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Posts from the ‘Personal Finance’ Category

How Much Should I Save for Retirement?

ING’s advertising campaign suggests that workers need to save millions of dollars in order to retire comfortably. You know the ads, where people lug around target savings amounts, all upwards of $1 million. It seems like such a burden to achieve these numbers. But recent research by Dr. Marlena Lee of Dimensional Fund Advisors suggests that maybe the retirement hurdle isn’t so insurmountable.

Dr. Lee’s research suggests that low- and middle-income households that target a savings rate between 2 and 11 percent may actually save enough for retirement. This is encouraging news for workers that will be reliant on 401(k) balances in retirement.

Dr. Lee starts by defining a replacement rate: the percentage of gross pre-retirement income that is replaced in retirement. If you earned $50,000 per year before retirement, a $25,000 annual pension would represent a 50 percent replacement rate. Dr. Lee finds that in order to achieve replacement rates that maintain living standards through retirement, the average household needs to save about 11% per year during working years. But that savings rate varies by household income. Read more

Ask a Researcher: Pay Student Loan Debt or Save for Retirement?

College grads often wonder whether to pay down student debt first or to save for retirement. Financially savvy folks recognize the need to save for retirement sooner than later, but they also know the detriment of carrying a large debt burden.

To answer this quantitatively, you must compare your expected rate of return on retirement savings and your student loan interest rate. If you expect to make 8% a year on your retirement portfolio but your student loan interest rate is only 5%, it would be advantageous to maximize your retirement savings and pay the minimum on your student loan debt.

Consider a $10,000 student loan at 5% interest, with a minimum monthly payment of $106.07. We’ll assume you have $300 per month to put towards paying down that loan or investing in a retirement account with an 8% annual return.

If you make the minimum payment on your student loan debt and save the remaining $193.93 for retirement, at the end of 10 years your student loan will be paid off and you will have $35,480 in your retirement account.

If you put all $300 per month toward your student loan debt, your loan will be paid in 3 years, leaving the full $300 to be put toward retirement for the next 7 years. At the end of 10 years, you will have $33,654 in your retirement account.

Even with this sizable difference between the interest rate and annual return, the final balance differs by only about 5%.

There are 3 big problems with this simple answer:

Read more

Household Investors Shun Stocks… Except In Bubbles

Equity Holdings By InvestorSince the 1950s, household investors have played a declining role in the U.S. stock market. According to Census data, the household sector has shrunk its equity holdings as a share of the overall market from about 90 percent in 1952 to around 35 percent in 2010. Of course, households also have an interest in equities through their stakes in mutual, retirement, and pension funds, which accounted for another 37 percent of the market in 2010. According to Gallup, 56 percent of Americans reported having some stake in the stock market in 2010, but that’s down from a peak of 67 percent in 2002. By 2013, the number had dropped to 52 percent.

While the declining trend in households’ share of the stock market has been persistent, there have been a few years when households increased their share—some that stand out are 1986, 1988, 1999, and 2006.

Change In Household Share of Stock MarketDo you see a pattern? Each year preceded a major stock market crash—Black Monday happened in 1987, the Friday the Thirteenth crash was in 1989, the dot com bubble burst in 2000, and the financial crisis hit in 2007. In fact, the only time since 1980 that a significant increase in the household sector’s share of the stock market wasn’t followed by a crash was in 1991.

Of course, the conventional wisdom is that everybody jumps into the stock market before a bubble bursts—that’s what makes it a bubble. But these data tell us that households jump in more aggressively than other types of investors, to the extent that they actually increase their overall share of the market relative to other investors. That also suggests they share a greater proportion of the losses when the bubble bursts.

At the same time that households were increasing their positions, other types of investors were reducing their exposure to the stock market. So who’s timing the bubble better than households?

Of significant investor categories, insurance companies and retirement/pension funds were reducing their share of the stock market in 1986, 1988, 1999, and 2006, opposite to the behavior of households.

Of course, households have a stake in retirement and pension funds, but they’re not making direct decisions about when to buy and sell stocks.

So what do these results indicate? Do household investors wait too long to go all-in on a market rally? Is their surging participation the proverbial straw that breaks the back of the market? It’s hard to say, because correlations in the data don’t always indicate causality. But if the experience of the last 30 years is a guide, when the household sector increases its share of the stock market relative to other types of investors, it may be time to look for a major correction.


Empowering Victims of Domestic Abuse with Financial Knowledge

Women EmpowermentAIER is in the process of expanding and strengthening its economic education initiatives. The Teach-the-Teachers Initiative will help raise economic literacy in America by providing customized training for high school teachers. Its internship and fellowship programs recruit the most talented scholars across the country to engage in economic research. And AIER frequently gives talks to students in this county to deliver important financial literacy exercises.

AIER is now exploring how best to deliver financial literacy services specifically to women. In particular, AIER is looking at ways that economic knowledge can increase the economic security of the 1.5 million women who are survivors of domestic violence.

