Personal Finance Concerns Go Beyond Politics

NYT says Americans' wariness about their economic circumstances may allow Romney to convince them he could fix their problems.  Polling numbers apparently show many people not having their act together financially.

• 67% - Worried about paying for their housing
• 20% - Owe more on their house than it's worth
• 40% - Will have trouble paying for their kids' eduction
• 33% - High gasoline prices ($200/mo per car roughly on average) are causing problems

These are amazing statistics.  Are houses' valuation is based on what the market will bear, and apparently that means prices that people can't afford.  Most people bought or rented a house they can't afford?  That seems hard to believe.

The next most shocking statistic is about fuel prices.  If the average car is driven 1000 miles/mo and gets 20 miles/gallon, that's 50 gallons/mo.  At $4/gallon, that's $200/mo.  $200/mo can make or break someone's financial world?  If a family with two cars received $400 more per month, i.e. free gasoline, it would change their financial circumstances?  Maybe this refers to people who use their cars way more than average for business or a special circumstance.  I wish the NYT probed further.

I also wish they had probed why 40% of Americans have had to alter expectations for the type of college they can afford for their children.  What changed between their old expectations and today's?  The stock market has recovered from the crisis three years ago.  Contributions to a typical college fund made during the crisis have nearly doubled. 

I am not trying to make light of the suffering behind these numbers.  They point to a problem bigger than what all the branches of all levels of government combined could do.

Fuel Prices Grab Inordinate Attention

I caught a great interview on Marketplace with President Obama today. Ryssdal asked good questions and followed up on the answers.

One thing that stood out is that we're still carrying on about fuel prices. I know this is just something politicians must talk about, but why?

President Obama mentioned someone who has to commute 50 miles per day being severely affected by fuel prices. Let's do the arithmetic.

50 miles/trip * 2 trips/day * 20 days/ month = 2000 miles/month. That twice the typical 1000 miles per month. This person puts almost 100,000 miles on the car in four years, causing it to depreciate faster than average.

If they get 25 miles/gallon, that's 2000 miles/month / 25 miles/gallon = 80 gallons per month. So if fuel prices go from $4/gallon to $2/gallon, that's $160/mo savings. That's nothing compared to the maintenance, insurance, and depreciation on a car being driven 2,000 miles/mo.

Critics will say, "yeah, but what about the poor and near poor? What about people living so close to the edge that the $160 really affects their life?" Poverty is a problem. People spending over an hour each way in a car every day is another problem. Trying to find a way to keep to squeeze $160 out of fuel cost is an unreasonable approach to these real problems. People need to find ways to earn more money, reduce their commute, and use an inexpensive car for long commutes (to minimize depreciation).

I suspect the reason we focus on fuel, is we sit and watch the meter tick off gallons with nothing else to do. The same people who unnerved by this completely ignore that a reasonably late-model car losses >$160/mo in depreciation. They also may being paying interest on the car and hardly think about that.

A politician can't be expected to be the one to do it, but someone needs to show people worried about fuel costs that fuel costs aren't that big of a problem.

Your Child Must Become a Millionaire

An article in Directory of Madison says Your Child Could Be a Millionaire. I agree and would go a step further and say your child must be a millionaire and must be nearly a $100,000-aire by age 18. $200 a month over a child’s life at an 8.4% return will be $100,000 by age 18. $100,000 is not a lot of money. $100,000 plus continued monthly contributions will pay for a medium-priced undergrad education. If your child doesn’t go to college or gets a scholarship, that money can pay for their first home. Having that will make it easier for an adult child to save for retirement, which will require more than a million dollars.

If you accept that a comfortable retirement costs more than a million dollars, you have to start out saying my child will be a millionaire. The only other option is to teach them to manage the condition of having no money. Knowing how to operate with little or no net worth is a good skill to have. People should never, IMHO, consider living broke to be their primary path. The primary plan has to be having a reasonable net worth available to take advantage of business opportunities, handle emergencies, and help others. The plan should include ways to transfer some of that wealth to children so they don’t have too many opportunities in life to use their skills at living life with no money.

None of this is to say child must become rich. This is saying they must have resources to manage life’s ups and downs, and having a million dollar net worth or more is one part of doing that.

