Good News, with a View

The editors of Forbes have asked me to contribute to a blog on their website and, while I am willing, I admit to being a tad intimidated.  Forbes is a big name and I’m just one generation removed from the other-side-of-the-tracks.  Yet, I digress and, besides, you know this.  Rather, I’d like to talk about some good news – the National Personal Finance Challenge. 

 

On 20 May, I traveled to Kansas City for the first National Personal Finance Challenge, where teams of four students; from the participating states of Oklahoma, Maryland, Kentucky, Missouri, Kansas, Illinois, Delaware, Nebraska, Tennessee, Minnesota, Arkansas, and Mississippi; competed for the national championship.  Each team had come up through state-regional and statewide competitions to be able to represent their state in the event.  The competition was the creation of the Missouri Council on Economic Education, and it was held at the Kansas City Federal Reserve Bank, providing space, food, and refreshments; while travel and accommodations for the students were paid by Wells Fargo Advisors.  It was a joy to spend the day with these young people. (A recap appeared in the Kansas City Star.)

 

The contest is simple.  (Yet, most American could not answer the questions.)  The students take individual multiple–choice exams for two rounds: Round 1: Spending and Credit and Round 2: Saving and Investing.  The highest three team-member scores are summed as the team score for each round.  For Round 3: Income and Money Management, the team submits answers as a team.  Finally, the top two teams (Minnesota and Missouri) engaged in Round Four: Personal Finance Potpourri – Quiz Bowl, to determine the winner; Minnesota – twelve correct to Missouri’s seven. (See below for a sampling of the Quiz Bowl questions.)

 

Why do I write about this?  I write about this, as this is an answer.  In my opinion, we have precious few answers.  I know the kids on the Missouri team, as they are from my son’s high school.  I know their teacher and the love she has for her kids and the passion she employs teaching them the principles of personal finance, as required for graduation in Missouri schools. Moreover, my youngest son was on the second-team from the same high school.  The competition really engaged him, like the other students, to learn as much as he could about personal finance.  In fact, the leader of the Missouri team is a 2010 Presidential Scholar – with a perfect score on the ACT and SAT – and, while he plans to attend Princeton to study political economy and government, he will be able to manage his money.  As a society, we have an obligation to help others do the same and too many of our country’s parents are not up to the task.

 

While I was watching the competition, the windows of the Fed provided a view to the north toward downtown Kansas City, the World War I Museum, and Union Station.  I could not help but reflect on the fact that many of our ancestors moved to, or through, Kansas City with dreams of a new and prosperous life.  While I was at the National Personal Finance Challenge, I spoke with many of the kids.  They were the children of these ancestors, “salt of the earth” kids living one of their lives’ successes with dreams of a new and prosperous life.  We need to remember, however, that adults devised the competition that gave them the chance to compete, to learn more about personal finance, and to celebrate their success with a trip to Kansas City.  Adults and corporations stepped up to help them realize their dreams.  Adults also set the example at home that made learning personal finance a natural act that can lead to financial success.  Yet, adults can and must do more.  Next time it is my turn to write, we’ll talk about an example; the Top Ten Teen Financial Tips; a program our MIZZOU undergraduates will present to fifty Missouri High Schools over the next school year. 

 

So, what are your suggestions for the Top Ten Teen Financial Tips?  Send us your ideas or add them to our blog at http://mufinancialtip.blogspot.com .

 

 

Sample Quiz Bowl Questions with Answers

1.     Name one type of trade restriction that causes prices to consumer to increase on foreign imports. Tariff or Quota

2.     According to the IRS, what is the maximum amount you are allowed to give up to any number of people, every year, without facing any gift taxes, and without the recipient owing any income tax on the gifts? $13,000 (in 2009 and 2010)

3.     A written authorization from a stockholder that empowers someone to vote on the stockholder's behalf. A proxy

4.     A 529 Savings Plan is designed to fund what specific expense? College education expenses

 

 

Price Gouging

Andrew Zumwalt, M.S.

