Four Free Books on Kindle June 10, 2019


Innovative Solutions to the College Debt Problem

Discusses existing policies and proposals on college financial aid and student debt and comes up with several new solutions that promise to reduce the number of overextended borrowers without imposing large burdens on taxpayers.

Defying Magnets:  Centrist Policies in a Polarized World

This generation of workers is getting screwed – higher student debt, multiple problems with health insurance coverage, and difficulties saving for retirement.   Three policy primers discusses these inter-related problems.

Things to Consider Before Purchasing Long Term Care insurance

Most people can’t afford long term care insurance.     Insurance companies often raise premiums and cut benefits, years after a policy is purchased.   The possibility of needing Long term care is a major risk.  But you need to solve other problems first.  Best to minimize debt, increase 401(k) savings, buy life insurance ahead of covering this troubling risk. 

Statistical Applications of Baseball

Book teaches introductory statistics through baseball.  A bit dated but baseball is and statistics are constants and book has a number of Interesting real world examples.  

A Centrist Health Plan

Introduction:

Most of the current health care debate in the Democratic party revolves around the adoption of a single-payer health care plan or the addition of a public option to the current system.

The Medicare for-all-option offered by Senator Sanders is on paper a comprehensive solution fixing all health insurance problems.   While many countries have high-quality public health insurance, there has never been an example of a country with an advanced private system abruptly replacing it with a public system

The proposals to expand Medicaid or Medicare currently circulating in Congress could help certain communities or groups.  The provision of Medicaid on state exchange market places would be useful in several rural counties where few private insurance companies choose to compete.   A reduction in the Medicare age or a Medicare buy-in option would benefit older workers who do not have access to employer-based health insurance coverage. 

The adoption of a public option, unlike single-payer proposals does not purport to be a comprehensive solution.  The task of fixing health care system without simply blowing up the current system is difficult.   President Trump, famously observed “Nobody knew that health care can be so complicated.”     There are multiple inter-related  health problems with our current health care system.  A policy that fixes one problem (say high premiums) can worsen another (say high out-of-pocket costs).

A centrist health care plan must do more than shore up state exchange market places through new public options.  The ACA expanded coverage to millions of people but even after the enactment of the ACA many Americans lacked health insurance and under the Trump Administration the number of Americans without health insurance has increased.

This article reports that the uninsured rate went from 10.9 percent in late 2016 to 13.7 percent in December 2018.

https://www.vox.com/2019/1/23/18194228/trump-uninsured-rate-obamacare-medicaid

Moreover, even after the enactment of the  ACA many Americans saw higher premiums, higher out-of-pocket expenses, and reduced access to specialists.  Increasingly, many Americans covered by insurance choose to forego procedures rather or prescription drugs because of high out-of-pocket costs.  Simply adding a public option does not fix these problems.

The remainder of this essay outlines health care problems and centrist solutions.

Health Care Problems and Solutions

Problem One  The Erosion of the Individual Mandate:   The ACA individual mandate was repealed in a recent tax law.  As a result, some people with pre-existing conditions have an incentive to delay the purchase of health insurance until they become sick.  The repeal of the individual mandate undermines state exchange market places and increases health insurance premiums.

Potential Solution:   There are two potential solutions to this problem. 

The first potential solution involves the reinstatement of the individual mandate.  Politically, this is a difficult option because the individual mandate is unpopular and strongly opposed by libertarians and other conservatives who believe that government has no right demanding people spend money in  a particular way.

The second  approach involves creating new financial incentives in the form of tax credits and other subsidies contingent on people holding continuous health insurance coverage.

Subsidies that could be made available only to people with continuous health insurance coverage include:  (1) a tax credit for contributions to health savings accounts, (2) a partial subsidy for high cost out-of-network treatments, and (3) subsidies for some prescription drugs.   Note that a tax credit for health savings account contributions would not even require an additional explicit linkage between the tax credit and health coverage because under current law contributions to health savings accounts are only available to people who have health insurance coverage.

Problem Two: Distortions caused by growing use of health savings accounts and high deductible health plans:   The growing use of health savings accounts coupled with high deductible plans has exacerbated three problems – (1) higher out-of-pocket health care costs, (2) increase in patients forgoing prescribed medicines and medical tests, and (3) reduced funds placed in 401(k) retirement plans.

Potential Solutions:   The distortions caused by the increased use of health savings accounts and high deductible health plans can be mitigated by several policy changes.

