When the Hoard Hordes

horde ( ˈhȯrd), noun

1 a : a political subdivision of central Asian nomads b : a people or tribe of nomadic life
2 : a teeming crowd or throng

hoard (ˈhȯrd), verb

1 : to lay up a hoard of
2 : to keep (as one's thoughts) to oneself

 

Mea Culpa….

 

Last week, one of our readers caught me using horde when I meant hoard.  I told him I would apologize and I hoped I could find a way to use it in the last tip of 2009.  (Yes, I'm taking a break until 8 January.)  While eating Thai food last Friday night, I came up with a title for today's tip and all I needed was something to write in the body of the tip to go with the title.  So, here goes.

 

We hear a lot about savings rates and the economy.   It can be argued that the more we save, the faster the economy will grow, as interest rates will be lower and we can invest in capital and equipment to increase productivity.  On the other hand of the economists, it is argued that if we save and not spend, the economy will be slowed – simply because people are not buying what is produced by the economy.  Lord Maynard Keynes called this the The Paradox of Thrift.

 

Below is a list of countries with their average savings rate and rate of growth in their Gross National Product (GNP) for the years indicated.  You can see that, for most countries, there is a negative correlation between the savings rate and the rate of GNP growth.  That means the following: as savings rates go up, GDP growth goes down – thus the negative.  Yet for a few countries, notably Greece, Korea, Mexico, The Netherlands, New Zealand, Poland, Spain, and Switzerland; the correlation between savings rates and GDP growth is positive.

 

Country	Years	Savings Rate	GDP Growth	Correlation
Australia	1959-2004	8.64	3.28	-0.102
Austria	1995-2003	8.53	2.14	-0.007
Belgium	1985-2003	13.3	2.23	-0.328
Canada	1970-2005	10.89	2.51	-0.128
Czech Rep	1995-2005	3.76	2.84	-0.030
Denmark	1981-2004	0.82	1.73	-0.396
Finland	1975-2005	1.96	2.62	-0.570
France	1978-2005	11.85	2.18	-0.188
Germany	1991-2005	10.77	1.49	-0.082
Greece	2000-2005	-6.17	4.16	0.744
Italy	1999-2004	10.43	1.39	-0.791
Japan	1996-2004	7.92	1.22	-0.462
Korea	1975-2005	15.28	6.8	0.176
Mexico	1993-2002	6.83	2.96	0.570
Netherlands	1995-2005	10.77	2.32	0.516
New Zealand	1986-2000	-0.91	2.1	0.064
Norway	1978-2003	3.41	2.77	-0.125
Poland	1995-2005	8.91	4.34	0.492
Portugal	2000-2002	4.03	1.84	-0.506
Spain	2000-2004	5.58	3.99	0.297
Sweden	1993-2004	7.16	2.83	-0.369
Switzerland	1990-2004	11.65	1.2	0.085
United Kingdom	1987-2005	3.27	2.5	-0.357
United States	1970-2005	4.55	3.07	-0.114
Europe	1991-2003	11.39	1.96	-0.531

 

To be honest with you, I do not know exactly what this means, although the average correlation is negative.  The negative implies that Keynes is correct and the more we save, the lower will be the rate of growth.  Of course a lot more goes on besides savings.  Innovations, exports, imports, creative discoveries, comparative advantages, wars, disasters, and other events often lead to greater or lesser economic growth, regardless of the savings rate.  (If you don't believe me, read more about the impact of the introduction of the computer to the world during the 1980s and through the 1990s.)

 

One thing I do know and I know this with certainty.  If you save, while others are spending and the economy is growing, your savings will accumulate and you'll be better off financially at the end of the period than the debtor – assuming your investment returns outpace inflation.  Thus, the mantra: Savings good, debt bad.

 

I wish everyone the best.  I've got to grade my finals and finish my shopping.  My son gets back from Michigan tomorrow and my daughter, from Pennsylvania, on Sunday.   We just had a visiting research scholar arrive from Beijing and she needs a place to call home for the year.  Simply, I've got productivity to add to our economy.

 

We are busy.  We are blessed.  Just like you.  Enjoy Your Holydays (sic).

