What is your personal cost of capital?

Most large companies use a concept called the cost of capital as a factor judge whether or not an investment is worthy to go ahead. This cost of capital refers to the cost of taking on debt to pay for the investment or to the loss of what that money could have done elsewhere.

How does a personal cost of capital translate to my own personal finances?

Using a cost of capital in your personal life can help you to prioritize between paying off loans or investing in yourself, your business, or investments. First, the main concept is that your personal cost of capital should be low risk. Next, your personal cost of capital should have the largest expected payback of your low risk options. It will serve as the bar that any other financial decision needs to meet in order for you to go ahead.

For most people your personal cost of capital will first be:

  1. The interest rates on any debt that you hold (car loans, credit cards, student loans, mortgages, etc).
  2. If you don’t have debt, it would be the interest rate on any CD’s or savings accounts.

Everyone’s cost of capital will be different due to varying options and opportunities.  It will also change over time as you progress through life.

Example with Student Loans

Let’s say you went to college and have student loans.  You’re getting a $1,000 bonus at work. Further, you already have 6 months of savings in your emergency fund. You aren’t sure which of these options you should take:

  • Option 1: Leaving it in your bank account for 1% annual interest.
  • Option 2: Paying an extra $1,000 to your $10,000 student loans. These loans are at 6.8% annual interest and have 10 years remaining.
  • Option 3: Paying to take a certification which will earn you a $100 raise at work every year for the next 10 years. This equates to a non-compounding 10% interest rate.

Basic Analysis

  • Option 1 will net you $105 over 10 years and is very safe, using the interest formula, [Ending amount] = [Starting Amount] eAnnual Interest Rate * Number of Years
  • Option 2 will net you a guaranteed $875  over 10 years. This was calculated by summing up $3,809 in interest without the extra payment, versus $2,934 with the extra payment. I used this student loan payback calculator from Bankrate.
  • Option 3 may net you $1,000 over 10 years. But, there is some risk, because maybe you will move to another employer in those 10 years.

In a business, we would look at these options and say, Option 2 is the cost of capital that we’re going to use to compare the other options against. It has a good return, low risk, and low effort. Your next decision would be whether or not to go for option 3. It has an even higher payback, but would require more research on what your plans and goals are in the future.

This concept should help structure your thoughts around how financial decision is going to affect you.  Finally, there are going to be a lot of other factors that will impact your final decision.  Your personal cost of capital is a small piece to help to put numbers around it. But, remember money is a tool not the goal, so put your money to the best use.

Mapping the Average House Age by County

Last year I moved into a city which had much older housing stock than other cities that I had lived in before. I was under-prepared for the housing market here, because I had not researched the factors that you should look into for older homes which vary a lot depending on the era that they were built in.  I created this interactive mobile friendly map to visually help show the differences in regions and counties.

Continue reading

Net Worth Trends by Age : Are you on track?

Is your net worth on track compared the rest of the US population? Here are a few graphs to see if you have increased your net worth at a similar rate to other American households. In this first graph, I’ve selected the 25th, 50th and 75th percentiles of net worth at various age ranges to allow you to figure out where you lie in relation to the rest of the population.  For example, at age 30:

  • the 25th percentile has a net worth of $700.
  • the 50th percentile has a net worth of $16,000.
  • the 75th percentile has a net worth of $77,900.

net worth trends 25th to 75th at various ages

Click to expand the graph.

There are many misconceptions about American wealth.  A common one is that Americans are heavily indebted. As this graph demonstrates most American have a positive net worth, even at the 25th percentile.  Net worth includes assets such as houses, stocks, retirement accounts, etc as well as debts such as mortgages, student loans, and credit cards.  You can follow the general trend of people saving more and more as they age.  This trend reverses around the standard retirement age of 65-70, and people begin to draw down on their retirement savings and other assets to pay for living expenses.  The drop is most drastic for those that are in the 75th percentile, which may be due to many causes such as retirees continuing to support the same level of lifestyle that they lived while they were in their income earning years.net worth trends 10th

Click to expand the graph.

Not all Americans are as fortunate, the 10th percentile of households is heavily indebted until age 50 when the net worth of the average household in the 10th percentile of wealth hits 0.  An important thing to keep in mind with these charts is that people will move between different percentiles due to different life circumstances.  Many of the households in the 10th percentile in the 20-35 year old age brackets are probably in debt from student loans.  These people probably have higher future earning potential and build up wealth faster than most other households.
net worth trends 90th

Click to expand the graph.

Those at the 90th percentile bracket follow the previous trend as the rest of the population, but with many times a much money saved as the average American household. At age 70, a household in the 90th percentile has almost 10% as much wealth as the average American household ($2 million vs $226k)! Are you saving enough?

You can calculate your own net worth percentile using our Net Worth Percentile Caclulator.

These graphs were generated from data from the 2013 Survey of Consumer Finances.

Young Adult Income and Debt Trends since 1989

Most Americans say that their children will be financially worse off than they were at the same age. I decided to investigate if the trends over the past 25 years show a downward trend for today’s Millennials just now starting to 20’s and 30’s.

