Materials for Lecture 20

1. Materials for Lecture 20 • Lecture 20 Annual Payment.XLS • Lecture 20 Monthly Payment.XLS • Lecture 20 Equity Growth.XLS • Lecture 20 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

2. Do You Want to Manage Debt or Wealth? • This lecture is not about business management • It is about personal money management • I ask again: “Do you want to spend your life managing debt or wealth?” • Recall I told you people work for 2 reasons: • Cover costs for necessities • Increase net worth (so we can retire) • To achieve this goal we must manage wealth

3. To Manage 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

4. Steps to Becoming Debt Free • 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 – If you think about it, you are paying for the car plus interest PLUS someone else’s profits

5. Build a Cash Reserve • Yes, before you start paying off debt build a cash reserve – your personal VAR fund • Why a cash reserve? How much? Where do I invest it? • Cash reserve pay for an emergency: as job loss Not to go on a vacation, go to a wedding, or … • Cash reserve should be equal to 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

6. How to 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

7. Need A Plan to Pay Off Debts • Sort debts from low to high: D1, D2, .., Dn • Pay themaximum extra you can on the smallestdebt (D1) until it is paid off • Use the money 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 • The euphoria from paying off a debt is great so get the feeling early by attacking the lowest debt Di first • Making double and triple payments

8. Do Not Get Back Into Debt • Do Not Get into Trouble with Credit Card Debt! • Look how long it takes to pay off a credit card debt: 2 interest rates

9. Do Not Get Back Into Debt • Use Cash or Debit Cards • Can I ever use a Credit Card? • Yes if your job reimburses your travel expenses • Have one 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 can pay cash • Save money for a house

10. Years/Cost to Finance a Car • The total cost of a $40,000 car • Financed 72 months =$46,382 to $49,101 • Shorter the loan, the lower total cost

11. Housing: Buy or Rent • 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

12. Years/Cost to Finance a Home • Examine total cost of a $100,000 home • Financing for 15 vs. 30 years is $77,076

13. 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 for 30 years?

14. Once You Are Debt Free, What’s Next? • Do not change standard of living -- SAVE • Save for what? • Retirement • Children’s educ – #529 College Savings Plan • Where do you invest your savings? • Low load mutual funds – lots to choose from • American Funds, ING, etc. • Make sure you can move money among the Funds Family without a cost • Get a broker, but do not let them make trades for you – account churning

15. Retirement Savings • When do I start? How much should I save? Is it to late? What about Social Security for my retirement? • In the future businesses will not provide retirement accounts • You are on your own to save through an IRA • Some businesses will provide matching funds • Some will offer managed IRAs with limited options

16. Retirement Savings • Start saving the day you graduate • Save as much as you can but at least save 15% of your gross salary annually • Keep working and paying into Social Security so I can collect it after I retire • Do not depend on Social Security to cover your retirement needs • Today’s estimate SS will pay me 19% of my current take home pay; after paying for 46 years • Social Security has no store of money, it will be in a cash flow deficit situation

17. IRS and Retirement Savings • Tax DEFERRED savings • Traditional IRA - $5,000/year per person unless over 60 then save $6,000/year • If you are in a company retirement plan can still use the maximum Traditional IRA • If you are self employed you can have a • SEP IRA – 25% of business income up to $46,000 • KEOGH plan – 25% of self-employed income up to $49,000 • Not tax deferred savings • You can save as MUCH as you want

18. Retirement Savings is a Risky Investment • Variables to consider • Current age and amount you have saved • Current salary and expected raises • Age you want to retire • Consumption pattern 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?

19. Retirement Calculator • I made a Monte Carlo simulation model to calculate retirement savings • With lots of stochastic & input variables

20. Output: Annual Value of Cash Reserves

21. Output: Probability of Positive Cash

22. Open the Retirement Calculator • Enter your own values • Simulate using the KOV table starting in row 172 • 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 longer to save for retirement

23. Summary of AGEC 622 • 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

24. What can you take to the job? • 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()