Monthly Archives: January 2016

Student debt is a financial decision

Student debt
With friends Sapan and Suzannah

If you go to apply for a mortgage, the bank will verify that you can afford the payments of your property. If you cannot afford it, then the bank will ask you for a cosigner. If you cannot get a cosigner you are out of luck.

With student loans it is not like that. The bank or the government give loans without calculating the capacity of the lender to pay it back. No verification, just get the money and get out. This is the same mentality which brought the U.S. to its financial crisis, lending money to people who cannot afford it.

Many students go to school not even knowing what is it they want to study. They take elective classes until they make up their mind. If their parents are paying for tuition, then that’s OK, it’s a gift from their parents. If the parents aren’t pay for the education, then they have to realize that borrowing money is a financial decision and the money have to be paid back.

I think that if students are not subsidized by their parents and they don’t know what they want, they should get a job and delay going into college until they make up their mind.

There are some careers which are in high demand and they will lead to well paid jobs. Some students get job offers even before graduation. But there are other careers which are not in demand and the only employers willing to hire the students are Starbucks and McDonald’s.

If you are studying one of those careers which have very little job opportunities, why not study part time? That way you will not be saddled with student debt for the next 10 or 20 years.

According to the Wall Street Journal, the average person changes career seven times in their lifetime. It makes no sense to get in debt for a career which most likely will lose its luster after a few years, yet the debt will still be there.

The average Canadian student has a debt of about $27,000. I have a friend who is almost 50 years old and she is still paying her student debt. I have another friend who is in her 40s and has about $40,000 in student debt.

We all know that there are careers which pay more than others, but the cost of tuition is practically the same. You could get a $100,000 salary or a $20,000 salary for the same four years of education and the same student’s fee. If you get in debt to get a six figure salary, I can can understand the logic behind that decision. But if you to college knowing that after graduation you will be struggling to pay your student debt, you’d be better off studying part time and paying for your tuition with cash.

Consequences of student debt

Student debts could have detrimental effects with lifelong consequences. High student debt could be the reason for:

  • High stress level, which could lead to poor health
  • Delaying having children
  • Delaying getting married
  • Delaying buying a house
  • Delaying retirement saving
  • Not being able to pay your kid’s education
How to get out of Student Debt

Getting out of student debt is similar to getting out credit card debt. Here are a few steps to consider:

  • If you have several loans, make sure you pay the one with the highest interest first, while making the minimum payment for all the others.
  • Stop all frivolous spending. Don’t go to restaurants, movies nor bars. Don’t travel. Don’t do any recreational activity which cost money.
  • Look for extra money. This is the sharing economy, the gig economy. You can rent an extra room through Airbnb (here is my affiliate link) or you can drive an extra few hours for Uber (here is my affiliate link). There many more things you can do… You can babysit, you can pet sit, you can assemble Ikea furniture, etc…

Assume that you owe $25,000 at 7% interest. If you pay about $100 per month you could be debt free in about 5 years. Of course, if you pay more you could be debt free even faster.

Additional tip. Assuming you have good credit, you could go to the bank and ask them for a loan (let’s say 5%) to pay your 7% student debt. The debt doesn’t go away, but the interest you pay on it is lower.

We all deserve a secondary education. Just remember that if you borrow money for education it becomes a financial decision.

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The Latte Factor in Everyday Life

What is the Latte Factor?
Latte factor. Eliminate unnecessary expenses and spend time with friends
Monthly meeting at my apartment

Latte factor is a term coined by the Financial writer David Bach. The idea is that many of us have some expenses that, if turned into savings, could help us become rich. Mr. Bach uses the example of a person who buys a latte every morning before going to work. If that person decides not to consume that latte, but instead puts the money in an investments account, those little cents could add up to hundreds of thousands of dollars over a long period of time.

Of course Mr. Bach uses coffee as a metaphor that we all can relate to, but it could be anything… it could be a pack a cigarettes per day, it could be a beer after work, it could be the daily newspaper, it could be the cable service. In short, there are many discretionary expenses that we could cut out of our budget and there are plenty of opportunities to save money.

In his website Mr. Bach has a Latte Factor calculator where we can input the cost of our recurring expense, the rate of return from an investment, and the amount of years. Then we  press “submit” and we have the result.

For example, let’s say that I have the habit of drinking a beer after work. The beer costs me $5 per day, and I go to drink 5 days per week. Also, assume that I have this habit from age 20 to age 50. If I plug all those numbers in the Latte Factor calculator, I will  discover that by deciding not to drink that beer and putting the money into an investment account at 8%, I could end up with $159,049. That’s a lot of money for giving up my beer habit.

