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North Broad Press is a joint publishing project between Temple University Press and Temple University Libraries, publishing works of scholarship, both new and reissued, from the Temple University community. All North Broad Press titles are peer reviewed and freely available online. More information and all North Broad Press titles are available at https://temple.manifoldapp.org/projects/project-collection/north-broad-press

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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All material in this work is licensed under a Creative Commons Attribution-NonCommercial  4.0 United States License unless otherwise noted. A copy of this license is available at https://creativecommons.org/licenses/by-nc/4.0/

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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I am grateful to the people at North Broad Press, Annie Johnson, Alicia Pucci, and Mary Rose Muccie, for all their excellent help in this book. I also thank my good friends at Temple University who helped significantly in this book, Fred Rowland and Jeff Rients. I also want to thank my peer reviewers, Karen Yancey (Community College of Philadelphia) and Dr. Renee Dyer (Limestone University), who offered thoughtful suggestions that improved the book.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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This book presents financial literacy in a real-world context. Therefore, I admit that some of the information is biased, based on my own experience. My experience includes thirty years as an executive in business, of which fifteen were spent running my own company in commercial real estate development. I bring that on-the-job, real-world bias to the information presented in this book. I have also distilled many years of experience in teaching economics and financial literacy into the opinions I express. For example, I have found that college students want to know the best way to finance the purchase of a house or automobile and not just a discussion of the various types of mortgages you can use to buy a house.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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This textbook is primarily written for a course in financial literacy for college undergraduates. However, they do not have to be business or economics majors. In my most recent class, using this book, there were Art History majors and Engineering majors who were quite comfortable with this textbook. The only math prerequisite is an understanding of high school algebra and ability to read graphs. Any formulae in the book are not complicated beyond elementary algebra.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Admittedly, some of the information in this book may be already out-of-date by the time you read it. This includes time-sensitive material such as current prices on the stock market, current interest rates, the fiscal and monetary responses of the federal government, and the status of the Pandemic Recession. In each case of time-sensitive data, I have provided you with website links to view current data. For example, you can watch real time activity of the stock market and of individual stocks on yahoofinance.com.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The economy’s performance in the Pandemic Recession, however, is a special case. As of the publication of this text, the Pandemic Recession is officially over, lasting only from February 2020 until April 2020. Thus, I have been able to discuss it from beginning to end and examine in detail the partial recovery of the 22 million lost jobs.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Overall, the advice in this book is based on sound economic theory, which has certainly stood the test of time. While there are some disagreements among economists, they are generally not about the fundamental principles of economics. The major disagreement among economists is between those that are Keynesian economists and those that are Free Market economists. This division is roughly the same as the split between “Demand Side” economists and “Supply Side (trickle-down)” economists. Demand side economists (Keynesians) believe that in a recession, the government needs to get money to the middle class to stimulate demand and to increase government spending to save jobs. Supply side economists believe the government should cut taxes on corporations and the rich who will invest in business and create jobs. As an economist, I am firmly in the Keynesian camp, as I have seen in economic history very little job creation or economic trickle down from Supply Side policy. After thirty years of deregulation by the U.S. government, beginning with the presidency of Ronald Regan in 1981, the income and wealth distribution in this country have dramatically worsened. Further, while the poverty rate has been slowly decreasing over the last decade, it still remains stubbornly high for a nation that is the wealthiest in the world: Therefore, my policy discussions in this book are Keynesian.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The first two chapters will upend most of what you have been told about how to find a job. My thanks especially to Dr. Eric Shlesinger, retired Director of Human Resources for The World Bank (and a Temple alumnus), for guiding me in the discussion on how to find a job. According to Ben Bernanke, former Chair of the Federal Reserve Bank, the “why” of economics is to increase wellbeing for people. Therefore, Chapter 2, which discusses well-being in the workplace and in your life, speaks to the heart of the purpose of economics.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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According to current psychological research, money is both a tool and an addictive drug. It is a tool in that we see money as the ability to fulfill our needs, wants and fantasies. It is a drug in that we are addicted to money. So, in Chapters 3 and 4, we discuss what money is, and we use Behavioral Economics to discuss our attitudes toward money and how we make economic decisions.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Chapters 5 and 6 will help you understand where you stand financially and how to become and stay financially healthy. Unfortunately, many people—either through necessity or bad habits—deposit their paycheck in their bank account and spend it until they run out of money in the account. These chapters will help with simple actions that will enable you to save money for future needs, such as emergencies, home ownership, college tuition, or retirement.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Consider these statistics about personal debt in America. More than 191 million Americans have credit cards. The average credit card holder has at least 2.7 cards. The average household credit card debt is $5,315. Total U.S. consumer debt is at $14.9 trillion. That includes mortgages, auto loans, credit cards and student loans. We need to reduce credit card and student loan debt, and we examine this in chapters 7 and 8.