Paris, Personal Finance 101 for Freshmen and an Issue Brief

Yesterday's news cycle was dominated by the Trump administration's decision to leave the Paris climate agreement. The treaty, a non-binding document signed by nearly every country in the world, committed the US to reducing CO2 emissions to 27% less than 2005 levels. Here at the Accountable Update, we worry less about what the government will do for us and more about what we can do. For instance, what would you be willing to sacrifice in the name of saving the planet?

Be honest, what would you sacrifice to reduce CO2?#ActOnClimate

— Jeff Weeks, CFP® (@ATXAdvisor) June 1, 2017

Of course, you can also consider allocating your portfolio in a more environmentally conscious way. The Dimensional Sustainability Core portfolios are alternative funds we can use in the Accountable Portfolios that shift your capital from companies with the highest greenhouse gas emissions to those with the least.

This week also marks the end of high school for The Class of '17. Leaving home and becoming independent is a right of passage for graduates, but all lessons don't need to be learned the hard way. Just because most of our children in the Westlake bubble have grown up surrounded by affluence, there are many gaps in their knowledge of personal finance. My new guide, Personal Finance 101 for College Freshmen, may help some of our bright progeny avoid some of the money mistakes that proliferate on campuses today.

The last part of this week's Update is the latest Issue Brief from Dimensional Funds. In it, they discuss if investors should be worried about potential rising interest rates.

As always, if these issues have you concerned about your plans, get in touch.

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Personal Finance 101 for College Freshmen

1. Debt is indentured servitude and should be avoided if possible. The average undergraduate walks out of college with over $30,000 in student loans. There is no question that completing your education can lead to higher lifetime earnings, but borrowing from your future to pay for the present should be your last alternative, not the first. See additional details on the growing student debt problem in this 2016 report, Student Debt and the Class of 2015.
2. Get ONE good credit card. Establishing credit and using it responsibly is an important life skill. The temptation to accept point of sale discounts for establishing credit accounts or accepting 0% balance transfer offers to delay paying off balances are slippery slopes to financial ruin. Getting cash advances or choosing to pay less than your full balance due are also common mistakes, with finance charges running as high as 20%! One example is the  Journey® Student Rewards from Capital One®. It has no annual fee, 1% cash back on all purchases, and .25% back for timely payments each month.
3. Don’t Pay Stupid “Taxes”. Late fees, penalties, and parking tickets are frequently the result of laziness, inattention, or let’s face it, stupidity. You were smart enough to get into college, you are smart enough to avoid these “taxes”.
4. Find a bank with free checking and ATM withdrawals. Local credit unions are always worth a look. One online option that is attractive is The Summit Account from Aspiration. They pay interest on your balance, offer unlimited ATM reimbursements, and have no monthly maintenance fee or minimum balance requirement. 
5. Shop around for books. College textbooks are a racket that cost the average student over $1200 each year, according to The College Board. Shop around and don’t overlook the campus library. Amazon, Chegg, and eBay are also worth a look. A more creative alternative is to go in with several other students to hack a book by scanning it to PDF files for sharing.
6. Take a bike instead of car. If you live on campus, consider leaving the car at home. Not only will you avoid “stupid taxes” like parking tickets, you won’t have to pay for insurance or gasoline.
7. Aggressively apply for scholarships. Unless you are a world class athlete or at the top of your class, colleges may not be aggressively recruiting you but that shouldn’t deter you from going after every scholarship dollar you can find. Start by checking out the Department of Labor’s Scholarship Finder. Other sites to check out are Cappex,  Collegeboard.com,  CollegeNET.com,  Fastweb.com, moolahSPOT.com, Peterson’s, Scholarships.com, Scholarship Monkey, and Unigo.
8. Graduate in 4 years or less. A year of college can cost up to $70,000. Taking Advanced Placement tests, dual credit courses, or classes at the local community college can get you credit for many of the huge lecture classes than many freshman struggle with while potentially saving thousands of dollars.
9. Start looking for internships your freshman year. High paying internships for juniors are competitive. Give yourself a leg up by seeking internships at companies in your field of study as early as possible. Reach out to smaller companies or startups where hiring managers may be happy to hire a lower paid resource than they would have to pay for in the open market. The experience you gain will make you a more attractive candidate for higher paying gigs later on.
10. Pay Yourself First. If you follow the previous advice, you may find that instead of graduating college with a monthly obligation that you can pay yourself instead. A dollar invested when you’re are 20 years old will grow to over $45 by age 60 if you can average a 10% return, which is roughly what US stocks have done long term. Even better, put the savings in a Roth IRA and it will grow tax free!

