Financial Illiteracy: An Epidemic With A Simple Cure

How do we learn about money? 80% of parents surveyed believe that schools provide classes for their children on money management and budgeting.

Sorry to break the bad news, Mom and Dad — your kiddos probably aren’t learning personal finance in school. Our school system requires English, math and science, but not a practical life-skills class like financial literacy. Ridiculous, isn’t it? I am all in favor of a well-rounded education, but what good is it if students learn where Shakespeare was born, but not what a tax-deferred retirement plan is? Or that n2x, but not that if you use Payday loans, you could pay an outrageous 1560% in annual interest!

Once we graduate from high school, the vast majority of us are responsible for earning an income, establishing and maintaining a respectable credit score, balancing our bank account, and saving for our future. We deal with money decisions almost daily — yet we are taught nothing about personal finance in school.

Braun Mincher (Braun Media, LLC) is currently producing a feature-length documentary film which exposes the financial illiteracy epidemic in order to bring awareness to this important topic. Braun’s goal is to show viewers why taking personal responsibility for their own financial wellbeing is so important. He wants to expose how little parents and the school system are doing to prepare the next generation for this growingly complex and relevant topic.

Braun conducted over 100 interviews with a wide variety of people: students, parents, educators, consumers, government officials, celebrities and personal finance experts. I was honored to be one of his interviewees. Here’s a short video teaser clip of my own money-life story and response to his million dollar question: “If financial literacy education is so important, then why are we not requiring schools to teach the subject, especially considering the current economic situation?”

(Email subscribers, click here to view the video posted on my blog.)

Incidentally, I think it’s supposed to look like I’m sitting at my desk but the office I was interviewed in is not mine — naturally, my office is wallpapered with family photos, colorful Treasure Maps (aka vision boards) and cute puppies!

I’ve served as a volunteer Junior Achievement instructor and have taught students basic economic, personal finance and small business management concepts. The kids and their teacher loved the program. So did the parents — in fact, several of the student’s parents had their kids ask me pressing, personal finance questions for them. Yet the only administrators in my area interested in offering the course were those managing private schools. There is a pathetic 2.3% percent national market penetration at the high school level — and Junior Achievement classes are offered for free!

What about you: Did your parents pass along their financial literacy skills to you? Were you taught personal finance in school? Do you think schools should be required to teach money management skills? And finally, if the cure for financial illiteracy is so simple, then why aren’t we doing it?

Read my tips on how parents can teach kid’s about money management.

Hyperinflation or Prolonged Deflation? Coping and Investing Strategies For Either Scenario

Rebecca commented:

I enjoy these posts – thanks for adding a voice of reason given the vast propensity to imagine the solution to the problem is doing more of the thing that caused the problem. We’ve collectively been telling ourselves the same stories so long it’s hard to ram home still that they *are* just stories; it’s good to keep hearing stuff like this to remind us. Like Anna, I’d love to read your thoughts on surviving the possibility of heightened inflation over the coming years – its impact on savings and so on. I know you suggested in a previous post you were concerned with this matter. Any thoughts?

Many fear hyperinflation, but after digging into the topic, I don’t think it’s as likely a scenario as prolonged deflation. From what I’ve been hearing, talk of hyperinflation might be driven more by politics than economics.

We are experiencing deflation right now. Using the 12-month change in the Consumer Price Index as the measure, inflation has been negative for three consecutive months. I think the more likely scenario will be like Japan: low inflation, low interest rates, and falling house prices for at least a couple more years.

… Japan, during what came to be known as its “lost decade.” A gigantic real-estate boom in the 1980’s came crashing down in 1991, bringing many other prices with it. Efforts to restart the economy foundered time and again, as businesses were not able to generate the kind of profits that would reignite prosperity’s cycle of hiring and spending. Not until 2005 was the deflationary era finally declared to be over. ~ New York Times

Because I’ve been sitting on a considerable sum of cash since I made my exit from the stock market during the first half of 2008, I’ve been mulling over this topic. I’m still trying to wrap my head around the implications of hyperinflation and prolonged deflation. I am not an economist, so please take my thoughts and opinions with a grain of salt. In other words, this post is not investment advice; just my best guess and opinion.

