Financial Tip of the Week: January 2013

Tuesday, January 29, 2013

Choices Are Everywhere: Why Can't We Just Have It All?

Each month the Federal Reserve Bank of St. Louis publishes a newsletter titled Page One Economics, which is a selection of useful economic information, articles, data, and websites compiled by the librarians of the Federal Reserve Bank of St. Louis Research Library.

There is a classroom version of Liber8 available to teachers for free at: http://research.stlouisfed.org/pageone-economics/uploads/newsletter/2013/PageOneClassroomEdition0113_Opportunity_Cost_Scarcity.pdf

To subscribe to their newsletter or for more information and resources, visit their website and archives at http://research.stlouisfed.org/pageone-economics/

The views expressed are those of the author and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis, the Federal Reserve System, the Board of Governors, the University of Missouri, the Personal Financial Planning Department or The Office for Financial Success.

Scott A. Wolla, Senior Economic Education Specialist

“You can’t always get what you want.”—The Rolling Stones

The public debate about the best way to reduce the level of government debt highlights our difficult situation: Our wants greatly exceed our ability to pay for them. In the case of government, purchases require current revenue through taxation or borrowing; the fiscal cliff arose from a level of debt caused by wanting more (and purchasing more) than we can pay for.

If we wish to reduce debt, we must make difficult choices. One choice is to cut government spending on goods and services—but which spending priorities should be cut? The other choice is to raise taxes—but who should pay more?

You might prefer one choice or the other or a combination of both. In fact, you may have very similar thoughts about your personal or family budget. These issues are based on understanding the economic concepts of scarcity and opportunity cost.

Personal and Household Spending

Let’s use a specific example to get a better grasp of these ideas. Suppose you receive a $20 gift card during the holidays. The $20 limit acts like a budget that constrains your spending. In other words, your resources are limited. How about your wants? Are they limited? If you are like most people, they are not—you would like to have much more than you can afford. This condition of limited resources and unlimited wants is called scarcity. The $20 limit means that you can’t have all the CDs, movies, or games you want; you must choose the one you want the most. Deciding between the recently released CD from your favorite band and the newest hit movie requires a choice, which involves an opportunity cost —the value of the next-best alternative when a decision is made. The opportunity cost is what is given up. So, choosing the CD from your favorite band means giving up the movie.

People make such decisions all the time. Managing a family budget is also an exercise in managing scarcity and opportunity costs. Household income determines the amount of money a family has to spend; that is, it constrains spending. And, unlike our gift card example, household wants are not limited to CDs, movies, and games. Rather, they include basics such as housing, medical care, education, food, and clothing. But, just like the gift card example, because our wants exceed our ability to spend, we must make choices, which involve opportunity costs. So, more money spent by a family on food might require less spent on clothing.

Credit cards and other forms of credit make it possible (and quite tempting) to exceed spending limits. Does debt negate scarcity? Does it permit you to buy more than your income would allow? It might seem so, but you still have a limit. Using debt means that you are borrowing your future income to buy goods today. As you repay the debt (plus interest) over time, you will have less income in the future to buy goods and services then. And remember that credit cards have limits, and lenders avoid lending beyond the borrower’s ability to repay the loan. At the end of the third quarter of 2012 (August 31), total consumer debt stood at $11.31 trillion.

Government Spending

In many ways, the government faces these same choices. Citizens have collective wants and the government attempts to satisfy these wants through its spending. Social Security, health care programs such as Medicare and Medicaid, and national defense are among the top federal spending categories. But the ability to satisfy our society’s wants is constrained by the level of government income, which is generated primarily by taxing workers and companies. Just like individuals who make spending choices, when the government chooses, there is an opportunity cost. If more money is spent on national security, the result might be less spending on health care. It is possible to raise taxes to provide additional income for the government to allocate, but that imposes further budget constraints on workers and companies who pay taxes—so, this policy choice also has opportunity costs. Of course, the government’s spending is not limited to tax revenue. Just as families can, the government can use debt to pay for some of its goods and services. At the end of the third quarter of 2012 (August 31), total federal debt stood at $16.07 trillion.

