Additional Layer of Risk

parents defualt rateI believe one of the most important ideas in understanding debt is what we call “Layers of Risk”. One layer that I have not taken the time to fully consider was brought to my attention in an article today. That layer of risk is student borrowers with children, and specifically single parents:

  • Nearly 50% of undergrad students borrowers defaulted
  • Of those, 70% were single parents
  • 10% of borrowers are single parents, but they represent 40% of all defaults

These stats also include additional factors and layers of risk. For example, as the article points out if you’re a parent of a child under 3, a person of color, or enrolled in a for-profit school your default rates are even higher.

Additionally, many of these defaulted loans are for students that were unable to complete their degree so they are stuck with a non-bankruptable debt and no degree with which to increase their earning potential.

Any system that disproportionately penalizes the most vulnerable needs to be reformed.

Alternative path to wealth

Dollar signLast week I teased that aside from hoping to strike it rich with a miracle investment, there was a better route to go. Here is my brilliant three-step plan:

One: Earn More

Dave Ramsey teaches that your most important wealth building tool is your income. To build wealth, you need to generate income. Saving money (income minus expenses) and investing (return on saved money) are impossible without generating income. Obviously more income increases your chances (but certainly doesn’t guarantee) of having a surplus. If we aren’t currently generating a surplus, we need to either (or both) cut expenses and/or generate more income. Here is some advice on generating more income.

Two: Get rid of Debt

Getting out of debt accomplishes two super important things. First, you take over control of your income. Debt is a lien against your future income. Take control of your future income – it will allow you to save which is step one in accumulate wealth. Second, if you are paying interest on debt, you can have a guaranteed return on an investment by keeping that interest for yourself. See this.

Three: Save cash

This seems counter intuitive, but having a large cash reserve is valuable for several reasons. First, you can negotiate significant discounts on things you are forced to buy. Second, you are prepared when assets that we know and understand become significantly discounted. Like when we get our next recession.  There is a lot more to be said about the advantages of liquidity, but I recommend trying it to see how it feels.

 

Concession from last week. While I’m steadfast that we should let go of the myth of being a great investor, it’s really important to understand that yielding a couple of extra percent yields a massive difference in returns over time. Over 20 years, the difference between earning 6% and 12% on an investment isn’t 2x the return, it’s 3x. This goes up even more over time and/or return.

Loan Forgiveness and PSLF

Tnythis article surfaced in The New York Times a couple weeks ago:

They Thought They Qualified for Student Loan Forgiveness. Years Later, the Government Changes Its Mind.

I’ve written several times including this long post in September of 2015 that I thought the Public Service Loan Forgiveness program was risky and I did not think it was wise to plan on the PSLF program to be your primary loan repayment strategy.

The risk that the government could change the rules at any time was one of the original reasons I wrote that I didn’t like the program. That is exactly what happened to the subjects of that NY Times article and we’ll see how the pending litigation plays out.

There are other alternatives. If you’d like some help working through those then hit me up.

Two Causes of Poverty

powell-poverty-quoteWhat causes poverty? Thinking about this question can teach us a lot about how to create personal economic mobility. Those are big words for get out of debt, build an emergency fund, save for retirement, and create stability for our children.

In my post-election reading, I came across this long interview (actually made and posted before the election).  The author makes a case that endemic poverty is caused by two main factors:

  • Social Structures That Harm. These are cultural forces that are weighted against the poor and against upward mobility. These aren’t unique to our society, the author of Proverbs 22 points out as a matter of fact that the “The poor are always ruled over by the rich.” In the past I have used the term “Risks” to bring personal awareness to some of these structures. Examples of these cultural forces include redlining neighborhoods, the town factory closing, poor educational systems, payday lenders, having bad parents, and corrupt governments. You might call these “Things that happen to you.”
  • Personal Choices. The interviewee calls this “helping people make better moral choices.” This is the personal responsibility that is required to change your life. Proverbs also address this in a number of says such as “Wealth from get-rich-quick schemes quickly disappears; wealth from hard work grows over time.” Examples of “Things you do to yourself” include substance abuse, not living on a budget, spending on wants vs needs, not deferring gratification, a poor work ethic, and having a negative attitude.