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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In order to make good decisions about money, we need to understand it and learn how to deal with it rationally. We need to think like an economist. Very few people have been taught that, even by their parents. Chapters 9 and 10 will teach you to think like an economist.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Owning a home is the American Dream. However, a home is both a nest and an investment.  Chapters 11 and 12 will examine how to buy a home, how to finance a home, and how to insure a home (and your other physical assets).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Almost everyone dreams about becoming a millionaire in the stock market. This is actually a very easy thing to do. Chapters 13, 14, and 15 will teach you how to invest and how to avoid all the traps of the stock market and other investment markets. Finally, chapter 16 explains the range of government policy that can be used (and has been used) to stimulate the economy when we are in a recession.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Everyone wants to find their dream job, but it might take you a few tries before you actually get it. A number of successful people in business, philanthropy, and the arts have told me they had to have a few different gigs before they landed their dream job.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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So what is a “dream job”? Simply put, it is a job you love. And, as the saying goes, “Choose a job you love, and you will never have to work a day in your life.” But even if you do not get it on the first try, you can still find a job you at least enjoy. The key is to match your character strengths (what makes you who you are) with the job you want.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Dr. Martin Seligman from the University of Pennsylvania emphasizes how important it is to identify your top character strengths. In his book Authentic Happiness, he states that if you find a career that utilizes your strengths, you will have higher job satisfaction.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Dr. Seligman has made it easy to figure out those strengths by providing the VIA Survey of Character Strengths. I strongly recommend you also take the Authentic Happiness Inventory and the Grit Survey. Click on the Questionnaire Item on the menu at the top of the page. Take the questionnaire titled, “VIA Survey of Character Strengths (Measures 24 Character Strengths).” This questionnaire takes about 50 minutes, so do not rush through it. You will be asked to create a username and password but do not worry about that. They will not contact you for any other purpose. The purpose is to identify you as a unique subject for their research. It also allows you to return to the site and take other questionnaires.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Once you find out your top character strengths, discuss them with your family, friends, and advisors. Ask them what they think of the findings (you will be surprised how much they agree with the results), and then ask them to help you think of careers that would utilize these strengths. For example, if you like science and you are good at working with others, you might be happy with a career in the medical field. Or if you prefer solitude and are interested in computers, you could look for a career in information technology instead.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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If you do not figure out your top character strengths before you search for a career, you will have no real criteria for choosing the kind of job you want. When you chose your major, you already took some steps in defining your career interests.  However, your major is not always a reliable indicator of where you will find job satisfaction. Several students change majors, and many graduates end up in fields unrelated to what they studied in college.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Now that you know your top character strengths, it is time to start looking for a job. In What Color Is Your Parachute for Teens, Carol Christen lays out four basic steps to finding your dream job: 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Since this is a book about financial literacy, this is likely your first or second job, and you will need to learn some of the fundamentals. First, you should remember that a job is immersed in a social setting. You have to get along with people—especially your boss and co-workers! Unfortunately, there is no manual for how to do this.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Instead, you have to use your people skills. Listen to your supervisor and do what they direct you to do. Do not question a supervisor’s orders; you will need to earn their trust before you can do that. With your co-workers, be willing to listen and to not be so vocal with your opinions. In the beginning, you are there to learn about the organization and build trust. A know-it-all will not be trusted.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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R.I. Dunbar states that “Analyses of freely forming conversations indicate that approximately two thirds of conversation time is devoted to social topics, most of which can be given the generic label gossip” (2004). This gossip is what you need to get connected to in your workplace, and you can find it by making friends at your job. Take co-workers out to lunch or, better yet, go for drinks after work.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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When you are with your co-workers, you should listen more than you talk. Your co-workers can tell you things like which bosses are mean, which co-workers will stab you in the back, and which men are sexual harassers. This gossip will also tell you who has power in the organization. For example, often a personal assistant controls access to the President, so it is important to be kind to them.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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More than just providing gossip, friends at work also increase your well-being. Remember that work is not just about doing your job but getting along with your co-workers. Modern organizations are built around teamwork, but more importantly, people who report that they consider a co-worker their best friend are much more likely to also report that they love their job.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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You not only need friends, though; you also need networks, both inside and outside of work. Adam Grant, a professor of Industrial Psychology at the University of Pennsylvania, talks about the importance of networks in his book, Give and Take:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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By developing a strong network, people can gain invaluable access to knowledge, expertise, and influence. Extensive research demonstrates that people with rich networks achieve higher performance ratings, get promoted faster, and earn more money. (2013)

