Personal Financial Planning for Graduate Students, Study notes of Financial Management

Download Personal Financial Planning for Graduate Students and more Study notes Financial Management in PDF only on Docsity! Personal Financial Planning for Graduate Students Manage Your Money Today Maximize Your Money in the Future Guidebook & Workbook August 2021 Introduction & Overview: Own Your Financial Future Page 2 of 243 Authors & Collaborators Page 5 of 243 AUTHORS & COLLABORATORS Most of this book was written by Brian Bolton (brian.bolton@louisiana.edu). Brian is a Professor of Finance and the Dwight W. Andrus, Jr. / BORSF Eminent Scholar Endowed Chair in Finance in the Moody College of Business Administration at the University of Louisiana at Lafayette. Brian joined UL Lafayette in 2019 after serving at IMD Business School in Lausanne, Switzerland, Portland State University in Oregon and the University of New Hampshire. Brian earned his PhD in finance from the University of Colorado at Boulder and his MBA in finance and strategy from the University of Texas at Austin. As of 2020, Brian is a CERTIFIED FINANCIAL PLANNERTM candidate. Brian has been teaching finance, economics, business and leadership since 1999 and loves his job because he gets to learn from hundreds of amazing students every year. And he loves taking what he learns from his students in the classroom into the finance laboratory for his research pursuits. Most of Brian’s research is focused on the relationships between the different stakeholders – or owners – within a firm and how to design systems that optimize those relationships to maximize the value of any firm. In 2015, he published his first book Sustainable Financial Investments: Maximizing Corporate Profits and Long-Term Economic Value Creation, which studies the short-term and long-term tradeoffs associated with making investments with natural, human, social and financial resources. Brian is currently writing another book titled A Culture of Ownership, studying how organizational culture is created and how it can be managed to create value for individuals, companies and societies. Brian wanted to write this Personal Financial Planning book because all students can learn more about personal finance, financial health and financial planning. All adults and humans can learn more, too. As student loan debt has increased, as various economic and social crises of the 21st century have challenged all of us and as the world has become increasingly more complex and more inter- connected, it has become more and more difficult for many people to take control of their finances and to achieve financial independence. Everyone – from high school students to college students to college professors – can learn more and can do better. So that’s what this book is about – helping everyone take control of financial situation and get on a path to financial independence. When you read “I” or “my” in this book, that is coming from Brian’s perspective. But Brian (I) has received significant help in this book getting into your hands. Dr. Bill Ferguson, Professor of Insurance and Finance and the G. Frank Purvis, Jr./BORSF Eminent Scholar Endowed Chair in Insurance and Risk Management at the University of Louisiana at Lafayette, wrote the insurance section in Chapter 5 and provided feedback on other sections throughout the book. Christine Williams, Maria Slater, Rachel Sam, April Jones, Kendall Laster, Mary Farmer-Kaiser, Philip de Mahy, Badar al Hamdani, Elizabeth Green, Monica Long and many others have provided suggestions, content and direction to this entire project. If you ever see them around campus or have them in class, be sure to thank them for their contributions. Consistent with Brian’s passion for learning from his students, as you will note in the Appendix, dozens of former and current students have contributed their thoughts and suggestions on how to best navigate graduate school. And this is the last time Brian will refer to himself in the third person. From now on, he is I. Table of Contents Page 7 of 243 TABLE OF CONTENTS CHAPTER 1: Taking Control of your Financial Future: Goals, Values & Financial Planning What Does Money Mean to You? Thinking About Money – The Lottery Mindful Decision-Making What’s Important to You – Your Values Why Financial Planning? Having the Right Mental Attitude What Are Your Financial Dreams? CHAPTER 2: Budgeting: Income, Expenses & Net Cash Flow Saving for Your Dreams & Goals Types of Budget Plans Budgeting 101: Income – How Much Money Do You Make? Budgeting 101: Cash Today vs. Career in the Future Budgeting 101: Expenses – How Do You Spend Money? Budgeting 101: Thinking About Spending Less Budgeting 101: The Behavior & Psychology of Spending Money Budgeting 101: Determining Your Net Cash Flow Budgeting 101: Net Cash Flow & Tracking Your Income & Expenses Your Financial Net Worth: Your Tangible & Financial Assets Your Financial Net Worth: Your Short-Term & Long-Term Liabilities The Plan for This Book Chapter 2 Summary – Commit to Improve Your Financial Fitness CHAPTER 3: Borrowing & Debt Management Paying Interest on Student Loans Good Debt vs. Bad Debt Student Loans & Financial Aid: The Nitty-Gritty of This Kind of Good Debt Federal Student Loan Repayment Options Student Loan Forgiveness for Certain Careers Credit Cards: Selling Your Future to Pay for Today Your Credit Score: One of the Strangest & Most Important Numbers in Your Financial Life Making Decisions About Paying Debt Having the Right Attitude About Debt CHAPTER 4: Saving & Investing Assessing Your Risk Tolerance Saving & Investing: What’s the Difference? Saving & Investing: What’s the Difference? In Numbers Investing – How Do You Do It? Risk: How Much Can You Handle? Chapter 1: Taking Control of Your Financial Future Page 11 of 243 CHAPTER 1 TAKING CONTROL OF YOUR FINANCIAL FUTURE: GOALS, VALUES & FINANCIAL PLANNING KEY ISSUES FOR GRADUATE STUDENTS • Financial planning is about trade-offs across time: living your life today while also preparing for your future. That’s exactly what you’re doing in graduate school. • You are currently making the biggest investment you will ever make: an investment in yourself. • You are in grad school in order to provide yourself with a better future: more impact, greater purpose, more flexibility, more opportunity, more money. But you’re investing a lot of time, energy and opportunity today to achieve that better future. That’s exactly what investing is. • You are already better at understanding the benefits of planning, discipline, perspective and investing than 99% of your neighbors. The goal of this book is to help you apply how well you already are investing in your education to how your plan for your financial future. • Personal finance is complicated because it is personal: we all have different situations, goals, values, needs, wants, relationships and emotions that will impact how we plan for your financial futures. Personal finance is about you. There is no ego in personal finance, there is no shame in personal finance. Only you know what is best for you. • The goals, values and plans you have today will most certainly change in the future. Your situation will change. Plan for this change, prepare for this change, celebrate these changes. And use financial planning help you enjoy these changes. Let’s start with a thought exercise. We will do a lot of thought exercises throughout this book. There are never any “right” or “wrong” answer to these exercises. These are just to help you think about your own personal financial health and plans. As you go through this book, and as you write down your thoughts on these exercises, you may want to write down the date when you responded; your feelings about many of these exercises will change over time, and that’s okay. We want you to explore and grow as you go through this book – and you may want to re-visit many of these exercises so you can think about different issues from different perspectives as you do grow. So, here’s thought exercise #1: What is money? What does money mean to you? On the following page, write down as many words, phrases, song lyrics, tweets, feelings, or stories that help define what money means to you. Chapter 1: Taking Control of Your Financial Future Page 12 of 243 What does money mean to you: ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ You can use space on another sheet if you need more room. Now that you have this list, go through it and put a + next to the items that elicit a positive feeling or sentiment and a – next to the items that elicit a negative feeling or sentiment. Do any of these statements conflict with each other? Do any inspire you? Now store this list away – and come back and revisit it periodically to see if you want to add new items or remove some old thoughts that you feel are no longer accurate. Thinking about of what money means to you will be a big part of your journey through this book. THINKING ABOUT MONEY – THE LOTTERY Imagine that a friend gave you a Lotto Scratch-Off ticket. And you won $500. What would you do with that $500? Write down up to 3 things you would do with your winnings: Chapter 1: Taking Control of Your Financial Future Page 15 of 243 Activity #3 – You choose to spend 4 hours on the weekend volunteering at the animal shelter. Benefits: __________________________________________________ __________________________________________________ Costs: __________________________________________________ __________________________________________________ Now, ask yourself…. Are the benefits of these choices greater than the costs of these choices? In theory, we should only be making decisions to do things where the benefits are greater than the costs, no matter how abstract or unmeasurable the benefits and costs may be. Happiness, purpose and peace of mind can be very important values – only you can decide what your values are. MINDFUL DECISION-MAKING Impulses are the enemy of financial planning – but impulsive behavior is very much a part of being human. And that’s why we want to make an effort to be thoughtful and intentional about what we do with our time and our money. The purpose of being thoughtful and intentional in making a financial plan is to be sure that your actions align with your goals and values. To be mindful of you financial (and even non-financial) decisions, take a moment to remove any impulses and think about the decisions you’re making. To be mindful of your decisions, ask yourself these questions: 1. What am I getting – either now or in the future? 2. What am I giving up – either now or in the future? 3. Are there other options that better fit with my values, goals and circumstances? Chapter 1: Taking Control of Your Financial Future Page 16 of 243 Think about your grad school investment. Your grad school education may be the biggest and most expensive investment you will ever make – perhaps even more expensive than buying a house. • Most of you have to pay thousands and thousands in tuition…plus living, family and other expenses. • Many of you will be doing this for 1-2 years, some of you will be in grad school for 5-6 years. • Many of you will not be able to work full-time while in graduate school. So why are you doing this? What are the benefits? I’m a college professor, so I am obviously a big believer in the benefits in education and in graduate school – for you as individuals and for the benefit you provide to society. But only you can decide whether the benefits of this experience are greater than all of the costs and sacrifices you are incurring in order to receive these benefits. When you decided to attend graduate school, it probably was not an impulse decision. You and your family had probably been thinking about it for many years. You analyzed many factors, comparing the benefits and costs of every possibly scenario. This was perhaps the most mindful – both personal and financial – decision you’ve ever made. What if you made all of your decisions with that kind of thoughtfulness? What if you were able to eliminate impulsiveness from all of your financial decision-making? Obviously, that’s probably ridiculous. You’re not going to prepare notebooks of analysis thinking about whether to buy a taco on a Friday night. But how might you add a little more thoughtfulness to many of your day-to-day decisions? • Only make purchases with a credit or debit card. Don’t use cash. Cash is tangible, but it can be difficult to monitor. Seeing all of your debit or credit card purchases online or in your monthly bank statement can help you manage and analyze your expenses. o Or, if you think differently, perhaps you ONLY make purchases with cash. Some people feel more intrinsic pain when spending cash, precisely because it is tangible. When the mafia invented casino chips, it was precisely to make it simple