First, lower income households would benefit from a refundable tax credit for contributions to a health savings account.  (Current law only allows deductibility of contributions to health savings account, a feature that provides less benefit to low-income low marginal tax rate households.)

Second rules governing contributions to health savings account could be altered.   Current rules only allow contributions by people with a high-deductible health plan.  The revised rule would allow health savings account contributions by people who have a plan with a lower deductible but a high coinsurance rate.   (People with high coinsurance rate plans can have substantial cost sharing obligations but may be less likely to forego needed treatments prior to the deductible being met.)

Third, many existing high deductible health plans now forego all payments on prescription drugs until health expenses exceed the deductible.   By contrast, many traditional health plans with lower deductible pay some prescription drug costs prior to the patient paying the deductible.   The combination of high deductible and absolutely no reimbursement for prescription drugs until the deductible is met results in many people with chronic health conditions like diabetes forgoing needed medicines.  This worsens health conditions and increases costs. 

A rule requiring partial reimbursement for prescription medicines needed to prevent expansion of certain diseases would reduce the incentive for people to forego prescribed medicines.  It might be possible for HHS to adopt this rule change without input by Congress because the current ACA allows high-deductible health plans to reimburse patients for certain preventive health care measures prior to the deductible being met.    

Problem Three:  The limited role of state exchange market places.   State exchange health care markets are much smaller and much less robust than the employer-based health insurance markets.  Around 8 million people are covered by state exchange market places compared to around 155 million people covered by employer-based insurance. 

 Household receiving health coverage from state exchange markets tend to be less affluent than people obtaining health insurance from employer based market.   Go to this post on my math blog for statistics on this point.

http://www.dailymathproblem.com/2019/05/comparing-employer-sponsored-and-state.html

There are relatively few young adults under age 26  in state-exchange markets compared to employer-based markets.  Go to this post in my finance blog for a discussion of this issue.

There is less choice and fewer high quality products in state exchange markets than in employer-based markets.   In some counties few health insurance companies offer coverage and often there is concern that no health insurance companies will offer health insurance in a county.  There is evidence that state exchange insurance policies are more likely to restrict access to certain hospitals and specialists.

Potential Solutions:   It should not be a surprise a small health insurance market with relatively few young adults, and relatively few affluent households will provide less desirable outcomes than a larger health insurance markets with more younger adults and a lot of affluent people. 

The characteristics and limitations of ACA state exchange market places are largely a result of the rules laid out in the ACA.

First, the ACA contains an employer mandate, which provides a financial penalty on employers with more the 50 full time equivalent employees who do not provide health insurance to their employees. The employer mandate could be modified to allow and encourage employers to pay for health insurance on state exchange market places rather than offer a company-specific plan.

Second, the ACA eliminates tax credits to people once they obtain a position offering employer-based insurance coverage.  The rule eliminating tax credits for people with employer-based health plans would be eliminated.

Third, state exchange market places do not provide any preferential tax treatment for the 41 percent of American households with income greater than 400 percent of the federal poverty line.  Households in this income group receive untaxed health insurance from their employer.  This rule reduces political support for state exchange marketplaces.   Support for state exchange marketplaces could be increased through an expanded tax credit.

A Political Note on the Role of State Exchange and Employer-Based Health insurance Marketplaces:

The introduction of state exchange market places to compete with employer-based health insurance is the central aspect of the ACA, a law that was strongly opposed by conservative economists and Republican politicians.   However, the provision of health insurance through private markets separate from the employer was an idea originated by conservative economists and supported by Republican politicians.   To be fair, there were major differences between Republican proposals, which allowed underwriting of premiums and denials of insurance for people with pre-existing conditions and the ACA.  

Republicans are on record of supporting reductions in the use of employer-based health insurance.  In fact, a health care plan offered by Senator McCain replaces the entire current employer based tax preference with a tax credit for the purchase of health insurance through state market places.   

The protections for pre-existing conditions and the limitations on underwriting of premiums increase access to health insurance for many people who would otherwise be uninsured.   (The election results of 2018 indicate the Democrats largely won this debate.)   There is some Republican support for moving the purchase of health insurance from the employer to private markets.   Could Republicans support proposals that move more people from employer-based insurance to current ACA state exchanges?

Problem Four  The introduction of short-term bare-bones health plan has increased household financial risk and undermined state exchange market places.  The  Trump Administration has enacted rules that allow use of short term health plans.   These health plans often do not cover many services that are considered essential health benefits in an ACA plan. The coverage gaps result in unanticipated bills and financial exposure.  The short term option reduces demand for ACA policies.