Here are two personal questions to ponder:

Do my thoughts and beliefs lean one way or the other?

One of the points the interview makes is that Liberal leaning folks tend to over-emphasize the social structures and those that bend Conservative tend to over-emphasize the personal responsibility.* This makes me think that you and I probably overemphasize one side or the other in our thinking and beliefs:

Do I think poor people are lazy? Do I believe it’s impossible to get out of debt in today’s society? Do I tell people that there aren’t any good jobs out there? Do I complain about my lack of money while wearing these sick new Jordans? Do I define my employability by the time I was laid off? Do I believe that employer really isn’t looking for someone of my age, sex, or color?

The biases and beliefs I carry will dramatically affect my ability to change my story.

Where is my personal greatest return on investment?

If you are called to change the social structures, I encourage you to go for it. I believe these are evil institutions of oppression and that Jesus was directly addressing these when he said the Kingdom of Heaven is advancing and the “Gates of Hell” won’t prevent good from eventually breaking these down.

However, practically for us today complaining and worrying about these cultural forces isn’t helpful. To personally change, we need to First recognize the cultural forces so I can artfully navigate around those to the best of my ability and Second accept the moral responsibility for that which God has entrusted me, managing my life.

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*Footnote:  An interesting side note on this I heard this week. The fundamental difference between a liberal and conservative world view is the condition of mankind. A liberal worldview leans humanist, meaning that given the right circumstances humans will move toward goodness. A conservative worldview lends itself toward humans in their nature doing the wrong things.

As I understand it, the Biblical worldview is more centric, that humans are created good and to do good (“In the image of God”) but that because we are infected with the virus of sin we will inevitably do what we don’t want to do (Romans 7:15-20).

Debt and risk taking – article reflection

AtlanticDoes debt influence risk taking? In this article on Millennial entrepreneurs, that is one of the propositions:

The answer begins with more debt and less risk-taking. The number of student borrowers rose 89 percent between 2004 and 2014, as Lettieri said in his testimony. During that time, the average debt held by student borrowers grew by 77 percent. Even when student debt is bearable, it can still shape a life, nudging young people toward jobs that guarantee a steady salary. Entrepreneurship, however, is a perilous undertaking that doesn’t offer such stability. There is also some evidence that young people’s appetite for risk-taking has declined at the same time that their student debt has grown. More than 40 percent of 25-to-34-year old Americans said a fear of failure kept them from starting a company in 2014; it 2001, just 24 percent said so.

Assuming that hypothesis is true, what risks are required for those going into Occupation Ministry?

Are church planters inherent risk takers? Does a candidate need a willingness to relocate? Do financial constrains restrict a pastors ability to start with a small congregation? Are church staff less likely to stand up to improprieties in leadership if they are financially stressed?

Emotional reaction to financial risk

Recently while driving I glanced back in the rear-view mirror to see the familiar sight of a police car merging behind me in traffic. Police rearviewEven though I was pretty sure I was breaking the speed limit by the socially acceptable amount, my heart still raced.

Why does that happen? Why does our “fight or flight” kick in at the prospect of a very affordable traffic ticket?

The bigger question: Why doesn’t our heart race the same way when faced with a financial risk over 100x greater – taking out a car loan or $40k in student loan debt?

The short answer is that we are very poorly designed to properly calculate risk.

15 Risks and Understanding Layers of Risk

ball-and-chainA couple recently came to me to seek financial counseling, and as I met with them I struggled in the moment to properly communicate the financial risks they were encountering. Dave Ramsey has a saying: Personal Finance is 80% Personal and 20% Finance. What he’s communicating is that this thing called LIFE isn’t a math equation or a formula – it’s a very personal journey.