for us to throw away chips because losing chips wasn’t as painful as losing cash was to people. o You have to figure out which type of person you are and which approach will make you the most thoughtful and mindful…and which approach will cause you the most pain when you spend money. A brief figurative shock can be very helpful if it slows down your impulse purchasing habits – find what works for you. • Wait 24 hours before making any purchase. Apply this rule even to your Friday night taco craving. That’s right – make yourself wait. And it’s even easier with most other purchases. Take your time and force yourself to think about how that purchase aligns with your goals and personal values. o For purchases over a certain larger dollar amount – say, $100 – force yourself to wait a week or a month before buying it. • Delete any apps from your phone that enable no-touch or one-touch purchases. The technology is amazing – but that technology is also designed to get you to spend more money, not to help you achieve your personal and financial goals. • Commit to saving more. For every purchase you make, whether it’s for a taco or something online, commit to moving 50% of the purchase price into your savings account. Chapter 1: Taking Control of Your Financial Future Page 17 of 243 There are many other strategies and tricks you can play on yourself to incorporate more diligence and mindfulness to the decisions you make with your money. You do not want to become a robot – but you also don’t want to be broke forever. Challenge yourself to find a nice mindfulness balance. WHAT’S IMPORTANT TO YOU – YOUR VALUES Let’s think about your values. We will do this regularly throughout this book, constantly encouraging you to make sure that the decisions you make are aligned with the values you hold dear. We’ve provided you with a list of 12 common values. In the space below the list, add 4 more that you think are important. Then, from this full list of 16 values, rank them. Give the value that’s most important to you a 1 and give the value that’s least important to you a 16. __________ Education __________ Family __________ Friends __________ Saving for the future __________ Charity __________ Personal appearance __________ Travel __________ Entertainment __________ Freedom __________ Creativity __________ Religion __________ Physical fitness __________ __________________ __________ __________________ __________ __________________ __________ __________________ As with most exercises in this book, this list and the rankings are just for you. You should re-visit your thoughts periodically to see how your thinking evolves as you think more about your personal financial planning and financial health. Let’s put these values to work – it’s easy enough to make lists and claim what we think is important, but it’s an entirely different matter to actually be faced with making decisions to see what we value. Chapter 1: Taking Control of Your Financial Future Page 20 of 243 Now let’s remind ourselves about some of the rewards that come from financial planning: ü Ability to maintain or improve your standard of living ü Controlled spending allows you to live well today AND tomorrow ü Accumulate wealth—Remember, whatever your income, you can spend it or save it ü Hope of avoiding much of the havoc that money problems wreak on your personal life ü Conflict over money is the leading cause of divorce in today’s society. So, what are we going to do – what do we mean by “financial planning?” For better or worse, financial planning is a constant, lifelong process…but it gets easier over time and it gets much more rewarding over time. 1. Set your goals. What do you want to achieve in life? What financial goals will make this happen? 2. Analyze your reality. What is your situation? What is your income? What are your expenses? When can you achieve your goals? 3. Create your plan. Focus on the short-term – the next 3-6 months – and the long-term – the next 1, 2, 5 and 10 years. 4. Execute your plan. Work to decrease your expenses. and to pay off debt. Work to increase your income and your savings. 5. Track your progress. How are you doing? Are you ahead of your goals? Are you behind your goals? 6. Adjust your plan to reflect your progress, your new reality and any new goals. 7. Repeat. Revise. Enjoy. As a graduate student, this may seem very abstract right now. You may not have any financial goals – you may not even know what financial goals are. That’s okay – we’re here to help. You will get more and more comfortable with the terminology and the process as you go through this journey. You will do a lot of introspection, thinking about your personal values and your personal dreams. You will do a little bit of math, converting your values, dreams and goals into numbers. You will also be converting your actions and behaviors into numbers. Much of this may be uncomfortable for you – I am always embarrassed to see how much I spend each month on coffee. But dealing with that discomfort is essential for being able to change your behavior and improve your situation. We will talk about income in the next chapter. You know better than anyone that as a student your income if usually much less than you want it to be. But that will change – both as you discover more opportunities for creating income and as your earning potential increases with your degree and expertise. Be patient yet be persistent. You will get there. You will make your dreams happen. Set Goals Analyze Reality Create Plan Execute Your Plan Track Progress Adjust Plan Chapter 1: Taking Control of Your Financial Future Page 21 of 243 HAVING THE RIGHT MENTAL ATTITUDE Here’s one more statistic that we didn’t include on the list above: only one-third of American adults have a budget or a financial plan. Just by reading this far and doing a tiny bit of thinking about your financial goals and situation, you are already ahead of most people. Congratulations! But you’re not done. Our next task will be to begin the financial planning process and to create your financial plan. But first, let’s analyze why you – or the other two-thirds of Americans – have not created a financial plan, yet. What’s holding you back? Why haven’t you begun to take control of your financial future? There are certainly other reasons you might include on this graphic – perhaps you’ve never had to worry about your own finances, perhaps you’ve never had the knowledge necessary or perhaps you’ve thought you’d never have enough month to worry about financial planning. One purpose of this book is to help you overcome these barriers. We want to give you the tools and confidence to take control of your financial future – and that journey begins now. We’ve already talked about your values and priorities a little bit; we’ll return to these concepts throughout this journey. But, the biggest goal of this book is to help you learn – so our next objective is to help you get started in knowing how to create a budget. Once you have a budget, based on your goals and your current situation, and once you start executing your budget or financial plan, many of the other reasons in this graphic will take care of themselves and go away. We will cover budgeting and expense management in Chapter 2. Having the right mental attitude is essential to financial planning. Earlier, we talked about “mindful decision making.” Being mindful about the financial decisions you make is critical to achieving your goals. But financial planning can be much more personal than just being mindful of the decisions we make. For many people, financial planning uncovers deeper issues. That’s okay. Little Things Adding Up Impulse Purchases (Coffee, Clothes) Not Knowing How to Start a Budget Having Trouble Creating a Budget that Adequately Reflects all of my Expenses, Debts, Etc. Monitoring Spending/Tracking Expenditures Unexpected Expenses— Friends Want to Eat Out, Etc. Not Having a Clear Budget & Clear Priorities Chapter 1: Taking Control of Your Financial Future Page 22 of 243 That can be healthy. Financial planning is about you and not anyone else. As you go through this journey, please remind yourself of the following bits of advice. Ø There is no shame in talking about money. There is no shame in financial planning. Ø There is no ego in talking about money. There is no ego in financial planning. Ø You will make mistakes. Don’t beat yourself up. Move on and improve next time. Ø You are not alone. We are all going through similar issues. Ø To be vulnerable is to be human. Let yourself be vulnerable. That is how we grow. Ø To be resilient is to be human. Challenge yourself to be resilient. That is how we progress. Ø You cannot change your past. You can only change your future. Focus on your future. WHAT ARE YOUR FINANCIAL DREAMS? We started this journey asking you to think about what you would do if you won $100,000 in the lottery. That’s fun – but it’s not very realistic (especially since, in Chapter 5, we are going to encourage you to avoid playing the lottery). So, let’s finish this chapter by thinking about some more realistic dreams. Please take 30 seconds to think about this question: What are your financial dreams? When we think about a vague question like that, we typically think about big, grand ideas: becoming a millionaire, retiring by the time I’m 40, travelling the globe, buying my first house, buying my parents a house, or something less sexy like becoming financially self-sufficient. Dreams like these are great – don’t let go of them. But they aren’t particularly actionable – they’re vague and it’s difficult to develop a plan for how you might achieve them. We will begin developing your financial plan in the next chapter, so let’s develop some ideas for what will be in that plan. Imagine that you were able to save $100 next year – What would you do with that $100? 1. ________________________________________________ 2. ________________________________________________ 3. ________________________________________________ Chapter 1: Taking Control of Your Financial Future Page 25 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 1: Taking Control of Your Financial Future Page 26 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 1: Taking Control of Your Financial Future Page 27 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 1: Taking Control of Your Financial Future Page 30 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 31 of 243 CHAPTER 2 BUDGETING: INCOME, EXPENSES & CASH FLOW KEY ISSUES FOR GRADUATE STUDENTS • Thinking about budgeting and income & expense management can be very frustrating for many grad students for one simple reason: your income is limited (or reduced) by being in grad school. • That’s okay – you knew that would be the case when you decided to pursue grad school. • The purpose is to get your mindset right and understand the trade-offs you are making, between income and expenses, between now and later. The right mindset can last a lifetime. • Thinking about budgeting can be painful for many people, too – because it uncovers certain behaviors that we might prefer to stay covered up. But we all know that problems will not go away on their own; we have to uncover these behaviors to correct them and improve the future. • As a grad student, your expenses are already probably pretty lean – but are there ways or places you can cut your expenses even further? Unused or unnecessary subscriptions. Raising insurance deductibles. Decreasing W-2 tax withholding. Potluck dinners at home. Be creative. • As a grad student, your income may be limited due to your studies – but are there ways to pick up income without compromising school? The gig economy – sharing, driving, freelancing. Additional opportunities on campus. Part-time jobs. Teaching. Be creative. • You have to look in the mirror, you have to do the math and know what you’re doing with your money. Only then can you make the best decisions that align with your values and goals. • Just like the work you’re doing with your education, the financial management behaviors you develop during graduate school can benefit you for the rest of your life – and that’s a good thing. This will be the math chapter. Sorry. But we have to do some math to figure out how you’re going to achieve the financial dreams you identified at the end of the previous chapter. In that last exercise in Chapter 1, you came up with three lists of what you would do with $100, with $1,000 and with $10,000. Take a minute to review those previous lists. Now pick one item from those lists to think about here. And, then fill in the following blanks: In the next year, I want to save $ __________ in order to _______________________ ____________________________________________________________________. ____________________________________________________________________. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 32 of 243 Now, how are you going to save this money? In the next year, I want to save $ __________ by doing the following: _____________ ____________________________________________________________________ ____________________________________________________________________. Coming up with dreams and goals is the fun part. You’re all good at that – after all, you’re in graduate school right now because you have big dreams and goals. The difficult part is developing the plan to come up with the money – or time or energy – necessary to make those dreams and goals happen. This chapter is about that plan – developing a financial plan and a budget to set you on a course to achieve all of your personal and financial goals. This will not be easy. You will have to think about yourself, frequently confronting painful experiences or behaviors. You will also have to think about your future – it’s always difficult for anyone to plan for the future because we have no idea what the future will bring. Whenever you face these difficulties, take a deep breath, go for a walk, re-center your mind…and then come back to this exercise and remind yourself that you will be better off after going through this journey. The purpose of this journey is to help you take control of your future. This journey will help you achieve your goals and dreams. I promise you, it will all be worth it. A journey of a thousand miles begins with a single step. Famous Chinese proverb (Laozi) TYPES OF BUDGET PLANS If you search for “types of personal budgets,” you will find a near infinite number of suggestions. That is obviously overwhelming. However, if you study this plethora of budget plans, you will see that they are all very similar – just will slight differences to help you think about the budgeting process. They all end in the same place – measuring your net cash flow – but they take slightly difference routes to get you there. The math is generally the same – but each helps you think about your income and expenses in slightly different ways. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 35 of 243 BUDGETING 101 INCOME – HOW MUCH DO YOU MAKE? All of the budget models that we looked at in the previous section have one thing in common: they compare your INCOME to your EXPENSES. Ultimately, that’s all that budgeting is – a systematic approach to comparing your Income to your Expenses. If your Income is greater than your Expenses, that’s great – it allows you to save today in order to have bigger and better opportunities in the future. If you Income is less than your Expenses, that could be a problem – it forces you to borrow (either from your savings or from a lender); in doing so, you sacrifice a little bit of your future opportunities in order to do something today. One thing is clear about any budget: If you don’t have any income – either today or in the future – you’re going to have big problems. So, let’s talk about income. Income, perhaps obviously, is money that you receive or earn. If you have money, you can do stuff – that’s how our society works. The more money you have, the more stuff you can do. Most of you are in graduate school for many reasons, and one of those reasons might be “to earn more” or “to increase your earning potential in the future.” Hopefully your experience helps you do that. For now, think back on the past 2-3 years and identify 5 different sources of income. Don’t include dollar amounts, just list the sources – work, family, scholarship. If you’ve had different jobs, list them separately. Feel free to list more than 5 in the surrounding space if you want to.: 1. ________________________________________________ 2. ________________________________________________ 3. ________________________________________________ 4. ________________________________________________ 5. ________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 36 of 243 The purpose here is simply to begin writing down all of your cash inflows and outflows. Your income is an inflow – we’ll focus on outflows in a little while. Think about your next 2-3 years. And now let’s make 2 lists. On the left, list your most likely sources of income, just like you did above. We’ll call this your Planned Income. On the right, be creative – think about jobs you’ve never done or sources of income you’ve never considered. We’ll call this your Possible Income. PLANNED INCOME 1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________ 5. _____________________________ POSSBILE INCOME 1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________ 5. _____________________________ What did you come up with for your Possible Income? How creative were you? Uber, Lyft, scholarships, work-study, other on campus work, residential advisor, intern, become a tutor, IT consultant (on campus or otherwise – you know more than you may think), freelance writer, freelance photographer, blogger, brand ambassador for the University or for a local business, research assistant, campus tour guide, research study participant, bus driver, landscape maintenance, errand runner. Perhaps you listed food service or barista in your Planned Income – what about delivering for Waitr or Uber Eats? Perhaps you listed childcare in your Planned Income – what about senior care or pet care (or even both at the same time)? Could you share your house or apartment with 1 or 2 more people? That might give you an excuse to spend more time at the library or at work. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 37 of 243 Take a minute to think about how often you have to explain to your parents and other family members how to use Facebook, Snapchat, Tik Tok, Twitter, Instagram or anything else – what if you could get paid for this advice? No, your family members might not pay you – but most local business owners are your parents’ age and just as needy. Find a business that you like and convince them to pay you to run their social media platforms. Could you even start your own business? It wouldn’t have to be much – turn your hobby into income. You can sell your design creations on Etsy, create your own app, start your own food truck or catering service. There are many, many opportunities to earn extra cash. You may not be able to pursue them all – perhaps you don’t own a car or you live on campus – but you can probably pursue more than you think. And, don’t forget about on-campus jobs and opportunities; ask around, because there are probably a lot more low-commitment opportunities to earn a little more cash than most people realize. BUDGETING 101 CASH TODAY vs. CAREER IN THE FUTURE? When I was a sophomore in college, I was assigned a mentor for a semester. My mentor was about 30-years old and he had been the quarterback of my university’s football team just a few years before, which I thought was pretty cool. He gave me a lot of good advice, but there’s one specific piece of advice that he gave me that sticks with me today: at some point you’re going to want to switch from having a ‘job’ to having a ‘career.’ The thing about this advice is this: there’s nobody in this world who can tell you when to make that switch – not me, not your family, not your boss, not some former-QB mentor guy. One of the best jobs I had in college was refereeing intramural basketball games – I made $10 an hour for hanging out at the gym and blowing a whistle. It was easy and it paid very well. I never had any desire to make officiating a career, but as a college sophomore I was more concerned about buying food next week than I was about advancing my career – both because I wasn’t sure what I wanted to do with a career, and because there weren’t a lot of professional jobs available for a 20- year old college sophomore. By the time I was a junior, I had a better idea what I wanted to do for a career, and I was able to get a part-time job at the end of my junior year; I continued this internship for 9 months, through the summer and halfway through my senior year. It was decent experience, it probably looked good on my resume and it helped me learn the finance business. But it paid $4 an hour. The $4 an hour (before taxes) that I was making at this internship did very little to help my financial situation….in the short-term. Given that I still enjoyed eating and doing other college things, I continued refereeing and making $10 a game. Some weeks I would only work 4 games as I didn’t have the time to focus on school and the internship and refereeing – but it worked out to be the perfect balance. At the time I needed cash and I needed work experience – now that you are in graduate school, it may be less feasible to take on this kind of extra work. You may already be employed full-time in a career or working toward a job pivot in the near future. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 40 of 243 In this list, you probably have 3 types of expenses: • Fixed Expenses, or those that are the same every month, like a car payment, rent, gym membership or media subscription. • Variable Expenses, or those that change from month to month, but always exist, like food, utilities, entertainment and possibly your phone (or maybe your phone is a fixed expense). • Periodic Expenses, or those that might only happen 1 or 2 times a year, like tuition, spring break and possibly insurance (if you pay it twice a year). Did you include all of your most recent expenditures in the list above? Go back and make sure. Now go back through this list and try to come up with 4-6 general ‘categories’ for each expense. You can make up whatever categories you want, but here are some common ones: food, phone, entertainment, school, housing, charity, gifts, indulgences. Maybe you have 8 categories – that’s fine. Write down the category to the left of the number in the list above. Now let’s classify each of these as “recurring” or “non-recurring.” Recurring means it’s an expense that happens regularly – perhaps weekly, perhaps monthly – and will continue to occur regularly into the future; rent, phone, food might all be recurring. Non-recurring means it’s an expense that does not happen regularly; something like tuition might be non-recurring, even though you’re likely to be paying it 2-3 times a year until you graduate. Gifts, entertainment, charity and indulgences might all be non-recurring expenses. As with most exercises in this book, the categories you choose and whether you classify an expense as recurring or non-recurring is entirely up to you. There are no ‘right’ or ‘wrong’ responses. The purpose of these categories and classifications is to help you analyze what you are doing with your money. As we go through this chapter, we’ll work on being mindful and analytical about how we spend our money, including thinking about expenses as non-discretionary and discretionary or required and optional. The list above only includes 10 of your most recent purchases. Now let’s make another list. Think back to all the purchases you’ve made over the past 12 months – and list the 5 biggest purchases you’ve made or expenses you’ve incurred. What are the 5 largest purchases you’ve made or expenses you’ve incurred in the past year? 1. ________________________________________________ _____________ 2. ________________________________________________ _____________ 3. ________________________________________________ _____________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 41 of 243 4. ________________________________________________ _____________ 5. ________________________________________________ _____________ Again, as we did with the 10 most recent expenses, go through this list of 5 expenses and categorize them into one of your expense categories and classify them as recurring or non-recurring. If you’re like most students (and professional adults), most of your largest expenses are non-recurring – but that’s up to you to figure out. So, what’s the purpose of these lists? The purpose of these lists is to help you identify and think about all of the money that is leaving your bank account. You probably work very hard, possibly in a job that you don’t love, possibly with a jerk boss who isn’t qualified to be your assistant – and you’re choosing to give up that money in exchange for all of these purchases. Is it worth it? Are you getting your money’s worth? How important are these expenses? BUDGETING 101 THINKING ABOUT SPENDING LESS Let’s face it – life is expensive. And being a student can be doubly expensive – because you have to incur certain expenses to further your education AND because being a student takes time away from your ability to work and earn money. That stinks. But you’re in school for a reason – you’re in school to advance your social and professional opportunities and to maximize your career options once you graduate from school. You’re making a long-term investment: you’re making a big sacrifice now in order to reap enormous rewards in the future. You are going to make that investment pay off. If you want to achieve your financial goals and to save money for your future and to give yourself the most wonderful opportunities in your future, as long as you’re still in school and your work opportunities are limited, cutting back on your expenses is probably the best way to save money to help you achieve your financial goals. So, what can you do to cut back on your expenses? Take a look at the follow list of money-saving ideas and circle the ones that you realistically think you could do in the next 3-6 months. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 42 of 243 Move to a better bank account Give up your television Give up a subscription Sign up for free customer loyalty programs Always make a shopping list Stop eating out Shop at a thrift store Shop at a yard sale Stop buying new video games Cut your coffee purchases in half Drink more water Avoid convenience stores Avoid fast food Avoid alcohol Quit smoking Buy food and staples in bulk Make a gift for friend or family member No online purchases Cancel unused memberships Share your dreams with a close friend Shop for new car insurance Spend your free time volunteering Avoid the mall Only walk to places within 1 mile Cancel magazine subscriptions Eat breakfast Eat leftovers Bring your lunch to work or school Only go to free entertainment events Take public transportation Carpool Pack food for road trips Eliminate cell phone services Eliminate cable services Spend 10 hours a week at the library Learn about employee offers at work Only drive within 3 MPH of the speed limit Drive a different route to work Eat less meat Use coupons Exercise more Pay bills online through your bank Many of these ideas are obvious money savers – using coupons, avoiding fast food, canceling unused memberships. Many others are less direct money savers, where the financial savings come from how you use your time or how you think about money. If you drink more water, you’re less likely to drink other beverages that cost more. If you spend more time in the library or volunteering, you’ll have less time to spend at the mall or online, where you might spend out of boredom or stress. If you exercise more, you’ll also have fewer opportunities to spend out of boredom – and you’ll be less stressed and feel healthier….which may make you want fast food less. If you take a different route to work, you might be less likely to stop at a fast food joint less. If you drive slower, you’ll save gas and reduce the likelihood you’ll get a ticket…keeping your insurance rates lower. We encourage you to re-visit the above list over the next few weeks or months and re-think where you might be able to save money. For now, look through all of the items that you have circled and identify the 5 items that you are most likely to achieve in the next 3-6 months. On the following page, write down what these 5 items are and write down how much you’ll be able to save each month. If you can’t identify 5, just write down the ones you can commit to; but really challenge yourself to come up with 5. And then once Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 45 of 243 One popular model for thinking about the connection between your emotions and your spending habits is the A + B = C model. + A Activating Event + B Belief _. = C Consequences The A/Activating Event triggers some emotion, negative or positive. This could be a grade or a relationship or really any thought that leads to you taking some action or making some choices. The B/Belief represents how that Activating Event makes you feel. The Belief is you internalizing that event and choosing to respond to it in some way. The actual “belief” can represent a thought, an opinion or an expectation. The key is that how we think about the Activating Event leads to some response. The C/Consequences represents our behavior. It represents the response. The Consequences can be good or bad. As you think about yourself and your money habits, simply recognizing the A + B = C sequence is the critical first step. When the Consequences are positive, take note of that and try to replicate that feeling and attitude with your future financial decisions. This might be something like rewarding yourself with a nice dinner after getting an A on a Final Exam. When the Consequences are negative, we want to make the effort to analyze what we are doing and why we are doing it. The A + B = C model might involve the following thought exercises. 1. Identify the A + B = C sequence. Notice what the A/Activating Event was and notice what your emotional response is. 2. Identify that emotional response. What is your instinct to deal with it? 3. Try to figure out the underlying B/Belief that is creating your emotional response. 4. Decide if your Belief is rational or irrational…if it’s a reasonable response to the Activating Event of if you are overreacting for some reason. Take a minute to ask yourself if your Belief is logical and if it is helping your get somewhere or accomplish something. 5. Decide what you’re going to do the next time you get the negative emotion in order to avoid any negative Consequences. Be specific. Have a plan. Stick to that plan. The purpose here is not to beat yourself up for having an emotional reaction to a certain situation; the purpose is for you to take control of your emotions and your responses that you can decrease the likelihood that you will experience negative consequences in the future. Obviously, this model is not specific to money management – but it certainly applies to how you think about your money and how you spend your money. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 46 of 243 Here’s another challenge for you: • Once a month, when you’re in a calm and balanced mood, go through the past month of expenses. • Identify which expenses or purchases were emotionally driven. Identify which could fit with this A + B = C framework. (Your cell phone bill is probably not emotionally driven; but some of your food and online purchases might be.) • Apply the A + B = C framework to these purchases. Analyze them. Identify the Belief and understand why this Belief is triggering some negative reaction. • Make a plan for not letting a similar Activating Event lead to a negative Belief that triggers negative Consequences for you in the future. The math of personal financial management and health is relatively simple: spend less than you earn and save or invest whatever is left over. Btu that is much easier said than done – and that’s because we are complex human beings with amazing minds and powerful hearts. Our beautiful complexity sometimes gets in the way of us letting managing our finances be as simple as it can be. The good news is that the amazing minds that create some of our problems can also be put to work to alleviate these same problems. RECOGNIZE — ANALYZE — THINK — PLAN — COMMIT — IMPROVE Use your amazing mind to take control of your financial planning. Use your amazing mind to own your financial future. Use your amazing mind to give yourself the most incredible opportunities your future self could ever dream of having. BUDGETING 101 DETERMINING YOUR NET CASH FLOW Now we can put all this together. Ø We’ve talked about your income, or the money that comes in and adds to your wealth. Ø We’ve talked about your expenses, or the money that goes out and subtracts from your wealth. Ø And, we’ve talked about some mental strategies that you can utilize to try to take the emotion out of financial planning to give yourself a stronger sense of ownership and control over your financial future. We need to do some math to see what all of this means…about today and about the future. Ultimately, what we care about is Cash. We’ve talked about money. Money is our unit of exchange. Money is currency. Money lets us do stuff. Money gives us options and opportunities. And Cash is what we care about. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 47 of 243 We have a very simple calculation for determining changes to your Cash: + Total Income that you receive in a month or a year – Total Expenses that you pay out in a month or a year = Net Cash Flow If your Income is greater than your Expenses – CONGRATULATIONS! This can become savings towards options and opportunities for your future self. If your Income is less than your Expenses – then you have a problem. But this is a common problem for students. There are a number of ways you can deal with this in a given period: • Borrow from your savings account – save money from positive months for leaner months. • Find opportunities to increase income (Uber, selling old clothes, part-time job) • Delay paying certain expenses, while being mindful of any penalties • Adjust expenses by finding alternatives (free concerts, public transportation, borrow books) • Do without certain things if absolutely no money is available – this is probably less painful than you think • Borrow from a bank or other lender – we’ll discuss this in the next chapter. If your Income is less than your Expenses – make a promise to yourself to change this. Make a plan to take actions that either increase your Income or decrease your Expenses. What can you change? How can you increase your Income? How can you decrease your Expenses? When can you make these changes? BUDGETING 101 NET CASH FLOW & TRACKING YOUR INCOME & EXPENSES Having the right mental attitude is critical to managing your financial future. And there’s a lot that you can do to think properly about money and to remove any emotions from your financial decision-making. But financial management involves a lot of math, too. Two will never be greater than three, no matter how awesome your attitude and mental perspective are. So, let’s do some math. You have already done a lot of the hard work in previous sections – you’ve already gathered and analyzed your recurring and non-recurring expenses. You’ve thought about what categories you should assign expenses to. And you’ve thought about some strategies for reducing your expenses in the future. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 50 of 243 2 YEARS FROM NOW 5 YEARS FROM NOW 10 YEARS FROM NOW INCOME Job #1 - Job #2 - Job #2 - Other - Other - Other - TOTAL INCOME EXPENSES Savings Rent or Housing School - Tuition & Fees School Supplies Phone Bill Insurance - Car Insurance - Home Insurance - Health Food - Grocery Food - Restaurants Coffee Subscription #1 Subscription #2 Subscription #3 Clothing & Shoes Entertainment (music, movies) Gym, Yoga, Fitness Other - Other - Other - TOTAL EXPENSES NET CASH FLOW or ADDITIONAL SAVINGS TOTAL CHANGE IN NET WORTH or TOTAL CONTRIBUTION TO SAVINGS (Add "Savings" to "Net Cash Flow") Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 51 of 243 What you just did required a lot of math, a lot of thinking and introspection and a lot of creative thinking. Believe it or not, most human beings – including most adults in America – have never done the exercise you just did…in their entire lives. And this might be one of the reasons so many people struggle with personal financial management (and also why financial issues are frequently cited as the leading causes of stress, divorce and other problems). Congratulate yourself – Be proud of what you just did! But don’t stop here. Effective financial management is a constant process that will always be with you. The good news is that – like most investments – the more you put into it early in your journey (now), the easier it will get in the future and the less you’ll have to worry about it in the future. Let’s review the budgets you just prepared. What was most the most difficult aspect? Was the “THIS YEAR” budget easy or difficult? What did you learn? What did you learn about your future self – what did you learn with the 2, 5, and 10 years from now budgets? What plans, goals and dreams did you use in making these budgets? What problems do you foresee? Do you have persistent negative Net Cash Flow? What can you do about these problems? What can you do to increase your Income? What can you do to decrease your Expenses? What about your emotional state as you estimated the numbers? Were you anxious? Did you feel shame? Did you feel fear? Looking back on your budgets, what’s your emotional state now? As always, only you can answer questions about you. But we want to help you answer the last question. It’s okay if your Expenses are consistently larger than your Income and you have negative Net Cash Flow. Most students do. Hopefully this exercise helps you feel a little bit of control. Hopefully this helps you feel motivated and inspired to take control of your personal financial situation. Like most problems in life, financial issues won’t resolve themselves without you taking them head-on. You’re working through this book to better understand what you can do to fix any problems and to maximize your future opportunities. Relax, keep thinking, keep working and keep making plans to create a better future for yourself. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 52 of 243 YOUR FINANCIAL NET WORTH Accounting…Assets…Liabilities…Financial Statements…Taxes… If you fell asleep just reading that previous line, you’re not alone. Accounting is one of the most challenging pursuits for most college students, for most graduate students and for most adults. That’s also why it’s one of the most in-demand majors – good accountants will always have job opportunities because they do work that other people hate. One very valuable service that accounting provides is calculating Net Worth. Think of Net Worth as your Financial Value – when you hear that someone is a millionaire, it generally means that their Net Worth is a million dollars or more. Your Net Worth is a single number as of a single day – it’s a snapshot of your personal financial value as a single point in time. Calculating your Net Worth can be very simple: we add up the financial value of everything that you own, we subtract from that the financial value of everything that you owe, and then we have your Net Worth. + Assets = Stuff You OWN – Liabilities = Stuff you OWE. = NET WORTH = Your Financial Value Conceptually, that’s not that complex – But actually doing the analysis and the math to determine everything you own and everything you owe can get pretty painful pretty quickly. So, we’ll start simple. ASSETS – The things you OWN are your Assets. Ø Your car, phone, computer, clothes, music equipment, furniture, textbooks, checking account, savings account, investments – items like these are your Assets. Ø When we determine your Net Worth and your Assets, we generally only consider tangible and monetary assets – we do not consider things like “intelligence” and “earning potential” or other intangible assets. LIABILITIES – The things you OWE are your Liabilities. Ø Your student loan, car loan, credit card balances – items like these are your Long-Term Liabilities. You cannot eliminate them – you have to repay them even if you get rid of the benefit associated with them (such as graduating or selling your car). Ø Your phone bill, insurance bill, cable bill – items like these are your Short-Term Liabilities. They exist on a monthly or periodic basis. You could stop them anytime, but then you lose the benefit of the service associated with them. Ø We add up your “Long-Term Liabilities” and your “Short-Term Liabilities” to get your total “Liabilities”. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 55 of 243 Now let’s switch from my latte addiction to your financial Net Worth. Think of all of the stuff that you own – your car, your computer, your checking and savings accounts, your clothes…everything else. In the table below, list your 5 most valuable assets – the 5 assets that are worth the most. YOUR TANGIBLE & FINANCIAL ASSETS 1. ________________________________________________ _____________ 2. ________________________________________________ _____________ 3. ________________________________________________ _____________ 4. ________________________________________________ _____________ 5. ________________________________________________ _____________ ======================================================= YOUR TOTAL ASSETS $ When we make these lists, for now, only lists tangible items, such as cash, investments or anything you could sell online or at a pawn shop. If you have money in a retirement account, either at work or an independent IRA, you can decide whether you include that money in this list. Maybe include it with an asterisk. Yes, the money is yours and it is an asset – but it is restricted. You want to avoid thinking of it as money you can use to buy a house a take a vacation; you want to wait until retirement to touch that cash. But it definitely is an asset that increases your financial Net Worth. Now let’s do the same for everything that you owe – your Liabilities. Think of all of your financial obligations – student loan, car loan, next month’s bills …anything else. In the table below, list your 5 most costly or burdensome obligations – the 5 liabilities that are worth the most. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 56 of 243 YOUR SHORT-TERM & LONG-TERM LIABILITIES 1. ________________________________________________ _____________ 2. ________________________________________________ _____________ 3. ________________________________________________ _____________ 4. ________________________________________________ _____________ 5. ________________________________________________ _____________ ======================================================= YOUR TOTAL LIABILITIES $ Now let’s calculate your Net Worth – also known to accountants as Equity. Take the amounts from the two tables above, subtract your Liabilities from your Assets to determine your Net Worth. + Your Assets = _____________ – Your Liabilities = _____________ ________________________________________________________________________________________________ = Your Net Worth = = Your Financial Value What’s the number? Are you a millionaire, yet? No? That’s okay – just keep working. Keep working to make it happen. Is your Net Worth positive? If so, that’s great. Keep working to increase it. Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 57 of 243 Is it negative? That’s okay – that’s normal for college students and graduate students. If your Net Worth is negative, what are you going to do about it? Can you reduce your expenses? Can you increase your income which can help you increase your savings? Will your salary increase once you graduate? How long will it take you to get your Net Worth to be positive? This last question may be very abstract right now – it’s okay if your answer is “I have no idea.” But one of the goals of this book is to help you come up with a plan for increasing your Financial Value and your Net Worth. By the time you get to the end of this book, your goal should be to come up with a financial plan for your future – for both the short-term (the next 1-2 years) and for the long- term (the next 3-5 years. Hope is beautiful and is an essential part of us being human. But hope is not a strategy – you need to develop a strategy that will help guide your financial future. Develop a plan to own your financial future….starting right now. Please use the following table to more formally calculate your Net Worth to help yourself think about your future financial strategy. Returning to this table and exercise several times a year is a big part of a long-term financial strategy – and a big part of you achieving all of your personal goals and dreams. ASSETS LIABILITIES Checking Account $ Credit Cards $ Savings Account $ Other Bank Accounts or CDs $ Auto Loans $ Student Loans $ Investments $ Property Loans $ Retirement Funds $ Other Loans $ Personal Property Total Liabilities $ (Value is market value, not original cost) Home $ Cars or Trucks $ Jewelry $ Household Items $ Computer, Phone & Technology $ + Total Assets $ Musical Equipment $ Clothing & Shoes $ - Total Liabilities $ Other Personal Property $ Current Net Worth $ Total Assets $ YOUR NET WORTH Statement of Financial Position aka Personal Balance Sheet NET WORTH & EQUITY Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 60 of 243 Chapter 2 Summary Budgeting: Income, Expenses & Cash Flow In the space below, please write down 5 things you learned in this chapter that will help you increase your Net Cash Flow, either by increasing your Income or decreasing your Expenses 1. _____________________________________________________________ 2. _____________________________________________________________ 3. _____________________________________________________________ 4. _____________________________________________________________ 5. _____________________________________________________________ ______________________________________________________________________________ My Pledge to My Future Self: I hereby pledge to continuously work to increase my Net Cash Flow. I pledge to make the sacrifices necessary – over both the short-term and the long-term – to increase my Income and decrease my Expenses in order to increase my Net Cash Flow and my future opportunities. ______________________________________ ___________________________ Signature Date ______________________________________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 61 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 62 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 65 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 2: Budgeting: Income, Expenses & Cash Flow Page 66 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 3: Borrowing & Debt Management Page 67 of 243 CHAPTER 3 BORROWING & DEBT MANAGEMENT When people pile up debts they will find difficult and perhaps impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their present wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that when the future difficulty arrives, they’ll figure it out. They don’t always do that. Michael Lewis in Boomerang KEY ISSUES FOR GRADUATE STUDENTS • Debt can be very beneficial to all of us – it helps us invest in ourselves today to create opportunities for the future. • It is critical to understand the differences between “good debt” and “bad debt.” • Good debt generally helps you create those better opportunities in the future and generally costs you less in interest (student loans, mortgages). Use good debt intentionally and thoughtfully. • Bad debt is generally about impulses or consumption today and does not benefit you for the future and generally costs much more in interest (credit cards). Avoid bad debt if possible. • The differences between a low rate of interest – anything under 6% – and a high rate of interest – anything over 12% – can be enormous. And this is cash out of your pocket. • Your credit score is one of the most important numbers in your financial life. As a grad student, you can work to increase your credit score so that you’re in a great position to use it to create opportunities and improve your financial situation after you graduate. Know what it is. • Before you ever borrow money in any form, have a plan for how you are going to repay that loan. If you do not have a plan before you borrow, you may endure significant pain and sacrifices when you have to repay that loan. How much of your future do you want to sacrifice today? Let’s start this chapter with a couple quiz questions: Assume you graduate with $10,000 in student loan debt. You are paying 5% annual interest on this debt. Assume you make monthly payments for the next 10 years and completely pay off this debt. Chapter 3: Borrowing & Debt Management Page 70 of 243 Think of the math problems we did to open this chapter. Let’s analyze these. If you borrow $10,000 for your education, and you end up paying a total of $12,727.86, are you okay with that? Think about this another way: What if you had $25,000 of cash in your bank account – would you be willing to pay $12,727.86 cash for your education? That’s over half of your cash. The answer is probably yes – because that education is likely to increase your net worth and future earning potential by way more than $12,727.86 (plus all of the intangible benefits you get with higher education, like knowledge and friends and purpose). Your student loan is probably “good debt.” Now what about the $10,000 you put on your credit card? The question doesn’t specify what you bought with this $10,000, but let’s assume it’s the same stuff most people put on their credit cards: nice clothes, cool shoes, lots of really fun Friday nights, an enormous TV and a few really fun trips. In the end, after you’re done paying off this loan, you will have spent $22,392.84 for all of this stuff…even though the price was only $10,000. If you had $25,000 of cash in the bank, would you spend over 90% of that cash for these cool shoes and fun trips that are only worth $10,000? You’re probably shaking your head “no” right now; that’s what I’m doing. I certainly don’t want to sacrifice an additional $12,392.84 of my future to buy this stuff today. I can wear my ugly shoes and take a simple road-trip to the beach. When you buy $10,000 of short-term wants and end up paying over $22,300 for them, that’s “bad debt.” It’s might make today more fun, but it can destroy your future. There are some types of debt that might be somewhere between “good” and “bad.” What if you have to put your school textbooks on a credit card? If that’s the only way you can buy those books that are essential elements of investing in your future, then even that credit card debt might