McCombs

Knowledge To Go

January 12, 2015

Financial Overview for Young

Alumni: Achieve Your Goals

by Kelly Kamm, Ph.D. FinanceSenior Lecturer, Department of Finance, McCombs

My Background & Choices

Ph.D. Finance, University career

Undergraduate, graduate, Executive Education

Advisor, MBA Investment Fund

Manage family savings, investments,

insurance

Also children’s education choices

(public & private) & savings

Investor in private enterprises

Homeowner - not too big house

My Background & Choices

Preference for used car, good condition

Pay monthly credit card bill in full

Have had loans / debt

College, home equity loan, etc.

Experience with job changes and need

for emergency savings

Very limited savings when children

young

Reasons to Live Below your means

Gives you lots of flexibility, financial freedom

Ability to take time off from work

Helps weather job changes (liquidity)

You can save for future when responsibilities may grow / retirement

Travel

Contribute to good causes

Forbes / EntrepreneurWhen your material needs meet or

exceed your income, you’re sabotaging your ability to really make it big.

Don’t shackle yourself with golden handcuffs (a fancy car or an expensive

apartment.) …

Be willing and able to take 20% less in the short term, if it could mean 200% more earning potential.

20 Things 20-Year-Olds Don't Get,

by Jason Nazar

Forbes / Entrepreneur (continued)

No matter how much money you make,

spend 25% less to support your life.

It’s a guaranteed formula to be less

stressed and to always have the

flexibility to pursue your dreams.

20 Things 20-Year-Olds Don't Get

by Jason Nazar

Reasons to Spend / Live at or above

Don’t be miserly, you can’t take it

with you

It’s o.k. to enjoy life or even spend a

bit “too” much for something (not

everything) if it is valuable to you.

It’s temporary … you are pulling

from savings for a short time

Graduate school, job change,

young children

Don’t Have to be an AsceticAll this isn’t say you should be an ascetic.

If you have done a good job saving and prioritizing, there is nothing wrong with

spending some cash.

Your 20s is certainly a time to cut loose and have fun if you lack the responsibilities of a

family and a mortgage.

But it’s also an opportunity to live small and work hard, setting yourself up for bigger

comforts later.

Top 10 Tips … 2015…How to Not Ask Your Parents for Help / Personal Finance (USA Today)

1. Financial Advice: General

Invest in Yourself / Your Career

Pay down college or other debt,

especially if high interest

Build up 3 to 9 months of living

expenses – an emergency fund

2. Advice: Savings & Insurance

Save 10% or more of income toward

retirement

Life insurance – 6 to 10 times annual

income

College Savings for children

Escalating college costs

your retirement comes first

3. Advice: Home and Car Ownership Home Ownership

Old, but seemingly out of date adage

“buy the most house you can buy”

keep housing costs ≤ 28% of income

recent trend “not too big house”

recent trend rent don’t buy

Automobile

Lease vs. buy

New vs. Used

Recent trend walk, bike, use public transport

Agenda & How it Relates to You

Kamm Commentary, Insights,

Examples

General Financial Advice

Savings and Insurance

Home (and Car) Ownership

No One Size Fits All

Your Stage of Life; but it might change

Your Preferences, Values, Ethics

If something doesn’t apply, goal to show

something interesting to you

1. Financial Advice: General

Invest in Yourself / Your Career

Pay down college or other debt,

especially if high interest

Build up 3 to 9 months of living

expenses – an emergency fund

Invest in Yourself / Your Career

Invest in attire for profession.

Sanity to enjoy life and excel in job

Housekeeper, gym by work

The cost of a professional designation

may be well worth it.

If considering graduate education,

evaluate whether it makes

Financial sense

Personal value

General: Sanity and Careers in U.S.

Sanity to enjoy life and excel in job

Housekeeper, gym by work

Gallup Poll 2014: Of full-time U.S.

workers who are paid a salary (not

hourly), approximate percentages by

hours worked weekly are:

50% report 47 hours or fewer worked

25% report 50 to 59 hours

25% report 60 + hours

Mark Cuban on Paying Down Debt

Pay off your debt first.