Of course there are other factors to consider. Assume that I am a computer programmer who works 40 hours per week in a dark basement isolated from people. When I go to drink that beer at the local pub, I get to interact with other people. This is the happiest hour of my day, I have a really good time. In this case, the value I get from that beer far exceeds the pleasure of having $159,049 30 years from now. What am I going to do with that money when I am old? Have a bottle of prime whiskey all by myself at my retirement house?

Selective consumption

We want to enjoy ourselves while we have energy and enthusiasm to enjoy life. There are some things which are more valuable to us and other things which are less valuable. We should spend the money on those things that make us happy and that we value more now than having lots of money in the future. Conversely, there are other things which don’t give us much satisfaction. Those things we should cut out of our lives. For example, I couldn’t care less about fashion, about brand names, about overpriced Apple products. If I can eliminate those things which are not important to me, then I can still afford to have a beer per day and save a significant amount of money for the future.

Delayed gratification

Let’s say that I do manage to apply the latte factor to one of my consumption habits and my savings account grows to a few thousand dollars. Well, that money has a different appeal. It could represent a vacation to the Caribbean, a new car, a year of education for my child, etc… the temptations are  enormous. The solution for that is to create different buckets with our savings.

In my case, I live a frugal life and every year I save enough to max out my TFSA account (this is my retirement money). Every year I save enough to take a one week vacation outside of Canada (this is my medium term money), and about once per week I eat at a restaurant (this is my enjoy-now money). My latte factor savings are enough to provide for the present and for the future.

And you, what is your latte factor? What is that habit that you could eliminate from your life without too much pain? Which consumption habits are you not willing to give up? When you save, what do you save for?

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How to Pay Yourself First

I pay myself first to enjoy life. Photo with friends.
Kanata, Ontario with friends Ivan, Cheryl and George

I am sure many of you have heard similar statistics in the news: “50% of Canadians are living paycheck to paycheck.” In the United States, our richer neighbor,  “75% live paycheck to paycheck.”

Whether it is in the States or in Canada, people are saving less and less and millions of them will struggle when they reach retirement.

Of course, the main reason for this problem is that people are not saving enough money. We continue falling prey to advertisers and keeping up with the Joneses. In some cases we are just lazy or lack ambition.

We continue crying about income inequality while we have the tools to do much better for ourselves. A combination of reducing consumption, earning a few extra dollars and investing in ourselves could represent the difference between a comfortable retirement or a retirement in which we are dependent of government help. If you work for 5 years as a cashier at Walmart, you should not blame Walmart for paying you low wages, you should blame yourself for not investing in yourself so that you could move up from the cashier position. The same line of thinking goes for all those who work at fast food restaurant. Working at McDonald’s should be a transitory job, not a life long career.

When it comes to the way we manage our money, the most important part is to spend less than we earn. I have written about this subject many time, but it has to be repeated times and time again. If we earn $2,000 per month we have to spend less than $2,000 per month.

How to pay yourself first:

Most people receive their paycheck and they pay everybody else first. They pay their utilities, their credit cards, their rent… then they spend some or all of that discretionary income. And finally, if there is any money left, they put it in a savings account.

Of course, at the end of the month there is hardly any money left to put in the savings account and they end up saving nothing.

The way to go around that is to put a set amount of money in your savings account first, then pay your bills, and ONLY if there is any money left, you could do some discretionary spending.

How much money should you save?

At the very minimum 10% of your income. Talk to your employer or to your bank and ask them to automatically transfer 10% of your income from your checking account to your savings account. Then you get to spend whatever is left.

This amount should be increased every year. Either you increase it after every pay raise or you increase it at a set date. For example, on January 1st of every year you could increase your savings by 2%. This is the technique I use.

Make extra payments to yourself.

Did you have a good month? Did you get some unexpected extra money? Did you get a nice bonus? How about if you take 50% of that extra money and use it for your own enjoyment and take the other 50% and put it in your retirement account. Over a life time, those sporadic additions to your saving account could represent a significant amount of money. Imagine that at age 20 you get an inheritance of $10,000 from your uncle who just passed away. You take $5,000 and spend it on a trip to Europe and invest the other $5,000 in your retirement account at 8% until age 65 (45 years).  You will end up with an extra $159,600 for your retirement. That is significant.

This is the way I do it. I pay myself first at the beginning of each month by transferring a set amount from my checking account to my savings account. Then I go about living my life through the year. At the end of the year, if I find that I have some extra money in my checking account, I put that extra money in my savings account and I start all over. I do all my re-balancing during the last week of December and/or the first week of January.

Conclusion.

If you follow a habit of not running into credit card debt, of paying yourself first, and of constantly investing in yourself, you will have a sense of security, optimism, self confidence and you life will be more joyful and fulfilling.

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