be good. What about a car loan? If you buy in a 1966 Mustang that will only go up in value, then it’s good debt. If you buy a low-priced, possibly used, economy car that’s essential for you to get to work or take care of your family, then it’s probably good debt. If you buy a tricked out jeep or sports car just for fun, when you could have spent $10,000 less to satisfy your needs, then that’s bad debt. The key difference is “needs” vs. “wants.” Good debt pays for needs, bad debt pays for wants. And you’re smart – you know what the difference is between needs and wants. STUDENT LOANS & FINANCIAL AID THE NITTY-GRITTY OF THIS KIND OF GOOD DEBT The best investment I’ve ever made is investing in myself and in my education. My undergraduate degree and my graduate degrees enabled me to obtain jobs that I would not have been eligible for without those degrees. Those jobs led to more opportunity and more money. But paying for my education was not easy. I was fortunate: my parents contributed to my undergraduate degree. But I did work part-time through both undergraduate and graduate schools and I took out student loans. One of the happiest days in my financial life was the day I entirely paid off my graduate school student loans – I was 29 years old and on my way to even more professional responsibility and freedom. Paying for graduate school is rarely easy. Many students will earn scholarships and stipends to cover some of the cost. Some students are fortunate to have family members help cover some of the cost. But, for the rest of us, we have to rely on a mix of sources – family, work and loans. In this section, Chapter 3: Borrowing & Debt Management Page 71 of 243 we’ll talk about student loans and financial aid – but we want to remind you that this information is general information that may or may not apply to you. Please stay in constant contact with your financial aid advisors – both on campus and with your lenders – to fully understand your financial aid rights and responsibilities. We all have different situations and different needs; only you can completely understand your situation. Be proactive and take control. Entire books have been written about this process and about helping you find the best programs and loans for you. We are not going to attempt to do the same here. What we talk about here will be specific to Federal Student Loan Programs – the general ideas will apply to other types of student loans (such as private lender loans), but the specific policies will certainly differ. What do you do first? The first step in the federal financial aid process is to review and complete the FAFSA – the Free Application for Federal Student Aid (available at fafsa.gov). From this, the federal government will create your Student Aid Report (SAR). This will summarize the information you included on your FAFSA and will put it in a standardized format. The SAR will not tell you how much financial aid you are eligible to receive; only your school can do that. How much do you need to borrow? While you may think the answer is “everything,” the Federal Loan Program and your school will use the following calculation to determine the “need-based” financial aid you are eligible for: + COA = Cost of Attendance – EFC = Expected Family Contribution = Financial Need Each school is responsible for reporting its Cost of Attendance (COA). For students attending school for half-time or more, the COA is the estimate of tuition, fees, room, board, books, supplies, transportation, loan fees, and other miscellaneous expenses (including computer needs, childcare, disability-related costs and study-abroad costs). Each individual will determine their own Expected Family Contribution (EFC). This calculation will be determined based on the information on your FAFSA and SAR. Your family’s income, your family’s taxes, your family’s assets and your family’s benefits (such as social security and unemployment) are the primary factors that determine your EFC. Need-based aid includes Federal Pell Grants, other Federal grants, Federal subsidized loans, Federal Perkins loans and Federal work-study. Each of these has different terms, different eligibility requirements and different repayment responsibilities. Talk to your financial aid office about the details of each and what you might be eligible to utilize. Chapter 3: Borrowing & Debt Management Page 72 of 243 Beyond “need-based” borrowing, each student is eligible to apply for “non-need based aid.” • Direct unsubsidized loan • Federal PLUS Loan • Teacher Education Access for College and Higher Education (TEACH) Grant + COA = Cost of Attendance – Financial Aid Awarded So Far (includes all sources: school, scholarships, other…) = Eligibility for Non-Need Based Aid Note that non-need based aid is not based on any Expected Family Contribution (EFC). Thus, you may be able to obtain non-need based aid to replace contributions from family members, lessening the overall burden for you and your family – though perhaps only in the short-term. With only a few exceptions, all loans you obtain through financial aid – whether federal, state or private, need based or non-need based – must be repaid. As we will talk about shortly, the good news is that you typically pay lower interest and you have a variety of flexible repayment methods. In the following chapter on Savings & Investment, we will talk about how great compound interest is – your interest earns interest, which you get to keep. That’s really cool – for saving and investment. It stinks when you’re a borrower – because you have to pay interest on your interest. This is true for student loans, just as it is for all other loans. This discussion applies to all students, whether undergrad or graduate students. However, as many of you well know, there are a number of significant differences between obtaining financial aid or student loans as a graduate student relative to obtaining aid as an undergraduate student. 1. You are independent of your parents – You still have to complete the FAFSA, but you only have to include your own family’s information, exclusive of your parents. This probably means you’ll have lower income and assets, potentially entitling you to larger loans. 2. There are no federal subsidized loans – When you borrow under a federal program, you start accruing/owing the interest expense as soon as you get the cash, not when you graduate. 3. Your interest rates and your borrowing amounts are typically higher. 4. If you’re working with good credit, there may be good private student loan options available. 5. Grants – such as Pell grants may be limited – Federally sponsored programs typically prioritize benefits for undergraduate education, which reduces the benefits for graduate students. However, there are typically more school-sponsored grants for graduate students. 6. You have a clearer vision of your future career, possibly with a focus on one that offers debt-forgiveness. This is discussed further in a few pages. The following table gives you some idea of what the full, true cost of your student loan will be over the complete term of repayment. This tables provides a variety of common student loan balances, five reasonable interest rates and three possible repayment terms of 5, 10 and 20 years. Chapter 3: Borrowing & Debt Management Page 75 of 243 Revised Pay-As-You-Earn Repayment Plan (REPAYE) Ø Your monthly payments are 10% of your discretionary income, which is a calculation based on your salary and the cost of living where you reside. Ø Payments are recalculated each year, based on your income and your family size – because your spouse’s loan balance might be combined with yours. Ø If your undergraduate loan is not fully repaid within 20 years or your graduate loan is not fully repaid within 25 years, it is forgiven. Gone. Written off. o But you will probably owe income tax on the amount of loan that is forgiven. Ø This Plan is a good option if you are seeking Public Service Loan Forgiveness. Income Contingent Repayment Plan (ICR) Ø Your monthly payment will be the lesser of: o 20% of your discretionary plan; or, o The amount you would pay on a standard plan over 12 years, adjusted annually as your discretionary income may change. Ø If your loan is not fully repaid within 25 years, it is forgiven. Gone. Written off. o But you will probably owe income tax on the amount of loan that is forgiven. Ø This Plan is not eligible for Public Service Loan Forgiveness. There are other options, most similar to the above, with minor adjustments, such as when you received your loan or how your file your taxes (single or married). The entire repayment process can get pretty overwhelming very quickly with all of the various differences between programs. As always, only you can determine which plan is best for you based on your income situation, family situation and personal preferences. Here are a few reminders to sort things out: Ø Flexibility is never free. It may be necessary, but you will pay for it. Ø You will pay interest. And, you will pay interest on the interest. If you graduate with $30,000 in student loan debt – which is about the average in the U.S. – and have a 6% interest rate, you will make payments totaling $39,769 if you repay in 10 years and you will make payments totaling $51,326 if you repay in 20 years. Again, flexibility can be expensive. If you’ve learned nothing else in this chapter, you should know that not all debt is created equal – there’s good debt and bad debt. We generally think of student loan debt as good debt because it enables you to have more career options and higher salaries than you otherwise would have had without the loan – it did so for me. However, while the loan provides you with this wonderful opportunity, it is your responsibility to turn your education into the best investment you’ve ever made. And some – but certainly not all – of that will relate to the career you follow after graduation. Student Loan Forgiveness for Certain Careers Despite what you may hear from commentators and cynics, the government does make a lot of investments in the future of its citizens. These investments can create new and amazing opportunities for you and your future. Chapter 3: Borrowing & Debt Management Page 76 of 243 One of these future-focused investments is the lower interest rate on subsidized student loans the government offers to millions of Americans. But, for many Americans, it goes even one step further: if you choose a career that the government deems public service, the federal government will forgive a portion or all of your student loan debt. Ø Teacher Loan Forgiveness – If you teach full-time for 5 consecutive and complete academic years in a low-income elementary school, secondary school or educational service agency (like a regional school district), you may be eligible to receive either $5,000 or $17,5000 of student loan debt forgiven. o If you are a math, science or special education teacher, you might be eligible for $17,500 of loan forgiveness. o Other teachers might be eligible for $5,000 of loan forgiveness. o Note – if your loan is in default or you have not been making the required payments during those 5 years of teach, you might not be eligible for loan forgiveness. Ø Public Service Loan Forgiveness – If you are employed by a federal, state, local or tribal government, and you have made 120 qualifying payments on your loan (10 years), then you may be eligible to have the remaining balance on your student loan forgiven. o If you work for a qualifying non-profit organization, you might be eligible. o If you are serving with AmeriCorps or the Peace Corps, you might be eligible. o If you work for labor unions, partisan political organizations, for-profit government contractors, and some religious organizations you might not be eligible. o Amounts forgiven are not considered taxable income, so you will not owe income taxes on any forgiven loans. Note that this is just a summary of the programs and primary conditions – be sure to read the fine print and consult a financial aid advisor to better understand that advantages and disadvantages to each of these programs. Should you choose your career based on the potential ability to have your student loan forgiven? As always, only you can determine that. We generally advise that you should choose the career that provides you with the most joy and purpose. Most of you will be spending then next 30-40 years in your chosen career, and this career will hopefully bring enormous joy and purpose to your life. Can you put a price or value on that joy and purpose? CREDIT CARDS SELLING YOUR FUTURE TO PAY FOR TODAY First and foremost, when you receive a message or letter telling you that “You’ve been pre-approved for our credit card!”, that does not mean you’re special. You’ve only been pre-approved because they want