• Lecture 26 Annual Payment.XLS• Lecture 26 Monthly Payment.XLS• Lecture 26 Equity Growth.XLS• Lecture 26 Retirement

Calculator.XLS

• Sources of information– Dave Ramsey -- The Total Money

Makeover: A Proven Plan for Financial Fitness. It is available at most book stores and on line

– Personal experience and observing successful people

Debt Management for Retirement Lecture 26

• This lecture is not about business management

• It is about your personal money management

• I ask: “Do you want to spend your life managing debt or wealth?”

• People work for 2 reasons:– Cover costs for necessities– Increase net worth (so we can retire)

• To achieve this goal we must manage wealth

Do You Want to Manage Debt or Wealth?

• First step is to become debt free• Second step is to build wealth• Reasons to build wealth

– Retirement– Security– Have Fun

• Money is Not the Root of all Evil • Desire of Money is the Root of all

Evil

To Manage Wealth

• Cut expenses so you live within your means and SAVE

• Stop using credit cards – pay cash or postpone purchases

• Buy used cars 1-2 years old, keep them a few years and trade again– After you have built wealth then you can

afford to buy new cars– NEVER lease a vehicle

• With a lease you are paying for the car plus interest PLUS someone else’s profits

• Companies do not lease cars to lose money

Steps to Becoming Debt Free

• Yes, before you start paying off debt build a cash reserve – your personal VAR fund

• Why a cash reserve? How much? Where do to invest it?– Cash reserve pay for an emergency: as

job loss Not to go on a vacation, for a wedding, or …

– Cash reserve should equal 3 times your after-tax Monthly Salary

– Invest it in a Money Market account, interest is low but MMs usually require a min check size of $250 so it discourages using it on little items

Build a Cash Reserve

• How do you build a cash reserve?• Sell something

– Garage sale– Extra vehicle– Move to cheaper house, etc.

• Get a part time job– Deliver papers before work– Deliver pizza after work– Start a business doing something other

people do not want to do for themselves• This is not permanent just to get a

reserve

How to Build a Cash Reserve

• Sort debts from low to high: D1, D2, .., Dn

• Pay the maximum extra you can on the smallest debt (D1) until it is paid off

• Use money you had been paying on D1 and add it to the payment on D2 until it is paid

• Continue this until all debts are paid off

• Euphoria from paying off a debt is great so get the feeling early by attacking the lowest debt (D1) first, then move to D2 …..

• Make double and triple payments

Develop a Plan to Pay Off Debts

• Use Cash or Debit Cards• Can I ever use a Credit Card again?

– Yes if your job reimburses your travel expenses

– Have a separate card for ONLY travel that will be reimbursed

• Avoid all kinds of debt– Save money to buy a car– Do not take vacations until you can pay

cash– Stay off of cruise ships – Save money for a house

Do Not Get Back Into Debt

• The total cost of a $40,000 car • Financed 72 months =$46,382 to $49,101• Shorter the loan, the lower total cost

Years and Cost to Finance a Car

Amount No. of Months Annual Monthly Total Cost/Borrowed for Loan Life Interest Rate Payment Interest Total Cost Initial Cost

40,000 72 0.05 644 6,382 46,382 1.16040,000 60 0.05 755 5,291 45,291 1.13240,000 48 0.05 921 4,216 44,216 1.10540,000 36 0.05 1,199 3,158 43,158 1.07940,000 24 0.05 1,755 2,117 42,117 1.053

40,000 72 0.07 682 9,101 49,101 1.22840,000 60 0.07 792 7,523 47,523 1.18840,000 48 0.07 958 5,977 45,977 1.14940,000 36 0.07 1,235 4,463 44,463 1.11240,000 24 0.07 1,791 2,982 42,982 1.075

• Renting – Provides no income tax deductions

• But do you have sufficient income to itemize deductions? Probably not when starting out

– Does not build equity• Ownership

– Builds equity (very slowly)– Often get over extended with large

payments– Small income tax deductions on the

whole– Do not acquire debt to reduce income

taxes!– Save for a house; make a large down

payment

Housing: Buy or Rent

• Examine total cost of a $100,000 home

• Financing for 15 vs. 30 years is $32,876– Finance for as short a period as possible

• Make large down payment to avoid added charges when making 10% down payment

Years and Cost to Finance a Home

Amount No. Year for Annual TotalBorrowed Loan Life Interest Rate Payment Interest Total Cost

100,000 5 0.035 22,148 10,741 110,741 100,000 10 0.035 12,024 20,241 120,241 100,000 15 0.035 8,683 30,238 130,238 100,000 20 0.035 7,036 40,722 140,722 100,000 25 0.035 6,067 51,685 151,685 100,000 30 0.035 5,437 63,114 163,114

Stochastic Equity Growth for a Home Loan

After 5 Years, how much equity do you have?

Depends on how long you financed

Will your job let you stay in a home for 30 years?