Banking Ad Aimed at Engineers

Several weeks ago I blogged about an article in Professional Engineering Magazine on how engineers are good at building wealth. An ad for a bank in the Jan 2010 issue of IEEE Spectrum Magazine (aimed at electrical engineers) made me think of this.

The ad designer did a good job. There’s an engineer in the foreground looking at a farm of windmills holding the plans in his hand. It reminds me of that slight feeling of disorientation I get when I first see something that I have been looking at on paper or the screen for months in its fully realized state. He’s holding the plans, and the text suggests he has "great plans for the future" for managing the money he’s earning. The information is organized into bullet points, similar to how they teach us to write in technical writing class. All the points are focused on saving money safely. There is nothing promoting debt.

I have no experience interacting with this company. I’m only commenting on the style of the ad.

This is such a contrast to some ads from local banks and credit unions, which focus on debt. My favorite one has a family in front of a really nice house. The text reads: Dream Home – Dream Mortgage. That’s one way to put it!

The Silver Bullet

Between circuit designs, I keep seeing stories about the government trying to do things to improve unemployment, healthcare, and real estate.

All of these issues are primarily issues for people who had no money to begin with. One thing the government could do to improve all of these things is to encourage people to save money. I propose that the government make savings accounts operate similarly to other tax-advantaged accounts such as IRA, Roth IRA, or HSA. The simplest approach would be to exempt savings accounts up to some limit from all taxes. It wouldn’t reduce people’s taxes that much, but it would be something the government could do to promote saving.

Most stories of problems people are having with unemployment, heathcare, or real estate would be mostly solved if the people or families in question had a savings account with $25,000 in it set aside to deal with trouble when it comes up.

This suggestion would do nothing to help the poor. People living at or near the federal poverty line will not be able to set aside $25,000. Poverty is a separate problem not addressed by this program.

It seems to me having a little money is a silver bullet that solves a lot of middle-class problems that the government is trying to address separately. If the entire population except for the poor save $10,000 to $50,000, depending on their estimation of the risks in their lives, the next recession, banking crisis, 10% unemployment will not be a big deal at all. People will be free to focus on their lives, part of which include activities that are productive for the economy.

The potential benefits are huge. We must move toward this and away from programs that try to fix each aspect of economic fluctuations separately.

PE Magazine: Engineers Good at Building Wealth

The Nov 2009 edition of PE Magazine quotes a study showing engineers are good at building wealth:

Anyone looking for the secret to accumulating wealth should take some tips from engineers.

According to a new survey by author and researcher Thomas Stanley, engineers are more successful than doctors and lawyers at transforming income into wealth.

Estate data from the Internal Revenue Service shows that about 1 in 13 (7.6%) of all male decedents with a gross estate of $1 million or more was once an engineer. Yet engineers account for only 2.3% of the male working population in the U.S. Thus, engineers are overrepresented by a multiple of 3.3 times the expectation.

Engineering is also the highest paid profession that requires only a bachelor’s degree. It is also one of the few professions in which you can often get a master’s degree completely paid for by a school or employer. It’s unfortunate that “doctors and lawyers” are often seen as the only iconic well-paid professions.

For someone selecting a profession, all of this is only somewhat important. These are the averages. The average person in any profession, even the highest paid, does not earn that much money. In every industry, even ones with low average pay, the best in the industry earn more than the average person in all other professions. You're better off going into something at which you can be above average than picking a profession with a high average pay and planning on mediocrity.

Even NPR Buys Into Banks' "Credit Score" Pitch

NPR’s Marketplace ran story a couple weeks ago about things to avoid charging on a credit card because banks or credit agencies might hold the charge against you if they don’t like the risk profile. I suspect this is not completely independent reporting. People involved in the banking industry actively promote “negative sell” ideas regarding their product. They want to sell loans. They say, “I don’t know if this product is for you unless our formula says it is.” You’re supposed to say, “Oh yes. The product is for me. I want to buy it!”

The banking industry has managed to get financial reporters to write articles about how worrying about your credit score is part of responsible personal finance. It is not. The credit score is based entirely on using their product (loans):

• Timely loan payments
• Outstanding loan balances
• Amount of time using loans
• Types of loans
• Number of loans opened/applied for recently.

Of course using their product makes them like you.

Net worth, income, and cash flow are not part of the formula, but they are way more important than whatever benefit you get from banks liking you as a customer.