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Interacting in networks (or teams) involves giving and taking, and Grant states that there are three different styles of reciprocity: giving, taking and matching. Each of these has a different type of network. A “taker” likes to get more than they give to a network or relationship. A “giver” (admittedly a rare breed in the workplace) prefers to give more than they get, and a “matcher” strives to preserve an equal balance of giving and getting.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Our personality is 50% the result of nature (or evolution, which equals genetics) and 50% the result of nurture (or the interaction of our genetics with our environment). However, where Grant takes these types as a given, Kurzban and Houser used experiments to establish that evolution has created a relatively stable mix of these three reciprocity styles (2005). According to Kurzban and Houser, this is the breakdown:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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I do not think I can stress enough how important Kurzban’s and Houser’s work is to how we can understand and develop professional networks. For example, if you have to work on a randomly assembled team, you will encounter a mix of cooperators, reciprocators, and cheaters. Grant reports that each of these reciprocity types deal with their networks in different ways:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Givers give a lot more than they receive. This is a key point: takers and matchers also give in the context of networks, but they tend to give strategically, with an expected personal return that exceeds or equals their contributions. When takers and matchers network, they tend to focus on who can help them in the near future, and this dictates what, where, and how they give. Their actions tend to exploit a common practice in nearly all societies around the world, in which people typically subscribe to a norm of reciprocity: you scratch my back, I’ll scratch yours. (2013)

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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However, Grant reports that even though takers and matchers get ahead, givers end up creating the widest network and become the most successful (as long as they do not end up as doormats for takers). If you are a giver, gossip once again comes in handy; matchers and other givers do not appreciate takers and will share this information widely among their co-workers.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Unfortunately, takers are fakers, and that can make them hard to identify. Everyone talks like they are a good member of the team so be sure to watch closely and remember that being agreeable is not the same as contributing.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Of course, sometimes you cannot avoid working with a taker. To help you understand what strategy you should use, we need to acquaint you with some economic game theory, specifically a strategy called tit for tat. This is usually a matcher strategy, as it requires you to match what the other player does. It will maximize your gains if you are dealing with a giver or matcher and minimize your losses if you are dealing with a taker. Thus, it is a max/min strategy.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

s_88_100

To understand how this strategy works, we can talk in terms of cooperating with or not cooperating with your teammate. The strategy works like this:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Behavioral Economics uses psychology, neuroscience and economics to examine how humans make economic decisions. It includes the process of studying the biases, rules of thumb, inaccurate or incomplete information, propaganda and other influences that interfere with our making optimal decisions. It also presents prescriptions for countering these irrational influences in order to make better decisions as employees, citizens, and family members.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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To begin to understand this field, we should look at one of the most pervasive and consequential biases that has affected our entire economy: the oft repeated belief that a company’s purpose is to “maximize its profits” and to only look out for the owners’ and shareholders’ interests. This idea has roots in the writing of economist and Nobel Prize Laureate Milton Friedman. In an article in The New Times Magazine, Friedman stated,

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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…there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud (1970).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The University of Chicago Department of Economics, where Friedman taught, was (and still is) the center of conservative free market economics in the United States. His general argument was that any employee of a business or corporation is an agent of the owner or its stockholders and has no right to spend their money in any way other than to increase profit. The owners and stockholders can then do anything they want with their profits, including spending it on some “social purposes.” Whether because of simple greed or true capitalist philosophy, this became a battle cry of capitalists and was widely quoted and used in corporate mission statements. It also was used in management and finance textbooks as a fundamental guiding principle and turned up in corporate annual reports as a mission statement to “maximize shareholder value.” The problem with Friedman’s entire theory is that it is simply wrong. Since this is a text about financial literacy, I will not spend a long time discussing the Friedman’s errors. However, I will make three points:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Corporations and partnerships must apply to a state to receive the permission to incorporate. This is not a right but a privilege. For example, according to Pennsylvania state laws, the state grants the right to incorporate for the “good of the Commonwealth.”