Potential Solutions:   There are two way to address problem caused by the introduction of ACA plan.

The first approach is to repeal the Trump era regulation and return to a system where short term health plans are prohibited.   Repeal creates a situation where people who took out short term health plans will either lose coverage or purchase an ACA plan with a higher premium.

The second approach involves modifying short term plans to allow for an annual cap but to require coverage of all essential health benefits.  People with expenditures over the annual cap would get automatic Medicaid coverage once the cap was reached.

This policy essentially converts Medicaid into a reinsurance program responsible for health care costs over the annual limit.  I loosely describe this approach in a 2008 paper on SSRN.  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1162887)

Problem Five:  Lack of access to elite out-of-network hospitals and specialists.  Typically, narrow network HMOs provide excellent health care and charge lower premiums.   However, people who get extremely sick with certain illnesses require treatment by specialists that are only offered at certain hospitals.   This is called the “breaking bad” problem as portrayed by the fictional high school chemistry teacher who chooses to make meth to pay for his cancer treatments.

Potential Solutions:  The “breaking bad” problem can be solved by having the government share part of the costs of expensive specialized out-of-network care.  Having the government pay for a portion of complex treatments that could only be handled in sophisticated out-of-network hospitals would reduce premiums for limited network HMO plans.  This reduction in health care premiums would also reduce tax subsidies on health care purchases both on the ACA state exchange subsidies and the employer-based health insurance subsidies.

This proposal offers two benefits – lower premiums on basic narrow-network health care and access to more expensive out-of-network care should the narrow network be unable to treat certain health conditions.

Problem Five:  A lack of affordable health coverage for people nearing the end of their careers who are not eligible for Medicare.

Potential Solution:    One approach to this problem is to allow the purchase of Medicare by individuals 50 or over without an offer of employer-based health.

An expanded Medicare option for people over the age of 50 could be combined with a higher (old-young) age-rate premium ratio to lower costs for younger households.    

Problem Six:   Limited State Exchange Offerings and High Premiums for Certain Counties.  Some counties have few health insurance companies offering ACA coverage.   It has been reported that in 2018 around half of counties had only  insurance company offering ACA coverage.

Heritage Foundation article on counties with limited health insurance coverage

https://www.heritage.org/health-care-reform/report/2018-obamacare-health-insurance-exchanges-competition-and-choice-continue

Potential Solution:  Senator Schatz’s health insurance bill allowing states to offer health insurance on state exchanges would create another option in many counties with only one or relatively few ACA providers

Go here for a description of the Schatz-Lujn legislation:

https://www.schatz.senate.gov/press-releases/schatz-lujn-introduce-legislation-to-create-public-health-care-option

Summarizing the Centrist Health Care Plan

A comprehensive centrist health care plan might both expand and improve health insurance coverage.   It would lower premiums and reduce out-of-pocket expenses.   The simultaneous achievement of these two goals is often difficult because many policy changes that reduce premiums increase out-of-pocket costs while policies that reduce out-of-pocket costs often increase premiums.

Here are some aspects of the plan:

  • Link all new tax subsidies and the standard deduction to a requirement that  people maintain health care coverage.
  • Change rules governing health savings accounts to allow for contributions by people who have high-cost sharing plans even if the plan has a low deductible.
  • Create tax credits for contributions to health savings accounts
  • Require partial insurance coverage for prescription drugs used to treat chronic health care conditions prior to health expenses exceeding plan deductible.
  • Modify the employer mandate to encourage businesses to subsidize state exchange insurance rather than choose and administer an employer-based policy.  
  • Modify rules governing tax subsidies for insurance on state exchanges to allow people to keep their state exchange policy after obtaining offers of employer-based coverage.
  • Repeal current short-term bare bones health plans.
  • Create health plans with an annual cap while guaranteeing Medicaid coverage once health expenditures exceed the cap.
  • Create a new subsidy for out-of-network costs for people with narrow-network plans who require procedures not covered in the narrow network.
  • Allow people over 50 without access to employer-based health plan the right to buy into Medicare.
  • Modify the age-rate premium formula to lower costs for younger households.
  • Allow states to authorize the sale of Medicaid policies on state exchanges.

Authors Note:  A lot of these ideas and proposals are discussed in greater detail in  the second chapter of my policy primer “Defying Magnets:  Centrist Policies in a Polarized World”  

Defying Magnets:  Centrist Policies in a Polarized World

The first chapter of the book examines student debt policies.   The third chapter examines retirement income.  