I have amazingly heard of people in disputes who are more worried about the other party getting negative information on their credit report than they are worried about the other party suing them and taking their money. I certainly don’t want people giving me a bad reputation, but spreading lies via the credit report is far more innocuous than actually taking my money.

Banks have done an amazingly good job convincing people that to be responsible you should buy their product.

I have no axe to grind with banks or credit agencies. My report contains only accurate positive info, and as far as I know, their score for me would be decent even though I don't use loans. I am very satisfied with the local banks my wife and I use for personal and business banking. My complaint is with the industry as a whole.

Credit Score Bliss

I have blogged in the past about how the value (to individuals) of credit scoring is mostly a myth that gets persists because it benefits banks.

Here is some unintentional humor from a company selling the service of finding your credit score. To promote their service they picked a stock photo of two young people looking excitedly at a computer. It was probably taken with the idea that wedding planners would buy it. It could be used to convey “OMG, this is perfect place to get married,” “OMG, I got an offer from my dream job,” or “OMG, they’re going to publish my book.”

(Click for a larger view)

OMG, here’s a number summarizing how much financial institutions like me! And here are three good points to remember:
1. Pay your debts on time.
2. Have a variety of types of debt.
3. Stay in debt. (Or at least keep the account open.)

This is obviously just a bad ad, but it unintentionally parodies a self-serving point of view promoted by financial institutions.

A Very Slow Shift Away from a Culture of Risk and Debt

More articles about saving money have been appearing lately in the personal finance section of Yahoo Finance. This makes me think that the mortgage problems are making people more risk averse, which IMHO is a very good thing.

In that vein, there was an article today with the promising title Some Live Without Credit Cards -- Could You? Unfortunately, most of the article buys into the banks’ way of thinking that some consumer debt is a good thing and that having a high credit score matters. These gems are just a small sample:

• Stop to consider the long-term implications on your credit score.
• A credit card is going to demonstrate how, if you pretty much have an open-end except for a credit ceiling, you can charge varying amounts each month, thus your payment each month is going to be different, and they like to see how you handle that.

If banks like it, I need to run out and do it? Why do we care what banks like to see? I guess because we want to borrow more money. But wait, I thought this article was about living without credit cards.

A third of the article is about things you can do to make banks like you and want to lend you more money. The rest is about people who can’t get banks to lend them money and people who do very stupid things for debt. The tenor is that some use of consumer debt is a smart thing as long as you don’t go overboard. There is only one sentence about the concept of spending only what’s in the bank account. All this is unfortunate, but still, front page articles even questioning consumer debt is a step in the right direction.

Debtorship Society Derailed, But Clouded Thinking Persists

The New York Times reports that the percentage of people renting is rising in the wake the of the housing bust.

The article dances around the idea that the bust is reminding people that increasing rates of home debtorship is not a solution to social problems.

Nationally, rents have increased about 11 percent since 2005, when homeownership rates started to decline, though that growth is slowing, according to the Bureau of Labor Statistics.

If these are nominal numbers, it means they've kept pace with inflation. You can go to the Bureau of Labor and Statistics CPI Inflation Calculator and verify this by asking to convert the value of $100 in 2005 into 2008 dollars. It's $111.

That means despite the recent increases in the number of people renting, real rent prices have stayed the same. If there were more people than places to live, we would expect rents to rise. Thanks to the 2000-2006 boom, though, there is a surplus of places to live. That's why the rent price "growth is slowing" while inflation is rising, i.e. real rent prices are falling.

The article mentions a 68 y/o woman with low income, weak credit, and no significant down payment who wanted to buy a house with some friends. She and the non-profit who tried to help her become a homedebtor lament that it was easier to qualify a few years ago. It mentions this after several stories of how going deeply into debt to buy a house destroyed people's lives. The article leaves it to the reader to realize this woman was lucky not be able to get herself into this same situation.

The confluence of factors has largely derailed what Mr. Bush called “the ownership society."

The so-called ownership society is a good idea. A debtorship society is a bad idea. We need to focus on things that help people increase their income and net worth. It's an easier path to get into debt than to improve net worth. The easy path leads to the horror stories in this article. We need to be on the hard path.