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Freidman’s view was not the majority view when he voiced it. In the mid-twentieth century, firms were an integral part of their communities and the prevailing view was that firms had a responsibility to their shareholders, employees and communities (Wells, 2020).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The “free market competition” that Friedman envisioned in his theory does not exist in most markets, It is a fiction made up by economists.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Money is most often defined as “a medium of exchange with no intrinsic value.” This essentially means that what people accept as money can be used as money. If you go back in history, you will see that people have used a number of different things as money, some that had intrinsic value (such as gold and silver), and many that had no intrinsic value of their own (such as seashells and cocoa beans). Currently, all countries around the world use money that is known as fiat money. From Latin, this term means, “Let it be so.” Essentially, this means that each country prints money on paper (or in some cases, plastic), and that currency is not backed by anything of intrinsic value except the full faith and credit of a country’s Central Bank.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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In the past, money was backed by silver (the silver standard) or gold (the gold standard). However, that came with its own set of problems. It meant that you had to have silver or gold equivalent in value to the amount of total money you had in circulation. This made it difficult to increase the supply of money in your economy, since you had to acquire enough silver or gold to back up the additional money you wanted to circulate. So the Central Banks of the world went off the “metal standard” for their currency. The U.S. abandoned the gold standard in 1933 but allowed holders of dollar currency to convert them to gold at the fixed price of $35 per ounce, an arrangement that was eliminated in 1971. The U.S. abandoned the silver standard in 1935.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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So, in a way, all paper money is fake! It is, of course, backed by “the full faith and credit” of the country that issued it, but that’s the only thing backing it. That means that unstable countries might end up with currency that cannot be used as payment for oil or food. Even if it is accepted, it is only at a greatly depreciated value. The world’s currencies fluctuate relative to each other according to the rules of demand and supply. For example, if you are trying to understand the exchange rates between the U.S. dollar and the Euro, consider how many U.S. dollars it would take to buy one Euro. If a lot of people who own dollars want to buy Euros but not an equal amount of people who own Euros want to buy dollars, the Euro will appreciate relative to the dollar.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Some economies in the past did not use money; instead, they used the barter system. It is a simple system. Let’s say that I have two extra bushels of corn, and I need some wheat. I will swap you my two bushels of corn for two bushels of wheat.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The problem is that the barter system depends on what is called a coincidence of wants. Now let’s say that I have three extra pigs, and I ask my neighbor ask to trade them for a cow. However, he does not have any cows he wants to trade, and he does not want any more pigs. That means I have to go searching for someone who wants to trade a cow for my pigs. Money solves this problem, because cows and pigs (and everything that is for sale) can be valued in terms of money. Instead of bartering, I can sell my pigs in the local marketplace and then use that money to buy a cow.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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It is a medium of exchange. A medium of exchange is something that can be traded for goods and services. As we showed above, it solves the problem of the coincidence of wants.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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It is a store of value. Money’s function as a store of value allows you to hold on to money and buy something in the future, and the money is still accepted. If you are going to hold onto money, you should, of course, not hide it under your pillow, but put it in a savings account and earn some interest on it. When we save money for our future retirement, it is functioning as a store of value, and we must have confidence in the money still being valuable when we retire.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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It is a unit of account. Money functions as a universal yardstick that expresses the value of goods and services in a single measure. For example, your labor might be valued at $15 per hour and then you can take that money you earn and buy a dozen eggs at $1.98 per dozen.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Some students may have received advice from their parents or other adults ranging from how to ride a bike to which fork to use at a formal dinner. However, many parents are reluctant to talk to their children about financial management. And if you got financial advice, it might be wrong, as so much has changed since they had to make the important financial decisions you are currently facing. Julia Carpenter, in the Wall Street Journal article “Your Parents’ Financial Advice is (Kind of) Wrong,” points out what is right and wrong about your parents’ advice:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The rules have changed…Americans entering the workforce in the decade since the financial crisis face a starkly different landscape than their parents did at the same age. They often have far higher student loan debt. Housing eats up a bigger chunk of each paycheck. And young households have lower incomes and fewer assets than previous generations did at the same ages (2019). 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Given these new conditions, Carpenter feels we need new rules. Below, I have listed these rules along with my commentary.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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In 2018, the average starting salary of a college graduate was about $60,000, while the average salary for a high school graduate was $28,000. On average, students complete their undergraduate degrees in five years; however, at more than a third of U.S. colleges, only half of the students will earn their degree in eight years. Those who do not finish end up with debt but not with the higher income they were hoping for. Further, four in ten college graduates are in jobs which do not require a college degree (New York Federal Reserve Bank, 2018).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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If you plan to go to graduate school, remember that if your starting salary after the degree equals the debt incur then it is probably a good investment. You want to be able to pay your living expenses and still have enough left over to pay off your loans in about ten years. If you think about it, “buying” an education after high school is really an investment and you should think about the kind of return you will be getting on that investment.