Wednesday, May 23, 2012

Exchange Traded Funds

Several online brokerage firms, including TD Ameritrade (100+ ETFs), Fidelity (31 ETFs), Vanguard (64 ETFs), and Schwab (11 ETFs), offer investors the ability to purchase Exchange Traded Funds (ETFs) for zero commissions.  That is not a typographical error.  One may purchase a diversified portfolio of stocks for $0 in commissions.  Before we take advantage of this bargain, let’s make sure we understand the characteristics of this increasingly popular investment.


Why are ETFs so popular?  First, they allow the purchaser to buy shares of a highly diversified portfolio of securities.  Second, there is no minimum purchase, like there is in many mutual funds, enabling the small investor to use their limited resources to diversify across and within sectors.  Third, the expense ratios of ETFs are low, relative to their cousin the “Mutual Fund”.  The average expense ratio for all ETFs is a little more than 50 basis points (bps), while it is over 100 bps for mutual funds.  Fourth, they are relatively tax efficient, as they are designed to mimic an index.  When an index is purchased there are fewer reasons to trade securities which results in fewer capital gain distributions.


What do they do?  ETFs mimic index mutual funds by tracking a broad based index while holding a diversified portfolio of stocks and/or bonds.  ETFs exist for most of the world’s major indices, as well as focusing on specific segments of the stock market.  This “indexing” reduces turnover and, hence, capital gains distributions.  Moreover, low-cost indexing is hard to beat as a strategy, especially for beginning investors seeking to achieve market returns.  For, if you own the market index, you should receive the return on that index, less the expense ratio of the index.


A characteristic of ETFs is that shares are purchased and sold on stock exchanges (hence, we call them exchange traded funds).  This is similar to other common stocks and, with the growth in low-cost internet trading platforms, make it possible to be diversified without having to spend a fortune.  (Zero commissions are pretty low commissions.)  The catch, if there is one, is that the price of an ETF is determined by both the value of the securities held within the fund – similar to other mutual funds – and by market supply and demand factors.  If, for example, there is a either a large increase or decrease in demand for an ETF investment, the price per share could increase or decrease, respectively, according to these external factors.  Another cost is that most stocks are sold on a bid/ask basis, where they are sold at the ask price and purchased at the bid price.  This creates a bid/ask spread which profits the market maker in the ETF.  This could reduce your returns.  These “hidden” stock characteristics, however, also allow for other aspects of stocks to exist in the ETF market.  Practices such as limit orders (set a limit on what you are willing to pay per share) and stop orders (set a price at which your security is sold) are available to the ETF investor, while the mutual fund investor simply buys or sells at the close of the day’s business.  Increasingly, the ability to sell ETFs short and to purchase them through a margin account, allows investors to invest in their beliefs with regard to market moves, as opposed to the moves in a single security. 


Whether you choose an ETF, a mutual fund, or individual securities to invest your money you must never forget the importance of disciplined saving, diversification of investments, and beginning while you are young to work toward your financial success. 


NOTE:  We discussed whether we should continue the Financial Tip of the Week over the summer months of June and July.  Our staff is skeletal during the summer and, as our biggest users are teachers of personal finance, we have decided to suspend publication of the Financial Tip until August.  If you receive it today, you will again receive it in August.  We are just taking a break, while we work on our own Financial Success.


May you have a summer to remember and many blessings within it.


Thursday, May 17, 2012

Degreeless in Debt

by Ryan Law

Student loans are a frequent topic of conversation around my office. We see students who are looking to take out loans, students getting ready to graduate who are looking at re-paying their loans and recent grads that are facing the possibility of not being able to pay off their debts. A group we don’t hear much from, however, are students who have dropped out of school before they graduate and have student loan debt – sometimes a significant amount.

Mary Nguyen, a research assistant at Education Sector, recently wrote an article titled “Degreeless in Debt: What Happens to Borrowers Who Drop Out”, which provides an excellent overview of the trends in student loan and dropout rates as well as the realities facing these students. In today’s Financial Tip I will provide an overview of the article along with some comments, but I highly recommend you read her full article at the link provided below.

First, here are some trends:

·         47% of freshmen borrowed federal loans to pay for education in 2001, while 53% of freshmen borrowed in 2009. While this may not seem like a large increase, it is an increase. A number of factors could be contributing to this, but certainly the increasing costs of higher education play into that. In addition, some people who have lost their job are returning to school and are likely borrowing, and at most institutions of higher learning there is an emphasis on recruiting out-of-state students (which could be an entire other article), who pay much higher tuition that in-state students.

