PREVIEW and OVERVIEW --- THE CRUX OF THE MATTER
"We're from the government and we're here to help" are dangerous words to live by --- dangerous indeed!
The following commentary includes math examples illustrating compound interest and the rule of 72 (the value of the investment doubles when (1) the average annual percentage rate of return on money invested multiplied by (2) the number of years invested are equal to 72).
These math illustrations don't represent the essence or important part of this posting, however. The crux of the matter is simply this --- government wrongly encourages college students to accumulate debt by its ubiquitous student loan offering to all comers, and government wrongly encourages a dependency on Social Security benefits in our old age.
Regarding student loans, this often perceived to be and treated as 'free money' by the young borrower is never accompanied by a government or college warning that debt accumulation may be dangerous to the young person's future financial health and well being --- and that the young would be borrower should proceed with caution.
We are heavily in debt, both as a nation and as individuals, and each day the debt burden on future taxpayers and American citizens is growing. If something can't go on forever it won't. This ever growing debt can't continue forever and therefore it won't.
Our national and individual future financial security and stability require that our young citizens become appropriately familiar about the perils of excessive indebtedness and its harmful lifetime consequences.
Outstanding student loans are in excess of $1.3 trillion and growing. And for oldsters, Social Security dependency is pervasive. In other words, we are too dependent on government money, and we all know where that has to come from -- future taxpayers.
So listen up, young folks. It's your future financial security that's at stake.
In sum, there's a strong link between student borrowings and Social Security dependency, and that's the entire point of this posting.
This is also a request of my fellow oldsters: let's caution the youngsters among us about the perils of excessive early indebtedness and reinforce that in life there's no free lunch.
In other words, beware of government freebies. They aren't free.
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MOM refers to managing 'my own money.' So let's discuss MOM and the years we spend from early adulthood to our retirement years.
The article Without Social Security Income, a Majority of U.S. Seniors Would Be Poor caused me to seriously consider the link between taking on excessive debt while young and its lifetime effects, including those during our 'golden years.'
Well, it doesn't have to be that way, so let's connect the dots and explain why that's the case.
Government makes available money in the form of student loans for all who wish to go to college, no questions asked. But unless these 'available-to-any-and-all-takers' government offerings are accompanied by a stern warning about the dangers of excessive debt accumulation, which they aren't, government is doing not a favor but rather a disservice to the young borrower.
To demonstrate that, consider two young persons entering college. One becomes a borrower and the other refrains from taking on debt.
Person A takes out $25,000 in student loans to attend college. Person B goes to the same college but doesn't borrow. Both students graduate and are compensated identically during their working careers.
Person B agrees with his parents to go to the local public college, live at home and work his way through school by taking on a series of part-time jobs. He'll pay his own way and not borrow any money along the way through college.
For that promise to pay his own way, he receives from his parents at age 17 a high school graduation gift of $25,000. {NOTE: Perhaps the parents borrow the money, or perhaps they have it. But even if our young Person B doesn't have such capable or 'giving' parents, he'll still be able to complete college without accumulating debt. In that case, assuming he saves the $25,000 prior to age 30, person B will still have accumulated ~$1 million at retirement, whereas Person A will have accumulated nothing. But now let's return to the base case and the example of Person B with the generous and capable of giving parents.}
That $25,000 'gift' will be immediately invested and earn an annual average rate of return of 10%. As a result, and upon retirement at age 66, our student turned retiree can reasonably expect to have a total of $3.2 million. In the alternative case where the parents don't have $25,000 to give, the non-borrower would still have ~$1 million if he saves and begins investing the $25,000 by age 30.
While Person A worked equally as hard and was equally as successful in his job as Person B, he just didn't acquire the financially good health habit of not borrowing. Nor was he able to develop the habit of saving and investing at an early age. All he did was repay his student loans with interest, and this very much negatively affected his lifestyle in adulthood, up to and including retirement.