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Owning a house is still part of the American Dream, but it might not make financial sense for you. For example, you might work in a city with a hot housing market. You might not be able to afford a down payment, or you could wind up depleting your entire savings. On top of that, if you do not expect to stay in a city for more than three years, you will likely not get back all the transaction costs (fees, title insurance, etc.) of purchasing a house. Do not buy a house just because you think you should.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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You should compare your salary (or potential salary, based on the average for your field) to a city’s cost of living. Many people think it would be cool to live in New York City or San Francisco, but the cost of living is so high that your salary has to be proportionate. Otherwise, you can find yourself commuting an hour or more from the only affordable living accommodations in the area. Some cities like Chicago, Philadelphia, Austin, and Portland,  although costly, have more affordable housing than San Francisco and good starting salaries. If, for example, you compare the salaries of high-tech workers and the cost of living in San Francisco to those in these cities, you will find you are financially better off living in the city with the lower cost of living. Cities around the U.S. are trying to attract tech companies and, although San Francisco had a higher percentage of high-tech jobs as a proportion of overall jobs, there are good high-tech jobs in the many cities.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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As a result of the Pandemic, remote work has increased substantially. The U.S. Census Bureau recently released its annual 2021 American Community Survey a survey of household behavior (September, 2022). According to the Census Bureau, between 2019 and 2021, the number of people primarily working from home tripled from 5.7% (roughly 9 million people) to 17.9% (27.6 million people).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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However, remote work is not evenly distributed around the country. In metropolitan areas, 19% of employees worked from home (with Washington, D.C. at 48% remote workers and Silicon Valley at 35% remote workers as outliers). Outside metro areas, only 9% of employees were working from home in 2021.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The opportunity for remote work is a factor to consider when seeking a position. It has its advantages, including working flexible hours and saving on commuting time. It also has its disadvantages, including the loss of comradery of office work and not being visible to your superior to take advantage of bonding and advice. 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Your parents might have followed this old rule: be frugal until you save up enough for the down payment on a house. Unfortunately, with student debt and the higher cost of housing, it does not work to do simple things like pack your own lunch or hold off on a vacation. It’s part of the American Dream that couples rent for a while, save up for a house, and then, when they are ready to have children, buy a house in a good school district. If they cannot do this, they might feel a sense of disappointment or failure. However, that should not cause you to throw up your hands and not work on saving for your future. There are still important goals for you to save for. First, although young people tend to live in cities, there are almost always suburbs that are more affordable.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Under the gravity model of real estate, the center of gravity is downtown where there are a lot of jobs. Then, unless there are physical constraints such as mountains or a coastline, housing construction proceeds over the years in concentric rings around center city. In general, the closer the housing is to the center, the more expensive it is. Housing that is farther out is then cheaper, but it could entail a longer commute. However, in many cities, young people are creating a new trend of moving into affordable suburban housing, and others have started looking for a job in smaller cities with good salaries and a reasonable cost of living. 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Outside of housing, you will need to save for a number of things. You should an emergency fund of, ideally, at least six months’ salary in case you lose your job and begin contributing to your retirement as early as possible. If you intend to have children and expect them to attend college, you should begin putting aside money for their college expenses. Put these savings into an account where the money will compound to a significant amount by the time you need it. Having these savings will reduce your financial anxiety and improve your well-being.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The true measure of financial success isn’t how much money you make—it’s how much you keep. That’s a function of how well you’re able to save money, protect it, and invest it over the long term. Sadly, most Americans are lousy at this(Hube, 2019).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Two-thirds of Americans would have trouble coming up with $1,000 cash (not credit) to pay for an unexpected medical bill or emergency. Even more disturbing, seventy-five percent are not saving enough or investing correctly for their future retirement requirements. While there are a number of external factors that exacerbate this problem—stagnant salaries, expensive healthcare and education and rising housing costs—there is a deeper issue: a lack of financial literacy. 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Parents are reluctant to talk to their children about money, and  high schools and colleges lack financial literacy courses. Individuals are increasingly left on their own to decide how much to save and where to invest their savings. To help, Hube laid out ten rules for financial freedom that I present here, along with my commentary.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The first step is to set goals: short-term. medium-term, and long-term. For example, a short-term goal could be to save up six-months’ salary as an emergency fund. A medium-term goal might be to save up for a down payment on a house. Finally, a long-term goal would be to save for retirement.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The sooner you set your goals, the sooner you will begin trying to achieve them. Goals motivate us, and when you have your goals to think about, you will likely squirrel away the extra cash.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Always keep this question in mind: “Do I need this thing or do I just want it?” It is hard to resist something you really want, like a new pair of shoes or a new kind of tool. However, you should it is not a good idea to buy something just because it gives you a jolt of pleasure.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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For example, my neighbor had a garage sale recently. Since my wife helped organize the sale, we got a preview on what was being sold. I saw three electric guitars, and I really wanted one. Luckily, my wife said, “You already have a guitar. You don’t need another one!” I must admit, it was hard to distract myself from that guitar, but the next day, I knew she was right. 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