I believe you will find the analysis and proposals innovative, potentially useful, and drastically different than what is being offered in Washington.

Overview of Health Insurance Issues


Republicans are seeking to repeal and replace the affordable care act, even as Republican candidates for office profess support for many parts of the act including protections for people with pre-existing conditions. The primary Republican achievement since 2016 involves a tax law that repealed the individual mandate and a Texas federal court ruling currently under appeal that voided the entire law because of the individual mandate repeal.

Democrats have robustly opposed Republican efforts to repeal the ACA but are now split between fixing the Affordable Care Act or moving towards a single-payer system.   Many 2020 Democratic candidates have endorsed Medicare for all without fully considering details of and implications of their proposals.

Some Democrats are now advocating proposals that would allow some private firms or some individuals to buy into Medicare or Medicaid. One advantage of adding a government (Medicare or Medicaid) option is that these options allow people to keep private insurance.

This section starts with a review of the current health care policy debates.   The analysis reaches the following conclusions.

  • Republican efforts to repeal the ACA would substantially increase the number of uninsured people in the United States.
  • Democratic Medicare for all proposals have not been fully vetted, would leave many people with private insurance worse off and would be more expensive than anticipated.
  • The combination of a decrease in the eligibility age for Medicare combined with a higher ratio of insurance premiums for older households relative to younger households could decrease the number of uninsured people in all age groups.

The section contains discussions of three technical health insurance issues with important implications for health insurance markets that have not received attention during the debate over repeal of the ACA.

The first issue involves modifications of rules governing health savings accounts and high deductible health plans.  Proposals designed to mitigate problems created by the increased use of health savings accounts and high deductible plans include:

  • Creation of a tax credit for contributions to health savings account by low-income and mid-income households.
  • Expansion of the type of health plans, which allow contributions to health savings accounts.
  • Require high deductible health plans pay a portion of prescription drugs used for chronic diseases prior to deductible being met.

The second issue involves modification of rules and incentives governing the use of employer-based insurance versus state exchange insurance.  

Proposals designed to strengthen state exchange insurance and to allow more firms to replace employer-based coverage with state exchange coverage include:

  • An expansion of the tax credit for premiums on health insurance policies purchased through state exchanges.
  • An alternative to the employer mandate for employers subsidizing the purchase of health insurance on state exchanges.
  • Financial incentives for young adults to leave their parent’s health insurance policy and obtain health insurance on state exchanges.

The third issue involves how to mitigate financial distortions caused by extremely expensive and complex health care cases.  Proposals designed to mitigate problems associated with the most expensive health care costs include:

  • Government and private firms sharing health care expenses over a certain threshold.
  • Automatic Medicaid enrollment for people purchasing a health plan with an annual benefit cap once expenditures exceed the cap.
  • Government assistance for certain health care cases that are difficult to treat in narrow-network HMOs.

The health care debate is eerily analogous to the student loan debate with each side taking extreme positions.  Republican efforts to repeal the ACA would increase the number of uninsured.  Democratic initiatives would crowd out private insurance for many households that are well served by the existing system.  The road to improving health care like the road to reduce student debt problems involves the analysis of arcane rules and incentives and the design of economically efficient alternative regulations.

PLUS Loans for Parents and Parent Income

PLUS Loans for Parents and Parent Income

Question:  How has the use of PLUS loans for parents changed over time for parents of student attending undergraduate institutions and for students attending graduate schools?   What is the share of PLUS loans taken out by parents with income in the bottom quartile?

Does it appear that parents taking out PLUS loans for students have adequate income to repay their obligations?

Why this issue is important:  Parents who have problems repaying PLUS loans are not allowed to default on the loan.   Increasingly, many parents with PLUS loan obligations have had problems repaying and in some cases the government has garnished Social Security benefits from these borrowers.   It is possible that many of the financial problems caused by use of PLUS loans could have been prevented if lenders had considered the adequacy of parent income prior to making the loan.

Data and Methodology:

I addressed this issue with TRENDSTATS from the NCES DATALAB.

https://nces.ed.gov/Datalab/trendstats/trends.aspx

TRENDSTATS allowed me to get data on use of parent plus loans by income quartile for five different survey years  — 1996, 2000, 2004, 2008 and 2012.

I created separate analysis for parents of undergraduate students and parents of graduate students.

