Chutzpah

Just received what I consider to be an outrageous campaign email from Joe Biden:

David --

President-elect Obama and I have been assembling our team, and we plan to hit the ground running next month.

We want to be ready to go, and that's why I'm asking you to help us honor an outstanding commitment we made during the election.

Our campaign pledged to help Senator Hillary Clinton -- one of the vital members of our team and our future Secretary of State -- retire her campaign debt. That's the money her campaign owes to the vendors across the country that make our political process possible.

Barack and I had the deepest respect for Hillary as an opponent on the campaign trail. Her undeniable intellect, talent, and passion strengthened Barack as a candidate and tested our movement for change.

We welcome Hillary as a partner in our administration, and I hope you will show your support by helping Barack fulfill our campaign promise.

Will you make a contribution of $100 or more now to retire Hillary's campaign debt?

I saw your generosity and commitment to this team throughout the election, and I know we can do it.

In the general election, Hillary was one of our strongest advocates. She traveled the country and did more than 70 events, raising money and bringing new supporters into our campaign.

As Secretary of State, she will be indispensable in furthering Barack's agenda for change.

Let's welcome Hillary to the team and thank her for her efforts in support of our campaign by helping to retire her debt to the hard-working individuals and small businesses that were a part of the election:

[url removed]

Your support and generosity got us this far, and I know I can count on it now.

Thank you,

Joe

I've never understood this. In the first place, if as a candidate you borrow a whole bunch of money and then can't repay it, that's your problem--it's not your supporters' problem, and it's certainly not your opponent's supporters' problem. Second, it is my understanding that the Clintons are worth tens of millions of dollars. And they want my money? Are they fucking joking?

This is the first email from the Obama campaign that has actively pissed me off.

Compounding repayment of debt is neat

Continuing along the same lines as a previous post, it seems to me that one reason it does not occur to many people to learn the basics about personal finances is that they have the impression that it is only applicable to people with money. After all, what good is knowledge about investing and compound interest and the like if you have no money to invest?

But one of the things you quickly realize when learning about finances is that the amount of money you are worth--even if that figure is in the negative--is relatively unimportant. What is important is the delta--the change--in your net worth from time A to time B. Thus, from an investing perspective, there is no meaningful difference between investing in a stock that rises 15% and paying off a debt at a 15% interest. In both cases, you are netting a (very healthy) 15% return on your allocation of money. In fact, repaying the debt is by far the "better investment", because--unlike the risky gamble on the stock--its returns are guaranteed.

One particularly neat application of this sort of thinking is compound debt repayment, which harnesses the awesome exponential growth powers of compounding to pay off debts much faster than you might have realized--for free. Let me explain what I mean.

Suppose you take out a $10,000 loan at an interest of 10% per year, i.e. 0.83% per month. The interest is calculated every month, which means that every month you get charged 0.83% on the total amount that you owe. Supposing that you choose to allocate $150/month towards this debt, this is what your payment plan looks like*:

(Click to enlarge.)

As you can see, in the first month we were charged $83.32 in interest bringing our total debt to $10,083.32--and then we paid it down by $150 to $9933.32. At this rate of $150/month, the debt is paid off in a little more than eight years.

However, a crucial thing to notice is that, though we may think we are being consistent in paying $150 every month towards the debt, in actuality we are allocating a smaller and smaller proportion of our income towards the debt each month. To see this, take a look at the amount of interest charged with each payment. Because the total amount owed decreases every month, the amount of interest charged also decreases every month. This is the same as additional income. So for example, in the second month we are charged $0.55 less for interest, which means that if we paid $150 towards the debt, then we would have an extra 55 cents rattling around in our pockets as compared to last month (remember, it is the delta that matters). Now, you could use that extra money towards food or a coffee or a movie rental--but you could also turn right around and use that money to pay off the debt. If you did this, instead of getting a 55 cent boost of income in the second month, your income would appear to remain the same as the first month.

A modest 0.55 cents might seem like it wouldn't make a significant difference, but it does--over time. If you were to continue to rollover the "income" provided by the decrease in interest every month, the debt would be paid off not in eight years, but in six:


(Click to enlarge.)

The paltry increase of $0.55 on the second payment turns into a mighty increase of $80 by the last payment. And if you can supplement that monthly increase in the nominal payment towards the debt--for example by redirecting money allocated on eating out, only if it's just one meal a month that is sacrificed--then you will shave even more time off of your debt repayment.