s_161_100

Look at your monthly after-tax income (disposable income), and add up all your expenses for the month. If your expenses exceed your income or if you are not saving any money monthly, you have to cut expenses. Finally, if you are buying things that you do not need or do not use (such as a gym membership or a particular streaming service), drop it and bank the money.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Pay into your savings, the same way you pay your electric bill: monthly and automatically. Assuming you have joined a credit union for your banking needs,  (See Chapter 10, Banks and Financial Institutions.) arrange for automatic bill payment and have a specific amount transferred into your savings account every month. Ideally, you will be saving 10% of your disposable income each month. However, this is impossible to do in your first or second job. Start out with 5% of your take-home pay and slowly ramp it up to 10%.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Begin saving early to take advantage of the compounding of interest. In simple terms, this means if you put $1,000 in a savings account, and in year one you earn 10% interest, this means you will have $1,100 at the end of the first year. If you leave the $1,100 in the account and continue to earn 10% interest, you will not only earn interest on the original principle of $1,000 but you will also earn interest on your year one interest. Thus, at the end of year two, you will have $1,210 in your account. 

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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There are websites such as www.bankrate.com that give you compound interest calculators to estimate the value of your principle over time, but the Rule of Seventy can also calculate your money’s growth. Take the number 70 and divide into it the interest you earn. Assuming compounding of interest, the result is the number of years it will take for your money to double. Using our example above, if you are earning 10% per year your money will double in seven years. (A 10% return is not an unrealistic goal. As you will see in Chapter 15, The Vanguard Group has shown that, going back to 1926, a mutual fund containing a very broad portfolio of U.S. stocks (i.e., the stocks in the S&P 500 Index) has earned 10% per year).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

s_171_100

If your employer provides a retirement plan, for example, a 401(k), and matches your contribution to it, always contribute the maximum your employer will match. If you really think about this, you are earning 100% return on your money; the employer is doubling the money you contribute. You should even give up your lunch or other non-essential expenditures to contribute the maximum.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