The table on PLUS loans for undergraduates only involves parents of dependent students.

The table on PLUS loans for graduate students uses the combined income of the student and the parent.

Results:  Two tables on PLUS loan use and income quartiles over time are presented below.

Percent of Dependent Parents with PLUS Loans by Income Quartile
Year Lowest 25th  Percent Lower Middle 25th  Percent Lower Upper 25th  Percent Upper 25th  Percent Total
1996 2.96 5.56 6.38 5.65 5.06
2000 3.56 5.48 8.61 6.76 6.07
2004 3.92 6.53 9.34 8.34 6.98
2008 4.33 6.73 9.37 8.86 7.25
2012 6.22 9.17 11.33 10.87 9.27
Percentage Growth 1997 to 2012 109.91% 64.96% 77.57% 92.49% 83.27%

Sample is all parents of dependent undergraduate students

Parent Plus Loans for Graduate Student by Quartile of

Sum of Parent and Student Income

Year Lowest 25th  Percent Lower Middle 25th  Percent Upper Middle 25th  Percent Upper 25th  Percent Total
1996 6.83 3.94 2.36 0.80 3.48
2000 7.37 5.75 4.14 2.90 5.07
2004 7.98 6.18 3.44 3.87 5.51
2008 9.82 8.14 5.48 3.88 6.76
2012 11.47 7.87 5.23 3.27 7.13
% Change 67.85% 99.63% 121.73% 308.91% 104.82%

Analysis of Percent of Plus Loans Across Income Quartiles:

Undergraduate Students:

The lower upper 25th percentile had the highest share of students dependent on PLUS loans for parents in all years.

Growth rate in use of PLUS loans for parents is highest in the lowest 25th percentile.

Graduate Students:

The lowest 25th percentile consistently had the highest percent of people dependent on PLUS loans for parents.

The upper 25th percentile had the highest growth rate in the use of PLUS loans for parents; although, the PLUS loan share for this quartile remained lower than all other quartiles in 2012.

Share of PLUS Loans Taken Out by Parents in First and Second Income Quartile:

Above I discussed the percent of students in each quartile that used a PLUS loan.

Here I look at the percent of students using PLUS loans that are in particular quartiles in each income quartile.

PLUS Loans for Parents Usage
Number out of 1,000 per income quartile
Q1 Q2 Q3 Q4 Total
Undergraduates 62.2 91.7 113.3 108.7 375.9
Graduates 114.7 78.7 52.3 32.7 278.4
Share in Each Quartile
Q1 Q2 Q3 Q4 Total
Undergraduates 16.5% 24.4% 30.1% 28.9% 100.0%
Graduates 41.2% 28.3% 18.8% 11.7% 100.0%

Calculations above are for 2012

Observations on use of Parent PLUS Loans Across Income Quartiles:

Lower-income people take out a lot of PLUS loans.

16.5 percent of PLUS loans taken out by parents of undergraduates are in the lowest income quartile.

41.2 percent of PLUS loans taken out by parents of graduate students are in the lowest income quartile.

Methodological Note:

I wanted the software to provide numbers of students in each income quartile based on population weights.   I would have obtained contingency tables based on population weights in SAS or STATA if I had access to the raw data files.  TRENDSTATS does not appear to have this capability.   Alas, I don’t have access to the raw data so this could not happen.

I attempted to switch the row and column variables in TRENDSTATS but the TRENDSTATS software does not allow for automatic creation of income quartiles when parent income of dependent variable is the column variable.

How then did I get the share of loans for all income quartiles?

By definition, each quartile has the same number of observations so I assumed each group had 1000 students.   I multiplied 1000 by share of students using PLUS loans for each quartile to get PLUS loan use per 1,000 students.

The sum of these numbers is total PLUS loan use across all students.   I divided PLUS loan use by income quartile by total PLUS loan use in the population to get quartile shares.

I am very interested in understanding the advantages and limitations of the POWERSTATS and TRENDSTATS education department software and will continue to make comments that might lead to improvements in the on-line databases.

Concluding Thought:

Barring really exceptional circumstances, student debt including PLUS loans obtained by parents is not forgiven or discharged even in bankruptcy.   Lenders happily give PLUS loans to lower-income parents because the loans are guaranteed even if the lender cannot make repayments.

The combination of government guarantees for loan payments and a prohibition on discharge of loans in bankruptcy has led to a thriving debt market geared towards people with little chance of repayment.

