Financial Literacy

When retirees are asked, “What is the best financial decision you ever made in your life?” The most common answer is saving for retirement.

Why did they conclude this?

Out of a lifetime of events, these retirees rated retirement savings as the most significant factor in a person’s life. They either enjoyed or observed all of the benefits of having retirement savings and suffered or witnessed all of the problems for those who did not save for retirement.

What does this mean to you?

It means the worst financial decision that you could ever make in your life is to avoid saving for retirement. Do not wait, even if your income is sporadic and low, you must take 15% of all income and it aside to invest and never spend.

Prices rise and fall in predictable patterns each year for all kinds of items. By making purchases at the time of year when prices are historically low and selling items when prices are historically high, you will continually pile up financial gains.

People that are financially aware routinely use price seasonality to their advantage. People unaware of price patterns are unknowing financial victims of these prices. For example, I know two colleagues that bought convertible cars last year. One bought a car when he wanted one, in June when convertible prices are near their price high for the year, the other patiently waited until winter. He said during the first two weeks of January, convertibles are 17% cheaper than during the summer and buying at this time saved him nearly $6,000 on the price of his car. Did you save 17% on your last car purchase or make an extra 17% when you sold it?

Many cheaper items also have price seasonality, for example you can save 70% on Christmas cards when buying in mid January; you can save 50% off your bathing suit buying it after Memorial Day in the fall; and you can save 30% on bicycles in September.

The same price seasonality applies to selling valuable item that you own, when the savings can be a significant amount of money. For example, your cars, homes, jewelry, and other pricey items. For a simple example, a neighbor buys a pig to be raised at a farm for slaughter once a year. Instead of buying at the March price peak like everyone else does, he buys in November at the seasonal low and sometimes sells the pig in March at the price peak for an extra profit.

Most items have price seasonality and financially literate people use these price points to their advantage on both buying and selling items.

Like any commodity, the price of local gasoline is always moving up and down. Over the course of a year, however, there is a seasonal price pattern that repeats. Over the last +30 years, in general, the price of gasoline is at its high price point for the year on May 1^st and is at its lowest price point October 1^st.

One tactic to manage your gasoline budget is to set aside some of the money that you saved when gasoline was relatively cheap – August to December, so that you’ll have some extra money when gasoline is more expensive – February to July. This way, when the price of gas is straining your budget early summer then you’ll be able to partially offset this cost from savings when gasoline is relatively cheaper.

You could also get more sophisticated and start your own baby hedge account to manage your price risk as professional businesses do. For example, let’s say that you spend on average $3,000 per year in gasoline. If the price of gasoline rose by 10% then you’d need to find an extra $300 in your budget to cover this increase in cost. If you were to hedge your annual purchase, then the 10% increase or $300 would come from the profit from your hedge.

One way to do this is to open a brokerage account so that you can trade a gasoline security that trades just like a stock, the exchange ticker symbol for this is “UGA”. This security moves in price to closely match the price of gasoline futures contracts. The price chart above is the last 4 years of price moves of this security.

Now, if you were to purchase $3,000 of this security then you have fully hedged one year of your gasoline purchases. If the price of gasoline rises sharply then you will have a profit that you can use to supplement your gasoline budget. However, the price of gasoline also falls and you may have a loss on your hedge. If gasoline becomes cheaper, you will be using less of your spending money on gasoline and you could move this savings into your hedge account to purchase more of your hedge at a cheaper price so you will have a larger profit for the inevitable price increase. The price of gasoline will move up and down and you will add to your hedge or release profits from your hedge as these gyrations occur. You could try to time your gasoline hedge by purchasing only when the price is relatively low and selling some when it is relatively high; I drew a trend line in red to show some relative low prices.

What are common signals that you are in trouble with your finances and need help?

• You won’t open bills because you don’t have the money to pay for them.
• You won’t open an investment statement because you can’t take seeing more losses.
• You have at least one credit card balance that is maxed out.
• You have no emergency fund or savings for predictable upcoming expenses.
• You do not know the interest rates you are paying on debt.
• You find yourself looking for items to pawn to pay for bills.
• You routinely run out of money before the end of the month.
• You are paralyzed and unsure about what to do to fix or improve your situation.