During deflation, debt is the enemy. Deflation is better for those with savings accounts because it increases the value of the money they have saved. Deflation rewards people like me (with cash) and retired seniors (who no longer need to worry about rising unemployment rates and would benefit from living cost containment).

During hyperinflation, the last place one wants to be is in cash. Inflation is better for those who owe money because it reduces the value of the money previously borrowed. Inflation is better for those in debt — including the US Government. So naturally, the Fed wants to create and maintain a moderate, steady rate of inflation.

Many people worry that the amount of money the Fed is spending to stimulate the economy will create hyperinflation. I think these fears are unfounded, at least for now. Last I heard, the Fed created about a trillion dollars, which sounds enormous, but is actually small when compared to the approximately $10 trillion drop in housing values and ~$10 trillion drop in stock market capitalization.

The Fed realizes they need to be careful — if they dilute the economy with too many dollars, they risk creating hyperinflation. Hyperinflation would be tough on everyone, including the Government, because foreigners would stop lending money to the US — unless they were sufficiently rewarded for taking on the heightened risk of investing in dollars.

Compensating foreign investors for taking on inflation risk means raising interest rates. But increasing interest rates would push homebuyers and homeowners with adjustable mortgages right over the edge. Mortgage rates have increased recently and if they keep increasing, we should see home prices fall further. Prices fall as interest rates rise, because a given monthly payment covers a smaller mortgage at a higher interest rate. Collapsing property values simply are not synonymous with hyperinflation.

According to this recent article in the New York Times:

For the short term, investment experts agree, deflation is more probable, with unemployment still climbing and the economy still mired in a recession. There’s talk of green shoots, but most everyone agrees that an earnest recovery is a long way off.

No one knows for sure what is more likely to occur: prolonged deflation or hyperinflation; or when the economy might change course. So how can we prepare for either scenario?

If you think hyperinflation is likely, you could invest in:

  • shorter-term fixed-income investments
  • TIPS (Treasury Inflation-Protected Securities)
  • foreign stocks and currency
  • real estate, REITS (real estate investment trusts)
  • commodities
  • precious metals
  • gold

During hyperinflation, the last place one wants to be is in cash.

If you think deflation is likely, you could:

  • raise and hoard your cash.
  • live below your means.
  • put off big purchases until prices drop more. You are, in essence, actively making money just by not losing it.
  • rent a home rather than own because home prices, like other hard assets, will continue to drop in value during deflationary times.
  • de-leverage yourself: pay off your credit debt as soon as possible — and don’t start building it up again. You don’t want your debt to expand at the same time dollars are becoming more valuable!
  • invest in dividend paying stocks. But it can be tricky to find a secure dividend paying stock in a deflationary environment.
  • play the currency market (certainly not my area of expertise).
  • play the short side using things like inverse index funds that move in the opposite direction of the market. Caution: While there are possibilities for making huge returns in this market, the rallies in a bear market can whomp you. Your timing must be precise.
  • build a CD ladder. The longer the duration the more risk there is, but at least your principal is protected.
  • invest in yourself and your education. Staying employed in such a downturn is the most important thing.

During deflation, debt is the enemy.

What am I doing? What do I plan to do?

Over the course of the past few years, I have positioned myself as best I can for the current economic deflation: I sold my home, paid off all of our debt, pulled out of equities and hoarded cash.  Today I am in a wait-and-see holding pattern and once deflation is curbed, I am in a great position to change course accordingly: I have cash ready to buy the hard assets (when they are cheap) that will help me weather inflation.

What about you? Do you think prolonged deflation or looming hyperinflation is more likely? Why?

When Should I Buy a Home? Have We Reached Bottom Yet? What Is The Right Price?

