Monday, June 20, 2022

Money rules for the rich

This is Joseph

One of the things that often makes me crazy is personal finance advice. Don't get me wrong, there is good personal finance advice out there. But it can often fall into one of several genres that end up not really being helpful to the median reader. One example is the "buy fewer lattes", which does get at a good point (small expenses can add up) but doesn't move the needle much for large financial challenges. 

The other is the advice that is very useful if and only if you already have a lot of money. This article was a good example of this genre. Was the advice good? You bet. Was any of it usable at my income level and life stage. No, not really. 

For example, consider these items of advice:
3. Strive to own your home, not rent — and try to buy in cash. This is particularly the case if you’re a moderate to high earner. Having more of your money packed in your home is a way to shelter it from federal and state asset-income taxation.

4. Mortgages are tax and financial losers. Pay them off ASAP. Think about it: If you have $100,000 that you can invest right now in a bond earning 1.5%, you’d have $1,500 in interest income over the course of a year. But if you had a $100,000 debt at a 3.2% interest that you could pay off right now, you’d save $3,200 over the course of the year in interest payments.

On balance, you’d make $1,700 with no risk by investing in debt repayment rather than investing in the bond.

Buying a home in cash is a formidable problem with income. The median house price in Chicago is $329,000.  Boston is more like $740,000. Cheaper prices might exist elsewhere but nowhere is this an inexpensive prospect. Median household income in Chicago is $62K. Saving 10% of pre-tax income would require about 50 years to save this much or about 40 years with a 1% post-tax and inflation-adjusted return. That's not bad for a stable investment (10 year TIPS bonds are under 0.3% at the moment and that is pre-tax). A long run stock market average is about 7% (so maybe 5% post-tax) and that'd work out after about 25 years. 

But the real assumption is that you have $300,000 or so in assets that you can chose how to allocate, in a way that does not cause liquidity problems. 

6. Your perfect home may be far cheaper several time zones away. Or it may be someplace with no state income tax, no state estate tax, and no state inheritance tax.

Moving is expensive. Not having a support network is expensive. International moves, in particular, can be quite challenging. 

16. Wait until age 70 to take Social Security retirement benefits. Retirees who wait to claim can get hundreds of dollars more each month than those who take benefits early.

Of course, this isn’t feasible for everyone. But here’s my plea: Before making any moves, figure out the strategy that maximizes your household’s total lifetime benefits.

This is good advice but it presumes that people are able to work until 70 or bridge the gap with savings. Maybe a good goal, but much more feasible for an economist than a roofer. 

But the one that I found the most worrying:

1. Don’t borrow for college. It’s far too risky and expensive. I don’t say this lightly. I’m a college professor. But you can get a fine education without mortgaging your future and potentially dashing your career plans.

It simply involves pursuing scholarships and applying to less expensive, if generally less prestigious, institutions. 

Even in Canada, which has cheaper education, one in two students graduates with debt. This is not simply a case of look for a cheaper school (in Canada there are not the large prices or price variations of the US) and it is unclear that there are that many scholarships lying around. Education is an earnings multiplier and a professional degree (e.g., Nursing) could open the doors to much better employment opportunities. The wage premium for a University degree in Canada is 53% or $13/hour. The median debt is about $20,000. Even post-tax that is 2-3 years of income to compensate.

Now don't go into huge amounts of debt -- yes, that is a good idea. The author is at Boston University and went to Harvard -- there are students in those schools who could well follow the advice to minimize student debt. But it is also the case that debt can be a form of investment in human capital and, done wisely, may well pay off.

Anyway, the big take-away is that financial advice is very context dependent. A lot of this advice is very good for upper-middle class to wealthy Americans who have assets and can afford to think about wealth management. But it really doesn't seem to be the points that the median family is going to be able to easily apply.  

1 comment:

  1. (from Andrew Gelman; the software doesn't let me log in)

    Relatedly, here's an example of advice to help the rich get richer:
    What struck me was not so much that this advice was out there, but that there seemed to be no recognition that this is what was going on.