 

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

 

Salus populi suprema lex esto. 

- Motto of the State of Missouri

 

The Final Days of the Dollar?

I read the title of today’s Financial Tip on one of those sidebar advertisments on a webpage that you are usually better off not reading.  Yet, I couldn’t resist.  The trouble is that others might have the same lack of discipline, when it comes to sidebar advertisements.  (Folks, I hate to tell you this but you probably won’t make $77 per hour with that on-line job that is being marketed.)  I then thought about what is going on with the dollar in relation to other currencies and I wanted to know more.  The result is a financial tip on exchange rate risk.  It just might be educational.

 

As a review, we all remember (don’t we?) that there are risks associated with investments and that risks include the possibilities of both losing and gaining more money than we expect at the time we make the investment.  We don’t worry much about business risk (the risk of the business doing better or worse than expected) or financial risk (the risk that over-indebted firms do better in good times and worse in bad times), as we can diversify away from these risks.  The other risks, however, are always present and we should learn to embrace them – all of them – in order to be properly diversified in our portfolio.  As a reminder, the other risks are:

 

·         Interest rate risk – the risk that security prices move in the opposite direction to that of interest rates.  If interest rates go up (down) the present value of future earnings/interest payments/dividends goes down (up).

·         Market risk – the risk that the psychology of the market causes all investments to go up or down.  (Remember how the value of stocks went down from October 2008 through March 2009?)  When people are feeling confident, their psychology causes them to place more faith (money) in the future – causing security prices to rise – or when they are uncertain, they horde their money – causing security prices to fall.

·         Reinvestment rate risk – the risk that an investment that pays a return of X% per year will have those payments reinvested at a rate either higher or lower than X%.

·         Purchasing power risk – the risk that increases (decreases) in prices will erode (increase) the purchasing power of the payments we receive.

·         Exchange rate risk – the risk that the currency in which our investment is held will either increase or decrease in value due to changes in what the currency is worth relative to the currency of the country where we live or, more importantly, where we spend our money.

Where do we stand today with respect to exchange rate risk?  The chart below indicates that, yes, the dollar has fallen relative to other currencies during 2009. Clearly, there has been a decrease in the value of the US Dollar Index, since March.  Yet, if one goes back far enough, the dollar is actually worth more against this basket of securities, than it was in late 2007.  (See the following website and change the “Periods” from 60 to, say, 1000 to observe this: Dollar Index Chart.)  Moreover, in the face of the financial crisis in Dubai and, some say, the looming financial crisis in Greece, the dollar has recently gained ground against the index currencies, as indicated by the uptick in December.  (The index broke above the 50-day moving average, typically interpreted as a bullish sign by technical analysts.)

The six currencies in the US Dollar Index (with their relative weight in the index in parantheses) are the Euro (57.6%), the Japanese Yen (13.6%), the English Pound (11.9%), the Canadian Dollar (9.1%), the Swedish Krone (4.2%), and the Swiss Franc (3.6%)  http://quotes.ino.com/chart/?s=NYBOT_DX&v=d12 .

What does this mean to you?  Let’s take a simple example and assume that you could have purchased a 100 units of the “index” (we will call the currency I$), in March, when the dollar index was at 89.  The foreign currency “index” would have cost you, in US dollars, $112.36 (= I$100 * (100/89)).  Today, when the dollar index is at 76, that foreign currency “index” could be sold for $131.58 (=I$100 * (100/76)), as the dollar is worth 14.6% less, relative to the index.  Naturally, if the dollar index would have risen against the foreign currencies, instead of falling, you would have lost money on the transaction.

Another concept that is currently being discussed is that, while the dollar is losing value against other currencies in currency markets, it is actually undervalued relative to what the dollar will buy in terms of real goods and services.  (If there is no under- or over-valuation, the market is said to be in Purchasing Power Parity.)  That is, how the dollar is trading in currency markets is different than how prices are being charged within and between trading partners for goods.  The following table shows that, for the currencies in the index, the dollar is undervalued in “purchasing power” relative to the Swiss Franc, the Japanese Yen, the Swedish Krone, the Euro, the Canadian Dollar, and the British Pound.  Or, rather, ALL OF THE CURRENCIES IN THE US DOLLAR INDEX!

http://fx.sauder.ubc.ca/PPP.html

 

“So what do I do now, in order to use this information to help me reach financial success?”, you ask. 

