails. Borrowing money costs you and limits your Financial Success.

Note: THANK YOU!!! Our subscriber list is growing. Many of you are teachers in our K-12 schools across the country. You are special to us but so are your friends. Please forward this email to others you think will be able to use the contents, in order to spread Financial Success.

Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Tips to New Graduates

Graduation season is upon us and many of you will be taking your first job. While your financial matters might not be foremost in your mind, it is important for you to begin your financial life as strong as possible. Doing so will set you on the path to Financial Success. Consider the following:

1. Get on a budget - To begin, keep an itemized list of all your expenses – from your monthly rent to that round of drinks you bought last night to celebrate your graduation. While keeping these records, make some choices along the way but, at the end of the month, see how much you spent on each category of expenditure. Then, make some changes. Remember one rule: Pay Yourself First and always put money away to establish your emergency fund, begin your retirement savings, and begin to save for your goals.

2. Payback your loans – If you’re average you’ve borrowed over $15,000 for your education. Know when your grace period for interest charges ends and make sure you make payments when they are due. Create an automatic withdrawal from your cash account to ensure you make your payments. Perhaps make additional payments, to reduce the principal. (See: http://mufinancialtip.blogspot.com/2008/05/student-loan-repayment-strategies.html )

3. Update your student checking account – Know how your student checking account changes upon graduation. Oftentimes, banks make checking accounts “free” for students but begin to charge the “ex-student”, following graduation. While some do remain free, some begin monthly charges as high as $10.00 per month. Understand how yours works and make a change if it is to your advantage.

4. Establish your credit rating – If you haven’t checked your credit report, do so. Annualcreditreport.com has links to the major credit reporting agencies. You are allowed one free report per year. If you want to see your credit score, there is typically a charge. Do not borrow, thinking that it will help your credit score. Your capacity to repay debt is greater the less debt you have.

5. Resist temptation – I know you want a new car. Try to resist. Save money to purchase a car, as opposed to borrowing the money, and remember the cost of operating the car. Do the same with current fashions. Purchase classic clothing that supports your professional appearance at work. Whether you like it or not, the old adage of “Dressing for the job you want” remains true in many settings.

6. Understand your benefits at work – Understand what your benefits are and use the ones that you need and know the others so, when you do need them, you can sign up for them. Start your retirement savings TODAY. Make sure you have medical insurance and disability income insurance, if available. Understand the advantages of a Health Savings Account and use it to your benefit. In the event of your untimely death, understand that your need for life insurance increases, as those that depend on your income increases. With your insurance portfolio, the goal is to have sufficient insurance to protect your financial goals – no more or no less. If you can self-insure, through greater deductibles, your insurance premiums will decrease and you’ll discover money you can save for your retirement, for your MBA, or for your BMW…whatever it is that defines Financial Success to you!

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Education Expensive? Try Ignorance!!

Here we are working through another week of finals at our campus. Many students are delighted to have their exams finished. Graduation is this weekend and there are many happy sons and daughters among us! Hurray for them (including my son)! On the other hand, I just questioned a student, who was waiting to speak to another professor, about the state of his semester and he replied, “I need help.” It appears that his dreams for a successful semester had run aground. His future at our institution is being questioned. He is concerned. He should be.

Why is education so important to this young man? The same reason it is important to you! His future depends on it. Like it or not, on the average, your Financial Success depends on achieving a quality education.

In 2006, median incomes (one-half the group above this income, one-half below this income) by educational level are as follows:

Educational Level for Americans, 25+ years	Median Income ($2006)
Less than 9th Grade	$ 20,901
9th to 12th grade, no HS diploma	$ 25,912
High School Diploma	$ 39,426
Some college, no degree	$ 49,691
College Graduate	$ 81,723
MS Degree	$ 88,422
Professional Degree	$100,000

(Source: http://www.census.gov/hhes/www/income/histinc/h13.html )

It is clear to see that income increases with educational level completed. Moreover, not only are annual earnings greater, but overall life-time earnings are much greater. For those with a bachelor’s degree, in 1999, their lifetime earnings were calculated to be $1,667,700 compared to those of a high school graduate of $994,080. (Don’t try to tell me you couldn’t use the extra, approximately, $700,000 over the course of your life!) Source: http://usgovinfo.about.com/gi/dynamic/offsite.htm?site=http://www.census.gov/prod/2002pubs/p23%2D210.pdf

Taking the earnings by educational level, for 2006, and calculating the average real rate of return for sequentially greater levels of educational achievement is an eye-opener. (The real rate of return is net of inflation, so one could easily add 3%-4% to these numbers to compare them with alternative “investments”.) Those completing high school, compared to dropping out of school at eighth grade, would achieve an, approximately, 17.19% return on their educational investment. Those completing some college, compared to the high school graduate, would achieve a 5.14% real rate of return on their education, while those completing college, compared to those with some college, would realize a 7.77% real rate of return on their human capital investment (the phrase economists use to describe the act of learning and investing in experiences that have market value). (Source: Calculations by the author based on the 2006 income figures above with a constant age of retirement and the cost being the opportunity cost of earning forgone while in school.)