Freedom from debt is worth

more than any amount you can

earn.

Mark Cuban, Owner Dallas Mavs, The Best

Financial Advice I Ever Got, WSJ, Jan 6, 2014

Pay off College & Other debt

Pay off credit cards in full each month.

It’s a lot easier to live below your

means than above your means.

Pay off debt, highest rate first.

It can make sense to save while paying

down debt.

Building up Emergency Savings

Saving at least 3 months of

expenditures may sound daunting.

Start small. Put aside something.

Should be liquid. Checking, savings,

money market.

Examples of Unexpected Costs: job

loss or change, computer dies

2. Advice: Savings & Insurance

Save 10% or more of income toward

retirement

Life insurance – 6 to 10 times annual

income

College Savings for children

Escalating college costs

your retirement comes first

Retirement: 401(k)

Defined benefit

Social Security Administration, 2009, Butrica et al

“The Disappearing Defined Benefit Pension…”

401(k) … Defined Contribution

Congress 1981 IRS Code

Employer sponsored, pre-tax payroll deduction

Capital gains grow tax-deferred

Employer may offer matching program

Fairly straight forward to set up through company

Company usually offers set of diversified funds

Retirement IRA Traditional

Traditional IRA

No company plan / to supplement company plan

Set up at a brokerage, mutual fund co., bank

On-line / phone help … to determine maximum

Contributions are / may be tax-deductible

Interest / Capital-gains grow tax deferred

Forced distribution at 70 ½

May be a 10% penalty if you withdraw funds

before retirement

Retirement IRA Roth

Roth IRA

Set up at a brokerage, mutual fund co., bank

On-line / phone help … to determine maximum

Pay taxes now, do not deduct from income taxes

Invest after-tax dollars

(Likely) tax-free gains

Withdrawals of contributions generally not

penalized

No minimum distribution at 70 ½

May earn too much to qualify for Roth

Most likely to qualify for Roth when young

So Many Choices: What to Do

If your company has a retirement plan

start with that

Traditional vs Roth IRA

Read limits on web site / chat on-line / call

Nights and weekends

Which assets or funds to choose? Depends on your preferences

Consider diversification

Retirement Savings Example

You are 27

You will retire in 40 years at 67

$1M needed in 40 years

Rate of return = 8%

Start monthly in 20 years = $1,697.73 / mo

Start monthly in 10 years = 670.98 / mo

Start monthly today = 286.45 / mo

If wait 20 years you will have to save about 6X as

much per month

Asset Allocation Decision Common Advice to Young Savers

Higher percentage in stock market

50%, 70%, 90%

U.S. vs. foreign markets

Smaller percentage in other assets

Fixed Income (bonds) / other

Check fees: no load or low fee

Approach Retirement:

Keep shifting into fixed income / money market

SP500 Index over 40 Years

Investment Grade Bond Index 40 Years

Stocks vs. Bonds + 3.44% per year over

Diversification and Indexing, John Bogle

The best way to own stocks is to

own an index fund.

John Bogle, Founder of Vanguard Group, The

Best Financial Advice I Ever Got, WSJ, Jan 6,

2014

Life Insurance and Disability Life insurance – typical advice is 6 to

10 times annual income

No one likes to consider a will or life insurance

Birth of child motivating factor

Cheaper the younger you are Age, less likely to have history of medical

conditions

Might consider policy in addition to company coverage

Kamm opinion: stay at home parent benefits from life insurance too

Disability Insurance

Disability Insurance is meant to provide income should you be disabled and unable to work.

It’s estimated by the Social Security Administration that over 25% of

today’s 20-year-olds will be disabled before retirement.

Business Insider, The 11 Worst Money Mistakes to Make in your 30s, by Kathleen Elkins, July 6, 2015

College Savings for Kids: Example

Suppose child just born and you have

goal to save 50,000 by end of 18 years

Assume 6% return

Start in 3 years = $171.93 / mo.

Start in 6 years = $237.93 / mo.

Start in 12 years = $578.64 / mo.

Start in 15 years = $1,271.10 / mo.