 

I answer, “I don’t know.”

 

I do know that changes in currency valuations are simply a transfer of wealth from countries whose currencies are devalued and toward countries where their currencies are gaining in value.  Yet, for those countries whose currencies are devalued, they should experience an increase in their relatively less expensive exports and a decrease in their imports – thus improving the balance of trade and their economic well-being, over the short run.  Moreover, an overvaluation or undervaluation of a currency based on Purchasing Power Parity will, over the long-run, be worked out and exchange rates will adjust toward parity.  If we accept this, the dollar is currently undervalued in currency markets and could be expected to increase in value, relative to the index (and foreign stocks), over the long run.

 

While I remember what the economist John Maynard Keynes said, “In the long-run, we are all dead”, I also remember what I believe about investments and the world.  For investments, diversification is a key principle and I believe that some exchange rate risk is good for a portfolio.  For the world, regardless of whether the world is getting smaller or if the world is getting flat (as described by Thomas L. Friedman in his book, The World is Flat), we will be increasingly cooperative with other nations and we will find ways to increase the economic well-being of the world.   To think we will choose otherwise, defies the lessons of history, the evolution of cultures, and accepts a long-run view where we are, as Lord Keynes said, all dead. I will not accept that vision of the future for our species.

 

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

Chair

Personal Financial Planning

University of Missouri 

Salus populi suprema lex esto. 

- Motto of the State of Missouri

 

Mrs. Weaver's Wise Ones

Many of our readers are students that are in either college or high school.  Others are teachers that work with those students.  One such teacher in our Columbia Public School system works to teach personal finance to IEP students.  They are today’s Wise Ones.  This semester they wrote a book entitled, A Teenager’s Guide to Our Financial Institutions.  According to the preface, “We are writing this book in order to teach teens about banking, the economy, the benefits of saving, and the structure of the Federal Reserve.”  (Nothing like a good challenge.)

 

I attended the book signing and I even purchased three copies of the book: one for me, one for the journalist from the local paper, and one for a financial planner friend who left his wallet in the car. (Like I’d never hear that one before!)   There were several local financial professionals that gave up their time to reward these students with some attention – mostly in the form of questions.  The students had sections of the book that they were responsible for writing and responding to questions, when asked.  My most common remark, at the conclusion of my interrogation of each student, was, “You know more about this subject than 90% of the people on the street.”  It was clear that the pride instilled by this project was bursting forth among these kids and, yes, my heart told me that there was no better place for me to have spent the hour, as IEP students are especially endearing to me.

 

One of my favorite sections was entitled, “How to be Financially Successful”.  It read:

 

What does it mean to be financially successful?  Well, in the words of Tennessee Williams, from his play Cat on a Hot Tin Roof, “You can be young without money, but you can’t be old without it.”  To me, that means that your parents can buy your necessities, or they can give you an allowance when you’re young.  However, when you get older and start living on your own, you can’t live without your own money because you have bills to pay.

 

I bet you are wondering “well, why do I need to know about being financially successful?”  I will tell you.  If you start saving while you’re young, you can get ahead in things like saving for college or saving for a dream home that you want.  What I am trying to say is that you can be more financially successful if you set a goal.

 

All of this made me begin to wonder about why we make the choices we make and how they can change our chances for financial success.  Particularly, since some choices greatly reduce our ability to succeed.  Perhaps, you’d like to ask yourself the following questions and discuss your answers with your friends.  The correct answers are at the end.

 

1.                The main reason for being in school is to ________

a.       Get a degree

b.      Get an education

c.       Get a job to pay for my car

d.      Party hearty

 

2.                   It is okay to go into debt for an education, as it is an investment in ourselves that has a greater return than many others and we can control it by our choices.  Along the way, however, be sure you ___________

a.       Have nice clothes while in school

b.      Join the hippest clubs and groups

c.       Go on a costly trip for spring break

d.      Finish your degree before you leave

 

3.                   The main reason college students leave school before they graduate is ___________

a.       Bad grades

b.      Legal problems

c.       Financial problems

d.      Health problems

 

4.                   It is ok to borrow money to go to college and, if I go bankrupt, I won’t have to pay the money back.