These rates of return make a strong case for earning your diploma - all of your diplomas. Moreover, the results do not depend on the race or gender of the person. (Yes, there are some downward biases to the earnings of minorities and women but, regardless, those with greater educational levels earn more than their counterparts without an education.)

If this doesn’t convince you, let me try the following and, when you read my words and study the figure, think about how this fact works to make it easier for you to achieve Financial Success. You simply work to increase your level of educational attainment.

Given current demographic trends and rates of educational attainment, the advantage of greater levels of education will increase – and soon! Why? Those with higher levels of education will become an increasingly smaller proportion of the population and that scarcity will add to the value society places on the educated (i.e., their earnings will increase!). The following table, from the US Census Bureau, demonstrates that between 2000 and 2020, the proportion of the population with each level of education decreases for all levels of education except those with LESS THAN A HIGH SCHOOL DIPLOMA.

BOTTOM LINE: education is your primary ticket to Financial Success.

- Robert O. Weagley, Ph.D., CFP(r)

Chair, Personal Financial Planning

University of Missouri

Columbia, MO 65211

Note: Thanks for sending this to your friends and colleagues to increase the size of our distribution. Our goal is to help young people and their instructors, particularly high school personal finance teachers, better understand financial concepts that relate to real life. We hope that financially stronger individuals and families will work to improve the world for all of us. Good luck and may you find Financial Success!

Student Loan Repayment Strategies

It is that time of year when many students reflect on their academic year. Oftentimes, this includes consideration of the money they have spent – including what they borrowed through student loans. Much press has been given to student loans and it is clear that student loan markets are tightening, particularly the market for private student loans. A recent article in the Wall Street Journal indicates that FICO credit scores of about 650 are now required to borrow from private sources. If you are a continuing student (we’ll have more about this later), consider federally guaranteed loans first and then look for private loans. If you are graduating, you may be considering repayment strategies, such as consolidation.

In general, you may consolidate your student loans with any lender you choose. The choice of lender is yours and there is no “right answer” that we can suggest that would be correct for everyone. Each lender has their own terms and incentives and the plan that fits your situation the best may not be the one that fits your roommate’s. Consider your career, prospects for growth in your income, and your personal values and then “do the math” to ascertain the best approach for your management of your loans.

Consolidation can reduce your monthly payments, reduce the rate of interest you are being charged, and make your bookkeeping easier – with only one check to write or one electronic transfer. In general, federal loans can be consolidated and they include both subsidized and unsubsidized Stafford Loans, Federal PLUS Loans, Direct PLUS Loans, Federal Supplemental Loans, Perkins Loans, Health Professions Student Loans, Health Education Assistance Loans, Federal Nursing Loans, and Federally Insured Student Loans. When you consolidate, however, a major choice is your desire for a longer, or shorter, repayment period.

If you plan on repaying your student loan over an extended period of time, look for loan consolidation programs that offer the greatest reductions in the rate of interest you are charged (APR). Often, state programs provide such benefits and information about some of the more popular programs may be found at http://financialsuccess.missouri.edu/stateprograms.pdf.

If you plan on repaying your student loan in a relatively short period of time, five years or less, consider a consolidation program that reduces your principal owed for making your monthly payments on schedule for a contractually stated period of time. Importantly, begin making payments to repay the loan principal as soon as you are able. Most loans have a six-month grace period following graduation where you do not need to make payments. If, however, your loan is an unsubsidized student loan, interest charges will be accruing against your account during this “grace” period, thus increasing the amount of your debt. On the other hand, if you have a subsidized student loan, no interest is accruing. If you make periodic payments during this period to your subsidized loan, the full amount of each payment will reduce the amount of principal owed, reducing the total you must repay over time.

Importantly, you must repay your student loan. Nonpayment will destroy your credit rating, making it nearly impossible for you to borrow for home purchase, graduate school, or to begin your own business. Nonpayment often results in finance charges, collection fees, or garnishment….something you’d probably not like your employer to know. Another, often neglected, fact is that student loans cannot be discharged in bankruptcy. As such, there is no relief other than to meet the contractual obligations that are yours. Try to forget the lattes you purchased with this expensive money and focus on how you can get the greatest return on the investment you made in yourself with the education you purchased. More than anything, this investment is the greatest key you have to open your door to Financial Success.