What is the downside of government debt? Using debt to buy goods and services today means the government is borrowing future income (that is, tax revenue)—which means less income in the future for buying goods and services then. In addition, there is a limit to how much credit lenders (or investors) will extend to a country; they will avoid lending beyond the government’s ability or willingness to repay the loan or will do so only at very high interest rates.

Conclusion

An understanding of scarcity and opportunity cost is crucial to making good economic decisions. Remember that scarcity describes the condition in which our wants exceed the resources necessary to satisfy those wants. Scarcity requires us to make choices and choosing involves an opportunity cost—the value of the item given up when a choice is made. So, making wise (and sometimes difficult) choices requires considering the opportunity costs.

GLOSSARY

Government debt: The sum of accumulated budget deficits. Also known as national debt.

Opportunity cost: The value of the next-best alternative when a decision is made; it’s what is given up.

Scarcity: The condition that exists because there are not enough resources to produce everyone’s wants.

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, January 23, 2013

Your Relationship with Money

This is inspired by an excellent book from an author who visits Mizzou regularly, Ted Klontz. The book is The Financial Wisdom of Ebenezer Scrooge, a book of readings/stories from various authors. The authors tell their life story and how it has shaped their relationship with money. (If you don’t think you have a relationship with money, try getting by without it!)

The author proposes that Bob Cratchit (of Christmas Carol fame) had a relationship with money that was just as destructive as Ebenezer Scrooge’s. Cratchit’s relationship with money was, however, different. You recall that Mr. Ebenezer worshipped money and held on to every single penny he made. On the other hand, Mr. Cratchit was quick to blow his paycheck on a single Christmas meal. It also described that someone as talented and obviously qualified to work for Mr. Ebenezer, should not have too much trouble finding a better paying job, or starting his own successful business. (Yes, to believe this, we need to forget that the 19^th century was quite different from our early 21^st century.)

The book goes on to describe that we all possess a “money script” which determines how we view money and most of us inherit our money script from our parents. It is no doubt that parents’ views of money vary widely and, within families, the views of the husband and wife can sometime be quite divergent. Throughout the book, the point is made that money is nothing more than a resource. It is a resource that we can use to buy things which bring us satisfaction including those things we require for sustenance. The authors emphasize that money should be viewed as a means to an end, not the end itself. (We doubt if Mr. Scrooge would have liked this part.)

Regardless, the authors implore us to consider the proposition that we all need a little Scrooge in us. We don’t want to be Charles Dickens’ character Scrooge, of course, but we need to be enough of Scrooge to keep us from spending every dollar and that comes our way. After all, it was Scrooge’s frugality that allowed him to amass so much money in the first place.

We must acknowledge that we, as Americans, have become spenders over the years. It is hard to recall when we used to be savers. Some of us even spend more than we make and some even justify it as the duty to help the country recover from the recession. Those who spend excessively will often say, “If I just had more money, everything would be better”. This is, simply, untrue. Consider the multi-millionaires who have squandered and wasted their money to the point of poverty. Many are professional athletes who did not learn the lessons of money management. Athletes such as Kenny Anderson, Wally Backman, Charlie Batch, Riddick Bowe, Mark Brunell, Billy Buckner, Jason Caffey, Jack Clark, Derrick Coleman, Dermontti Dawson, Lenny Dykstra, Rollie Fingers, Ray Guy, Tony Gwynn, Steve Howe, Dorothy Hamill, Harmon Killebrew, Bernie Kosar, Terry Long, Darren McCarthy, Denny McLain, Greg Nettles, Jonny Neumann, Gaylord Perry, Andre Rison, Warren Sapp, Billy Sims, Leon Spinks, Lawrence Taylor, Duane Thomas, Bryan Trottier, Johnny Unitas, Michael Vick, Antoine Walker, Danny White, and Rick Wise are on this list (http://www.businessinsider.com/a-shocking-list-of-athletes-who-have-declared-bankruptcy-2012-10 ).