True or false

 

5.                   In order to have enough money to make it through the semester without getting into financial problems, I can’t go out and have any fun.

True or false

 

Answers:

1.        A.  Get a degree.  Five to six years of college without a degree, while you learned a lot, indicates only one thing to most people: You did not finish.  Employers want to hire finishers - not quitters.  DO NOT LEAVE until you have earned your degree.  An “education” is not enough.  You want the degree and, the more you do learn in the process, the better will be your return on the time it takes.

2.        D.  Finish your degree.  DO NOT LEAVE until you have earned your degree.  (There is an echo in here.)  College debt must be paid back whether you finish your degree or not.  Leaving school with debt, but without a degree, is a disaster waiting to happen.

3.       C.  Getting into financial problems can derail your plans to finish a degree – in fact; it is the main reason students are forced to leave school before earning a degree.

4.       False!  Student loans are not able to be discharged through bankruptcy.  You have to pay them back - unless you die.  (The “death” solution is not recommended.)  If you envision difficulty, get help through credit counseling – NOW!

5.       False!  You may not be able to go out four nights a week or buy every CD you want; but if you don’t go out occasionally or pay to purchase or download a CD, you will get burned out really fast.  It is ok to enjoy yourself.  Do not forget that. 

PS  I owe a thank you that sent me a response indicating resources that you would recommend to teachers.  Some of you told me about arrangements you have with local colleges and some of you even invited us to come to your school.  We thank you and ask all of you to keep in touch.  If you want us to come visit, after the first of the year, give me a reminder email and we’ll see how resources are matching up with needs.

 

 

 

 

Drs. Carole Bozworth, Cynthia Crawford, and Robert Weagley

Personal Financial Planning

241 Stanley Hall

University of Missouri

Columbia, MO  65211

 

573.882.9651 - office

573.884.8389 - facsimile

573-673-4605 - personal cell

 

Salus populi suprema lex esto. 

- Motto of the State of Missouri

 

Big Ticket Turkeys

The approach to the Holiday Season is over.  The season for giving both thanks and gifts is upon us.  If you don’t believe me, you’ve not gone shopping in the past three to four weeks.  To celebrate, people often make the choice to purchase a big ticket item for the family; a TV, a car, a surround sound system, a new computer, or any other consumer good that a family member believes embodies the spirit of the season.  What do we know about shopping for and buying these items?  First, I’ll present a little consumer search theory to be followed by some bullets to take with you to your shopping experience.

 

Assume you know that the good you are planning to buy costs either $1,000 or $1,500, depending on the store.  You know that half the stores charge $1,000 and the other half charge $1,500.  If this is true and you shop only one store, there is a 50% chance the price will be $1,000 and a 50% chance the price will be $1,500.  From a probability/price evaluation, your expected price from shopping one store would be $1,250 (=0.5*1000+0.5*1500).  What happens when you shop two, or more, stores?  If you shop two stores, the expected price falls to $1,250, as there is only a 25% chance that both stores will charge the higher price and a 75% chance that one, or both, of the two stores will charge the lower price.  The bottom line is clear, the more stores you shop, the lower the price you should expect to pay.  The following table displays the number of stores, the expected price, and the marginal savings from each successive store:

 

Number of Stores	Expected Price	Savings
1	$1,250.00	0
2	$1,125.00	$125.00
3	$1,062.50	$62.50
4	$1,031.25	$31.25
5	$1,015.63	$15.62
6	$1,007.81	$7.82
10	$1,000.49	$0.50

 

As can be seen, the greater the number of stores you plan to shop, the lower will be your expected price.  You must remember, however, that you will pay either $1,000 or $1,500; depending on the effectiveness of your search.  Also, note that the more stores you search, the lesser will be your expected savings from adding each successive store.  As economists, we believe that people, on average, will search until the marginal benefit from searching another store (savings column) equals the marginal cost of an additional search (travel, time, parking, and et cetera).  Clearly, if the costs are greater, you will search less – like shopping on Christmas Eve! – but if the costs are small or the savings gains large, you will shop more.