Price gouging sounds like a horrible thing. The “gouge” part really carries the negative connotation. When someone hears “gouge”, usually it’s in reference to “gouging out someone’s eye” which sounds pretty gruesome. It is surprising, then, to hear Professor Mike Munger, Chair of the Political Science Department at Duke University, talk about the positive effects of price gouging. The point Dr. Munger was trying to emphasize was the valuable information that prices convey. The best way to illustrate this is with same story he told.

 On September 5, 1996, Hurricane Fran slammed into Raleigh, North Carolina. Category 3, 120 MPH winds and 10 inches of rain caused trees to fall and damage to buildings. Roads were blocked and electricity was out for several days. With the absence of electricity, refrigerators stopped working and food started to spoil. Important medications like insulin and baby formula that must be kept cold began to warm and spoil in the September heat. Stores that had ice quickly sold out or the ice melted. The price of ice quickly rose to infinity, since ice could not be bought at ANY price.

Into this ice void, several young men from a nearby town that had been untouched by the hurricane rented a refrigerated truck, bought 500 bags of ice, and headed out to bring ice to Raleigh. They realized that the demand for ice would be greatest in the center of the city, so they cut through the obstacles with chainsaws and moved blockages off the road. When they got to the center, they opened their truck and sold ice for $12 a bag.

Twelve dollars a bag!?!! Ice normally sold for $1.70, and people were outraged about the high price of ice. Those outraged still bought ice, because the alternative (no ice) was worse and more costly in terms of spoilage, but they were still unhappy. Eventually, the police were called and the young men were arrested for price gouging and the truck with ice was impounded (and turned off in the impound lot, causing a big puddle). The price gouging law in North Carolina makes it illegal to sell items at a price “unreasonably excessive under the circumstances.” According to the story, people in line clapped when the police arrested the price gougers.  The clapping is confusing because the price of ice for those still waiting in line rose from $12 back to infinity (no ice at any price).  

The high price of ice actually provides some valuable information. First, the high price signals to consumers that ice is hard to come by or scarce. Consumers should only buy ice if they really need it. Who decides if the consumer really needs ice? The consumer! The consumer makes that decision by examining the benefits and costs of using that ice. For example, if ice was $12 a bag, you may not choose to keep the diet soda cold -- the benefit of a cold diet soda is not worth the cost. However, if one had to keep insulin or baby formula cold, they might consider the ice ‘cheap’ because having to replace those items might be very expensive, especially in the wake of a hurricane.

Second, the high price of ice sends a message to suppliers: Get ice here quick! The premium for ice encourages suppliers to redirect ice from places of plenty or produce more ice. The high price more than compensates for hurdles or obstacles that the supplier might encounter. However, as more suppliers or producers provide ice, the price of ice will fall as competition intensifies.

Both of these benefits disappear with anti-gouging laws. The important message about the scarcity of ice disappears when the price remains unchanged. Consumers may buy three bags of ice to keep their diet soda cold, and, if the supplies are limited, those bags may be gone when the consumer with the insulin or baby formula arrives. Empty store shelves of bread and milk before a big snowstorm is an image you may have seen.

The message to suppliers is also lost. If a premium cannot be charged to deliver goods through obstacles or at a greater cost, then suppliers may not have enough incentive to produce or deliver the goods. This lack of incentive causes a perverse lengthening of the shortage until obstacles or challenges are removed. In this way, anti-gouging laws are similar to price controls. The best example for the effects of price controls is the rationing of gasoline during the 1973 oil crisis. By limiting the rise in price, suppliers may have little incentive to deliver. They may have other incentives (corporate goodwill?), but there will be a definite subdued response.

In summary, anti-gouging laws may cause more immediate and lasting harm by not allowing prices to send their powerful signals to both consumers and producers in the wake of a disaster. Suppliers may have little incentive to supply goods at the before disaster price, and consumers will not have a strong incentive to curtail their consumption.

Other sources for information about price gouging:

The article that inspired this tip: They Clapped: Can Price-Gouging Laws Prohibit Scarcity?