My question has to do with the timing of buying (a home), especially in the current market. I would like to know from your perspective when a time to buy might be. I’m not asking for you to predict a date, but rather I’m interested to know what indicators and trends you might look at to make a decision to buy a home. Any response you have is much appreciated!” ~Adam

(Ed Note: The following is a reprint of an analysis I wrote in April, 2008. My family and I have since moved into a different rental home so the numbers I used to illustrate these concepts would be different today. However, the concepts remain the same. I’ve also added an update after the conclusion of this post.)

Using three indicators and the home my family currently rents as an example, I’ll illustrate how I gauge whether (or when) the time might be “right” to buy a home.

The home I rent today might sell for $250,000. We pay $1,295 per month for rent. It is a single-family home located in Colorado with four bedrooms, three baths, a two car attached garage, a fenced yard and 2,120 square feet.

First “Price is Right” Indicator: The Price-to-Rent Ratio

Rents are a useful barometer for tracking housing markets. Like a P/E (price-to-earning) ratio for a stock, a P/R (price-to-rent) ratio can help identify relative real estate bargains. The lower the ratio the better. The current price-to-rent (P/R) ratio for my home is 16.09 ($250,000 price divided by $15,540 annual rent).

The New York Times article, Ratios of Home Prices to Rental Prices in Selected Metro Areas indicates that the P/R ratio in Denver during the first quarter of 2000 (before the US asset-based economy switched from stocks to housing) was 11.6.

Therefore, the current P/R ratio on my home is 38.7% higher today than it was in 2000 (16.09 versus 11.6). If the P/R ratio for my home was to return to year 2000 “pre-bubble” levels, my home would sell for $153,250 today rather than $250,000. Therefore, unless I find a “bargain” – a foreclosure, short-sale or bank-owned property with a reasonable P/R ratio, I’ll probably wait until my local market returns to pre-bubble price-to-rent levels.

Second “Price is Right” Indicator: When will buying real estate make sense for landlords?

I recall times when local investors could buy a house with 20% down, rent it out at market rates, and make a positive cash flow in year one. In fact, I’ve done it before. But during the real estate bubble, investors speculated. They bought homes that created a negative cash flow, then counted on home appreciation to pay them back someday in the future. As with any investment, the more speculative, the more risky. I’d rather wait until I can buy rental investment homes that create positive cash flow from the get go. Future price appreciation would be icing on the cake.

My (speculative?) landlord bought our home in 2006, near the peak of the housing bubble. Here’s an estimate of the annual costs our landlord incurs on our home:

Item Annual Cost Notes
Down Payment $2,000 20% of $250k = $50k down. $50k x4% in T-bill, CD or bond instead.
Mortgage Payment (P+I) $14,772 $200k @ 6.25% 30 yr fixed
Property Taxes $1,500 0.6% of hm value
Insurance $900
Maintenance, Repairs $2,331 15% gross annual rent (this is the minimum allowance typically recommended)
Property Management Fees $1,399 9% of gross annual rent (8-10% is typical)
Vacancies $1,295 1 month per year allowance
Marketing and Leasing Fee (by Mngmt Co.) $583 90% of 1 mo. rent every 2 yrs (80-100% is typical fee)
Auto Expense $0 (assuming owner relies 100% on mngmt company)
Total Annual Cost $24,780

+ $15,540 Annual Gross Rent Collected

– $24,780 Annual Costs

= $9,240 Annual LOSS

Obviously our landlord was betting on home price appreciation to continue at unprecedented rates. Bummer.

In order to break-even in year one, our landlord needs to increase our rent from $1,295 to $2,065 per month. Of course if he tried to do this, we’d move out, no one would move in, and his investment property would sit vacant. Not good! So he’s not likely to raise the rent.

Alternatively, if he had bought at the “right” price with the intent to create a near break-even cash flow in year one, he’d have paid only $130,000.

$130,000 is 48% less than the current value of $250,000! Ouch!