 

So, how do we decide what to buy and what tips can I offer you to think about and discuss with your family and friends:

 

·         Don’t use your credit card unless you plan to pay the balance off in full before interest charges accrue.

·         Determine what your needs are, select appropriate models/manufacturers and search on the internet to find typical prices.  (That is, determine the potential gains from search.)

·         Use Consumer Reports or CNET.com for quality and price comparisons.  When comparing store prices with internet prices do not forget about sales taxes, shipping costs, maintenance and repairs, and additional necessary equipment.

·         Set a budget.  Set a budget.  (It is worth repeating.)  Yet, do not buy the lowest priced item you find as it may not be the quality you wish to purchase.  Sometimes a few dollars more at purchase will result in a product that lasts much longer than the lower priced goods.  Here, the time you expect to own the good might be the determining factor.  (When I was in graduate school a rear window of a pickup truck on top of a cantaloupe crate served as my coffee table for several years.  When I moved, I left the window behind and carried my 12” LPs to their new home in Missouri in the cantaloupe crate.)

·         Do not be afraid to negotiate.  Sometimes you can do this, simply, by looking hesitant.  The fact is that, at some point, if you don’t ask them to dance, they will not dance with you.  If you don’t ask, the answer will certainly be “NO”.

·         Avoid extended warranties.  Yes, I know that you’ve heard people talk about how glad they were that they had a warranty.  Remember, however, that the ones who paid $200 for a warranty on a $1,000 TV, never brag about the $200 they wasted or how much better they slept, knowing they could have gotten their TV repaired, if they did not use the warranty.  Extended warranties are a huge profit center for merchandisers.  The price for the warranties and the probability of the warranty being used are on the side of the merchant.  It is like gambling and the odds favor the casino – every time!

·         Be skeptical of “no interest” or “no payments until ____” offers.  If you qualify and have the money to repay in full at the end of the grace period, they can be good.  Remember that the additional “credit” will affect your credit score.  Also, make sure you read the fine print and to always remember, If it is too good to be true, it is not true.

 

In closing, enjoy your Holidays and enjoy the process of giving.  Be thankful for what you have, as well as what you will receive.  We are blessed to have the opportunity to celebrate and show our thanks.  At the same time, remember that others may not be as lucky.  Extend a hand of friendship and fellowship to those that may benefit from your generosity.  This week, eighteen of my students took me to the local food bank to package food for the needy in our town and surrounding area.  That night, the manager told us that 9,400 households, of 53,094 households, in Boone County live from the food donated by our local Food Bank.  That is one out of six households in one of the more affluent counties in Missouri.

 

Truly, if you’ve food on your table and optimism in your heart, you have many reasons to give thanks.  If food on the table is the minimum for financial success, let us all hope that people can make the right choices and that more are able to share in our bounty.   Enjoy your giving of thanks!

 

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

Salus populi suprema lex esto. 

- Motto of the State of Missouri

 

Giving Freely or Freely Giving

It is the time of year that we begin to be increasingly asked for charitable donations.  From the friendly volunteers ringing bells for the Salvation Army to this year’s packet of “free” return address stickers with the accompanying request for a donation, we are often inundated with requests to share our income and wealth.  And share our income and wealth is what American do.  According to Giving USA 2009, Americans donated an estimated $307.65 billion in 2008.  Although the recession is credited with this 2% decline (current dollars) in giving over 2007, it still represents charitable giving of about $1,000 per person in the United States.

 

Having said that, two-thirds of public charities saw decreases in funding in 2008, compared to 2007; while 54% of human service agencies experienced an increase in demand for their services.  The result is that 60% of human service agencies are cutting expenses, through services or staff.  Unfortunately, those most likely to report a downturn in their funding are those serving children and youth and those working to provide families’ basic needs (food, shelter, clothing, etc.) with more than half (53%) reporting a funding shortfall.  (Giving USA is a publication of Giving USA Foundation^TM, researched by the Center on Philanthropy at Indiana University.)

 

How do you decide to whom to give and how much?  Is this an individual decision, a family decision, or one driven by self-interest or habit?  Do you check to see if the charity is a Better Business Bureau Accredited Business?  Do you even know where you give your money?