The podcast that inspired this tip: Munger on Price Gouging from EconTalk

The Price of Everything: A Parable of Possibility and Prosperity by Professor Russell Roberts; chapters 1 and 2 are available for free

Missouri Attorney General’s website on price gouging

An economist responds to his mother about price gouging from Marginal Revolution, an economics blog

Recently, a water main broke in Boston causing a scarcity of clean water. Several economics writers took the time to remark on the price gouging actions:

See the Invisible Hand is a companion blog to the textbook Modern Principles of Economics authored by Tyler Cowen and Alex Tabarrok

What’s wrong with price gouging? Is an editorial written in The Boston Globe about price gouging.

Freakonomics Blog post about the event

Andrew Zumwalt, M.S.
Director of the MoTax Education Initiative
162 Stanley Hall
University of Missouri
Columbia MO 65211

 

A Little Economics Goes a Long Way

Antoine Cournot was a 19^th Century French economist, mathematician, and philosopher.  He is widely known for his theory of monopoly and duopoly but I like him because of his mathematical proof known as Cournot Aggregation.  Cournot aggregation, mathematically, is written as follows; W_xx_x,x + W_yx_y,x = -W_x [i].  (For those of you better versed in English, as opposed to Greek formula, you may want to skip the endnote that explains the formula.)  In plain English, it is like my high school friend Monty would have said, “If the price of suits goes up, I don’t care.  I don’t wear suits.  But if gasoline for my ’57 Chevy goes up, I’m in a world of hurt, as that 327, V-8 engine purrs on premium gas!”  Monty probably didn’t get more than 8 miles to the gallon and he drove a lot of miles. On the other hand, if the price of gasoline fell to half of what it was, Monty would have had enough money to take his girl to the drive-in movie[ii].

 

The following is a table of the rate of price change for broad categories of goods that we purchase (for more information: Bureau of Labor Statistics).  The second column is the percentage change in prices between March 2008 and March 2009, the third column is the percentage change in prices between March 2009 and March of this year, while the fourth column is the combined rate of inflation over the period 2008-2010.  I have taken the liberty to highlight double-digit increases in prices in blue and any decrease in prices in red.  As you can see, the change in prices is not uniform across categories.  Take, for example, prices from 2008 to 2009, across all goods, fell by 0.4%.  Yet, for most categories of goods, prices actually went up but these increases were outweighed by the decreases in prices for transportation and fuel during the 2008-2009 time period.

 

Category of Expenditure	Rate of Change March 2008 – March 2009	Rate of Change March 2009 – March 2010	Rate of Change March 2008 – March 2010
All Goods	-0.4%	2.3%	1.89%
Food and Beverages	4.3%	0.3%	4.61%
Food	4.4%	0.2%	4.61%
Food at Home	4.3%	-0.7%	3.57%
Food away from Home	4.6%	1.2%	5.86%
Alcoholic Beverages	3.6%	1.1%	4.74%
Housing	1.4%	-0.6%	0.79%
Fuels and Utilities	0.6%	0.9%	1.51%
Household furnishings	1.8%	-2.3%	-0.54%
Apparel	1.4%	-0.4%	0.99%
Transportation	-13.1%	13.3%	-1.54%
Private Transportation	-13.6%	13.8%	-1.68%
Motor Fuel	-39.6%	41.1%	-14.78%
Public Transportation	-5.0%	6.1%	0.79%
Medical Care	2.8%	3.7%	6.60%
Recreation	1.7%	-1.1%	0.58%
Sporting Goods	3.2%	-1.2%	1.96%
Other Recreation Goods	-3.5%	-3.1%	-6.49%
Recreation Services	2.4%	-1.2%	1.17%
Education	5.6%	4.9%	10.77%
College Tuition	5.8%	6.0%	12.15%
Communication	1.7%	0.0%	1.70%
Other Goods & Services	5.7%	4.9%	10.88%
Tobacco	18.1%	15.9%	36.88%
Personal Care	2.1%	1.2%	3.33%

 

Now, look at what happened to fuel prices and transportation between 2009 and 2010.  You will note that while prices for fuel fell from March 2008 to 2009, to 60.4% of their March 2008 price, their price rose to 85.2% of the March 2008 price, by March 2010.  (Here’s the math: If something cost a $1 in 2008, it would fall to $0.604 in 2009, with a 39.6% decrease.  Then, if the $0.604 price increases by 41.1%, you would have $0.852.  Still, this price is below $1, but that bloke that purchased the Hummer in March of 2009, sure thinks that gasoline is more expensive!)