your money. They want to take advantage of you. They do not want to help you and they do not want to be your friend. Ignore it. Shred it. Throw it away. The term “credit” is one of the most common terms in finance. When someone – a store or a bank or a credit card – gives you “credit,” they’re giving you money – or, they’re loaning you money that you have to pay back….with interest. Chapter 3: Borrowing & Debt Management Page 77 of 243 The words “credit” and “interest” sound like good things – in most uses, they are good things. A professor might give you credit for writing a great paper. You might take an interest in someone at a party. You might earn interest on your savings account. But, in finance, these words can be super dangerous – and that’s how lenders get you! These words should come with a warning; instead they are used to entice you into buying stuff today…in exchange for paying a lot more in the future. We have already talked about good debt and bad debt. We have already determined that most credit card debt is bad debt. We have already looked at some of the numbers about the true, full cost of using a credit card. If you’re not scared straight yet, keep paying attention. Let’s assume you have a great deal and your credit card company is only charging you 15% interest. This 15% number is called the “Annual Percentage Yield” or APR. For each $1.00 that you put on your credit card, you will be paying $0.15 additional per year in interest. And, if you don’t pay off your credit card at the end of the year, you will pay $0.15 for each dollar still on your balance in each subsequent year. What does that mean? It means that, if you pay off that $1.00 in 5 years, the total cost to you of that $1.00 purchase will be $1.43. Imagine you buy a $5.00 latte with your credit card – if you take 5 years to pay that off with your credit card, you will have paid $7.14 in total. How does that feel – is a $5.00 latte really worth $7.14? Maybe you still think it is. Okay, what if you find some shoes online that cost $100. Maybe they’re on sale and you’re getting a great deal. But, if you put that on your credit card and take 5 years to pay for them, that “great deal” will end up costing you $143. Not such a great deal anymore. And these numbers get even more painful if you take longer to repay. If you take 10 years instead of 5 years to pay for your $5.00 latte, the true, full cost will end up being $9.68. Those $100 shoes will end up costing you $194. You get to keep shoes worth $100 and the bank gets $94. The tables on the following page show you the true, full cost of paying for a purchase with your credit card assuming different credit card balances and different interest rates, assuming you repay over either 5 years or 10 years. Chapter 3: Borrowing & Debt Management Page 80 of 243 What about penalties? Yes, that’s right – credit card companies love to make you pay penalties. When you receive your monthly statement, the credit card company will indicate a “Minimum Payment Due.” This is, perhaps obviously, the minimum amount you must pay by the due date to avoid a penalty. If you do not make this payment, then you owe a penalty – frequently 25% or 40% of the minimum amount due. Do everything possible to avoid ever missing a minimum payment due so you never have to pay this penalty. Finally, what about annual fees? Many credit cards charge you an annual fee simply for the privilege of using their card. NEVER EVER pay an annual fee on a credit card! There are hundreds or thousands of credit card options available. You can certainly find one that does not make you pay an annual fee. Find one. Note – for some businesses, there are credit cards that have unique benefits, such as purchase insurance or fraud protection; it may be worthwhile to pay an annual fee to get these benefits in some rare cases, but it will almost never make sense for individuals. You may have noticed that I referenced “my credit card” above. That’s right, I have a credit card. In fact, I have three. I use one for automatically paying my recurring bills – utilities, cable, phone. I use another for periodic discretionary purchases, like a latte. And, I use the third for big non-recurring purchases, such as airplane tickets. I do this to make budgeting easier and to assign my purchases to different accounts in my mind – even if all 3 cards are tied to the same checking account. For how my brain works, this makes sense. This process helps me with the accounting and it prevents me from running up large balances on any single card without knowing what those actual purchases are for. For many people, having and using 3 credit cards would be very dangerous because they would run up balances on each without knowing what they’re doing. If you are one of these people, do not use more than 1 credit card….out of sight might be out of mind, but it will still accrue interest. Finally, to assure you that I am not being a hypocrite as I simultaneously warn you about using a credit card and tell you about my own credit card usage, here are a few more ways I use my cards: • I have been using credit cards for more than 25 years and I have never paid an annual fee. • I have never paid any interest on credit cards – for over 25 years, I have paid off the entire balance on each due date (“Minimum Payment Due” means nothing to me – I always pay the “Statement Balance”). • I have never taken a cash advance from a credit card. I’m not going to tell you to never use a credit card. But, as with everything, you have to understand both the advantages and disadvantages associated with using one. If the disadvantages and risks are greater than the advantages, then don’t use one. Only you can determine how your mind works and any risks associated with your behavior – and only you can determine if having a credit card is too dangerous for you. Banks and credit card companies have beautiful offices and buildings. That’s good for them – but, I don’t want to pay for those offices. Chapter 3: Borrowing & Debt Management Page 81 of 243 YOUR CREDIT SCORE: ONE OF THE STRANGEST & MOST IMPORTANT NUMBERS IN YOUR FINANCIAL LIFE Let’s start with three simple “yes” or “no” questions: (1) Have you ever heard of a “credit score?” (2) Do you have a clue where it comes from? (3) Do you know how important it is? We’re going to assume that your answers to questions (2) and (3) are “no.” We’re here to help. But first, a little history. Borrowing has not always been easy for all people. Prior to the 1950s, banks and other lenders were very particular about which individuals and companies they lent money to. Many of these practices were racist and sexist. Many of these practices were based on relationships and not necessarily on the ability of a potential borrower to repay. Government regulators and many lenders were eager to create a uniform, objective and consistent process to evaluate a potential borrowers’ ability to repay. Two individuals, Bill Fair and Earl Isaac created such a process in the late 1950s – they named their company “Fair Isaac Company” and they called their product the FICO Score. After a while of fine-tuning their scoring system and working with lenders and regulators to establish its objectivity, the FICO Score became widely used during the 1970s. Its use continued to expand and by the early 2000s it became the gold standard around the world for lenders to determine whether or not a potential borrower is worthy or borrowing money – and to help lenders determine what interest rate to charge a borrower. That’s both good news and bad news. The good news is that we have one global standard, that is relatively objective, for evaluating whether or not an individual is a high risk or a low risk. Using one single number eliminates much of the objectivity from the lending process. The bad news is that this one single number is far from perfect as it can be systemically biased. Does your SAT or GRE score properly convey how intelligent you are? No, of course not. But universities use them more than any other number to determine whether or not to admit you – perhaps because it’s easy for them, perhaps because they haven’t found anything better. The same logic applies to your FICO Score – it’s not perfect, it does have some biases, and it does have some weird features. There’s no way that it can fully and accurately represent your ability to repay a loan. But, like it or not, it’s the best we have and almost every lender uses it. Note – There are other credit scores out there. The FICO Score is not the only one that exists. But it is the most popular, used by over 90% of lenders. Thus, while what we talk about here is specific to the FICO Score, the general principles apply to the other scores in use, too. So, how is your FICO Score determined? There are 5 distinct, mostly objective, categories that the FICO Score includes. Chapter 3: Borrowing & Debt Management Page 82 of 243 What does each category mean? Let’s evaluate them: 35% Payment History – This is perhaps this simplest category, as it looks at how well you repay all borrowed amounts on credit cards, retail accounts, auto loans, utilities and phone bills, other installment loans and other debts. The better you are at repaying, the better your Payment History. Pay your bills on time. 30% Amounts Owed – The amount you owe is not simply about how much money you owe, but it’s also about how much of your available credit you use. If you have a credit card limit of $5,000 and your balance is $4,000, that’s worse than having a limit of $20,000 and a balance of $10,000. There are many trade-offs within this category and it can be confusing. Owing a larger amount can be helpful to your Score if you always make the required payments. – this indicates good credit behavior. 15% Length of Credit History – This is also pretty simple – the longer your history of paying bills and loans, the better off you’ll be. Yes, this does bias against younger borrowers – but if your behavior in the other categories is strong, you should be okay. Be patient – you’ll build your history. 10% Credit Mix – Perhaps ironically, it can be better to have 5 different accounts that you repay regularly than it is to have just 2 different accounts. The greater the variety of accounts you have, the more opportunity you have to indicate that you are a low credit risk. Of course, if you have 5 accounts and you miss your payments, that will be doubly bad. Pay your bills on time and the Credit Mix will take care of itself. 15% Length of Credit History 10% New Credit 35% Payment History 30% Amounts Owed 10% Credit Mix COMPONENTS OF THE FICO SCORE Chapter 3: Borrowing & Debt Management Page 85 of 243 So, what’s the moral to you? Establish a credit history, pay all your bills on time, work to get your FICO Score up above the average of 700 and everything will take care of itself. You can always check your Score to see where it is, and if you ever get concerned you can contact one of the three credit bureaus – Experian, Equifax and TransUnion – to get your credit report, which is the primary resource for calculating your credit score. If you see anything on your credit report that is not yours or is wrong, you can appeal to the bureaus and work with them to have it corrected. Be responsible, be proactive, and, as always, take control of your financial future and you’ll be better off for it. MAKING DECISIONS ABOUT PAYING DEBT Back in Chapter 1, we asked you what you would do if you won the lottery. Let’s try that exercise again, but now with different numbers and different options. Imagine that a friend gave you a Lotto Scratch-Off ticket. And you won $10,000. What would you do with that $10,000? Please rank the following 4 things: 1. Spend the $10,000 on a trip around the world ___________ 2. Spend the $10,000 on a home entertainment system ___________ 3. Put all $10,000 in a savings or investment account ___________ 4. Pay off $10,000 of high-interest rate debt ___________ If you’ve been paying attention throughout this chapter, hopefully you would pay off the debt first. It is the biggest burden on your life – both today and in the future. Paying it off, getting rid of that burden, will free you up to begin working towards your goals and dreams – without worrying about increasing interest rates or debt collectors. As you’ll learn in the next chapter, your second choice for putting the $10,000 should be to put it in savings. When you deposit money into a savings account, it earns interest; and if you leave it in the account long enough, the interest earns interest, which is like free money to you (that’s called “compound interest;” stay tuned for more on that). Nothing in this book can guide you on whether a trip around the world or a home entertainment system if a better use of your lottery winnings. You have to decide that yourself. But