 

Over the past five-years, while I’ve been my father’s custodian, I was amazed at the phone calls and letters I received asking for his donation for the year. We know that some charities focus their efforts on the elderly, while others focus solely on their members, as do churches. Yet, we need to budget charitable giving like any other expenditure.  While some households make an annual gift to United Way, allowing their local board to make allocation decisions, others find themselves sending a token check to every solicitation that contains their favorite or most dreaded word, such as “Veteran”, “Cancer”, “Ducks”, “Disabled”, “Nature”, “Children”, “Refugee”, or whatever.  My guess is that those in the latter category have little idea about how much they give and how the money is being spent.  This conclusion is even more likely to be true, if they don’t itemize deductions on their taxes – which is likely if they don’t have a mortgage on their residence.

 

Several years ago, I did a presentation on “Living Better on Less” in a farming community that had been hard hit by, then, low commodity prices.  In the question period, a dapper, older gentleman stood up and said, “I’m doing better than most of the people in this room.  Each time I received a paycheck, I, first, gave some money to God and then I gave some money to me.  I saved it.  Now, when the chips are down, I’m doing alright.”  Since then, his advice has echoed in most every lecture I’ve given on budgeting.  While I do not care if God is first on your list, I do care that you are no lower than second on your list.  (It is, however, your list.)  In order to make this happen, you must include charitable giving as a budget category and make some hard decisions.  Today, with solicitations increasing to address the shortages in budgets, this need for you to act on behalf of your budget is even greater.

 

Given that we live in a free country, I’m not going to tell you where to give your money.  I can, however, tell you where others give their money.  If we take total charitable giving and divide it into each recipient category’s share of total charitable giving, it looks like the following.  I’ve included the dollars given in charitable giving to each category of recipient, the percentage of total charitable giving to that category, and the percentage change in charitable giving to that recipient between 2007 and 2008.

 

Category	$ Charitable Giving	% Total Charitable Giving	% Change 2007 to 2008
Religion	$106.89 billion	35%	+5.5%
Education	$40.94 billion	13%	-5.5%
Foundations	$32.65 billion	11%	-19.2%
Health	$21.64 billion	7%	-6.5%
Public-Society Benefit	$23.88 billion	8%	+5.4%
Arts/Culture/Humanities	$12.79 billion	4%	-6.4%
International Affairs	$13.30 billion	4%	+0.6%
Environment/Animal	$6.58 billion	2%	-5.5%
Other	$48.98 billion	16%	na

 

In the above table, for a recessionary year with declines in overall income, charitable giving increased in some categories, while it decreased in others.  (Real median household income in the United States fell 3.6 percent between 2007 and 2008, from $52,163 to $50,303.  – U.S. Census Bureau) The “expenditures” (charitable giving is an expenditure) that increase when income increases are called normal goods. When expenditures increase when income declines, the good is called an inferior good.  When expenditures increase by a greater percentage than income increases, the good is called a luxury good. (I am not claiming that any category is superior to any other, I am merely pointing out the facts and teaching some language of economics.  Those that have increased would be in the category of inferior goods; those that have decreased by less than the rate of income decrease are normal goods; while giving to a foundation was a luxury good expenditure.  It is also the case that some of these categories are deeply bound by habit, tradition, or group membership that precludes any changes in level of giving. )  Research, also, indicates that those with the highest incomes give a lower percentage of their total income to charities, than do those with the lowest incomes.

 

While this Tip did little to help you with your finances, it might help you make some decisions.  In exchange, these decisions could make you happier with your finances and have more money for items you need and, perhaps, want.  If they do, we reach our goal of you reaching financial success – as you define it.  Regardless, I am not suggesting you stop giving.  I am suggesting you make decisions to ensure that your dollars express your values, in support of your goals for our “grants economy”.  (The phrase “grants economy” was first used by economist Kenneth Boulding (1910-1993).)

 

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

Chair

Personal Financial Planning

241 Stanley Hall

University of Missouri

Columbia, MO  65211

 

Salus populi suprema lex esto. 

- Motto of the State of Missouri