 

Look back at the Financial Tip from the last week of January 2010: Are You Middle Class?.  In it you will see the proportion of the average household budget spent on various categories of goods.  The table tells us that housing takes up the largest proportion of the average budget.  Thus, when the price of housing decreases, assuming you don’t own the now low-priced home, the total effect on you is an increase in consumption of other goods, including savings.  On the other hand, if you are working part-time while you are going to school and much of your income purchases college tuition, you notice the decrease in your consumption of everything else, as college tuition rose, on average, by 12.15% over the past two years. 

 

You might be wondering, “How is this a financial tip for financial success?”  The lesson is simple, yet not widely practiced.  First, be modest in your expenditures and keep them at a reasonable level, relative to your income.  If the average budget share for your income category is 20% of expenditures, try to keep yours below 20%.  If you do this for all categories of expenditures, save 10% of your income, and have an adequate reserves to provide liquidity in the case of an emergency, you are a financial success.  Moreover, you didn’t have to learn Greek, nor spend like them, to get there.

 

ps:  For ideas on how to save money, check out this link: 66 Ways to Save Money.

 

---

[i] The mathematical “bottom-line” states that a percentage change in the price of a good x will have a resulting percentage change in the consumption of good x (x_x,x, own price elasticity of demand) and all other goods y (x_y,x, cross-price elasticity of demand) that, when weighted by their respective budget shares (W), is equal to the negative of the share of the consumer’s budget that is spent on good x (-W_x) .  Thus, changes in prices have a greater effect, the greater the proportion of your budget you spend on the good with the price change.

[ii] I know that many of our student readers have never seen a drive-in movie, nor do they have the foggiest idea what is so special about a ’57 Chevy.  Take it from me, however, that magic would follow when a ’57 Chevy was paired with a date to a drive-in movie, during the 1960’s.

Missouri Personal Finance Challenge

Yesterday at the Reynolds alumni center at the University of Missouri eight teams from high schools across Missouri got together to compete in the State Personal Finance Challenge.  Our department was invited to participate in this event as judges and scorekeepers, and we were so impressed with these bright high school students that we decided to dedicate this entire Financial Tip to them.

First – some background on the Personal Finance Challenge.  Missouri’s Personal Finance Challenge is sponsored by the Missouri Council on Economic Education (http://cas.umkc.edu/mcee/).  On their website we read:

You can't read the news without seeing why a fundamental understanding of economics and finance is so important to the future of our youth and our country.

The admonishment of Arthur Levitt, former chairman of the New York Stock Exchange, that “the American economy is the eighth wonder of the world; the ninth is the economic ignorance of the American people,” is true.

Lou Harris and Associates recently polled and documented the extent of economic illiteracy among high school students and adults. The poll revealed that:

·         Fewer than half the students surveyed can define a budget deficit

·         Fewer than half of the adults and 1/3 of students understand what it means to say that the Gross Domestic Product has increased

·         Most adults thought that economists would recommend increasing regulations to reduce pollution rather than increasing the costs to those who pollute

·         Sixty-percent of high school students did not know that if rent controls are placed on apartments that eventually there will be fewer apartments to rent

(http://www.financechallenge.org/index.html?s=26&l=1)

The Missouri Council on Economic Education is dedicated to improving the quality of education received in the high schools across the state and to change statistics like you see above.  Mike English, along with his very talented team, put together this year’s challenge.

All high school students were invited to first participate in an online challenge.  Up to three teams from each school went on to participate in a regional competition, and the top two teams from each region were invited to come to yesterday’s state competition.

Here are the high Schools that were represented at the state competition:

·         Parkway Central

·         Liberty

·         Savannah

·         Humansville

·         Hannibal

·         Ozark

·         Rock Bridge Team A

·         Rock Bridge Team B

The teams competed in individual and team tests consisting of questions about credit, saving/investing and income/money management.  The two highest scoring teams faced off in a quiz bowl.  In the end, Rock Bridge Team A won (in a very close game) and, along with their teacher Susan Lidholm, are headed to Kansas City on May 20 to compete in the national competition!