For many women, domestic violence is often associated with economic calamity. When a victim of domestic violence decides to leave her abuser, she is usually making the choice between her personal safety and her financial security. A Government Accountability Office report explained in 1998 that not only do women suffer emotional and physical ramifications as a result of abuse, but abusers also often destroy women’s employment and education opportunities, and they frequently deny women access to banking and credit. These stresses cripple a woman’s financial choices, ultimately impeding many of them from making their own financial decisions.

AIER is conceptualizing a curriculum catered specifically to women who are survivors of domestic violence. Such a curriculum would ideally teach the concepts most crucial to this population’s economic security: financial goal-setting; budgeting, or juggling competing needs; negotiating skills; checking and savings accounts; and credit, debt, and predatory lending. This financial knowledge will not only help to empower women; it will also bolster AIER’s mission of educating all individuals, thereby advancing their personal interests and those of the nation.

A Penny Saved

Penny JarWhat is a penny saved worth? A goofy analysis suggests it’s worth a penny earned.

For baby boomers retiring today who had foresight, that penny might be worth about 6 seconds worth of retirement each year. Enough time to sneeze, maybe even twice.

A penny saved in December 1983 and invested 100% in the S&P 500 would be worth about $0.23 at the end of 2013. At the traditional 4% withdrawal rate, that $0.23 can be converted to about…a penny a year!

If we take a retiree that hopes to withdraw $50,000 per year, that penny represents about 6 seconds worth of retirement each year. Live to a robust 100 years of age, and that penny bought you a comfortable 3.5 minutes of retirement.

Wish I had more pennies…

A Penny Saved

Please revisit us often so that we may discuss the realities and/or fallacies of the 4% drawdown rate and historical equity premiums.

Ben Franklin proverbs here.

“A Penny Saved is Twopence Dear”

There are three faithful friends — An old wife, an old dog, and ready money.”

“An old young man will be a young old man.”

“Blessed is he who expects nothing for he shall never be disappointed.”

[Photo: Flickr/formatc1]

The Weather and Your Wallet

The Weather and Your WalletMuch has recently been made of the harsh winter’s effect on the economy. The conventional wisdom is that people are less apt to go on shopping sprees when the biting wind can be felt through your goose down jacket and you have to wade through two feet of snow and slush (Floridian readers need not respond). If only we could live in a world like Pretty Woman spending our way down Rodeo Drive, the economy would really flourish.

But perhaps there’s more to the equation than just the shopping difficulty presented by the weather. Heating costs are a very important part of our spending. Those of us in the northern part of the country may be feeling that crunch more than ever.

Not surprisingly, the data show that it has been colder than normal. Heating degree days, a measure of how much energy your furnace needs to exert to maintain a stable temperature, have increased as compared with the last two winters. Home heating fuel prices have also increased this winter, further exacerbating the issue.

We looked at heating degree days (in Pittsfield MA, our local weather station) and New England heating fuel prices to determine the relative cost increase this year.

In my house that uses oil, heating costs have increased a whopping 18 percent during this December and January as compared with the last two years. My neighbors that use propane have it even worse, seeing an increase of 23 percent this year! The patterns are similar across much of the country. In Kansas City, for example, heating degree days are nearly 30% higher this year.

020614 Home Heating

Get out the extra blankets, kids.

[Photo: Flickr]

Getting Rid of Student Loans

Natalia Presenting on Student LoansAs average student loans increase to $29,000, many students are faced with a serious debt burden upon graduation. Tuition rates continue to hike, and incomes are shrinking. While it is of course better to avoid debt altogether, AIER has spent time strategizing how to best face it head on after accruing it. Dr. Natalia Smirnova and I shared two of these strategies last week to Williams College students:

  1. Advocate to your service lenders, and
  2. Know that a little extra money goes a long way in reducing student debt.

Here is the presentation.

We started the presentation to students, directors of student organizations, and a member of the financial aid office by demystifying loan amortization. This is the process by which students pay off debt in regular installments over a period of time. Currently, the average payment duration for a government student loan is 10 years, amortized to 120 payments (or one payment a month for 120 months).

Once we broke down the math, we showed students that adding just $20 a month extra to your payment would reduce the duration of a $20,000 loan from 10 years to 7 and a half.

The students did the same exercise on their own. They first told us what graduate degrees they wanted. Using some average debt burden price tags, the students then brainstormed how they could negotiate with their service lenders and put away some extra money each month toward their payments.

Average Student Debt Burdens by Graduate Degree

Graduate Degree Average Debt ($) Calculated Monthly Payment ($)
Medical school 175,000 1,760.17
Business school 100,000 1,005.81
Law school 80,000 804.65
MA degree 30,000 301.74
MSW degree 36,000 362.09
PhD degree 58,000 583.37

One student said she would reach out to her lender to ask about payment forgiveness programs. Another reported he could try to give up eating lunch out every day. And a third even thought that she could substitute teach on the side to earn some extra money.

While student loans are probably not going anywhere, students should learn ahead of time what their debt burden will be. They should understand how to prepare themselves. And perhaps most important, they should have confidence in the fact that the average 10-year payment plan is flexible, negotiable, and can easily be reduced by half with the right saving strategies.