While we are inspired by the escalating salaries of professional athletes, the stories of their lack of success in controlling their money to support their goals are numerous. Many overvalue their buddy with the “can’t fail” business idea. These athletes, the lessons of those who fail, are just as important as the stories of the people who get ahead in life by saving 20% of their income religiously. Yet, saving 20% of your income over your lifetime is a certain way to have a better financial and consumption life when you are older than by spending your money in the hopes of being happier today, with a greater chance of being a financial failure when you are older. This is certainly true if you use too much leverage (i.e., borrow too much) which can make the bad times worse, just like it can make the good times better.

Just remember it’s not how much or how little money you have, it is your relationship with the concept of money that will determine the quality of your life. Or, like an insurance friend of mine told me over lunch, “When I’m dead it won’t matter how much money I have. All that matters then is whether I’m in heaven or hell.” I will venture to guess that going bankrupt is a lot closer to hell, than it is to financial success, regardless of your religious persuasion.

- Matthew Ott, recent graduate Personal Financial Planning

- Robert O. Weagley, PhD, CFP^®, Personal Financial Planning

Thursday, January 17, 2013

“We plan for what we can, and we figure it out as we go, too.”

by Lucy Schrader

It's the beginning of a new year, and I'm going through financial papers at home to prepare for taxes, clean files and look ahead for the coming year. I had our college fund statements out when my 9 year-old son asked what they were. Then of course, he wanted to know how much he had in his account. After I told him, he very dramatically told me, "Mom!! That's not enough. That's not anywhere CLOSE to enough. How can I go to college? I don't have a job. I don't have that kind of money!!"

At first I was impressed—wow, he's actually developing a sense of how much things cost and learning that money doesn't grow on trees. My next actions were to try to help him realize that no, it's not anywhere near the full amount to cover college and that's ok; that we're saving what we can and will have more by the time he goes; that there are different ways to pay for college (scholarships, loans, that he may have to help pay for some of it with a job, but he'll gain new skills as he grows and can do more than he does now, etc); and that we will figure it out as we go. We do not have to have all of the answers right now.

Now, being realistic, my very logical reasons did not completely calm him. What I hope, though, is that we're beginning those many conversations and repeated messages of "we plan for what we can, and we figure it out as we go, too."

I also have to admit, that I had a gut wrenching moment just the week before–we're not saving enough; we don't have everything planned out; "they" [magazines, media, etc] say we need more. And that's where I get stuck. How on earth am I supposed to know how much I'll need in the future and in retirement? How can I truly guess at all of these things? I don't know for sure what tomorrow holds, let alone in 30 years.

I also had to talk myself through those moments and remind myself of several points I found very comforting to follow from the book The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money by Carl Richards (I was also lucky enough to see him speak at the 2012 MU Financial Symposium). Mr. Richards, a Certified Financial Planner™, reminds us that we cannot control everything. There are so many global and national events that happen that are out of our control, so we have to look at our personal lives and own financial lives and find what we do have control over. Have a plan, but be willing to adapt to the present situation.

In his book, he relays a story that he was working with a client and asked the client how much was enough to save for the kids' college. The man replied that in his mind it's not about what's enough—it's about saving what he can at this time and that will be enough, because that is all he can do. In my "it's not enough" moment, I had to remind myself that, yes, we've got a plan. We're saving what we can. It might not be enough to cover all expenses, but it's what we CAN do right now. Maybe in a few years we can save more, but at this moment it's what is reasonable for our family.

Mr. Richards also suggests that once you have a plan, focus on shorter time frames and look at the next year or two years (or the next day, week or month). Find what you can control in those time frames, since we don't know for sure what will happen in the future.

Instead of thinking "I don't have enough saved," think "what can I control right now to stay the course on my plan?" One example might be, I can bring my lunch today instead of going out to eat to save money on the food bill. That in turn will help us save money for the college funds this month. Spending is easy and saving can be more difficult, so give yourself credit for these day-to-day actions. Instead of negative thinking that you are not saving more, shift your focus and thoughts to the positive, which helps reinforce the actions you want.