Despite all the negative data we usually hear about high school student’s knowledge of economics and personal finance, all of the students that competed today showed that personal finance initiatives across the state are not just working, but working well.  We have no doubt that these students will go on to be industry leaders who will help change the economic future of their families and communities.

Congratulations again, Team A from Rock Bridge High School!  We look forward to seeing you and cheering you on in Kansas City!

Ryan H. Law, MS, AFC
Department of Personal Financial Planning

 

Office for Financial Success Director

University of Missouri Center on Economic Education Director

 

239 Stanley Hall
Columbia, MO 65211-7700

New Credit Card Website

As a consumer, it pays to be smart when choosing and using a credit card.

 

The Federal Reserve Board, whose goal it is to protect the credit rights of consumers, has launched a new website at

 

http://www.federalreserve.gov/creditcard/

to help consumers better understand the new credit card protections that took effect in February and provide general, unbiased information about credit cards, credit scores and credit laws.

 Important features of the website include:

 

·         Basic facts about common credit card options, interest rates, and fees

·         Interactive features that  allow consumers to learn more about credit card offers and the new features of their monthly statements

·         An online credit card repayment calculator that provides estimates of how long it will take to pay off a credit card balance and help consumers develop a plan for paying off their balance sooner (English & Spanish)

·         A glossary of common credit card terms for quick reference

·         A list of federal credit protection laws

·         Links to resources for consumers who are experiencing problems with their accounts

·         Printable PDFs of 3 consumer publications

§  What You Need to Know: New Credit Card Rules

§  5 Tips for Getting the Most from Your Credit Card (English & Spanish)

§  5 Tips for Improving Your Credit Score (English & Spanish)

·         Articles about a variety of topics including:

§  Interest rates

§  Fees

§  Lost or stolen cards

§  Billing errors

§  Managing credit

§  And more

 

We encourage you to spend some time on the site learning more about credit cards and your consumer rights.

Ryan H. Law, M.S., AFC

Department of Personal Financial Planning

Office for Financial Success Director

University of Missouri Center on Economic Education Director

 

239E Stanley Hall

University of Missouri

Columbia, MO 65211

 

573.882.9211 (office)

 

China: A Snapshot

Wednesday was our Personal Finance Symposium: “Your Financial World Begins at Home”.  I think it was a great success and I missed seeing some of you.  The group was quite diverse, ranging in age from an 11 year-old, home-schooled child to an elderly, well-respected resident and owner of a local insurance company.  (I think he is elderly, only because it is publicly recorded that he watched a Buster Keaton film at the opening of Columbia’s lovely Missouri Theater in 1928.  You’d never know it by his love of life and knowledge.)

 

I presented an overview of what we know about Chinese households, while both the Chair of the Finance Department and the Dean of the Business School of Renmin University in Beijing gave an overview of how and why the Chinese make the decisions they make.  It was fun.

 

So, in case you weren’t in the audience, here is a quick overview.  You should know that these data are from 2,095 households in tier one and tier two cities in China, representing the more affluent Chinese. The data were collected in 2008.

 

ASSET OWNERSHIP:

 

The above is based on an average level of assets of $81,010 (US Dollars), with $22,630 of those assets in financial assets.  The key points that I find of interest are:

·         A higher proportion of Chinese own individual stocks (27.84%) compared to mutual funds (16.43%).  This is as a result of a relatively new mutual fund industry that has performed poorly and where trust in the firms has yet to develop.  Moreover, the Chinese population is quite independent, as well as analytical, resulting in more “stock picking” and less diversification.

·         Only 7.48% own bonds, a lower risk asset. 

·         Over 50% have cash-value life insurance.  The growth in the life insurance industry in Asia has been phenomenal over recent years.

·         Only 15.59% own an automobile!  I will admit that when I was in Beijing it seemed like everyone had a car.  Yet, with a population of over 17 million – there are a lot of cars!

·         85.29% own a home.  This is greater than the rate of homeownership in US cities.  While many of these homes are passed from generation to generation, there is a lot of speculation occurring in the urban Chinese housing market.  Everyone is trying to buy a home.  For more information check out this article, China must end property bubble; even if painful.