The Elimination of Subsidized Student Loans

The Trump Administration is proposing the elimination of subsidized student loans.  This post provides estimates of the additional costs of this proposal based on the number of years students stay in school.

Introduction:   Currently, low-income undergraduate students can take out a total of $31,000 in federal student loan.  Subsidized student loans are only available to people in low-income households.  The main difference between subsidized and unsubsidized student debt is that the government pays all interest costs on subsidized debt when the student is in school while interest accrues on unsubsidized loans.

The current limit on subsidized student loans is $23,000.  The total limit on undergraduate federal student loans is $31,000.

The Trump Administration is proposing to eliminate all subsidized student loans.

The purpose of this post is to model and analyze the  impact of this policy change for a student who is planning to take full advantage of subsidized student loans.  I also examine how this financial cost depends on the number of years it takes for the student to graduate.

Methodology:   I set up a spread sheet where the key model inputs are number of years it takes for a student to graduate, the interest rate on the student loan, and the maturity of the student loan.

Key Assumptions:

In this model, I assume the student borrows $31,000/n each year where n is the number of years it takes for the student to graduate.  When subsidized loans exist the annual total borrowed for subsidized loans is $23,000/n and total unsubsidized loans for the course of the person’s undergraduate career is $8,000.

(An expanded version of this model will consider uneven borrowing scenarios, where student borrows a different amount each year or perhaps drops out from school for a few years.)

Student remain in deferment until six month after graduation or leaving school.

Student does not apply for loan deferments for economic hardships or when unemployed.

The interest rate is 5 percent.

Student loan maturity is 20 years.

The procedure to calculate lifetime costs involves two steps.

Step One: Calculate the total loan balance on the day the student borrower starts repayment.  The subsidized loan at time of repayment is equal to the balance when issued since all interest is paid for. The FV of the unsubsidized loan is determined at time of graduation and multiplied by (1+0.05)0.5 to account for the six-month delay in repayment after graduation.

Inputs of FV function:

INT interest rate 0.05 or some other assumption.

NPER number of periods in this case number of years in school.

PMT is payment in this case the annual loan amount.

PV in this case 0

Type is ! for end of period.

The FV gives the value of the loan at graduation.   Repayment is six months later.   The value of the loan at repayment is FV0.5

The total loan balance is the sum of the subsidized and unsubsidized loan balance at time of repayment.

Step Two:  Calculate total payments over the lifetime of the loan.  This is done by using PMT function to get monthly payment and then multiplying by the total number of payments.

Spreadsheet for person who graduates in four years:

row Subsidized Loans No Subsidized Loans
2 Date of First Loan Payment 9/1/10 9/1/10
3 Subsidized Loan $23,000 $0
4 Unsubsidized Loans $8,000 $31,000
5 Interest Rate 0.05 0.05
6 Number of years In school 4 4
7 Date Repayment Starts 3/2/15 3/2/15
8 FV of subsidized loans $23,000 $0
9 FV of unsubsidized Loans $9,275 $35,940
10 Total Loans $32,275 $35,940
11 Loan Maturity 20 20
12 Loan PMT -$213 -$237
13 Lifetime Payments -$51,120 -$56,925
  • The elimination of subsidized loans increases lifetime repayment costs of the loan by $5,805 when the person graduates in four years and starts repayment six months after graduation.  (The other key assumptions are a 5% student loan interest rate and a 20-year student loan.)

Impact of delays in finishing schools:

The addition cost stemming from the loss of the subsidy can be obtained by changing line 6 of the spreadsheet number of years in school.   Below we present results for # of years in school for 4, 5, and 6.

Calculations are below:

# of Years in School Payments with Subsidized Loans Payments with No Subsidies Difference
4 $51,119.83 $56,924.81 $5,805
5 $51,496.04 $58,382.62 $6,887
5 $51,884.94 $59,889.61 $8,005
  • The elimination of subsidized loans leads to even higher costs for the person who spends more years in school.   Additional lifetime costs of loans are $6,887 for the person who graduates after 5 years and $8,005 for the person who graduates after six years.

Authors Note:  My student debt book looks at existing student debt and financial aid programs and proposals offered by both the Trump Administration and candidates in the Democratic party.   I then offer my own solutions to the problem.

The book is available on Kindle.