s_172_100

Employers often have 401(k) plans where they will match your contribution up to 4% of your gross salary. These plans have taken the place of the traditional guaranteed pensions and have shifted the burden of managing each worker’s retirement fund from the employer to the worker. However, if you put your retirement contributions in a mutual fund of all stocks with a good manager such as Vanguard, you can earn the 10% annually. The value of a 410(k) plan is that the money you contribute and the money your employer matches are tax-deferred (but not tax-free). That is, you are not taxed on these contributions nor on the annual return (presumably 10% annually) until you withdraw money for your retirement. If your employer does not offer a retirement plan or if you are self-employed, you can create either an Individual Retirement Account (IRA) or a Roth Individual Retirement Account (Roth IRA) and still earn the same returns. As of 2019, you can contribute up to a maximum of $19,000 into a 401(k) and $6,000 or $7,000 into a Roth IRA.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Until you are within a couple of years of retirement, you should invest your retirement funds and other extra income for growth, which means investing in stocks. Although stock prices have more volatility than bonds, they return double what bonds do over time. You will need to be able to stomach that volatility in order to get the higher return. In Wall Street terms, a bull market is a market in which prices are going higher, while a bear market is a market in which prices are going lower. This archaic language comes from the fact that a bear hits downward with its paws while a bull gores upward with its horns. See Chapters 14 and 15 for more detail on the joys and risks of investing in the stock market.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Debt used for investing in something, such as a house, your education, or your car is good debt.  Credit cards are bad debt—debt for consumption purposes. If you buy something with a credit card, pay it off at the end of month. Credit cards charge anywhere from 9% to 25% per month, depending on your credit score. If you pay only the minimum each month, you can end up paying double the original amount you borrowed. If you really need to pay for something on a credit card, such as car repairs or a new computer for school or work, use the credit card that charges the lowest interest rate and then use another credit card for your other purchase and pay it off every month.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Do not overpay on fees or commissions for investing in stocks and do not overpay on your taxes. I talk about each of these issues in the chapters on investing and on taxes. Financial advisers usually charge 1% of your assets annually to tell you what stocks to buy. None of the actively managed portfolios or mutual funds has consistently exceeded the return on the S&P 500. Index funds or Exchange Traded Funds will hold all the stocks in the S&P 500 or similar indexes and will charge less than ¼% of your assets annually and still return 10% per year on average. Furthermore, do not overpay on other big purchases, such as televisions and appliances. Shop around.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The ideal goal is to build up a fund worth six months’ expenses. This is a very difficult goal to accomplish, so when you are young try to save at least one month’s rent for starters. Why do all the experts pick six months as the ideal amount in this emergency fund.? This is because it takes about six months to find a new job if you are laid off. You can go on your job search without falling apart emotionally. Also, buy renters insurance (It’s very cheap) and, if you own a house, a decent house policy with a reasonably low deductible.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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You may have an accident and be unable to work. Many employers pay for a minimum amount of disability insurance that will pay you 60% of your salary if you are disabled long term. If you own a home and have a family, you should consider buying some long-term disability insurance as a supplement to your employer’s. It is pretty inexpensive. As to life insurance, do not buy a whole life policy. Whole life insurance is a rip-off. If your life is financially complicated with a house and family, buy term life insurance. It is much cheaper than whole life insurance.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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As I said above, keep your investments simple. Do not chase fads, such as cryptocurrency or 3D printing companies. Invest in an Index Fund that has the S&P 500 stocks in it, and you will pay low fees and earn on average 10% per year. Also, a mutual fund with the S&P 500 stocks in it will have Google, Apple, Facebook, and any other significant stock worth holding, so you can still ride the high-tech wave with your mutual fund.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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I strongly advise you to go to Vanguard and invest in one of their index funds. Vanguard is owned by the customers who invest in its mutual funds, so it is essentially a non-profit. There are no stockholders, so they can keep their fees low. Jack Bogle, the founder of Vanguard, invented Index Funds (passively managed funds that track a stock market index like the S&P 500) because he saw that actively managed mutual funds were not beating the S&P 500 returns and were charging a fee of 1% of assets.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

s_198_100

Finally, do not buy individual stocks from a stockbroker, and do not buy mutual funds that charge you a commission to get into them. You cannot pick the consistent winner stocks and the brokers who charge you a commission to get into a fund often sell you the investment that gains them the highest commission, not the investment that fits your needs.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Personal and household savings are important, both for you and for the economy. For you, savings creates a buffer for unexpected expenses and can also be used to finance a down payment on a house or to help pay for college. You can deposit your savings in a financial institution or buy a mutual fund that invests in the stock and bond markets. In other words, your savings becomes an investment; that is, it is money that you put into a financial institution or instrument for which you receive a return in the form of interest or dividends.  