·         The increases in student-loan borrowing were highest at for-profit schools:

o   For-profit less-than four year schools saw a 24% increase, from 62% to 86%

o   For-profit four-year increased 11 points, from 76% to 87%

o   Public two-year went from 30% to 35%

o   Public four-year dropped 3 points, from 61% to 58%

o   Non-profit four year also dropped, from 70% to 65%

o   NOTE: For-profit schools expanded heavily during the 2000s due in part to heavy recruiting and enrollment of low-income students. During a down economy people return to school, and promises made by for-profit schools can draw unemployed people in.

·         Among those who borrowed, however, more students are dropping out:

o   Between 1996-2001, 23% of borrowers dropped out

o   Between 2001-2009, 29% of borrowers dropped out

·         Although increases in dropouts were higher at for-profit schools, every sector saw an increase in drop-outs.

So what happens to borrowers who drop out? They face three realities: higher unemployment rates, lower income and higher default rates.

Higher Unemployment Rates

·         In 2009 the unemployment rates for borrowers who dropped out was 10% higher than borrowers who graduated (25% vs 15%)

·         Interestingly, certificate-only holders faced a higher unemployment rate than borrowers who dropped out (26% vs 25%). Obviously this is an issue that needs more studying.

Lower income

·         Borrowers who graduated have a median income of $30,000, while borrowers who dropped out had a median income of $25,000. Over their working lifetimes this gap will become much larger than first-year median income differences.

Higher Default Rates

·         About 3.7% of borrowers who graduated defaulted on their loans, while 16.8% of borrowers who dropped out defaulted.

·         Default is a serious thing – it will affect your credit report for at least 7 years, the federal government can garnish your wages without a court order, you may be ineligible for future loans, professional licenses can be revoked, and collection fees can add up to an additional 25% to your loan balance. In addition, student loans never go away – there is no statute of limitations (how long they can collect), and they are rarely to never discharged in bankruptcy.

Understanding all of this, would it be better if students didn’t borrow at all? What if, instead, they enrolled part-time and worked part-to-full time to fund their education?

It turns out that these strategies actually increase the drop-out rate. Among borrowers who dropped out:

·         45% delayed entry into college – choosing to work instead for a time

·         16% enrolled part-time

·         28% worked full-time

Interestingly, these same factors are even higher for non-borrowers who dropped out:

·         54% delayed entry into college

·         42% enrolled part-time

·         35% worked full-time

Each of these strategies are used by students to help finance their education, but can obviously hurt them as well. If a student is working too much it may be difficult to focus on studies, thus increasing the likelihood of dropping out due to bad grades. It is entirely possible to borrow too much, but some students they may be under-borrowing. This is not always true – recall Dr. Weagley’s student from last week’s Tip (  This student took 7 years to finish school, working full-time, and is graduating debt-free.

As Dr. Weagley also stated, it is important that students understand their potential income after graduation.

There are several things to consider as you look at your own education (or that of your children, or grandchildren), either now or in the future:

·         Defaulting on student loans is a serious situation to be in, and one that should be avoided at (almost) all costs. Obviously food, clothing and shelter come first, but student loans should be fairly high on your list of priorities.

·         Consideration needs to be given to how much your chosen career pays after school. Amassing a large amount of student loan debt to obtain a degree that doesn’t have a high payout is not a smart strategy.

·         Consideration also needs to be given to how much you will work while going to school. I happen to know the student Dr. Weagley mentioned last week, and he is extremely disciplined and could handle the schedule mentioned. Can all students do the same, however? Probably not. It may make sense for them to borrow moderately to not have to work so much.

·         Before dropping out due to financial considerations, talk with someone. At the University of Missouri we have the Office for Financial Success. At other universities you can usually find some help thought the Financial Aid office (they will know who to refer you to if someone is available).

·         Parents, teachers and others who have influence on students – talk with them! They may be adults now who can take out large amounts of loans without your approval, but if you talk with them they may listen, even if they pretend not to. Most 18 year olds don’t understand the repercussions of taking out $24,000 or more in student loans. Helping them understand what that will mean in the future may help them to make wiser choices. In addition, help students with debt see the full spectrum of repayment strategies. It is possible for a low-income person to have $0 payments under the Income-Based Repayment strategy.

·         Encourage students to enroll in student success classes. These classes teach basic study skills, time-management, goal-setting and what resources are available on campus (such as the Office for Financial Success and other counseling centers).

o   Tulsa Community College who take these courses are 20% more likely to remain enrolled and earn a C or better in future courses.

o   Durham Tech Community College reported a 30% increase in retention from students who took these courses.