 

DEBT:

 

 

What more can I say that is not said in the above picture?

·         Only 8.78% of the households hold a mortgage, while over 85% own a home.

·         Less than 1% of the households have automobile loans, while 15.59% own a car.

·         Less than 1% have consumer loans, while 100% are consumers.

 

I don’t think I need to say anything more.  I do hope, however, that this makes you think about your choices and our future for financial success.

 

 

Reflections on Prior Tax Seasons

Today is April 16th, the day after tax day. For most people, this day is just another day, just like April 17th, 18th, 19th, etc... But for me, April 16th is when I breathe a bit easier. I coordinate the free tax assistance site on the MU campus, and I support several other free tax prep sites around the state. So April 16th represents the walk down from the summit of April 15th. So on this special day, I decided to reflect on some lessons my tax clients taught me from prior tax seasons. 

First, when you sell something, it is very important to know how much you paid for it. 

 

The financial services industry has made it incredibly simple and cheap to buy stocks, bonds, and other financial instruments. You can go online and buy securities with the aid of a discount broker, or you can walk into a brick and mortar store and sit down with a financial advisor. It is also relatively easy to sell securities. The problem comes with connecting the two transactions at tax time. 

 

Years ago I had a client who had sold some shares of stock that his father had bought him in the 1950s. Not only were the initial shares bought several decades ago, the dividends from the stock had been faithfully reinvested every quarter so that the client had doubled the number of shares in his stock. Of the two transactions, the sales price was easy. His broker had sent him a trade confirmation that listed the date sold and the proceeds of the sale. The trouble began when I asked him, "So what did you pay for the stock?" The client looked at me and said, "I have no idea. My father bought it for me when I was a boy." I then had to explain that if he didn't have the cost basis on the return, the IRS would most likely tax him on all of the gross proceeds from the sale. He went home and spent several days reconstructing the past. Luckily, he was able to piece together the history of purchases and reinvested dividends, and we were able to enter in a cost basis for his shares. 

 

Fortunately, Congress and former President Bush helped fix this problem. The Emergency Economic Stabilization Act of 2008 requires financial companies to start tracking cost basis information on January 1, 2011. They must deliver this information to the IRS at the end of every year with your 1099s. Also, transferring accounts between financial institutions will not cause a problem as cost basis information will now be transferred as well. 

 

While this is great news for taxpayers who will sell stocks that will be bought after January 1, 2011, this law will not help you if you already have stocks. You will still need to track and be aware of your cost basis in stocks, i.e. what you paid for them. This is especially important for taxpayers who have been gifted stock. We have seen college students come to the tax site who have sold some stock their grandparents had given them. Unfortunately, when the grandparents gifted the shares of stocks, they also passed along their cost basis. The main exception to this rule is when securities are received through an inheritance; generally, the cost basis is "stepped up" to the fair market value on the date of death.

 

Second, before you put money into a ‘special’ account, be sure you know how to get the money out. 

We have so many different 'special' accounts that Congress has written laws for: Health Savings Accounts (HSA), Flexible Spending Accounts (FSA), Roth Individual Retirement Accounts (Roth IRA), Traditional IRA, Educational Savings Accounts (ESA), and the list goes on. Each special account offers favored tax treatment and limitations on the use of the funds. Before you place your money in an account with limitations, be sure to fully understand what you're agreeing to. Can you take the money out if you are disabled? Can you take the money out if you lose your job or want to buy a house? Can creditors come after the money? What happens to the funds after you die? All of these questions should be answered before you fund these accounts. The worst time to ask is after you have pulled the money out. Also, do not be afraid to ask a tax expert in addition to your financial planner.

If you would like to email me with comments or questions, feel free to do so at ZumwaltA@missouri.edu

 

Resources:

 

Publication 17, best tax resource for general questions: www.irs.gov/pub/irs-pdf/p17.pdf

 

Publication 551, best tax resource for cost basis questions: http://www.irs.gov/pub/irs-pdf/p551.pdf

 

 

Andrew Zumwalt, M.S.

Director of the MoTax Education Initiative

162 Stanley Hall

University of Missouri

Columbia MO 65211