Since most of us aren’t independently wealthy enough to not work, income is the major factor behind most people’s financial health.  For households who’s heads are are between the ages of 20-30 years old, inflation adjusted incomes have been  trending slightly down since 1989.  Since the data is grouped by the age of the head of a household,  most full-time students will not be represented in this age bracket.  So the trends should only include financially independent 20-30 year olds who have left their parents households.   In the graph you can see that the educational income premium for 20-30 years is very significant.  Fluctuating at a roughly 40% increase for college graduates over high school graduates.

20s income over time

The inflation adjusted incomes of the older millenial and the younger Gen-Xers (represented in the 30-40s age groups in the 2013 data)  also follow a similar trend of staying relatively stable since 1989.  College graduates have seen a slight over-all increase but not much.  So it looks like at least looking at just income, Millenials and young Gen-Xers are doing roughly the same as the the previous generations in terms of income.30s income over time

So far, we’ve seen that things are not bad for college graduates, not great but at least for the most part today’s Millennials are starting off at roughly the same incomes as the previous generations.  The other educational income groups aren’t doing quite as well as college graduates, but their overall trends are not quite as terrible as headlines would suggest.

 Income isn’t the only measure of financial health though.  Debt is another important factor and as the graphs show, debt is increasing significantly for college graduates. Debt from housing (such as mortgages) has been the category with the largest dollar value increase over the past 2 decades.  There was a spike in debt leading up to the great recession that appears to have followed the 30-40 year old households as they have aged. For the 20-30s bracket is seems as though enthusasim over home ownership has reverted back to the historical levels of debt despite the current low interest rates.  Car loans have also been largely stable and are almost unchanged, since 1989.  The biggest consistent percent increase has been in student loans which comprise roughly a third of 20-30 year old debts and about a tenth of 30-40 year old debts in 2013.debt college educated 20s vs income debt college educated 30s vs income

OOverall from these selected figures, younger Millennials are not doing worse than previous generations, but older Millennials are carrying far greater loads of debt that any comparable age group before.

These figures are results off of the Survey of Consumer Finances conducted by the US Federal Reserve.  All figures are stated in 2013 inflation adjusted dollars.

Tips to finding the best way to travel home for the holidays

Ever since I graduated college, I’ve lived in states far away from my parents.  So, if I wanted to go home for the holidays, I had to make a plan so that I could still meet expectations at work, and avoid breaking the bank. Here are a few of the tips that I’ve learned along the way.

Tip 1: Use Google Flights

My favorite flight comparison website is Google Flights.   Not only do they do a good job at showing the lowest prices for that ticket, it’s also really easy to figure out the cheapest times/days for your flights that would work in your schedule.  The only downside is that Southwest flights aren’t part of the search.

One of the best features are their calendar views.  If you click where the yellow cursor is (right in one of the date selection boxes) another set of options will pop up.
google flights 1

You’ll first see the calendar view, which shows you the cheapest days to depart if you were to shift the start of your vacation to that date.  So if you initially searched for a departure and return flight that were a week apart, the calendar will show you the best prices for departures and returns a week apart.

google flights2

The next view is the price graph which gives you a nice representation for how the prices are trending.  I use this to figure out the absolute lowest price the flight goes for before deciding if I’m going to wait and chance it or buy a ticket now.

google flights3

In general, prices are pretty erratic 2-6 months out, so if you check the prices pretty frequently, you might get a deal.   Once you wait till 1 month or less, the prices are pretty stable but trend up the longer you wait.

Tip 2: Book a Refundable Southwest Ticket and then check Google  Flights every single day.

The standard Wanna-Get-Away Southwest ticket is refundable for an equal flight credit which will expire. So if you want to lock in a ticket just in case the flight prices skyrocket, you can book a flight with Southwest and keep checking Google Flights to see if something better pops up.  You should really only do this, if you’ll fly enough to use the credit before it expires.  It’s way better if you use Southwest reward miles instead of money,  since those are 100% refundable.  So if you cancel your flight you won’t incur any penalties or limitations.

Tip 3: Try the Bus or Train

If you don’t like driving long distances, buses and trains are an option.  I personally would not do this if it involves a transfer or is longer than 8 hours.  The buses that I have ridden have had wifi, built in outlets, and comfy seats so it’s about as comfortable as flying.  Amtrak has way more comfortable seats than most airlines, but most of their trains lack wifi or outlets.

Tip 4: Get Airline Points

If you’re planning 6 months ahead, you could try to get an airline rewards credit card.  Many airline credit cards have sign on bonuses of 40,000 – 50,000 points for meeting a minimum spend of a few thousand dollars within the first few months of getting the card.  It takes time for you to receive the points, so you have to start the process early enough in the year so that you can use them for holiday travel.  I would check out the subreddit /r/churning for more information on which cards are the best.

Good luck, and happy holidays! If worst comes to worst, you can always rent a car.