Bottom line --- Person B has somewhere between $1 million and $3.2 million at retirement. Person A has zero.
And it's largely attributable to how college was financed and how much it cost to attend.
The takeaway message is straightforward. Young people should do what they can to work hard and save and invest as early as possible in life, and refrain from borrowing to attend college.
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But there are other financial messages worth learning along the way as well --- such as why the $3.2 million may not be the end result if Person B isn't 'MOM' careful about investing his savings in adulthood. Please read on and find out why achieving a basic understanding of personal finance is a must for young adults. But first, let's take a break and offer a brief commentary on the stock market's recent travails.
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STOCKS versus Bonds and the DIY Way -- Stock prices have been erratic and have often fallen heavily on a daily basis in recent weeks, although they made a strong comeback yesterday. But whatever stocks do in the short term or even intermediate term, over time they will rise. They always have and always will in a free market economy.
Accordingly, this is definitely no time for us to panic and sell stocks. So let's do some simple math. It may help to calm our 'investment' nerves.
The days of high inflation are gone, at least for the next several years. And that simple fact is very important for individual investors to factor into how we construct our personal investment portfolios. Stay away from owning bonds.
Rather than bonds, I prefer owning blue chip dividend paying and dividend growing stocks. In fact, I purchased some more GE (3.6% current dividend yield), Intel (2.9%), Pfizer (3.7%), Boeing (2.4%)and Exxon (3.1%) Friday. While they represent different industries, they each pay cash dividends of ~3% currently, and these dividends will increase over time in line with earnings increases. Their share prices should increase too. In comparison, 10 year U.S. treasury bonds purchased currently will pay interest of less than 2.2% now, and that interest rate is fixed. Finally, there will be no increase in the principal amount of the bond, assuming it is held to maturity.
In other words, interest rates are at historic lows and there is only one way for them to go over time -- higher. In my view, interest rates on ten year government bonds, even as they climb over the next several years, won't yield anywhere close to 6% or more, which is what not long ago they used to yield -- at least not for a very long time.
So let's assume that we will be able to buy a high quality 10 year bond yielding ~4% within the next several months or so.
And let's further assume that high quality stocks will increase in value by ~10% annually over time, dividends included.
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Here's what Person B should not do.
A 'normal' IRA/401(k) portfolio consists of a 50/50 mix of bonds and stocks. It also pays commissions or fees of perhaps ~2% annually to the so-called "expert" manager or adviser.
In that case, our typical individual long term investor can expect to earn a blended average annual rate of return of ~5% going forward (4% on bonds and 10% on stocks, or an average of 7% on investments, which after subtracting 2% for annual fees paid to advisers, nets to 5%.
Example #1 --- $25,000 invested over 49 years at an average annual rate of return of 5% will grow to ~$250,000 (10% on stocks and 4% on bonds in a 50/50 portfolio with 2% subtracted annually to feed and care for the expert adviser and his family).
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Now here's what Person B should do.
Example #2 --- $25,000 invested entirely in blue chip stocks over 49 years at an average annual rate of return of 10% will grow to $3.2 million.
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Both cases are the rule of 72 at work (rate of return multiplied by years invested results in a doubling of the initial investment when the product of the two is 72).
At 5%, the $25,000 will double every 14.4 years, or approximately 3 times over 49 years in example #1 (5 X 14.4 = 72).
At 10%, the $25,000 will double every 7.2 years, or almost 7 times over 49 years in example #2.
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Summing Up
As a long term oriented DIY investor, Person B knows enough about the rule of 72 to go for the all stock portfolio which will return approximately 10% on average annually.
Thus, that's why Person B and other DIY investors should strongly consider adopting an all stock portfolio of high quality stocks (or a low cost passive S&P 500 Index fund), take the long view, get in the game early and stay in the game despite the market's short term ups and downs.
It's a self interested, family first, long term focused "MOM thing."
That's my take.
Thanks. Bob.
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