If our landlord had bought this home for $130,000, this is what the math might look like:

Item Annual Cost Notes
Down Payment $1,040 20% of $130,000 = $26k down x4% in T-bill, CD or bond instead.
Mortgage Payment (P+I) $7,680 $104k @ 6.25% 30 yr fixed
Property Taxes $780 0.6% of hm value
Insurance $900
Maintenance, Repairs $2,331 15% gross annual rent (minimum)
Property Management Fees $1,399 9% of gross annual rent (8-10% is typical)
Vacancies $1,295 1 month per year allowance
Marketing and Leasing Fee (by Mngmt Co.) $583 90% of 1 mo. rent every 2 yrs (80-100% is typical)
Auto Expense $0 (assuming owner relies 100% on mngmt company)
Total Annual Cost $16,008

+ $15,540 Annual Gross Rent Collected

– $16,008 Annual Costs

= $468 Annual LOSS (almost break-even)

Third “Price is Right” Indicator: An “old” rule of thumb for establishing fair value of rental property is to multiply the annual gross rent by 6 (in not-so-great neighborhoods) to 10 (in premium neighborhoods). This gives you a “business” estimate of the value of a rental. In my case:

$15,540 annual rent x 6 = $93,240 value of rental (in not-so-great neighborhood)


$15,540 annual rent x 10 = $155,400 value of rental (in premium neighborhood)


In my area, house prices are still elevated relative to rents.

Using the above indicators, the price of the home I’m renting should be between $130,000 and $155,400 — rather than the current $250,000. Significant price declines are needed to bring home prices back to their historical relationship to rents (and/or rents need to increase substantially) before the P/R ratio makes sense again.

June 2009 Update:

A year ago, we moved to a 3 bedroom, 2 bath condo. We pay $1150 per month in rent and this includes our water, sewer, trash, cable TV, yard maintenance, clubhouse, swimming pool, hot tub and exercise facility. These HOA benefits cost our landlord about $200 per month. Our landlord bought our condo for $177,100 in 2002. Therefore, our P/R (price to rent) ratio is just under 13 if you include the HOA benefits in our rent; or about 15.5 without them. The most recent comparable sales price I can find for a similar unit was $160,000 in March 2007. I don’t know what our condo would sell for today, but the price would need to drop to $132,240 for the P/R ratio to match our local 11.6 pre-bubble average.

We will continue to rent for as long as it is cheaper to do so. We enjoy our modern condo with all of it’s amenities and proximity to a huge park. This said, we ARE looking to buy land or a home eventually — but only if we can find one for the right price! We are in an enviable position — we can make a low price offer sound appealing to the right seller — because we don’t require a mortgage, we can pay cash if necessary, and we don’t have any home sale contingency to delay closing. When the time and price is right, we will find (or build) our little green dream home.

Readers: What indicator(s) are you watching to access real estate values? When do you think the market will hit bottom? Please do your own math for your own local market and leave your results in the comments for comparison and discussion.

Recommended reading: US Housing Crash Continues: It’s Still A Terrible Time To Buy: Falling House Prices Are The Solution, Not The Problem

Debt Is Slavery

I was a typical naive college freshman, relishing my first day on campus. Lining the hallways of the crowded student center, financial companies competed obnoxiously for our attention.

“Apply for your first credit card and you could win a brand new TV!”

“Step right up! We’ll make it easy for you to buy things now… then pay for them forever!”

The Giant Marketing Machine deftly defines what is fashionable and brainwashes us to spend. As young adults, my friends and I were perfect targets.

Too bad Michael Mihalik’s book, Debt is Slavery: and 9 Other Things I Wish My Dad Had Taught Me About Money wasn’t prerequisite reading prior to admittance into those hallways, littered with credit card applications.

Michael’s short book offers preventative medicine for students and young adults — plus concise treatment for anyone struggling with debt. This author didn’t create words simply to increase page count. He created a short read that gets right to the point. In his just-the-right-size book, he offers practical advice and illustrates financial concepts with relevant examples.

Golden nuggets of wisdom are sprinkled throughout each chapter. Here are some of my favorites:

Chapter 1: Debt is Slavery

Do you ever wake up in the morning and groan, “I don’t want to go to work today?” As you lie in bed toying with the idea of staying home, your thoughts turn to all the bills you have to pay. So you drag your tired self out of your warm bed, drink a pot of coffee, and drive to work (in your cool car–only 43 more payments and that baby is all yours!). You drag yourself out of bed and go to work, because you have to. Isn’t that a form of slavery?