We are interested in your comments on this and other articles. To share your ideas and stories, go to

Full article by Mary Nguyen:

Ryan H. Law, M.S., CFP®, AFC
Personal Financial Planning Department
Office for Financial Success Director
University of Missouri Center on Economic Education Director

162 Stanley Hall
University of Missouri
Columbia, MO 65211

573.882.9211 (office)
573.884.8389 (fax)


Wednesday, May 9, 2012

At what price a college education?

The other day I received the following excerpt from an email I received from a student in our department.  I can’t get it out of my mind.


I have had to work full-time (40 hours/week) at the University Hospital for the past 7 years while I pursued my bachelor's degree due to the fact that I come from a poor family and have no other form of support.  Some days I went to class from 8 or 9am till 3 or 4pm, then walked over the hospital where I would then work till 11pm, 12pm, or sometimes even 1am, and then do it again the next day.  However, I am graduating debt free since I paid my own way.  And the entire experience has made me a better person for it. 


Today, the news has articles discussing how Republicans in the US Senate blocked a vote on Tuesday to extend the current 3.4% interest rate on Stafford student loans.  Stafford loans are advertised on their website as follows: 


Stafford Loan Information: Benefits

·         Low fixed interest rate - Stafford loan rates for the 2011-2012 school year are as low as 3.40%

·         Increased borrowing limits - up to $20,500 per year depending on degree status and years in school

·         No payments while enrolled in school

·         Acceptance not based on credit


There is no mention of the costs of a Stafford loan at , nor is there any mention of the benefits of a college education.  Both seem germane to the decision.  Today, in discussing the current congressional debate it is becoming apparent that student loan debt has surpassed both credit card debt and automobile loan debt in the United States.  While the amount of student loan debt is less than certain, estimates ranging from $867 billion to $1 trillion, it is certain that default rates for student loan debt exceed those of both credit cards and automobile loans. The argument is growing louder as to whether this is the next economic “bubble” in our country, where education is increasingly funded by students borrowing against their future earnings – the benefit of a college education.


Data on the benefits of a college degree, future earnings, can be found at the website of the United States Bureau of Labor Statistics: .  This table provides the median (50% of the sample above and 50% below) income for hundreds of occupations in the United States.  When one compares the median salary from a “high school” occupation with that of a “bachelor’s degree” occupation, a benefit can be found.  If one takes the difference, one has an “annuity” the holder of the degree can expect to receive over their working life. 


Data on the costs of a college degree may be found at the National Center for Education Statistics, where data are presented on both public and private colleges and for both two and four-year programs.  While not always discussed, the costs of college have been increasing faster than the wages of those with a college education.  Thus, it takes longer for a degree to pay for the cost of earning the degree.


Let me present an example that I have specifically chosen due to the fact that the salary for a high school educated “substance abuse counselor” is not that different from a college educated “mental health and substance abuse social worker”.  The former has a median salary of $31,120 and the latter a median salary of $38,600 for an education “benefit” of $7,480 per year.  Of course this comes with the cost of $19,300 per year of education from a four-year public institution and four years of forgone earnings of, say, $31,120 per year.  If we use the current cost of student loan borrowing of 3.4%, we find that the net present value of this college education is a negative $35,927.  This amount balloons to a negative $91,388, if the cost of borrowing is increased to 6.8%.  The conclusion is that the educated is worse off than the uneducated.


On the other hand, if the bachelor’s degree educated social worker pursues a career as a “medical social worker”, the median salary rises to $47,230.  In this case, the net present value of the decision to attend college at 3.4% is a positive $136,804 and $1,108 if a 6.8% rate of interest is used to discount the cash flows back to the present.


What can we conclude?  First, the cost of borrowing should have a huge effect on the decision of young people to attend college and work toward a degree.  Greater costs can drastically reduce the number pursuing education, as well as the number deciding the realized benefit is not worth the cost and, hence, they decide to default on the loan.  Second, one needs to make sure that the degree they seek actually has the monetary benefits to counteract the costs of the education and to employ their human capital appropriately.  Third, if the cost of higher education were not as great, more people would receive an education in their attempt to grasp financial success.  In a society endeavoring to compete in the world economy of the 21st century, such a subsidy for those who create our future, the young, appears to be just as valid as our decisions to subsidize the health care expenditures of the aged.  Finally, perhaps my student is correct and taking longer, while working for your goal, does “make you a better person for it”.