“It’s not hard to make decisions when you know what your values are”
– Roy E. Disney
Difficult Decisions
Which of these options would you choose?
Paying $8,000 of interest over 10 years
Paying $5,000 of interest over 5 years
Paying $3,500 of interest over 2 years.
A little overwhelming isn’t it? This list could be your choices for student loan repayment options, with different payback periods and interest rates. How can you possibly figure out which is best?
If you said, “Option 3, duh…”, you’d be paying less interest overall, but at what cost? What you can afford to pay, depends on your income. If your monthly payment is too high, you can’t afford to live. You can’t give up too much of your income for student loans or else you can’t pay rent.
So, the smallest interest might not be the best? That also depends on what you think your money is worth over time.
This comparison is a time value of money problem. You remember what we said about investing:
If you invest at 5%, you need just $7,102 today in order to have $50,000 in 40 years.
Okay, now turn this around. The net present value of $50,000 in 40 years at a 5% rate of return is $7,102. How does that help? It allows you to compare everything at one point in time, today.
I know, it takes some really good technique with a calculator. In future posts, we will try to tackle more of this.
“The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”
-Ernest Hemingway
College, Cars and Why College Costs Are a Scam
You got cheated on college. Badly. It’s been in the news and on your facebook feed. But how exactly? Well, you know that a dollar invested will grow. However, at the same time, the prices for goods and services also grow. When goods and services become more expensive over time we have inflation. How does this prove you got cheated? Here’s an example, using cars and college:
Your parents could’ve bought a new car in 1975 for an average price of $4,950. If you bought a car in 2015, the average new car price was $31,252. The price increased 600%. That is the impact of inflation.
Now let’s compare the cost of just 1 year of college. The average cost of college tuition, room, and board in 1975 was $2,577. 40 years later, the average for college tuition, room, and board in 2015 was $43,921. College costs jumped 1700%!!!!!!!!!!
It’s absurd and that is why so many people today are saddled with insane debt.
Inflation affects all prices for goods and services, but it really hit college and health care costs the worst. Anyone who graduated college in the last decade or so knows it!
“We must use time wisely and forever realize that the time is always ripe to do right.“
– Nelson Mandela
Investing and time
Your retirement is on sale. Right now. And at a big discount.
If you invest now, you will be in better shape than if you wait. Much better. Every dollar can grow. Sounds magical, doesn’t it? But your money can grow, if you invest it. Plant your dollar in a patch, tend to it and it will produce a crop of interest, dividends and growth called capital gains. Something else magical happens, the crop of one year is added to the crop that grows in the following year. So, you not only get interest, dividends and capital gains on the initial dollar, but you also gain interest, dividends and capital gains on the interest, dividends, and capital gains. And this happens every year. It is called compounding and it’s awesome. The investment growth in any single year usually isn’t a big deal. Over time, like several decades until you hit retirement, the impact is huge. Some examples:
To have $50,000 in 40 years, you’ll need to invest $7,102 today (assuming 5% growth market average is about 7%). Yes, just $7,102 in your patch will grow to be $50,000 in 40 years at 5%.
But if you wait, and want to have the same $50,000 in 30 years, you need to invest $11,569 at 5%. That’s a big difference.
Waiting a decade means that you need to save over 60% more than if you just start now, and it doesn’t take a lot to get started. Fintech companies like Betterment have a balance minimum of $0, which means you can start saving just a little bit here and there. Your retirement really is on sale now. So start saving!
In future posts, we will describe more on investing. Just as you have to water and weed your garden, you have to monitor and re-balance your investments. Also, just as picking what will grow well, producing the best harvest in your garden, while getting rid of plants that no longer grow as well or that interfere with others growing, your investments need to have the right mix.
“Budgets are nothing if not statements of priorities”
– Jeff Merkley
Think of Yourself Like a Business
Imagine you have been put in charge of your favorite coffee shop. You really like their coffee, so you want to do all you can to keep it going. Could you manage it or would the shop go out of business?
While you may not have the industry knowledge to manage a coffee shop…yet, you should have the skills to manage your own income and expenses like a business. If you don’t manage your income and expenses? Then you could go out of business! Okay, that’s a bit harsh, but who enjoys feeling broke all the time, and not being able to afford the things you really want? Every dollar serves some purpose and you need to know what that is.
Back to the coffee shop. If you did manage it, you would need to keep track of everything that came into the shop and everything that left.
You would know what cash and credit card payments you received. That is your Income. Also, you would know how many cups of coffee, pounds of coffee beans, and all the paraphernalia the shop sold. These are your sales (sort of like the hours you “sell” to your employer). You would keep track of what you paid for supplies, rent, electricity, water, and insurance. You would also know how much you paid each employee and what you paid in payroll taxes and benefits. These are your expenses. Finally, you would know what you made, which is the coffee shop income less its expenses. That is called your profit (before taxes).
What would you do with that profit? You would pay income taxes, of course. You might create an emergency fund so you would be prepared for some unexpected calamity, like a delayed coffee shipment, or a broken storefront window. If you were really forward thinking, you might even set aside funds to replace broken equipment or maybe even save up to buy a building rather than continue to rent.
What if, instead of a profit, your expenses continually exceeded income? You have a loss – ouch! You don’t want to lose the coffee shop, so you might borrow some money to cover bills. That only postpones your problem; it doesn’t fix it. So you create a budget to learn why your expenses were so much compared to income. You might hire a bookkeeper to make sure you didn’t miss anything.
You could even hire a coffee shop planner who would tell you if you are buying too many supplies compared to what you sold. The planner would make sure you charge enough for coffee and she would tell you to stop paying that Friday night blues band that wants free coffee and isn’t actually improving business.
I’m sure you figured out where this is all going: You need to know what you make and where you spend each dollar.
If you don’t know, look at the last 12 months of income and spending, even start a budget so you see why you keep borrowing on credit cards instead of saving for your future.
In the end, there is no left over money. Every dollar needs to work for you, as hard as you work to make every dollar.
In future posts, we will look at the ways you spend, your “fixed expenses,” like income taxes, health insurance and rent, your “variable expenses” like food, phone bills and clothing, and your “discretionary expenses” like Netflix and, you guessed it, coffee!