When I or my son start down that negative path, we need to help each other to "keep calm and carry on." Have a financial plan and follow it as you can, but realize you might not have all of the answers. Follow through with things that make sense for your family. Small steps DO make a difference.

Reference

Richards, C. 2012. The behavior gap: simple ways to stop doing dumb things with money. Penguin group: New York.

Lucy Schrader
HES Associate State Specialist and
Building Strong Families Program Coordinator
University of Missouri Extension
162 Stanley Hall
Columbia, MO 65211
573-882-4071 or SchraderL@missouri.edu

http://extension.missouri.edu/bsf

Wednesday, January 9, 2013

The Affordable Care Act in Plain English

by Ryan Law

“At the end of the day, what everyone wants is a way to make sure we’re taken care
of when we’re sick, and that it doesn’t ruin us financially to get that care.”
– Jonathan Gruber, architect of the Affordable Care Act

There is a lot of controversy, confusion, misunderstanding and unfortunately, even blatant lies in the media about what the Affordable Care Act (ACA or Obamacare) is and how it will affect you, your insurance coverage, and the amount you pay for insurance.

Whether you like it or not the ACA is the law and it is important you understand what it is and how it relates to you and your family. After all, your health is one of your most important assets!

My attempt with this article will be to describe, non-politically, what the ACA is in plain English. If you want to hear a partisan description of the law you can tune in to your favorite Liberal or Conservative commentator. Trust me; they have plenty to say about it!

Jonathan Gruber, Mr. Mandate

The ACA was put together by Jonathan Gruber, an MIT Economist who has studied and analyzed the effects of health-care reform extensively. When Mitt Romney was governor of Massachusetts he called Gruber in to help design a health-care law for Massachusetts, which has become known as Romneycare.

In 2008 Obama called on Gruber to help him design the ACA. Gruber has written extensively about the law. He says it is the opposite of public health care and that insurance companies like the law because they get more customers, especially young, healthy ones that will pay insurance but not need as much healthcare. He says that the most important provision of the ACA is the individual mandate – without requiring people to get insurance it doesn’t work. There will be more on the mandate later in this article.

Goals of the ACA

§ Decrease the number of uninsured Americans. There are currently 44 million uninsured Americans[1], most of which are either young and they don’t think they need insurance, or they are poor and cannot afford insurance. The ACA should reduce this by 30 million.

§ Reduce health care costs

Important Provisions of the ACA

§ Pre-existing conditions: Requires insurance companies to cover all applicants of the same age at the same rate, regardless of pre-existing conditions or gender. This provision is something that will be extremely beneficial to millions of people who were denied coverage due to a pre-existing condition.

§ Coverage up to age 26: If you are under the age of 26 you can stay on your parent’s plan, regardless of whether you live at home or on your own, or are single or married.

§ Individual mandate: This is one part of the law that the government was sued over and that went all the way to the Supreme Court[2]. Because the Supreme Court upheld the Constitutionality of the individual mandate it will go into effect in 2014. Essentially it says that if you don’t buy insurance you will be charged a $95 penalty or 1% of income (whichever is greater) in 2014. That amount will increase until it reaches $695 per person or 2.5% of income in 2016. Regardless of your family size you will never pay more than three times the penalty amount if all your family members are without insurance. However, if health care coverage would cost you more than 8% of your income you don’t have to pay the tax.

§ Health Insurance Exchanges: By 2014 each state is required to set up a health insurance exchange (states that don’t set one up will use the national one) where consumers can compare health insurance policies and premiums.

§ Elimination of lifetime coverage caps: In the past health insurance plans typically had a maximum you would be covered for over your lifetime. It was often as low as $1,000,000. With the ACA coverage caps were eliminated.