This couple had taken on an enormous amount of risk, but they didn’t see it because unlike one large risk (50k in credit card debt for example) they had layered lots of smaller risks on top of one another.

Our brain is really ill-equipped to understand risk at all, much less how lots of different risks interact with each other. One of the main points author Michael Lewis made in his book “The Big Short” was that Wall Street investment banks – who’s only job was to understand and mitigate risk- didn’t understand how all their risks layered onto each other.

We’ve developed a lot of tools to help us mitigate risk in the 20% ‘math/finance’ portion of “Personal Finance”, but there isn’t a lot of understanding and tools around the 80% ‘personal’ side.

What is personal risk?

We understand from Jesus parable of the talents that we can’t go through life without taking any risks. Taking no risks in life is actually cowardly and a big risk in itself. We take both eternal and temporal risks – a great teacher once told me that we take risks in the direction of our hope.

Financially, we also take a lot of risks, calculated on a hoped for return. We put money in the markets with the hope of it returning to meet a future need. We also are born into and voluntarily take on a variety of financial risks. The couple I counseled had six of these risks at the same time. To help us understand this idea I’ve compiled an incomplete list here:

BIG RISKS:

These are risks of which any singular one of them can make life very challenging.

  1. Lower income: A lifetime of low income (as much of the 3rd world faces) makes meeting life needs very difficult.
  2. Debt: The Bible warns about debt being bondage – and “It was for freedom that Christ set us free”.
  3. Lower education: Wisdom is knowledge rightly applied. Without knowledge, there it’s hard to succeed in life.
  4. Substance abuses:
    1. Gambling
    2. Alcohol and drugs
    3. Pornography
  5. Dumb Friends: “Do not be misled: ‘Bad company corrupts good character.’”

LIFE HAPPENS:

These are risks (often by no choice of our own) that we encounter that add a layer of complexity to our financial picture.

  1. Having children very young: See the statistics on teen moms
  2. Being a Minority
  3. Come from a poor/broken family

These circumstances all permanently change our worldviews and relationships with money.

ATTITUDES

There are also a variety of ‘mindsets’, worldviews, or attitudes that can have a dramatic effect on our ability to navigate life’s financial complexities.

  1. ‘Love of money’: Paul warned “Those who want to get rich fall into temptation and a trap and into many foolish and harmful desires that plunge people into ruin and destruction.”
  2. Dreamer, serial entrepreneur: There are a lot of unemployed musicians, screenwriters and artists of all kinds that are waiting ‘to be discovered’. Success virtually never happens this way. If you’re wired this way, there are a number of amazing books like “The War of Art” that detail the path from dreaming to working.
  3. Aversion to Authority: This is me. If you have a strong aversion to authority, it is very difficult to have a boss, work inside a team, and generally succeed in most forms of employment.
  4. Materialism/Spending: Thomas Stanley’s life work (Stop Acting Rich, Millionaire Next Door) was dedicated to proving through statistics that the average millionaire didn’t care about material status symbols and instead focused on Needs versus Wants. In fact, he pointed out, a high status symbol job (doctors or attorney for example) was actually a hindrance toward long term financial success.
  5. Entitlement: Thinking the world owes you anything is a wonderful way to be disappointed the rest of your life.
  6. Being Lazy: Proverbs 10:4 “Lazy hands make for poverty, but diligent hands bring wealth.”
  7. Assuming on the future: Jesus told a parable about someone that grew rich and assumed on the future. Paul and Solomon warned against it. The reality is we don’t know our future health, the political or economic conditions that the future holds.

It’s important to note that none of these fifteen risks are a death knell in and of themselves. They are all addressable through well documented strategies. The point of this article is that we often layer several of these risks on top of each other and we don’t have any clue about the combined risk they play together. In fact, ‘layers’ gives the image that they add up one by one. Risk’s actually multiply together.