Reading this passage brings back haunting memories of the relentless “BEEP! BEEP! BEEP!” of my old alarm clock. Aack! I hated that obnoxious beast! When I say that I haven’t set an alarm clock in years, I truly mean it. Financial freedom has set me free from that blasted beeping slave master.

Chapter 2: Time May Not Be Money, But Money Definitely Is Time

…if I earn $12 per hour and want to buy something for $12, I am spending an hour of my life. I quantify all potential purchases with two questions:

  • How many hours do I have to work to pay for it?

  • Is it worth that much of my life?

Bingo. We trade our time for money and our money for stuff. Problem is this: while we can make more money, we only have a finite amount of time. See my relevant post, How to Revolutionize Your Spending Habits by putting a price tag on your time.

Chapter 3: Possessions Are a Prison

Don’t love something that can’t love you back.

I have friends who define their self-worth on what kind of car they drive. They just love their car. But is that love returned? When you love a thing, the love will never be returned. A car will never comfort you when you’re sick. It will never help you when you’re in trouble. If you’re going to love something, make sure it can love you back.

Powerful concept. Have you ever participated in “retail therapy”?

Chapter 4: Be Aware of the Ongoing Campaign to Separate You from Your Money

We have become so desensitized to advertising that we are unaware of its insidious effect on our lives. We have become sheep who buy what we are told.

Isn’t that a little extreme? Are we really sheep?

So what kind of clothes are “in”? What kind of car should you drive if you want to look successful? How do you know what’s “cool” and what’s not?

Advertisers and marketers tell you.

What I appreciate most about our Tivo boob-tube box is that we can skip past the commercials, thereby reducing our exposure to advertisements. We avoid magazines for this reason, too.

Chapter 5: Money Buys Freedom

Money may not buy happiness, but it does buy freedom, options, and opportunity–and freedom, options, and opportunity may lead to happiness.

This is certainly true for me and my family.

Chapter 6: Don’t Sell Your Soul for a Salary

Sunday nights fill many people with dread because they know they have to go back to work Monday morning. So why do we end up at jobs we don’t like? Because we sold our souls for a salary.

Yep, the salary that’s required to pay for the vacation you charged to your credit card — two years ago.

Chapter 7: Own

Most wealthy people, especially if they’re self-made, are aware of the difference between income-producing assets and income-consuming assets.

I’m tickled pink that Michael recognizes and demonstrates the difference between the two — especially when it comes to real estate!

Personal real estate may appreciate over time, but it does not produce income. It consumes income. It consumes income because you have to spend money on maintenance, utilities, repairs, taxes and insurance. The only way you can extract money from real estate is by taking out a home-equity loan (debt!) or by selling the property.

As I’ve said several times here before, home-ownership is not normally the most effective way to create wealth and financial freedom.

Chapter 8: Spend Less Than You Earn By Controlling Your Expenses

…you have to value your peace of mind and financial security more than the things you buy.

Chapter 9: Save 50 Percent of Your Salary

If you save 50 percent of your salary, for every month you work, you will save enough to take a month off– without changing your lifestyle.

(The author doesn’t take compounding interest into consideration here — which would grow your future savings balance exponentially.) He illustrates his point by sharing a personal story of financial hardship: he was able to withstand two job layoffs, lasting a year or longer, because he had sufficient savings to see him through tough times.

Chapter 10: Control Your Money or Your Money Will Control You

Change your attitude toward debt. Every time you use credit for a purchase think, “Debt is slavery; I am making myself a slave.”

In this chapter, the author provides step-by-step instructions for creating a written financial plan aimed to minimize expenses, eliminate debt, and start saving.

While Debt is Slavery: and 9 Other Things I Wish My Dad Had Taught Me About Money might not be particularly suited for advanced finance readers, I enthusiastically recommended it for young adults and those struggling to break free from the handcuffs of debt.