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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For the economy as a whole, these savings create economic growth. Firms borrow money (your deposits) from financial institutions or sell shares to your mutual funds and then use that money to expand their businesses. Before we go further, though, we should break down some of these terms. First of all, it’s important to understand that personal savings is equal to income minus personal outlays (or consumption) and taxes:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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From another perspective, savings can be viewed as the portion of personal income that is used either to provide funds to capital markets or to invest in real assets such as residences.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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What happened to the U.S. savings rate in the recent Pandemic Recession is quite unusual, to say the least. As you look at the graph below, you will see that from 2000 to 2020, the Personal Savings Rate averaged about 5% to 7% of Disposable Income. However, as the Pandemic Recession began (in February 2020) the Personal Savings Rate skyrocketed.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The total amount of consumer credit outstanding at the end of the first quarter of 2020 was $14.3 trillion. Of this amount, here are the types and amounts of the outstanding loans as of the end of Q1, 2020 (note that the Pandemic Recession began in February 2020, but the President’s order to shut down restaurants, hotels, bars, etc. was March 16, 2020).

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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As a practical matter, we need to divide interest rates into short-term interest rates—those where the principle must be repaid in one year or less—and long-term interest rates—those where the principle must be repaid over a period in excess of one year. Some short-term interest rates include credit cards, treasury bonds with maturity of less than one year, business or personal lines of credit, and corporate paper loans. Long-term interest rates include automobile loans, home mortgages, student loans, and home equity lines of credit.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Interest rates, both short- and long-term, are ultimately determined like any good or service; that is, by the laws of demand and supply. The equilibrium interest rate and equilibrium quantity of loans borrowed is determined by the intersection of demand for loans and supply of loans. The graph below calls the good we are examining financial capital. It is often also called the demand and supply of loanable funds or the demand for and supply of loans.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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We can see who creates the demand for loans and the supply of loans by using a simple model known as the circular flow of the economy. Households supply labor to firms and receive wages in return. Firms produce goods and services by using labor along with the plants and equipment they own (physical capital), as well as natural resources and raw materials (sometimes called “land”). Firms then sell these goods and services to households (consumption spending).  Households spend some of their disposable income and save some of it:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Households supply Loanable Funds to banks through deposits. How much Loanable Funds households supply is determined by the price they will be paid for their savings (the interest rate) and other factors, such as how much income they make. Firms, households and the government demand Loanable Funds. The price of Loanable Funds and other factors, such as the state of the economy, determine how large the demand is. Banks are the intermediaries, who collect the deposits and lend them out to the borrowers, adding a markup, of course, to cover their overhead and to create a profit for their stockholders.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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In general, financial intermediaries are in business to make a profit. While this is not true of credit unions, they still have to pay interest to their depositors, cover their workers’ wages, and fund overhead; they just do not have to make money above their expenses to pay to stockholders. In any case, financial intermediaries supply banking services. As a producer of banking services, we can characterize their production function like any other firm:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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For financial intermediaries, their total revenue is the interest they earn on the loans they make plus some investment returns (usually Treasury Bonds). Their costs are the interest they pay their depositors, interest on Commercial Paper, physical capital expenses, and employee wages. Thus, a financial intermediary defines profit as such:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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To cover all its expenses, the financial intermediary must decide what breakeven interest rate it must charge on its loans. In order to understand this, we can think of interest rates as having three components:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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The current amount of outstanding student loans is approximately $1.7 trillion; meanwhile, the total outstanding credit card debt stands at $922 billion. As you can see below, student debt has risen continuously over the past decade and a half, continuing a trend over the previous four decades.

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy

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Borrowing money for a college education is an investment. In 2020, the average annual salary of a high school graduate in the United States was $37,000 while the average annual salary of a college graduate was $61,000. Those with a college degree will earn at least 60% more money for over their lifetime. In addition, a college degree is more likely to lead to career advancement. Considering a cost/benefit analysis of college degrees, we can calculate a return on investment (ROI) for a college degree. In 2019, the College Board reported that a moderate college budget for a four-year in-state public college averaged $26,590 while a moderate budget at a private college averaged $53,980. Thus, the return on investment would look like this:

Economics for Life: Real World Financial Literacy

Donald Wargo

https://open.umn.edu/opentextbooks/textbooks/economics-for-life-real-world-financial-literacy