we do know you shouldn’t do either until you’ve paid off your debt and at least established a savings account. Chapter 3: Borrowing & Debt Management Page 86 of 243 Now let’s look at that $10,000 of debt that you’re paying off a little more closely: Imagine that a friend gave you a Lotto Scratch-Off ticket. And you won $10,000. You’ve decided you’re going to pay off $10,000 of debt with your winnings. Very smart. Which debt would you pay off first? Which debt would you pay off last? Please rank the following 4 types of debt in terms of which you would pay off first: 1. Student loan debt with an annual interest rate of 5% ___________ 2. Credit card debt with an annual interest rate of 18.99% ___________ 3. A finance company or pawn shop loan charging 3% per month ___________ 4. An auto loan with an annual interest rate of 7.50% ___________ By now, you’ve probably noticed that many of the activities in this book do not have ‘right’ or ‘wrong’ answers. That’s intentional – many finance decisions are situational and personal. But this one is not situational or personal. This one absolutely has ‘right’ and ‘wrong’ answers. What’s the right answer or ranking for paying off these 4 different types of debt? #3 should be paid off first. It has the highest interest rate (36% per year) and it probably has the highest potential ‘other costs,’ such as someone coming to physically collect the debt. #2 should be paid off second, simply because the interest is so high. Pay off your credit cards every month to avoid the high interest rates, plus any late fees or maintenance fees. #4 should be paid off third. This is actually a form of ‘good’ (or at least ‘decent’ debt). The rate isn’t super high, and with an installment loan like this, assuming you make regular monthly payments, you can establish good credit history and increase your credit score. #1 should be paid off last. The student loan has the lowest interest rate and the most negotiable repayment terms. You should pay it off eventually, but other debt may take priority. Making regular payments can help improve your credit score, which is a good thing. If you said you should pay off the student loan before the auto loan, that’s okay. That can be a personal decision. Yes, the auto loan has the higher interest, but it also has a shorter term. Seeing this shorter term may help make the end real for you. For many people, there can be something very empowering about retiring debt – and this empowerment can gain momentum and inspire you to completely pay off other debts. Chapter 3: Borrowing & Debt Management Page 87 of 243 By now you’ve also probably learned that personal finance is both a math game and an emotional or mental game. Maximizing the opportunities you create for yourself through financial planning requires doing the math on some different options, but it also requires you managing your emotions to best align your action and behavior with your short- and long-term goals. Retiring an outstanding debt can be one of the most powerful personal finance investments we can make. It gives you control. It gives you confidence. It gives your plan purpose. And all of those are very good things. FINISHING HOW WE STARTED HAVING THE RIGHT ATTITUDE ABOUT DEBT Michael Lewis is one of the best modern day finance writers. He writes stories and books about really big finance issues in ways that are readable and enjoyable for even the most novice student of finance. And the reader always learns something from his books. His book The Big Short about the 2008 Financial Crisis was turned into a wonderful movie (of the same name); if you haven’t seen the movie, it’s a great way to better understand one of the biggest shocks to the financial systems in history (your parents, bosses and professors lived through this Crisis, and seeing this movie might help you better understand their boring stories about how that Crisis changed their lives forever). He followed that with a book titled Boomerang, which was a simple and brilliant study of how five different nations dealt with the 2008 Financial Crisis and the following turmoil the hit each country in the following years. One of the biggest causes of the Crisis was debt: money that individuals, companies and nations borrowed, with the obligation to pay it back in the future, hoping that that borrowed money would change their futures. Lewis ends the book with the quote at the beginning of this chapter – as a warning to people to be mindful and careful about how we borrow money. Good debt can be great, bad debt can be disastrous. We have to know the difference. When people pile up debts they will find difficult and perhaps impossible to repay, they are saying several things at one. Our actions reveal our values. We’ll talk about this a lot in Chapter 6. When you borrow money, you are telling the world about your values. They are obviously saying that they want more than they can immediately afford. We have to borrow because we can’t afford something. If we’re borrowing for good debt, that’s probably fine; if we’re borrowing to indulge and live a life we haven’t earned, then that could lead to serious problems. Chapter 3: Borrowing & Debt Management Page 90 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 3: Borrowing & Debt Management Page 91 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 3: Borrowing & Debt Management Page 92 of 243 SPACE FOR NOTES, THOUGHTS, PRACTICE & PLANNING ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ Chapter 4: Saving & Investing Page 95 of 243 CHAPTER 4 SAVING & INVESTING KEY ISSUES FOR GRADUATE STUDENTS • Saving and investing can be the key to meeting many of your long-term financial goals – buying a house, education planning for children, retirement. But it can also be extremely difficult to think about while in grad school with limited income. We all know this. • The goal – while in grad school – should not be to maximize your saving; the goal should be to develop habits that set you up to implement an investment plan once you graduate and once your income situation allows you to save and invest more. If you set aside $10 or $20 a month now, it will help you think about your spending and help you get used to saving for the future. • Identify your long-term goals – over 2 years, 5 years, 10+ years. What do you want to achieve with your saving and investing? Specifying your goals is critical to developing an investing plan. • Every single human being has different risk tolerances. You are unique. Recognize how you are unique – and then develop an investing plan for the future. • Nobody alive can tell you how the stock market or other investments will perform in the future. Nobody. Frenzies like Gamestop, Bitcoin, Dogecoin, Tesla and others look like free money when they’re going up – but they can become very painful if/when their prices start falling. • You are in graduate school to become an expert in a specific field. You are – or will soon be – better than 99.9% of humanity in that specific field. But that may not mean you are also better than most of humanity at investing. Know your expertise, know your limitations, have a plan. Let’s start this chapter with a few quiz questions – these are easy questions because there’s not really ‘right’ or ‘wrong’ answers; please just pick the answer you prefer based on your own situation or preferences. #1 Which would you rather we give you: (A) $100 in cash today (B) $100 in cash in 12 months #2 Which would you rather we give you: (A) $100 in cash today (B) $500 in cash in 12 months #3 Which would you rather we give you: (A) $100 in cash today (B) $120 in cash in 12 months Chapter 4: Saving & Investing Page 96 of 243 #4 Which would you rather we give you: (A) $1,000,000 in cash today (B) $1,000,000 in cash in 12 months #5 Which would you rather we give you: (A) $1,000,000 in cash today (B) $5,000,000 in cash in 12 months #6 Which would you rather we give you: (A) $1,000,000 in cash today (B) $1,200,000 in cash in 12 months These questions are designed to get a sense of your risk tolerance. Financial management is about making trade-offs, usually between benefits today vs. costs in the future or costs today vs. benefits in the future. Much of what finance does is put a price on time – the finance industry is built around trying to structure investments that satisfy people’s preferences and risk tolerance over time. When you deposit $100 in a checking or savings account at a bank, that makes the bank happy. Now the bank has an additional $100 that it can use to make a car loan or a student loan or a credit card loan – and, as we all know very well from the previous chapter, the bank is going to charge us interest on that loan. The bank can do this because money is limited and it is doing us a favor by giving us that loan – so we have to pay for that favor. Of course, your $100 deposit is valuable to the bank. You shouldn’t be giving your money to the bank and doing it a favor without you charging the bank for giving it the ability to use your money. Thus, the bank is (usually) going to pay you some interest on your $100 deposit. If you have money deposited in any bank, savings and loan or credit union account and they are not paying you interest, you might want to look for another place to store you money – your money is valuable, both to you and to any financial institution, and that institution should be paying you for you doing it a favor. But what’s the right rate for the bank to pay you to use your $100 deposit? And what’s the right rate for the bank to be charging individuals and companies that borrow from it? Determining the right rates to charge on everything is very complex – but, in general, it’s about opportunities and risk. What other opportunities do you have to use your $100? What other loans could the bank be making? What is the risk of the bank not repaying you’re your $100? What is the risk of a student not repaying its student loan to the bank? While we said that there are not any ‘right’ or ‘wrong’ answers to these six questions above, there are some questions that have some responses that most people will have in common. Chapter 4: Saving & Investing Page 97 of 243 Questions #1 and #4: Most of you probably answered (A). If you have $100 today, you can spend it, use it, save it, invest it and enjoy it. Why would you wait 12 months for that $100? Most of us wouldn’t – and there’s usually no great reason to wait. Question #2: Most of you probably answered (B), suggesting that you would be willing to sacrifice a little bit in the short-term – give up $100 today – to earn a much great reward in the not-too-distant- future - $500 in just 12 months. That’s a sacrifice most of us would be willing to make. Question #5: In theory, the answer should be identical to your answer to Question #2. The only difference is that the numbers are much bigger, exactly 5 times bigger. But these bigger numbers make it feel like you’re making a much bigger sacrifice. The idea of getting $5,000,000 in 12 months is super-exciting…but the idea of giving up $1,000,000 today might feel very painful, much more painful than just giving up the $100 you had to give up in Question #2. Questions #3 and #6: These are the tricky ones. Here the reward-to-sacrifice ratio is much smaller, and we have to think harder and maybe do some math to figure out whether we prefer (A) or (B). There really is no way of knowing – or of us telling you – which you should prefer. And this reward-to-sacrifice ratio is what saving and investing are all about. Let’s focus on Questions #3 and #6 and think about all of the questions you might want to know before deciding whether you’d prefer (A) or (B). Here are some of the things I need to know: Ø What can I do with the $100 or $1,000,000 today? Ø Do I have any immediate needs in the next 12 months – school tuition, medical expenses, food – that I cannot otherwise afford? Ø If I take the $100 (or $1,000,000) today and invest it and earn 21%, then I will have more than $120 (or $1,200,000) in 12 months. Can I find an investment – with a similar or lower amount of risk – where I can earn 21% or more? Ø Can I borrow money today and pay less than 20%? If I borrow $100 today, owing 10% interest, repay ($100 x .10) + $100 = $110 in 12 months, my net profit is $10 cash. Ø What is the likelihood that the payer will still be able to pay in 12 months? Can I trust them to make that payment in the future? Certainly, there are other issues you might be concerned about. We all have different situations and different issues that we might need to think about. The point of this is to highlight the notion that financial planning – and finance in general – constantly involves tradeoffs between the present and the future. This is not new to you – graduate school is all about making sacrifices and determining tradeoffs.