Q. In harvesting a range of views on personal finances, should we include ChatGPT or other forms of AI?
Xavier, Washington DC
Q. “Should I use ChatGPT for financial advice?” Kinda John Henry v. The Mighty Steam Drill.
–Clay, Denver CO
No bots here! We don’t need their kind. Only humans.
Just kidding.
Look, from what I can tell, an online chat-based AI can address 98 percent (I made up that number) of our personal finance questions, with a straightforward answer that is mostly right, most of the time. The right thing to do in personal finance doesn’t change much from year to year, decade to decade. One of my deeply held beliefs is that Benjamin Franklin’s The Way To Wealth contains practically everything we need to know about personal finance, even though that was published in the mid-18th Century.hy
An AI will only rarely get things wrong. But so will humans!
Like an AI, you will see me at times overconfident in my answers and advice. Still, my human hubris in offering my version of something an AI can do quite well is to add a bit of humor, a bit of contrariness, and a bit of go-beyond-the-average. Only time will tell whether the result will be better than a bot.
Finally, a bit about me, the human behind these answers. When I first read the John Henry name, I thought you meant the owner of the Red Sox, as I’m a New Englander by birth. Then I thought it was a reference to the AI in Terminator: Sarah Connor Chronicles, as I’m a sci fi nerd.
But that coincidental link to AI is not what you meant. Rather you were referencing a children’s book by the same name.
Note: An ex-student of mine reached out to ask a question many face… Is it best to use savings and investments for graduate school, or to take out loans?
Dear Banker,
I saw you answered a question from a former student about paying down debt and being unemployed on your blog. So I thought I would give it a shot! I am going back to school in January for 1 year accelerated program that will cost 40k-50k, I am not quite sure yet.
Side note: I thankfully do not have loans from undergrad.
So I will have to take out student loans but I am unsure if I should take out the whole 40k-50k or use some of my assets to have less debt after I finish.
I currently have $9,000 in Betterment.com and individual investments with Capital One, $12,000 in Mairs and Power mutual fund that my parents put money in since I was a child. I also have $3,000 dollars in my savings account. I know I shouldn’t use all the money I’ve invested and saved but I was thinking maybe $10,000 dollars to have less students loans to pay back? I’m not sure what is a better decision financially. What would you suggest?
I saw your blog on Facebook and thought I would ask!
Thanks,
M.C. (San Antonio, TX)
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Hi MC,
Thanks for your question and for thinking of me. I’d like to think a few of the things we talked about in class were helpful.
I hope post-College life is treating you well. Congrats on having real savings and investments at this point…this is really commendable. Plus, no undergrad debt is also a blessing. A good place to be! About your future decision to use savings vs. take out debt for a nursing degree:
I don’t think there’s a single obvious solution. You could approach this various ways and still be making the ‘right’ choice. Also, I’d probably need more info on your situation to give more confident advice. But, here’s the principles I would keep in mind:
1. Student loans – especially for a professional upgrade in skills – are not “bad debt.” Mostly they have low interest rates, with generous payback terms. If they help you achieve a good salary and life-satisfaction, they are “good debt.” $50K of nursing school debt is a lot, but manageable in the long run. The fact that you’ve got some savings and investments already also suggests that you are able to live below your means, which bodes well for your ability to pay back debt over time after you get training and when you are earning money again.
2. If any of your Betterment, Capital One, or Mairs & Power accounts investments are in retirement accounts – tax advantaged accounts like an IRA – don’t take any money out of there to spend now. You might pay taxes and penalties to extract the money, so its better to leave those for the next 40 years to accumulate compound returns.
3. For invested money not in retirement accounts, its ok to take the money out and spend some on a worthy project like a professional upgrade. BUT…if you’re able to resist taking money out, it’s better for you in the long run. It’s so very difficult to actually accumulate savings and investments – especially when you’re in your twenties – that I think you should try extremely hard to preserve it, invested in the markets. This will mean more debt (and therefore more risk) but it seems justifiable, at least to me.
4. Leaving money invested in stocks/ mutual funds is tax efficient (meaning, every time you sell you’ll owe taxes on the gains.).
5. It’s also slightly riskier (stocks/mutual funds can lose value). But the longer you can leave them alone untouched, the better your prospects for building wealth with that money.
6. I think, psychologically, its easier to save and invest if you already have something saved, rather than zero. So I wouldn’t want you to go to zero on your investments.
Those are my thoughts. Feel free to write back or call if you want to discuss/clarify/argue about any of this.
By the way, how do you like Betterment? I haven’t really explored it but it seems like the targeted solution for your demographic. I’ve been enjoying an app called Acorns which I quite like. I wrote about it here: http://www.bankers-anonymous.com/blog/check-out-this-acorns-thing/
Michael
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MC’s response:
Thanks so much for getting back to me! I’m sorry it took me a while to respond I went away for a week right when you wrote me back.
I was thinking that it would be better in the long run to not touch my investments but taking out such a big loan does make me nauseous when I think about it. However, I think I will stick with that strategy because I know if I leave nursing school with no savings I won’t feel good about that either. Thanks for going through the pros and cons its way more helpful then my internet searches have been!
I don’t have an IRA right now but I know I should set up a Roth IRA soon but I wasn’t sure yet if I wanted to use that money for school.