Other sources of interest:
For ideas on Federal consolidations:
http://www.federalconsolidation.org and http://www.ed.gov/students/college/repay/edpicks.jhtml?src=ln

For ideas on private consolidations:
http://www.finaid.org/loans/privateconsolidation.phtml


I apologize for this tip coming out later than usual. My goal for delivery is 5:00 a.m. Central Time. Yesterday, my freshman daughter came home from college and I was asked to be chef for 20 of her high school friends. Then, this morning, I met with the Hospice Care Team with regard to my father’s end of life “game plan”. Yes, we all live the life we have been blessed to live with the tools we acquire through time. I am grateful for those I’ve acquired.

As usual, if you have friend, colleague, or family member that you think would benefit from receiving the MU Financial Tip of the Week, please forward this to them. Tell them to send an email to financialsuccess@missouri.edu with “Subscribe” in the Subject: line. We wish to be your objective source of financial information for today's young adults and students. It is a part of our mission, as a respected land-grant university.

- Robert O. Weagley, Ph.D., CFP(r)
Chair, Personal Financial Planning
University of MissouriColumbia, MO 65211

2008 Financial Literacy Survey

The 2008 Financial Literacy Survey, conducted by Princeton Survey Research Associates on behalf of the National Foundation for Credit Counseling and MSN Money was released on April 29. It key findings are useful for each of us to consider, while we reflect on our own financial situation. Feedback is essential for management and gauging our financial performance against the average person can be useful in supporting what we are doing or in motivating us to change. The key findings, with links to Office for Financial Success resources, follow.

Significant numbers of households struggle with mortgage payments. One in ten homeowners, with a mortgage, reported being late or missing at least one mortgage payment last year. One quarter of all renter households say that they do not know enough about owning a home to buy one. http://financialsuccess.missouri.edu/tipoftheweek/homeshopping.pdf

Millions have serious difficulties paying bills each month. The majority of the public pays their bills on time. However, seven percent of the population report receiving calls from credit collectors or are contemplating filing for bankruptcy. For those in the 18-29 year old category, only 59% report paying their bills on time every month, a basic practice for sound household finances. http://financialsuccess.missouri.edu/tipoftheweek/creditscoring.pdf

Only a minority of the population has a budget. Keeping a budget is a key to sound financial planning, yet only 42% report keeping close track of how much they spend on budget categories. This does not vary by income, gender, or age. http://financialsuccess.missouri.edu/tipoftheweek/freebudgettools.pdf

Emergency funds are lacking. The majority of the public does not have an adequate emergency fund, defined as 3-6 months living expenses. More than one-third have no money saved in non-retirement savings and one-quarter have no retirement savings. http://financialsuccess.missouri.edu/tipoftheweek/EmergencyFunds.pdf

Many are underinsured. Only one-quarter of the population of baby boomers reports having long-term care insurance. Only one-in-ten renters have renter’s insurance. Insurance is a cornerstone to protecting our financial lives. http://financialsuccess.missouri.edu/tipoftheweek/rentersinsurance.pdf

Credit report, what credit report? Slightly more than one-third of consumers, thirty-seven percent, report having checked their credit report over the past year. This free service is a key to protecting your identity and knowing your credit score. http://financialsuccess.missouri.edu/tipoftheweek/freecreditscore.pdf

Parents and home are the financial educators for most of the public. Almost half of those reporting that they keep track of their finances say that they learned it from their parents. Unfortunately, the half that does not monitor their finances, probably learned that from their parents, as well. Parents have a huge influence over us, especially with respect to money matters. If the influence of your parents is not quite what it should have been, then learn it on your own. You have no choice. Take a personal finance class, learn from financial professionals, or seek the help of a valued friend or co-worker to help you in this area of life. http://financialsuccess.missouri.edu/tipoftheweek/educationresources.pdf

Americans worry about their income. Only one-quarter of those surveyed report that they are confident their income will keep pace with inflation. Approximately one-half report that they believe their income will decrease in purchasing power. One must continually update their human capital by staying abreast of changes in their fields. Look for positive things that you can do to set you apart from your co-workers to help your earnings grow over time. http://financialsuccess.missouri.edu/tipoftheweek/howtogetrichinamerica.pdf

The above information was taken from the 2008 Financial Literacy Survey, produced by Princeton Survey Research Associates on behalf of the National Foundation for Credit Counseling and MSN Money and released on April 29, 2008. If you find this Tip to be useful and you know a friend that would benefit from reading it, pass it along and encourage them to sign up to receive the MU Financial Tip of the Week. All they need to do is to send an email to financialsuccess@missouri.edu with Subscribe in the subject line. Thank you and enjoy your Financial Success.

- Robert O. Weagley, Ph.D., CFP(r)
Chair, Personal Financial Planning
University of MissouriColumbia, MO 65211