§ Businesses must offer insurance: Businesses with 50 or more employees must offer health insurance or they will pay a $2000 fine per employee. They don’t have to provide it for employees working less than 30 hours a week. Businesses with less than 25 employees could qualify for a subsidy to offset the costs of insurance.
NOTE: Some companies have said they may have to lay off employees or reduce employee’s hours due to this portion of the law, the most famous of which was Papa John’s CEO John Schnatter. Schnatter later said he was taken out of context and plans to comply with the law and that his company is still doing analysis on how it will affect them.

§ Deductibles and out-of-pocket maximums: Employer plans have a maximum annual deductible of $2000 per person, or $4000 for a family. By 2014 the out-of-pocket maximum per person is $6000 per person per-year (out-of-pocket includes your deductible and co-pays).

§ Preventive Care: There will be no co-pay, co-insurance or deductibles for preventive care.
NOTE: This portion is sometimes referred to as the Contraceptive Mandate because under this portion of the law contraceptives and the “morning-after” pill must be free to people with insurance. Some groups, including the Catholic Church, have sued the government over this as they are religiously opposed to contraceptives. Other groups (Hobby Lobby being the largest) have sued the government because they are opposed to providing the morning-after pill to employees. There are currently 28 separate lawsuits about this provision. Under current rulings churches are exempt from providing contraceptives or morning-after pills, but church-run hospitals and schools are not exempt, and they were given until August 1, 2013 to comply. Hobby Lobby and others opposed to offering the morning-after pills were given until January 1, 2013 to comply or they will pay $1.3 million per day in penalties. Hobby Lobby has chosen to stand by its principles and pay the fine rather than offer the pill.

§ Insurance subsidies/tax credits: The Central Budget Office has predicted that insurance premiums may go up 10-13% due to the ACA. To offset this, low-income Americans will not pay anything for health insurance, and many in the middle-class will get some form of tax credits. Individuals making between $14,400 and $43,320 and couples filing taxes jointly making between $29,330 and $88,200 will receive some tax credits.

§ Insurance company profits: Insurance companies must pay out 80-85% of insurance premiums received in medical costs and can use 15-20% for administrative needs and profits.

Costs of the ACA

§ Jonathan Gruber claims that by his analysis the ACA should reduce the federal deficit by $143 billion by 2019 and by $1 trillion within 20 years.[3]
NOTE: Niall Ferguson in the August 19, 2012 Newsweek cover article[4] claimed that the CBO (Central Budget Office) and Joint Committee on Taxation have said net federal spending will be $1.2 trillion by 2022 even after all taxes and penalties have been collected. However, the CBO has actually said that it will decrease the deficit by more than they originally thought.[5][6] I believe the jury is still out on this one – in 2022 we will know for sure, but I struggle to see how it will actually reduce the deficit. I hope I am wrong, though!

Paying for the ACA

The following taxes, fees and penalties have been put into place to help pay for the ACA:

§ .9% tax on incomes over $200,000 (individual) or $250,000 (family).

§ 3.8% tax on unearned income over $200,000 (individual) or $250,000 (family).

§ Insurance providers will pay an annual fee.

§ Pharmaceutical companies and other companies that manufacture medical devices will pay taxes and fees.

§ The 7.5% AGI floor for itemized deductions is being raised to 10% (You can deduct your medical expenses if they exceed 7.5% of your Adjusted Gross Income and itemize deductions – that is being changed to more than 10% of your Adjusted Gross Income).

I hope this article has helped you understand the law better and how it will affect your family and your insurance. I’m sure we will see more lawsuits and attempts to change portions of the law through legislation – if there are any major changes we will follow up with additional articles.

NOTE: If you are looking for more detailed information about the law I recommend you check out the following resources:

· HealthCare.gov – this website contains the most comprehensive information about the ACA: http://www.healthcare.gov/index.html.

· Gruber wrote a book titled Health Care Reform: What It Is, Why It’s Necessary, How It Works. This is actually a good book for understanding the ACA, and best of all, it is written in comic-book format. It’s worth checking out from your local library.

Ryan H. Law, M.S., CFP®, AFC®