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When Rates Go Up, Do Stocks Go Down?

June 2017

Should stock investors worry about changes in interest rates?

Research shows that, like stock prices, changes in interest rates and bond prices are largely unpredictable.[1] It follows that an investment strategy based upon attempting to exploit these sorts of changes isn’t likely to be a fruitful endeavor. Despite the unpredictable nature of interest rate changes, investors may still be curious about what might happen to stocks if interest rates go up.

Unlike bond prices, which tend to go down when yields go up, stock prices might rise or fall with changes in interest rates. For stocks, it can go either way because a stock’s price depends on both future cash flows to investors and the discount rate they apply to those expected cash flows. When interest rates rise, the discount rate may increase, which in turn could cause the price of the stock to fall. However, it is also possible that when interest rates change, expectations about future cash flows expected from holding a stock also change. So, if theory doesn’t tell us what the overall effect should be, the next question is what does the data say?

Recent Research

Recent research performed by Dimensional Fund Advisors helps provide insight into this question.[2] The research examines the correlation between monthly US stock returns and changes in interest rates.[3] Exhibit 1 shows that while there is a lot of noise in stock returns and no clear pattern, not much of that variation appears to be related to changes in the effective federal funds rate.[4]

Exhibit 1. 
Monthly US Stock Returns against Monthly Changes in Effective Federal Funds Rate, August 1954–December 2016

Monthly US stock returns are defined as the monthly return of the Fama/French Total US Market Index and are compared to contemporaneous monthly changes in the effective federal funds rate. Bond yield changes are obtained from the Federal Reserve Bank of St. Louis.

For example, in months when the federal funds rate rose, stock returns were as low as –15.56% and as high as 14.27%. In months when rates fell, returns ranged from –22.41% to 16.52%. Given that there are many other interest rates besides just the federal funds rate, Dai also examined longer-term interest rates and found similar results.

So to address our initial question: when rates go up, do stock prices go down? The answer is yes, but only about 40% of the time. In the remaining 60% of months, stock returns were positive. This split between positive and negative returns was about the same when examining all months, not just those in which rates went up. In other words, there is not a clear link between stock returns and interest rate changes.

Conclusion

There’s no evidence that investors can reliably predict changes in interest rates. Even with perfect knowledge of what will happen with future interest rate changes, this information provides little guidance about subsequent stock returns. Instead, staying invested and avoiding the temptation to make changes based on short-term predictions may increase the likelihood of consistently capturing what the stock market has to offer.

Glossary

Discount Rate: Also known as the “required rate of return,” this is the expected return investors demand for holding a stock.

Correlation: A statistical measure that indicates the extent to which two variables are related or move together. Correlation is positive when two variables tend to move in the same direction and negative when they tend to move in opposite directions.

Index Descriptions

Fama/French Total US Market Index: Provided by Fama/French from CRSP securities data. Includes all US operating companies trading on the NYSE, AMEX, or Nasdaq NMS. Excludes ADRs, investment companies, tracking stocks, non-US incorporated companies, closed-end funds, certificates, shares of beneficial interests, and Berkshire Hathaway Inc. (Permco 540).

Source: Dimensional Fund Advisors LP.

Results shown during periods prior to each Index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.

Eugene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

[1]. See, for example, Fama 1976, Fama 1984, Fama and Bliss 1987, Campbell and Shiller 1991, and Duffee 2002.

[2]. Wei Dai, “Interest Rates and Equity Returns” (Dimensional Fund Advisors, April 2017).

[3]. US stock market defined as Fama/French Total US Market Index.

[4]. The federal funds rate is the interest rate at which depository institutions lend funds maintained at the Federal Reserve to another depository institution overnight.