CFP Board eNewsletter
July 2008
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CFP Board eNewsletter |
| Kids and Money III: The College Years |
In this, the third in a series of four articles on kids and money, It’s Your Turn presents some tools and tips to help parents as well as college students get a handle on personal finance. The first article in this series focused on The Early Years, the second on The Adolescent Years. The final article will focus on young adults who are still living at home. Here are some statistics that will strike fear into the hearts of parents everywhere. College freshmen receive an average of 11 pre-approved credit card applications each month. Unfortunately, they don’t seem to be tearing up the mailings and throwing them away. According to the 2006 Credit Card Study by student loan lender, Nellie Mae, the average outstanding balance on graduate student credit cards was $8,612, an increase of 10% from 2003; 94% of respondents used credit cards to pay for some of their direct education expenses (for 28%, this included a portion of their tuition); and 67% said they took out their first credit card as an undergraduate. In 2004, Generation Broke: The Growth of Debt Among Young Americans, a survey published by think tank Demos, found that young people between the ages of 18 and 24 spent nearly 30% of their income on debt payments, double the average percentage spent in 1992. It’s bad enough that the cost of higher education (as well as food and fuel!) is going through the roof, but just as kids are getting ready to leave the nest they are vulnerable to having their wings clipped by excessive credit card debt. How can parents — and students — avoid that trap? In his book Predictably Irrational: The Hidden Forces that Shape Our Decisions, Dan Ariely suggests a novel solution: the “ice glass” method of credit card management. “Put your credit card into a glass of water and put the glass in the freezer,” Ariely writes. “Then, when you impulsively decide to make a purchase, you must first wait for the ice to thaw before extracting the card. By then, your compulsion to purchase has subsided.” For those who find the “ice glass” method a bit impractical, Joline Godfrey has an alternative. “The first time the credit card bill comes in, go over it with your child and point out the fine print,” says Godfrey, author of Raising Financially Fit Kids and founder of the financial education firm Independent Means Inc. “Otherwise, it’s so abstract. Without direction, it’s so easy to mismanage credit cards. To develop a great (tennis) backhand, you need coaching; to manage credit cards, you need coaching, too.” Godfrey tells the story of a woman whose daughter went away to college, ran up her credit card and couldn’t pay it off. So mom paid it off for her. Then the credit card company sent her daughter another card, this time with a higher credit limit. The daughter maxed that one out, too, and her mom paid it off. So the credit card company sent the daughter a third card, with an even higher credit limit, and she maxed that out, too. Only then did mom say, ‘I can’t afford to do this anymore.’ “We infantilize our kids for so long,” Godfrey says, “and then ask, ‘Why don’t they support themselves?’ Part of the reason may be that we didn’t give them the skills to do so in the first place. We need to work with our children to make sure they know how to deal with the consequences of their behavior, that they understand what it means to demonstrate accountability and independence. A period of pain may be required, but the longer it’s put off the more difficult it becomes for the kids.” Richard Martinez, Jr., president and CEO of Young Americans Bank and Young Americans Center for Financial Education in Denver, agrees: “The next time you get the call ‘I’m out of money,’ let them struggle a little bit. Your first instinct is to rescue them, but it will be better for them if they struggle a bit. You could say something like, ‘Your allowance will come in a week and you’ll just have to get by until then. And maybe you’ll learn how to budget your spending better next month.’ They’ll survive. Parents have to beware of becoming the lender of last resort because they can quickly become the ATM of first resort.” Another thing parents can do to help their college-age kids, according to Martinez, is to serve as role models. “It’s hard to pass on good financial habits to your kids if you’re doing something different,” he says. “Kids get used to a certain lifestyle when they’re living at home, then when they’re out on their own they want that same lifestyle. They don’t realize — that was then, this is now. And they are often not realistic about what they can do financially. It helps if parents have limited their own spending and governed themselves regarding what they think they need versus what they can actually afford.” Apart from living on their own for the first time, many college-age kids are also starting to earn their own money, whether through summer jobs or part-time employment while at school. This is the ideal time to introduce them to the concept of financial planning and how sound financial management can help them meet their goals, both now and in the future. To help students and parents get started, CFP Board’s Website features information on Financial Planning Basics and on the Financial Planning Process. College is an exciting time of personal and intellectual growth. With a little planning and preparation, it can be a time of growing financial independence and autonomy, too.