These are alerts that you are in financial trouble and likely need outside assistance to get your financial life back on stable footing. This help can come in many forms, a trusted friend or relative, your own online research, if you are in bad shape you may not be able to afford a financial councilor but your bank will likely offer some free budgeting assistance. You need someone who is financially literate to guide your decision-making until you become financially literate on your own. It is not difficult. Please do not wait until there is a financial calamity, let go of your pride and embarrassment and get the help you need, the sooner the better!

A teenage relative was uncertain about how to save up for a vacation. He was working part-time while going to school so I helped him chart it out. “You need $2,100 for the trip and have $700 already saved which leaves a gap of $1,420. Since you have a little over 7 months left to save, we divide by 7 and learn that you need to set aside $200 per month, or $100 from your biweekly paycheck.”

When you put your savings schedule into graphical form, you create a right triangle. Starting with zero savings on the left, you slowly accumulate savings over time to your target on the right hand side, the fully funded amount for your goal.

Let me show you how this applies to everything; I’ll use a car as an example. Since everything physical wears out and must be replaced, many elements of a car will eventually need replacing as well. For example, you’ll have financial triangles for tires, brakes, the muffler, along with oil changes and other fluids. But you’ll also have them for the water pump, bearings, clutch, and even windshield wiper blades. (The image above is my attempt at these for a car). Some of these predictable expenses for your vehicle are inexpensive but others are not and need to be saved for so you’ll have the money when you need it. The financial triangle you reach the quickest for a vehicle is fuel and the slowest triangle is the purchase price of your next vehicle. When do you think the financially literate start saving for their next car? That’s correct, just after they purchase their current car. Your vehicle is always wearing out and losing value, and as this happens you need to be replacing that drop in financial value with new money. These financial triangles are all around you – your computer, cellphone, home, vehicles, sports equipment, etc. If you are not funding these financial triangles, then sooner or later you’ll be unable to afford a predictable expense to repair or replace your things.

There are many industries built around people that are struggling with money: pawn shops, payday lenders, car title lenders, and others that charge loan rates from 30% to 300%, when annualized. By offering an advance, and not a loan, these firms avoid interest-rate limits on loans by state usury laws. Now another type of lender has sprung up that loan on retiree pension payments, called pension advances. As the Baby-Boomer generation is now retiring with poor-performing retirement accounts there is naturally a growing number of people who could use a loan. Selling their pension payments is how many are paying it back. Today, these pension loan firms are charging annualized rates of 25% to 105% which is an onerous expense for a retiree on a fixed income. Some pension advances also require a life insurance policy with the lender as the beneficiary.

The first and best defense to avoid money struggles will always be financial literacy, no matter what your age. The earlier you learn how to create, maintain, and increase financial stability for yourself and your family, the more cash and credit options you will have when the drama of life creates some unexpected expenses. A high level of financial literacy will provide you with more reasonable options than loans at a rate of 30%-300% that eat away at your income and net worth.

Experian recently reported that in the last three months, 17% of new car loans were issued with a term of 6 to 7 years. The amount of loans with these long terms has increased 55% from only 4 years ago. It is likely that lower household incomes combined with higher taxes and cost of living is forcing people to reduce monthly loan payments by extending the length of loans. Unfortunately, loans that are this long guarantee being upside down or having negative equity in your vehicle for a long time. This makes it expensive to sell or get out of the vehicle if your situation changes or if there is an interruption in your income.

There is no unique debt aspect to buying a car; it is personal consumption debt which is always a financial mistake. A vehicle is just a functional appliance like a computer, lawn mower, or dishwasher. These are items that depreciate in value until they are no longer functional. Like all purchases, they must be affordable to your level of income and purchasing vehicles with debt needlessly increases your cost by at least 25%. If instead you lease the vehicle, then you are nearly doubling your lending costs when you add up all of the additional expenses. Protect your income, net worth, and financial goals by purchasing vehicles only with cash.