Ratio: start when child is 15 vs. 6

You must invest about 5 ½ times as much per

month

Education Savings Plans

Coverdell Education Savings Accounts

Investment limit of (perhaps) $2,000 per year

Must meet / be under income limit

Invest after-tax dollars; capital gains not taxed

(federal) if used for qualified education expenses

No state-tax deduction / elementary through

college

529 College Savings Plans

Investment limit very, very high

Invest after-tax dollars; capital gains not taxed

(federal) if used for qualified education expenses

Possible state-tax deduction / college only

Education Savings Plans: What to do

Emergency, Retirement, Insurance first

Add college savings plan next if

desired

You can set up with a brokerage or mutual fund

company / planner – check fee arrangement

Automatic electronic transfer

Select funds yourself / or target date fund

Consider Coverdell if might have private

education costs prior to college

3. Advice: Home and Car Ownership Home Ownership

Old adage that seems out of favor

“buy the most house you can buy”

Housing costs far exceed monthly rental

Recent trend “not too big house”

recent trend rent don’t buy

Automobile

Lease vs. buy

New vs. Used

Recent trend walk, bike, use public transport

Reasons to Rent Lifestyle choice / flexibility / other

things more important

Downside: rent often increases

Saving for a down payment

Interest rates are high

Buy less house, floating rate

You might move w/in 2 or 3 years

Costs associated (6% brokerage twice)

Give yourself time to know the location

Traffic, schools, areas of town

11 Reasons I Never Want to Own …

Homes often tempt people to borrow more than they can afford

Houses take a lot of money

You’re still paying a lot of interest

I liked being a homeowner. I just happen to like being a renter more.

Forbes / Taxes, 11 Reasons Why I Never Want to Own a House Again, Sep 27, 2013

Buying a Home: Things to Consider

Build up principal / ownership

Interest may be tax deductible

All costs: Property taxes, insurance, maintenance

Consider larger down payment

Faster build up of principal

Lower overall interest paid

15 years: quicker build up of principal

30 years: lower monthly payment more flexibility in terms of monthly payment

generally no penalty if pre-pay

How Much You …Spend on a Home

For most people, a house is the biggest purchase they will make in their lives, one they will pay off for years, even

decades, to come.

But spending too much on a house could leave you with little money for other

goals in life, such as retirement, college funds and vacation.

The Wall Street Journal, How Much You Should Spend on a Home, How-To Guide, Buying a Home

Tips …Spend on a Home

The cost of your home -- including taxes, maintenance and other costs

-- should not exceed 28% of your monthly income.

The Wall Street Journal, How Much You Should Spend on a Home, How-To Guide, Buying a Home

Buy Less than You Can Afford

Look for a house that costs less than what you can afford…your property taxes and home insurance premiums are going to rise at an

unknown rate. You will also have to budget for future repairs and unexpected non-housing

expenses.

Though a house … will likely rise … the real rate of change may be less than what you

think.

The Wall Street Journal / Wealth Management, Buy Less House Than What You Can Afford, Charles Rotbult, V.P. of

American Association of Individual Investors

No Car, Lease, Buy New, Buy Used

Automobile Purchase or not

logic follows along with most of what we have covered = personal choice

Keep in mind that though home prices usually (not always) rise, not the case with cars

According to edmunds.com: New car loses 11% upon leaving the lot

On average a car depreciates 15-25% each year the first 5 years

On average, at end of 5 years total depreciation is 63%

Last but not least All PPTs represent Kamm view (not

necessarily fact or what you should do).

Talk about financial matters with family, friends, etc. Read about financial matters

Consider different opinions and then pursue what you think is right for you.

Start with one area.

Start small, then you can improve.

If you have a business major, it may make sense to: Hire an advisor to advise you and manage finances

Do discuss benefit and all fees of financial advisor

Or, manage finances yourself

Financial Overview: Hope you enjoyed

the webinar, learned something new

and /or reflected more on your finances

by Kelly Kamm, Ph.D. FinanceSenior Lecturer, Department of Finance, McCombs

Please Give Back to McCombs!

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Advisory Boards, coordinated by alumni for the benefit of the Alumni Network.

Please get involved with the Alumni Network!

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