Next month: Kids and Money IV: The Boomerang Years.
Online Resources
Credit Abuse Resistance Education (CARE) Program
NEFE’s CashCourse
Nellie Mae’s Credit Card Corner |
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| The Facts about Inflation |
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As food costs climb, gas prices soar, and utility bills surge, few people can find much good to say about inflation. But in moderation, inflation — the rate at which prices for goods and services rises — is a normal part of the economic cycle. Inflation only causes trouble when it is too high or too low. When inflation is low, prices rise gradually, more or less in line with increases in wages and salaries. Inflation that is too low can lead to deflation: as prices drop and profit margins shrink, companies may lay off staff, which can in turn fuel further price drops and more layoffs. When inflation is higher, like now, prices rise more quickly, faster than wages and salaries can keep up. That’s when inflation hits consumers hard in the wallet. Here are a few tips to lessen the impact. General prices have increased 5% over the past year, as measured by the Labor Department’s consumer price index, with the cost of some items—like food, gas and energy, for example—increasing much faster. A recent survey by the National Energy Assistance Director’s Association found that fuel-oil prices are up more than 40% and gasoline prices are up more than 33%. That poses two challenges to consumers: how to stick to a budget as the day-to-day cost of living goes up, and how to protect longer-term investments from the loss of purchasing power that inflation brings with it. “We have to recognize that in finance, just as in life, there are always things we can’t control,” says Michael Rubin, CFP®, founder of the financial education firm Total Candor and author of the financial planning book Beyond Paycheck to Paycheck. “We can’t control the prices of bread and gas, but we all have to eat and get to work. So to reduce costs, we have to ask ourselves: What other areas of my spending can I target?” To keep inflation from busting a hole in your budget, Rubin observes that the same rules apply that ordinarily apply to saving — they just take on a heightened importance. High costs of gas getting you down? “Look at things like carpooling, combining trips, or discontinuing unnecessary trips,” Rubin says. “You may decide not to make a trip because you don’t want to spend that kind of money on gas. And there’s nothing wrong with carpooling even when inflation is low; after all, it’s a green strategy.” Rubin also suggests that it’s crucial to distinguish between your ‘wants’ and ‘needs’: “ ‘Disposable’ income makes it sound like you can afford to throw the money away, but periods of higher inflation are great times to rein in your discretionary spending. You can’t control the price of bread and gas, so focus on what you can control, maybe by cutting back on the things you want so you can afford to buy the things you truly need.” The hidden danger of inflation is loss of purchasing power. When most people think of losing money, they think of loss of principal. If you invest, say, $100 in a company, that $100 is known as your principal, the amount of cash you actually put in. If the company goes bankrupt, your $100 is gone — you’ve lost your entire principal. Loss of purchasing power, which occurs when your investments don’t keep pace with inflation, is more subtle. As inflation rises, a dollar buys progressively less and less. If inflation is, say 4%, then a $100 pair of shoes will cost $104 twelve months from now. Now apply that same math to your $100 investment. If your $100 grows at a rate of 2%, you’ll have $102 in a year. Imagine that at the end of that year you withdraw the money to buy a new pair of shoes you’ve had your eye on for some time. With inflation running at 4% and your investment growing at only 2% over the course of the previous twelve months, you will have lost $2 in purchasing power: $104 (cost of the shoes) – $102 (worth of your investment) = $2 (loss in purchasing power). Of course, a $2 loss in purchasing power in any one year may not be such a big deal. But if inflation remains high over a longer period, then that loss adds up — especially when it eats away at savings intended for longer-term goals like education or retirement. To see how inflation gnaws at your savings, click on the Inflation Calculator located in the middle of the homepage of the U.S. Department of Labor’s Bureau of Labor Statistics. To take just one example: $100 worth of goods in 2003 now costs $117.73, an increase of 17.73% over five years. “Loss of purchasing power means that the money in your wallet is worth less,” Rubin says. “You have to keep that in mind when planning because it means long-term goals will require more savings. That can be scary because it means increasing savings at a time when you’re also paying more for immediate expenses.” No one knows what the inflation rate will be in the future, and Rubin advises that no investment decision should ever be made in response to short-term market fluctuations. But he also warns that “if your investments are too conservative or you’re on a fixed income, then high inflation is guaranteed to hurt your purchasing power.” Rubin cites the importance of Social Security in this respect because it is indexed to inflation, meaning that payments rise with inflation so there is no loss of purchasing power. The key is to make sure your investments earn a higher rate of return than the rate of inflation. If, for example, your investments earn a 6% return while inflation is running at 4%, your real rate of growth is 2%: 6% (rate of return) – 4% (loss of purchasing power due to inflation) = 2% (real growth rate). To make sure your investments are sufficiently insulated against loss of purchasing power, you might want to check with your financial adviser. “It’s never too early or too late to invest appropriately,” Rubin says. “The sooner you begin, the longer the time horizon—and the more flexibility—you will have.”