The Regulation Argument: Auto Loans Up, Credit Cards Down

Two recent articles from Quartz look at how lending and credit have changed since the 2007 recession and show how government regulation can impact (or not impact) American consumer economics.

The first article, which looks at sub-prime auto lending trends in the last few years, found that independent lenders are giving more car loans to U.S. customers with bad credit. Nearly 27 percent of all auto loans in the past five years were to consumers with credit scores of 500 or less. A loophole in the Dodd-Frank financial reform act of 2010 is seen as a cause of this trend.

From Quartz:

“That law had created the Consumer Financial Protection Bureau (CFPB) to act as a watchdog for retail lending, but had explicitly carved out auto dealerships from supervision. This made consumer advocates nervous but had investors seeing an opportunity to charge high costs for loans at a time of low yields.”

While regulation (or lack there of) has made it easier (if not safer) to get a car loan in 2013, it has had the opposite impact on credit cards. The second story looks at the way credit card debt has decreased in America since implementation of the US Credit Card Accountability, Responsibility and Disclosure Act (CARD) in 2010.

From Quartz:

“The CARD ACT … blocked credit card companies from extending credit without assessing the customer’s ability to pay … implemented rules on marketing to people under the age of 21 to crack down on abuse at college campuses … limited a credit card company’s ability to levy penalty fees … and restricted the circumstances in which the company could jack up interest rates.”

The results of CARD, according to the story, include a 2 million decrease in the the number credit cards issued to Americans under the age of 21 since 2007, and that credit card companies have “just stopped giving cards to people on the bubble.”

You can read both stories on Quartz by clicking the links below.

More Bad Borrowers are Getting Car Loans

The U.S. Has Kicked its Credit Card Addiction

Financial Literacy Lessons Learned

finlitThis Tuesday, I attended the Massachusetts Financial Education Collaborative Summit at the Boston Federal Reserve Bank. The event gathers interested teachers, non-profits, government representatives, and private sector institutions from across the state to discuss financial literacy initiatives. Here are four lessons I learned about financial education in Massachusetts:

1. Most initiatives are in Boston.

AIER was actually the only organization representing the Berkshire region at this event. While this does not necessarily mean there are no initiatives going on in the Berkshire region towards increasing financial literacy, it does definitely call for an increased need in the Western part of the state.

2. Financial literacy is not the same as economic literacy, but both are necessary.

There has been much written on the state of financial education on the U.S. The New York Times has covered surveys that reveal most Americans are not confident in their knowledge of basic financial concepts, such as inflation, interest, and investments. The MFEC event captured much of this problem. Many of the workshops were aimed at helping students learn to make financial decisions. However, in the public sphere there has been less frequent attention paid to economic literacy. Common core standards point out that economic literacy represents the in-depth conceptual understanding behind financial decision making. Thus, perhaps both types of literacy are important in increasing financial education.

3. While Massachusetts is technically failing, organizations are working hard.

In 2013, Champlain College released its annual national report card on state efforts to improve financial literacy. Most states aren’t doing too well. Massachusetts, in fact, received an “F” in high school financial literacy education. It does not require high schools to have personal finance classes, nor does it require that students take economics.

While the state hasn’t made the grade, organizations within the state are certainly working hard to come up with innovative and interesting ways to teach students about economics and finance before college.

Cape Cod Five Cents Savings Bank, for example, has a Credit for Life fair where students fill out a real budget based on what they want their dream careers to be.

Blue Hills Bank has reached more than 80 schools with its free musical on saving and other concepts catered to elementary students.

4. Technology matters.

Almost every workshop had some nod to the importance of technology. These took many different forms: from video games and computer modules being pitched to students to text polling at the event itself and video presentations. Many authors have written about the new generation “i” (iPod; iBook; iLife), wherein new students need engaging, quick, animated, and technology-laden materials to learn best. It was interesting to hear that new financial literacy initiatives are jumping on board.

[Photo: Chris Drumm/ Flickr]

AIER Projects the 2014 COLA at 1.4-1.6 Percent

icon (1)With the government shut down and no data being released officially, the Associated Press published a story about estimates of what the Social Security Cost-of-Living Adjustment for 2014 might be, projecting a 1.5 percent increase, one of the lowest adjustments since the 70s.

From AP:

Polina Vlasenko, a research fellow at the American Institute for Economic Research, projects the COLA will be between 1.4 percent and 1.6 percent.

Her projection is similar to those done by others, including AARP, which estimates the COLA will be between 1.5 percent and 1.7 percent. The Senior Citizens League estimates it will be about 1.5 percent.

Lower prices for gasoline are helping fuel low inflation, Vlasenko said.

“In years with high COLA’s, a lot of that had to do with fuel prices and in some cases, food prices. Neither of those increased much this year,” Vlasenko said. “So that kept the lid on the overall increase in prices.” 

Vlasenko’s in-depth article on next year’s COLA can be read on  AIER’s website here.