Input for the Loan

Amount No. Year for Annual First Year ofBorrowed Loan Life Interest Rate the Loan

100,000 5 0.07 2011=SCENARIO(P25:P30)

Value Home GRKS for Appreciation in Value105,000 -0.1 0.03 0.07

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

-20,000 0 20,000 40,000 60,000 80,000 100,000 120,000 140,000

Prob

Net Worth CDFs for 6 Financing Periods

NW 5 Yr NW 10 Yr NW 15 Yr NW 20 Yr NW 25 Yr NW 30 Yr

• Do not change standard of living -- SAVE

• Save for what? – Retirement and fun– Children’s educ – #529 College Savings

Plan• Where do you invest your savings?

– Low load mutual funds – lots to choose from• Every investment house has several

– Make sure you can move money among the Funds in the Family without a cost

– Get a broker, but do not let them make trades for you – can lead to account churning

Once You Are Debt Free, What’s Next?

Example of Types of Mutual Funds

• When do I start? How much should I save? Is it to late? What about Social Security for your retirement?

• In the future, businesses will not provide retirement accounts

• You will be on your own to save through an IRA – Some businesses will provide

matching funds – Some will offer managed IRAs with

limited options

Retirement Savings

• Start saving the day you graduate or today

• Save as much as you can but at least save 15% of your gross salary annually

• Save 50% of each raise • Keep working and paying into Social

Security so I can collect it!– Do not depend on Social Security to cover

your retirement needs– Today Social Security will pay me 16% of

my current salary; after paying for 50 years

Retirement Savings

• Social Security has no store of money• Congress will be forced to CUT these

entitlements– Debt ceiling, sequestration, budget

reductions – All these add up to lower payments for

your generation to receive as Social Security payments

• Probable changes in Social Security– Extending retirement age– Means testing based on wealth or income– Reduced payment rates for everyone

Social Security and Medicare/Medicaid

• Tax DEFERRED savings– Traditional IRA - $5,000/year per person

unless over 60 then can save $6,000/year– If you are in a company retirement plan

can still use the max Traditional IRA – If you are self employed you can have a

• SEP IRA – 25% of business income up to $50,000 tax deferred or

• KEOGH plan – 25% of self-employed income up to $49,000 tax deferred

• Not tax deferred savings– You can save as MUCH as you want

IRS and Retirement Savings

• Variables to consider– Current age and amount you have saved– Current salary and expected raises– Age you want to retire– Consumption expenditures after you

retire– Annual rate of inflation pre & post

retirement– Returns you expect on savings until

retirement– Returns on savings after you retire– How long do you & spouse expect to live

• Which of these variables are stochastic?– Nearly all of them!

Retirement Saving is Risky

• I made a Monte Carlo simulation model to calculate retirement savings

• With lots of stochastic & input variables

Retirement Calculator

Output: Annual Value of Cash Reserves

Output: Probability of Positive Cash

• Enter your own values • Simulate using the KOV table starting

in row 183• What age do you have a zero wealth?• How much do you have to save to

give yourself a 95% chance of having wealth when you are 90 or 95 or even 100?

• Did you marry the right person ($’s)?• Remember divorce cuts your wealth in half so it

takes twice as longer to save for retirement

Open the Retirement Calculator

• Linear programming – what ought to be• Probabilistic forecasting – capabilities of

forecasting with multiple regression, exponential smoothing, seasonal analysis, and time series analysis

• Monte Carlo simulation – what could be ….– Frame your problem in a systems framework– Model design and development– Parameter estimation for stochastic variables

and deterministic component of a forecast – Validate simulated variables– Univariate and MV distributions

• Apply these tools for business and personal decision making using stochastic efficiency

Summary of AGEC 622

• Improved Excel skills• Applied econometrics• Ability to organize & build a business

model• Make any business model a risk analysis

tool• Rank risky alternatives• Deterministic and probabilistic forecasting• Simetar

– Available as long as you are a fulltime student– After you graduate, buy it at www.simetar.com

• If you do not have Simetar, you can use @Risk=NORM() same as =RISKNORMAL() =UNIFORM() same as =RISKUNIFORM()

What can you take to the job?

• May 6 in this room • Open book, notes and computer programs• Please bring your own computers if you want• Two parts to the exam – Part A is short, do it first• Print each part as you finish it. • DO NOT wait until the end to print Part A!!!!• No talking, texting, tweeting, face booking or

other social interaction during the exam• Pizza will be provided at noon. Take a short break.• The type of problem for Part B will be familiar to

you• Practice advice: Redo all Labs on simulation and

old Lab Exams

What to Expect on Lab Exam

• Questions on all aspects of the material covered in class since the last exam

• Short answer essay questions– You should not need more space than what is

provided for a complete answer– DO NOT repeat the question as part of your

answer• It wastes time for you and ME

• A few calculator questions• NO Cheat Sheet is permitted

What to Expect on Final Exam