In 2011, for the first time in history, a large country surpassed the U.S. in household wealth. The average Canadian net worth surpassed the average U.S. net worth. The Canadian average in 2011 was $363,000, 16% higher than the U.S. average at $320,000. Since then, the Canadian economy surpassed the U.S. in another milestone, national wealth as a percentage of GDP. In 2013, Canadian wealth is now at 648% of GDP, 18% higher than the U.S. wealth at 550% of GDP.

What is going on?

For decades, the International Monetary Fund has had a 4 point prescription for countries in a fiscal crisis. The simple prescription is time-tested and creates short-term pain but gets the economy back on solid footing quicker than any other method. The four prescriptions are:

1. Raise interest rates.
2. Cut government spending.
3. Deregulate and open the economy to attract investment.
4. Let insolvent banks fail.

Notice that the U.S. response to the 2008 fiscal crisis was the opposite of this prescription:

1. Lowered interest rates to zero.
2. Dramatically increased government spending.
3. Sharply increased regulations that repelled even domestic investment.
4. Bailed out the banks and declared them “too big to fail”.

Meanwhile, Canada, who wasn’t even experiencing a crisis, has been following the IMF prescription in recent years:

1. Government reined in spending and reduced deficits.
2. Reduced the corporate tax rate to 15%.
3. Enacted 11 free-trade deals in the last 10 years.
4. Reduced regulations with labor laws that allowed business to grow.
5. Their banks never had a crisis because, unlike the U.S., the government didn’t mandate that they make loans to people who couldn’t afford them.

The big question for your personal finances:

Have you chosen to put your career and investments in a state or country that is following the successful IMF prescription or do you have them located in a place where the government is doing the dismal opposite?

The odds of winning any grand prize are so minuscule that a friend of mine considers them a “Stupid Tax” and would never consider purchasing them. I don’t care if anyone buys a hopeful lottery ticket; I’ve even bought them when jackpots are high.

This weekend I was in line to pay for gasoline and a man in front of me was buying $300 in Megamillions lottery tickets. While we were waiting for all of the tickets to be printed I mentioned, “I wish you the best of luck but statistically you might expect to win about $30.” He replied, “I know the statistics but I don’t need the jackpot, I just want the 2^nd place win of $250,000.” I said something polite and let it go, it was none of my business, but unfortunately the condition of his car gave me the impression that he could not afford a $270 loss.

For my own curiosity, I ran a few simulations on two popular national lotteries to see how many years it may take to win their 2^nd place jackpot. The simulations estimated that it would take over 70,000 years of buying tickets for each twice-weekly drawing to win 2^nd prize (it took over 500,000 years to win the jackpot). In neither case did the amount of money won for 2^nd place cover the cost needed to buy all the tickets to get that win.

Go ahead and buy a ticket if you want but please don’t spend an unaffordable amount thinking that you may come out ahead financially.

How often do you examine all of the interest rates that you are paying and receiving? Then do you compare these to the inflation rate to determine where you are getting ahead or falling behind? The financially literate do this periodically so they can actively optimize their financial situation. This is both to take advantage of rates for your financial benefit and to avoid the rate pitfalls that would hurt your finances.

For example, the U.S. is one of many countries keeping interest rates extraordinarily low to try to spur economic growth. The British central bank just proudly announced that their low rates had saved 70 billion pounds for mortgage holders over the last 4 years. However, a savings group in Britain determined that these low rates have simultaneously cost British savers 100 billion pounds in lost interest income, plus an additional 120 billion in increased costs due to higher inflation. So for every pound they saved in mortgage costs, they lost 3 times that amount elsewhere!

If you do not actively manage your money for your financial benefit, you’ll likely be left similar to the average British citizen who is losing money on interest three times as fast as they are gaining. The average citizen of any country is unaware that they are figuratively held captive inside of a casino with horrible odds and where the government makes all the casino rules. You must find levers and opportunities to neutralize or tilt the odds in your favor.