May 2009 Archives
A college student acquaintance of mine is home for the summer and jobless. I don't know a whole lot about their family situation, but if they are like most families, paying for college requires the student max out on loans, possible grants and perhaps the parents have even signed for a parent loan. This student is transferring from a private college where she spent the past two years to a state college where she will have a different major, and a possible extra semester or two. over the course of funding her college she will amass approximately $22,500.
Preliminary data from the 2007-08 NPSAS suggests that the average amount of debt among undergraduate seniors at 4-year institutions has increased to about $22,500. (www.finaid.org) Using the current student loan interest rate of 5.6%, once she graduates she will be obligated to a $245 monthly payment for the next ten years. In the meantime we hope she can get a job in her field and one that will pay here enough to not only pay back the student loan, but also help finance her first car, get her into an apartment, maybe get married and start a family. Oh, and her career field will require that she have a master's degree within a few years of starting work. Now here employer may provide some assistance with those payments, but possibly not.
So, you may be asking, where does the $1,100 decision come in? And what about her job prospects in this down economy? Our community streets department has a job opening for currently enrolled college students. (Probably funded by the Pennsylvania Higher Education Assistance Agency PHEAA). When I saw the ad in the newspaper, I called her and asked if she subscribes to the paper and if she saw the ad. She answered in the affirmative to both questions. It was her next statement that set me back, leaving me speechless. "I can't get up that early. I'd have to be at work by 6:00 a.m." So I did some calculations, The summer assistant at my office can earn $3,600 through PHEAA. If the streets job would pay that much our student in question would not have to borrow the $3,600 she could earn. By making the decision not to apply for the job, she has made the decision to pay back a loan in the amount of $3,600 and an additional $1,100 in interest! ($3,600 at 5.6% paid monthly over 10 years.) That is the "opportunity cost" of sleeping in this summer. Sleep in today, to work extra hard in the future to retire those debts.
Despite nearly 50% of the US population having investments in the stock market (by way of 401k or pension funds) most are unfamiliar with how the market works and how to manage financial risks. Often I hear people mention that investing in the market is "risky". Actually, everything we do has it's risks, from the time we get out of bed in the morning to the time we head back there in the evening, we each face a myraid of risks. What if you slip in the shower and hit your head? What if your morning eggs are undercooked and you get salmonella poisoning? What if someone runs a red light at an intersection and T-bones your car? And yet, despite these risks, most of us get out of bed, get a shower, eat breakfast and drive to work!
"Buy low and sell high" is the foundation of investing. And yet during recent months, many Americans have done exactly the opposite. Declining stock prices have caused many people to "lose" money on their investments, particularly their retirement funds. People forget that those investments were purchased over time and that despite the current lows, they may actually have purchased some of their stocks at an even lower price. So the value of their portfolio indeed grew and is now lower than it had been. They haven't lost "real money" until they do indeed sell.
Greed and fear are the two emotions commonly discussed regarding investor behavior. Greed motivates us to put money into the market with the hopes of at least maintaining the value of our investment but many of us hope these funds grow exponentially, creating wealth. Fear, on the other hand motivates us to sell on fears that while our investments have lost value, they might experience even further losses. Researchers have discovered that our brains are wired to react more strongly to losses than to gains.
Former Federal Reserve Chairman Alan Greenspan, in a 1996 speech used the phrase "irrational exuberance" to capture what his sense of the stock market performance at that time. I guess I'm thinking that "irrational pessimism" captures the emotions of today. Yes, I too have "lost" value in my retirement funds. My employer matches my contributions so when I evaluate my current performance, on the surface, I see that I have "lost" some of the money Penn State contributed. Overall tho, if I looked a little further, some of the mutual funds shares I've purchased over the past 12 years of my employment were bought at rates even lower than today! I'm not planning to use my retirement funds for at least another 15 years and more likely not for another 25 to 30 years. Frankly, I'm enjoying buying low each month. I have limited my debt capacity and am working to pay down my mortgage. By carefully managing my financial risks, including 6-months of emergency funds, I am not subject to the fears others are facing. My 10 year old car and paid off credit cards, as well as my planning and tracking my spending are other ways I'm avoiding the irrational pessimism that is being perpetuated by the media. Hey - they have to get you to watch tv and read the paper! Those researchers hadve it right - we react more strongly to bad news that we do to good news!