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| Don’t Let Debt Become a Four-Letter Word |
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The rising price of gasoline and groceries are capturing all the headlines these days. But there is another, even more dangerous threat to your financial situation – debt which compounds monthly. If you're in debt, the best thing to do is to pay it off as quickly as possible. The longer you wait, the more excessive it can become. There is no quick fix – getting out of debt requires time and effort. But here are some tips to help you get started: Take control. Review your records to determine levels of income and expenses. In one column, list all reliable monthly income, such as salary, pension, or unemployment payments; add average amounts for additional, less consistent sources of money. In a second column, list all expenses. Start with major costs, like mortgage or rent, utilities, food, transportation, credit card payments, etc. Remember to include expenses that happen other than monthly, like property taxes and insurance. Refer to bank statements and purchase receipts; don't overlook cash expenditures. Create a budget. Based on income and expenses, set up a budget that allocates monthly amounts for all categories of spending. Eliminate unnecessary costs: eat at home rather than dine out; rent movies rather than go to movie theaters; cancel cable television service. Develop a plan to pay off credit cards, especially those with high interest rates. It's often a good idea to include the entire family in the budgeting process since it will define the scope of their purchases and activities. Improve the Balance. Re-examine the numbers, looking for ways to increase income and further trim expenses. Can another member of the family take on a job? If you are renting, is it feasible to move to less expensive housing? Determine if you are eligible for government programs, such as unemployment benefits, food stamps or housing programs. The Credit Union National Association (CUNA) provides an online calculator to help you with financial decisions. Contact your creditors. Speak directly with the organizations to which you owe money. They may be willing to arrange a payment schedule that enables you to temporarily reduce monthly contributions. If you own your home, ask your mortgage company about a forbearance agreement, which can lower or eliminate payments for a set period of time. Managing debt is critical to your financial health, that’s why “Managing Debt from Credit Cards to Foreclosures” is among the topics that will be explored at CFP Board’s Financial Planning Clinics on Saturday, Sept. 13, in Washington, DC, and Saturday, Nov. 15, in Miami. The Clinics are free and open to the public. In addition to workshop presentations, the Clinics include free one-on-one consultations with CERTIFIED FINANCIAL PLANNER™ professionals qualified to answer your financial questions. To learn more and register to attend, visit www.CFP.net/clinic or contact CFP Board at clinic@CFPBoard.org or 800-487-1497.
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| 401(k) Loans on the Rise |
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Workers in America are tapping into their 401(k) retirement accounts to weather financial hardships such as unemployment, medical emergencies and buying a home. And they're doing it even though borrowing a modest $5,000 can dramatically erode their retirement savings over time, according to a study released this month by the Center for American Progress. Loans from defined contribution plans rose sharply, increasing almost fivefold in inflation-adjusted terms to $31 billion in 2004 from $6 billion in 1989, according to a report, Robbing Tomorrow to Pay for Today, released by the Center for American Progress Action Fund of Washington, DC. While money is withdrawn from retirement accounts it doesn’t earn any returns, according to the report. Over the past few years, many account holders have used their retirement savings plans to “bridge the gap between slow income growth and rapidly rising prices” for houses, food, energy and health care, according to the report. Loans from retirement savings plans can substantially reduce retirement income, according to the report. Typically, borrowers can repay loans within five years without penalty. Loans for first-time homes must be repaid within 15 years to avoid penalties.. Middle-class families in particular are turning to retirement money to get through financial crises such as unemployment and medical emergencies, the study found. The bad news, though, is that while the money is out of your retirement account you are not receiving an investment return. You are also paying yourself a below market rate of interest, which means that as a lender to yourself you are not being paid in full. And should you fail to pay the loan back you will have to pay taxes on the monies and pay a 10% penalty on top of that. Finally, the interest payments you are paying yourself are helping to grow your retirement savings, but you have paid them in after-tax dollars, and will have to pay taxes on that “gain” again when you retire and receive money from the account. The study said that a 30-year-old who borrows $5,000 and makes only the loan payments (i.e., doesn't make both loan payments and contributions while the loan is outstanding) will reduce retirement savings by as much as 22% by age 65, even if the loan is repaid without incurring a penalty.