Innovative Solutions to the College Debt Problemhttps://www.amazon.com/Innovative-Solutions-College-Debt-Problem/dp/1982999446

 

Asset Allocation for Twelve Sector Funds

Asset Allocation for Twelve Sector Funds

Issue:  Under an asset allocation investment strategy, an initial allocation is assigned to all assets in a portfolio and the portfolio is rebalanced from time to time to maintain the original composition of assets.   The rebalancing can be at scheduled dates or whenever the portfolio manager observes large changes in relative asset prices.

The original allocation of assets is maintained by selling assets that do well and buying assets that do poorly.   This approach can backfire.   A hedge fund manager who bought horse and buggy stocks and sold car stocks after the introduction of the car would not have done well.  However, asset allocators who sold internet firms prior to the tech bubble in the late 1990s did quite well.

Question:   Table one below has stock price information on 12 sector ETFs offered by Vanguard for three dates – 7/1/13, 7/1/16, and 6/29/18.

Using this price data, calculate the average annual return between 7/1/13 and 7/116 and the average annual return from 7/1/16 to 6/29/18 for the 12 funds.

What do these annualized return statistics suggest about the likelihood of success of an asset allocation strategy, which starts out with equal shares of the 12 ETFs on 7/1/2013 and rebalances on 7/1/2016.

Adjusted Close Stock Price for 12 Sector Funds
Symbol Fund Description 7/1/13 7/1/16 6/29/18
VDC Consumer Stables 93.55 133.53 134.27
VDE Energy 103.12 88.25 105.08
VFH Financials 38.12 47.48 67.45
VHT Health Care 86.84 133.78 159.14
VIS Industrials 79.06 106.53 135.81
VGT Information Tech 73.07 112.61 181.42
VAW Materials 82.52 104.33 131.56
VNQ Real Estate 56.70 84.58 81.46
VOX Communications Services 68.28 94.02 84.92
VPU Utilities 72.52 106.33 115.96
GLD Gold 127.96 128.98 118.65
SLV Silver 19.14 19.35 15.15

A note on calculations:   The return between two dates is obtained from the formula (APt/ APt-n(1/n)-1

The first period is three years and the second period is two years.   (n is 3 for first period and 2 for second period.)

The table below sorts the funds from least to highest annualized return during the first period.

Annualized Rate of Return for 12 Funds
Symbol Fund Description July 2013 to July 2016 July 2016 to July 2018 Diff.
VDE Energy -5.1% 9.1% 14.2%
GLD Gold 0.3% -4.1% -4.4%
SLV Silver 0.4% -11.5% -11.9%
VFH Financials 7.6% 19.2% 11.6%
VAW Materials 8.1% 12.3% 4.2%
VIS Industrials 10.5% 12.9% 2.5%
VOX Communications Services 11.3% -5.0% -16.2%
VDC Consumer Stables 12.6% 0.3% -12.3%
VPU Utilities 13.6% 4.4% -9.2%
VNQ Real Estate 14.3% -1.9% -16.1%
VHT Health Care 15.5% 9.1% -6.4%
VGT Information Tech 15.5% 26.9% 11.4%

Observations:

Information Technology, the best performing fund in the first period, was also the best performing fund in the second period.  This asset allocation strategy would have reduced holdings of an asset, which continued to out-perform all other assets in the portfolio.

Energy, the worst performing fund, in the first period, had a return 3 percentage points over average of the 12 ETF returns in the second period.

Four of the six worst-performing sectors in the first period realized improved returns in the second period.

Five of the six best-performing funds in the first period had worse returns in the second period.  (The only exception is the previously mentioned information technology fund.)

The median annualized return in first period was 10,9 percent.   Only four funds had annualized returns over this level in the second period.

Two sectors – financials and information tech – are positive outliers in the second period.  However, financials have underperformed in last few months.

Concluding Remarks:   Information Tech, the best performer in both time periods, did spectacularly in the second period.  Asset allocators sold the best fund.

Asset allocation strategies tend to work more consistently when the investor holds broader funds, including both the overall stock market and debt funds.  Subsequent research will look at situations where asset allocation provides better results.

Authors Note:  Interested in financial problems caused by student debt.   Take this quiz on student debt trends and proposed policy changes.

http://financememos.blogspot.com/2018/07/a-student-debt-quiz.html

Are Tech Stocks Overvalued?

Are Tech Stocks Overvalued?

Issue:   Professor Jeremy Siegel maintains that the stock market and tech stocks are still fairly value.

http://www.cnbc.com/2017/05/26/were-not-in-the-danger-zone-for-overheating-says-longtime-stock-bull-jeremy-siegel.html

He supports this argument with the observation that the PE ratio of Tech stocks in the S&P 500 is still under 20.