Now, if you read this twice and said, "Wait a minute, this is bullshit--you don't have an extra $0.55 rattling around in your pocket at all", then there is something that needs to be clarified about what a loan is. For some reason we have a whole lot of separate jargon when it comes to money that obscures a crucial insight about it, which is that it is no different than any other product out there in the market. It is no different, for example, than a DVD--there is demand for it, some companies supply it, and when demander and supplier agree on a price, the transaction goes down. In precisely the same way that you can rent a DVD by going to Blockbuster and paying a small fee for the privilege of taking out a copy of Coyote Ugly and returning it by a certain due date, you can go to a bank and pay a small fee for the privilege of taking out some dollar bills and returning them by a certain due date. The only difference is the jargon: for DVDs we say "rent" and with money we say "borrow", and with DVDs we say you pay "a rental fee" whereas with money we say you pay "interest".

So keeping this in mind, it is important to keep track in your ledger the distinction between what you are renting from the bank (the ten thousand dollar bills), and the fee the bank is charging you for the rental. In fact, what causes a whole lot of confusion is the fact that it just so happens that what you are renting from the bank is kept in bank accounts along with your real money--making it look like the rented dollar bills are a part of your whole system of income and allocation, when in fact they are not. They are better thought of as objects, like DVDs, that you rent and keep around the house and have to return at a later date. What is a part of your system of income and allocation, however, is interest, since this is similar to the $2 fee you pay to Blockbuster to rent the DVD (and certainly, like DVD rental fees, money rental fees are something you want to track as an expense).

With all this straightened out, we can see why it makes sense to say you have "an extra $0.55" rattling around in your pocket in the second month of repayment. The actual expense of borrowing--or renting--the ten thousand dollar bills is the interest payment. When you "pay down" the principle, what you are really doing is returning some of the bills that you had rented out. Of course, since you're renting out less bills, you will be charged less in rental fees. What compound repayment of debt says is: hey, now that you're paying less in money rental fees, you don't need to have as many dollar bills rented out! Return those bills, it's expensive to keep them rented out so long!



*These calculations are rough estimates. In the first place, the numbers were clumsily rounded before being displayed (don't worry--the numbers computed internally were not rounded), so some of the arithmetic shown might not be consistent to the penny. Second, there might be some float point inaccuracies. But I don't think the numbers are big enough that this would make a huge difference. Long story short: I hastily slapped this together to demonstrate a point in a blog post, so take it with many grains of salt.

Financial literacy

The commentariat is slowly turning towards the issue of personal debt and financial literacy, led by reports in recent months about the terrible average savings rates for individual Americans. And it's about bloody time--I've always wondered why this very critical issue never gets any play.

Stephen Dubner at the Freakonomics blog at the Times has a must-read entry about financial illiteracy in America, and the subject's absence from school curricula:

I’d like to think I’m at least adequate in taking care of my family’s finances and everything that includes in the modern world: real-estate and insurance decisions, saving for college and retirement, investing and tax planning, etc. But it has been a bit of trial-by-error mixed with trial-by-fire — and to be honest, I was very fortunate to have an older brother who is smart, frugal, patient, and who worked for many years in finance. If it weren’t for him, I’d be in considerably sadder shape.

But here’s my point: I’m not exactly undereducated. I had 13 years of public schooling, 4 years of college, and another 2 years of graduate school — and after all that schooling, I don’t know if I learned enough to answer all three of Lusardi’s questions correctly. The subjects simply didn’t come up. Just as they apparently didn’t for the two-thirds of the older respondents to Lusardi’s questions.

I have similar story. Basically I wouldn't know jack about anything finance related if weren't for a fellow I work with named Karl who happend to press into my hands a book called The Four Laws of Debt Free Prosperity. The book sounded, and was, fairly cheesy, but it was short and in those few brief chapters made me realize that I had been out to lunch on an extraordinarily important subject, a subject that--if ignored--could literally ruin a person's life.

So it's always been sort of crazy to me that they don't make a serious effort to scare kids in high school into never, ever running a credit card debt, or show them how a steady and conservative savings plan begun early enough can make them into millionaires when they are old. And I never understood the point of quibbling over various ways to refine Social Security when a large number of Social Security recipients will have frittered away their incomes over the span of decades because they simply did not know what they were doing with their money. Financial literacy seems to me the first and most important step in establishing a sane set of policies dealing with retirement and supporting the elderly crowd, and yet in our politics it's treated as an afterthought.

Clinton's debt

I really don't understand this idea that Obama has some sort of obligation to Hillary Clinton to help her pay her debt from the primary campaign. Attitudes like this are completely mystifying to me:

Some Clinton supporters are grousing that Mr. Obama has yet to make the symbolic gesture of writing a check for $2,300, the maximum allowable campaign donation, to help retire her debt of over $12 million.

Am I missing something here? Clinton went into debt because she made the calculated decision to borrow money to win the primary. Why should someone else pay it off, let alone the very rival she borrowed the money to defeat? Moreover: aren't the Clintons supposed to be worth far more than $12 million? When their tax returns were released a few months ago, it was revealed that they had earned no less than "$109 million in the the last eight years". So it seems to me that Clinton ought to be more than capable of paying off her debts by herself.