Living on the Economic Edge

If anonymous comments from officials are to be believed, the US House has come up with a stimulus package. Any increased borrowing is reckless, but at least some of this borrowing will benefit the needy. The deal to make rebates available to the working poor in exchange for not doing anything for people with no earned income seems reasonable.

We need to step back and ask how we got in a position to need to borrow money for a stimulus package. We need a stimulus package because GDP is growing around 1% instead of around 3%. But why is 1% growth a crisis? It's a crisis only because so much of the economy operates with no breathing room.

We like to save our money in stocks because they provide higher returns than bonds or money market accounts. This additional return is a risk premium: higher returns in exchange for increased risk. Stocks are priced based on their current earnings and investors' opinion of their future earnings. If investors' opinion of future earnings goes down, we watch our portfolios sink.

This is not so bad because maybe next year things will turn around and our portfolios will grow to new highs. The problem comes when we accept the risk premium but can't tolerate the risk.

This affects consumers with little savings and who spend all the money they make even more so. If the economy stops expanding (around 0% growth for a few quarters) and that affects their jobs or businesses, they are quickly in a personal crisis.

Why have we set up our society such that if we produce the same amount as last year, it is a crisis?

It is a mystery why people behave this way. How much benefit do investors get from taking a little more risk than they should? How much benefit do consumers get from spending all the money they make instead of just 80% of it. Some commentators say there's a middle-class squeeze and people earning the median income cannot afford to consume only 80% of what they earn. These commentators should ask all the people who happen to earn 80% of the median income how they do it.

Whatever the psychology behind this behavior, it would do us good to consider the long-term consequences of our financial decisions. When the US decided to invade and occupy two countries at the same time and pay for it by borrowing, it indirectly decided not to spend as much on future endeavors like healthcare, education, or the next military action. When people borrow money, they indirectly decide to forego the option of more time with friends and family and to increase the impact of blips in the economy or in their lives.

These decisions are not bad, as long as they're recognized as decisions. Unfortunately, people have been living on the edge for so long, they don't even recognize they're making these tradeoffs. Maybe many Americans are in a precarious financial situation that justifies more borrowing, in the form of government deficit spending, to keep the whole thing going. Maybe this problem here-and-now is more important than things like shoring up Social Security and Medicare in the future.

We need to ask how long we want to keep living like this. We know markets go up and they go down. We know GDP goes up and on occasion goes down. We should plan for it, and act accordingly. It will make us happier in the good times and more resilient against any peril we may face in the future.

Caution about Borrowing Money

In an earlier post, Why Credit Scores Should Be Ignored, I argue that credit scores are unimportant and that they encourage people to do things that benefit banks at the expense of consumers. I also suggest most borrowing by individuals is a bad idea. Most readers will agree that credit can be misused, but what about responsible use of credit? Isn't it a benefit to responsible borrowers to have a credit report containing things banks like to see?

Responsible Credit – The Math

The idea of responsible credit is to borrow money for activities that return more than the cost of interest. A worthwhile business ought to return more than the cost of borrowing money. Therefore, the reasoning goes, if you believe in your investments and businesses, you ought to borrow the most you can to fund them.

In the most common scenario, individuals borrow money on their homes and invest it. They hope to make 12% (8% after taxes) on it. The loan on their home is 6% (4% after home mortgage deduction). So they're borrowing at 4% and making 8%. This seems like a no-brainer.

But they should ask where that borrowed money's coming from. It's coming from people making deposits at an even lower rate. Why are depositors accepting a lower rate instead of investing in what you're investing in? Maybe it's because they're unsophisticated or very risk averse. Then why are the financial experts at the bank lending the money to you instead of investing at higher rates? It all comes down to risk. There is some risk in a portfolio that provides higher returns. Individuals borrowing from the bank to invest (or keeping investments while they're making payments on a home loan) need to be aware that they have chosen to accept risk in exchange for more money. There's nothing wrong with doing that. But they should not be surprised if at some point in their life they have to make quick changes when their portfolio goes down at the same time they lose their job.

A similar argument applies to business debt. If the businesses does not work, the borrowers will have to sell whatever they must to repay the debt.