What are the limitations of using the PE ratio for a basket of stocks to measure the valuation of the portfolio when some stocks in the portfolio have negative earnings?

Does an analysis of the PE ratios of the stocks in the Vanguard Information Technology ETF support or contradict Professor Siegel’s view on the valuation of Tech stocks?

Is Professor Siegel correct in his assertion that tech stocks are valued correctly?

Discussion of ETF PE Ratios: 

Professor Siegel pointing to a PE ratio for a basket of tech stocks in the S&P 500 has argued that the sector is valued fairly.   My problem with this argument is that published statistics on ETF PE ratios often fail to accurately include information on firms with negative earnings.

Firms with negative earnings have negative PE ratios.  These firms often have a lot in common with high PE firms.   Often startups have negative or low earnings.   If earnings are negative the PE is negative.  If earnings are slightly positive the PE is large.

It would be incorrect to average negative PE firms with positive PE firm because the result would be to reduce the PE of the portfolio even though the negative PE firms have high valuations compared to their income.     Some web sites including yahoo finance report and include negative PE ratios.   Most analysts omit negative PE ratios from their calculation of the portfolio PE.   However, this procedure will also understate valuation relative to income because firms with negative PE ratios have high valuation compared to earnings.

PE ratios have no clear economic interpretation when earnings are negative.  When earnings are slightly below zero (a small loss) the PE ratio is a very large negative number.   When a company has a larger loss the PE ratio is a smaller negative number.

Why PE ratios make no sense for firms

 with negative earnings

Earnings per share

Price per share PE ratio

(0.10)

3.00 (30.00)
(5.50) 3.00

(0.55)

In short, PE ratios incorrectly rank firm valuation when earnings are negative.

It would be incorrect to average negative PE firms with positive PE firm because the result would be to reduce the PE of the portfolio even though the negative PE firms have high valuations compared to their income.     Some web sites including yahoo finance report and include negative PE ratios.

Most analysts omit negative PE ratios from their calculation of the portfolio PE.   However, this procedure will also understate valuation relative to income because the firm with a negative PE ratio has a high valuation compared to earnings.

I am not the first to write about the problem of measuring ETF PE ratios.  Here are some additional resources.

Why ETF Price/Earning Ratios Lie.

http://www.etf.com/sections/blog/23121-why-etf-priceearnings-ratios-lie.html?nopaging=1

Understanding Negative PE Ratios for ETFs

http://www.etf.com/sections/blog/21801-understanding-negative-pe-ratios-for-etfs.html/page/0/1?fullart=1&start=2

Data used in this study:

I obtained a list of stocks in the VGT mutual funds from Zachs guide at the link below.

https://www.zacks.com/funds/etf/VGT/holding

Vanguard Technology Fund VGT has a total of 356 firms.  This study examined the PE ratios of all firms where the equity investment was greater than or equal to 0.1 percent of the value of the VGT portfolio.     There were 109 such firms.

Results:   The frequency distribution of dollar share values invested and number of firms for five PE categories – less than zero, 0 to 15, 15 to 30, 30 to 40 and over 40 – are presented below.

 

   Shares of Firms in VGT by PE category

PE Category

Dollar Share Invested by PE Category

Percent of Companies

<0 6.31 17.43
0-15 5.74 6.42
15-30 36.19 34.86
30-40 31.16 12.84
40< 13.12 28.44
Total 92.52 100

Sample consists firms in VGT where the equity position was greater than or equal to 0.1 percent of the total value of the VGT portfolio.   There were 109 firms meeting this criterion.   These 109 firms represent 92.5 percent of the value of the VGT Portfolio.

Observations:

Around 6.3 percent of dollars invested in the 109 positions of VGT are in firms with negative earnings.  Around 17.4 percent of the 109 firms had negative earnings.

Over 13 percent of dollars invested in the 109 VGT positions had PE ratios over 40.   Over 128 percent of the firms in this group had a PE ratio over 40.

Analysis:

 What can we conclude about the question of whether tech stocks are overvalued after examining the distribution of stocks in VGT?

The large number of tech stocks with high PE ratios or worse yet negative earnings is consistent with a bubble.   Perhaps the bubble is in the early stages and some people can buy, sell, and make money before the crash.   However, there are a lot of overtly optimistic analysts and a lot of inaccurate or misleading information out there.

This is not going to end well.