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| Social Security Unveils New Calculator |
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The Social Security Administration unveiled its new retirement estimator on its website. With just a few points and clicks and some personal information, the calculator produces benefit estimates within a few minutes. The new calculator will be followed this fall by an updated online application for benefits that Social Security Administration estimates will reduce application time from the current 45-minute process to 15 minutes — and eliminate the need for follow-up visits to agency field offices. "These initiatives will help us better handle the baby boomer wave and make it easier for the public to do business with us online," a spokesman for the Social Security Administration said. Workers now receive an annual benefit estimate in the mail. It's based on prior earnings but assumes people's salary stays the same until retirement age. The online calculator supplements the annual mailing but won't replace it. The online calculator permits future retirees to create a more accurate estimate of benefits since people can factor in a higher estimate of their upcoming earnings, the agency said. People can also factor in different alternatives for retirement ages. history, a time-consuming process that could involve considerable guesswork for people who don't keep detailed records. The new version uses the Social Security database to provide accurate earnings information, though the calculator requests the most recent year of earnings since there's a lag in getting salary information into the Social Security database. There's inherent uncertainty about the estimates since for many people it's not easy to predict future earnings. That's especially true for younger workers. The closer someone is to the retirement age, the more accurate this estimate is going to be, according to the agency. What is more, Social Security benefits are likely to be at least somewhat curbed in future years as lawmakers shore up the system to prepare for the retirement of millions of baby boomers. Social Security now runs a surplus and is expected to do so until 2017, when the agency will have to start cashing in special Treasury notes to help pay benefits. Social Security's trustees say it's possible to produce actuarial balance over the next 75 years in various ways, including an increase in the combined payroll tax paid by workers and employees from 12.4% to 14.1% or an immediate reduction in benefits of 12%. More likely there will be some combination of the two. The agency also said it has taken steps to make sure people's personal information won't be divulged. The agency has also worked up a new security system for when it accepts online applications, though many foreign-born recipients will still be required to furnish proof of retirement age at field offices.
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| Financial Alerts |
Deposit Insurance and Your Savings In truth, most depositors don’t need to worry about their bank accounts. A deposit in an FDIC-insured bank or savings institution is one of the safest ways to protect your money. The FDIC protects those deposits under federal law, with basic insurance coverage up to $100,000 per depositor per insured institution, in the unlikely event that a bank fails. There might even be situations where your deposits are covered for more than $100,000. If you want to learn more about deposit insurance and your savings, read the FDIC guide, Insuring Your Deposits, about structuring your accounts to maximize the insurance coverage. The FDIC also provides an interactive Electronic Deposit Insurance Estimator that allows users to calculate the insurance coverage of their accounts and generate a printable report that clearly states if their deposits are fully insured or not.
NASAA Identifies Traps Likely to Burn Investors This Summer Read more financial alerts.
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| About This eNewsletter |
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CFP Board's "It's Your Turn" eNewsletter is sent monthly to those who have subscribed through CFP Board's Web site, www.CFP.net/learn. CFP Board exists to make people aware of the benefits of financial planning and to encourage people to seek out individuals who can help them apply the financial planning process to improve their financial lives. This eNewsletter is designed to provide information about financial planning, financial planning tools and resources, consumer alerts and more. Suggestions and feedback are welcome at mail@CFPBoard.org.
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