Consumer debt is the worst because it's used to buy things that are not expected to return any money. Oddly though, the line of reasoning that leads people into mortgage debt and business debt can be used to rationalize consumer debt. People think their investments or business are so good that they should maximize all borrowing so they can maintain their consumption while investing all possible money. Even if their investments do return more than the cost of the debt, there is a hidden cost of consumer debt: It makes it very difficult to track income vs. expenses. Having all this money flying around to and from loans complicates basic budgeting. It also makes people vulnerable to liquidity problems if there are unforeseen expenses or income interruptions.

Should We Never Borrow Money?

Everyone needs to look at the risk and answer the question for himself. IMHO, if people do not have the money to buy a house but could borrow the money at roughly the same payment as renting the space, they should do it. They are taking the risk of a problem with the home or a decline in prices, but they get the benefit of the potential profits their landlord would have made.

If someone with no money needs tools or a vehicle to get a job, borrowing money could make sense for them. IMHO, they should explore all other avenues, e.g. a job that provides tools and does not require a vehicle.

Caution

The point of this post is to urge caution. Many people borrow money on cars assuming that their income will remain steady. They borrow money on houses without even considering that they could lose money. Even people with jobs that they know are unstable continue to ignore the reality. When one of life's hiccups eventually occurs, they are shocked. After the fact they call on politicians to subsidize their mortgages or to try to bring back post-WWII era job security. I am not commenting here on whether politicians should do those things. I'm simply saying that until they do, intelligent people should see the risks of the financial products they buy and take caution.

When a salesmaker approaches people on a car lot, they are rightly cautious. They may preface questions with, "I'm just browsing." They know that the salesperson may want to sell them products that are not right for them. They know they need an independent opinion.

In the case of financial products, however, much education comes from financial institutions themselves. They teach people to "protect their credit score". They produce educational materials for children explaining why financial products are part of the path to responsible adulthood. They train so-called "financial planners" to sell financial products to people who are seeking financial advice. Most of the financial education the average person comes across is aimed at benefiting financial institutions, not consumers.

Many financial products are worthwhile. It's important to take the time go over each of them, as we would with any purchase, and ask if we really need them and if we're getting a fair deal.

Caveat emptor.

Why Credit Scores Should Be Ignored

I heard a news report from a mainstream news outlet putting forth the claim that protecting your credit score is an important part of good money management. This is a lie promulgated by the financial services industry and repeated by most everyone.

The three credit bureaus are private organizations that keep track of how well people pay their bills. They also summarize this information into a single numerical value, so that lenders can quickly work out the risk of lending to a consumer.

People who want to "establish a good credit score" do something like this:

• Open a few accounts to increase their unused credit line but not so much that they are penalized for requesting credit too often.
  
• Borrow some money and pay it back on time, while not borrowing so much that they are penalized for lack of available credit.
• Take great care with anyone who has the ability to put a negative market on their credit reports.
• Monitor their credit reports frequently for erroneous information.
• Pay the credit bureaus extra (beyond the cost of a credit report) to compute their score for them so they can get feedback on to what extent their financial lives match what the bureaus want to see.
  

What do they get for jumping through these hoops? They get the ability borrow money at a lower interest rate and to borrow money for things that lenders think are risky.

If you want to borrow money for a house and have a good down payment and enough income to make the payments, you do not need good credit. The underwriting guidelines are not that strict. A person without a long credit record or a high credit score can get the same interest rates available to someone with a high credit score. The person with the high credit score, however, will be able to buy a more expensive home with no down payment, borrow to buy a car, borrow money unsecured, and so on. In short, having a high credit score allows you to do things that are costly and risky for the consumer and profitable for lenders.

This situation really bothers me when I hear someone suggest a financial move for the purposes of "building credit", especially if the financial move profits a bank at the expense of a consumer. It also bothers me to hear people considering settling a dispute with someone because they're scared that the other party will put a negative mark on their credit bureau. It goes like this: I got this letter saying I owe money. I don't think I do, but instead of refusing until I see proof that I owe the money, maybe I should just pay it to protect my credit report. We have courts to resolve disputes like this. The credit bureaus' opinion on a dispute should be irrelevant.

The bureaus make a clear distinction between their customers and consumers. Customers are banks and anyone else who pays for a credit report on someone. Consumers are the people who want to borrow money from banks. The bureaus get their money from their customers, so that's who they're accountable to.

It's wise for people to avoid borrowing money and to ignore the opinions of banks and credit bureaus.