RISK

letter blocksUnderstanding financial risk is not a natural human process. When I’m jogging and see a dog running at me or when I see a police officer in the rear view mirror my heart races with a hard wired ‘fight or flight’ reaction to a real physical risk.

Perhaps it’s the abstractness of numbers on a page, but for reasons I don’t fully understand we don’t emotionally register financial risks that are far greater than a speeding ticket.

This point is made well in a story from Peter Drucker:

A year or two ago I attended a university symposium on entrepreneurship at which a number of psychologists spoke. Although their papers disagreed on everything else, they all talked of an “entrepreneurial personality,” which was characterized by a “propensity for risk-taking.”

A well-known and successful innovator and entrepreneur….was then asked to comment. He said: “I find myself baffled by your papers. I think I know as many successful innovators and entrepreneurs as anyone, beginning with myself. I have never come across an ‘entrepreneurial personality.’ The successful ones I know all have, however, one thing-and only one thing- in common: they are not ‘risk-takers.’ They try to define the risks they have to take and to minimize them as much as possible. Otherwise none of us could have succeeded.”

He then adds, “The innovators I know are successful to the extent to which they define risks and confine them”. I’ve seen this with the successful real estate investors I know personally. They will look at a project and before they invest they will try to figure out how many different ways they could get out of the project without losing money. These ‘exit strategies’ define the deal. They truly see, understand, and mitigate the risk better than most. While we would see these as ‘high risk ventures’, if they’ve done as Drucker said – defined and confined the risk- they don’t see them as all that risky.

A major point before we continue: This discussion has nothing to do with the upside or return. Greater return doesn’t mitigate risk. I strongly believe in the value of higher education, specifically my pastoral leader having a seminary education. This is value is unrelated to defining and confining the risks. This article also doesn’t address the cost risk of higher education. Generally I believe it to be a good value, but we are confining the scope of this conversation to just the risk of BORROWING to pay for that education.

When it comes to student loan debt, how do we ‘define the risk’? First, we need to admit that when it comes to seeing risk, we’re lousy. Our brain doesn’t do a good job of predicting what we will have to give up in the future to pay for debt we’re accumulating now. Second, we need to understand the time-value of money. Control of money earned in the future is extremely valuable. In addition, compounding interest makes makes today’s dollars more expensive. Third, student loans offer very limited ‘exit strategies’. Unlike virtually every other type of debt, defaulting and bankruptcy are not options.

So how do we ‘confine’ these risks? Here are a couple of thoughts:

  1. Don’t Borrow at all. Boom, risk confined.
  2. Borrow Less. The risk of borrowed money can be confined by borrowing an amount that is easily repaid. I would look at this primarily as a percentage of future income. It’s not a perfect formula, but in general I recommend TOTAL accumulated student loan balances of less than your first year’s starting salary.
  3. Do I have other ways of paying beside my income? You can confine the risk if you have other options beside your future income to pay the debt. These might include family money, savings, spouse income, other assets (i.e. your home) that could be sold, or other income sources. I strongly recommend selling stuff and earning extra income. These are the cornerstones of debt reduction.
  4. Get done fast. An ‘extra’ year of income can dramatically reduce your debt load moving forward.
  5. Cut your expenses to zero. The more expenses you can eliminate, the lower you reduce your risk. I can’t recommend enough – living with another family, bike instead of owning a car, ‘beans and rice’, no subscriptions to anything (Spotify, etc.), no eating out, limit your electronics purchases, etc. If anyone asks why you’re not going out, just tell them ‘risk mitigation’.
  6. All of the above.

Understanding and confining risk isn’t something that we’re good at doing, but it is a skill that can be learned. My hope is that this article is a first step in changing the way you see and limit financial risks – specifically those around student loan debt.

*Drucker quote from Innovation and Entrepreneurship (p139) quoted in Killing Sacred Cows by Gunderson (p152).