As for Betterment, I really like it! I started an account in August 2011 and just give about 60 dollars a month. According to my performance chart my return rate is 37% with an allocation of 100% in stocks. If I had 80% stock and 20% bonds it would be 44% right now. My original allocation was actually 70% stocks and 30% bonds but after your class I decided to try 100% stocks which, just like Acorns, Betterment refers to as ‘aggressive”. The majority of the investments are in different Vanguard funds and iShares. I like that part of it as well because if I’m not mistaken to open these account individually sometimes you need 1,000 or up to 3,000 dollars. I think Betterment is great for people my age! I always tell my friends to sign up who don’t know anything about investing.
Thanks again for responding and teaching a great class I think all students should be required to take it!
MC
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MC, Ok good luck! You’re going to do great, because you’ve already done the hard part, which is to begin saving and investing in your early 20s.
This is your former student, one year post personal finance class, and I am in need of advice.
Here’s the backstory. After spending one year in the IT Consulting world, making 70K and being equally stressed to the detriment of my health, I jumped ship (per the advice of my employer, they noticed I wasn’t sleeping). I left on good terms and with a fair severance pay. At this point of life re-evaluation I like the idea of taking however much time is necessary to ensure that misery is not a part of my daily routine at my next gig.
I have about 30K in student loans not paid off, interest rates ranging from 3.4% to 5%. The actual breakdown:
Loan A, minimum monthly payment $130/mo for 120 months: [12K @ 5%];
Loan B, total 18K, minimum monthly payment for all of Loan B $150/mo for 120 months [10K @ 3.4%, 5K @ 4%, and 3K @ 4.5%]).
My monthly expenses run between 1K to 1.5K and I have around 15K in savings (not including emergency funds, which is 3K and then 4K in a HSA account which can only be used for health expenses, I’m wanting to use all of that 15K towards paying off loans).
What advice do you have for planning my budget? I want to remove as much principal from my loans now to lower my interest payments. I may be able to defer paying monthly payments with no interest accruing for both my loans citing unemployment as the reason, another case might involve interest accruing as normal but monthly payment not required.
Any and all advice would be appreciated, thank you! Let me know if any of this info needs clarifying.
Sincerely,
AF in Houston
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Dear AF,
Thanks for reaching out, I’m glad to hear you’re continuing to track a lot of the things we discussed in the Personal Finance course last year.
Congrats on building that cash cushion – that’s admirable and rare for anyone one year out of college. It sounds like unemployment is not as scary to you as being stressed out – so the cash cushion allows you to take some time to figure out the next step, which is really great.
The way I read your note, you mentioned three financial factors you’re trying to optimize, and then a few more unmentioned financial factors that I think you should include in the mix for decision-making.
Your mentioned factors:
1. Cash burn of $1,500 cost/month (aka unemployment)
2. $30K student loans
3. $15K savings
Your unmentioned factors:
1. Maxing out your Individual IRA when at you’re age 23
2. Finding work that covers your lifestyle costs and doesn’t leave you stressed out and unhealthy.
So…as far as important financial decisions in the next year, the most important is probably solving the issue of cash burn. You’ve got ten months, at your reported run rate, to solve that one (That’s $15K divided by 1.5K per month).
Ideally, you combine employment with the unmentioned factor #2, namely getting work that pays and keeps you healthy. Until you solve that one, I wouldn’t get aggressive about paying down your students loans.
Why do I say that?
If you decide to use your $15K cushion to pay down student loan debt, you shorten the time you have to get good, healthy work. Finding good work can take time. You don’t necessarily want to take another job that doesn’t suit you, and leaves you stressed out again, if you’re forced into the next job by the problem of running out of cash.
In addition, it’s very admirable to want to pay down your student loan debts with your savings, but in this particular situation I wouldn’t advocate that. Your student loan debt is low-interest debt, meaning it is compatible with good long-term financial decisions. (If you told me you had $30K in high-interest credit card debt, or any amount of credit card debt for that matter, I’d be strongly advocating paying that down as quickly as possible, as priority #1)
Then there’s another – in my opinion better – use for your savings if you’re trying to maximize your financial situation with your cash.
You didn’t mention contributing toward your $5,500 limit in an individual IRA. Hopefully you remember our discussion in class on the compounding effect of growing that money over the next 50 years. (Undoubtedly you can still do the math that shows your $5,500 becoming $101,311 fifty years from now at a reasonable 6% compound growth rate. Right? Please tell me yes.) Combine that with the 25% income tax relief you’d get on making a $5,500 contribution this year (so, up to $1,375 that you keep, not the federal government) and I think a strong case could be made for prioritizing your IRA contribution over student loan principal repayment.
Obviously you have to stay current on your student loans, but I don’t think its a bad idea to pay the minimal required amount, at least until you figure our your employment situation.
An implied part of my calculation here is that, given your education and past earning power, you’re capable of getting a high-paying job in the next year. The trickier part – in the long run – is finding a high-paying job that doesn’t leave you stressed and unhealthy.
My summary thoughts would advocate either of the following to routes: The cautious approach – Hoard your cash long enough to get a good job, pay the minimum on your student loans, but don’t pay down principal on that debt until you’ve figured out how much your new job pays.
The more aggressive wealth-building approach – contribute generously to your Individual IRA (up to $5,500) and keep the rest in cash. That leaves you more like only 6 months to solve the cash burn problem (aka unemployment), but hopefully that’s enough time for a smart guy like you.
Feel free to write back and ask for more clarifications or even to challenge my assumptions.
Best of luck and keep me informed!
Next January, when I receive the proceeds for a house I’m selling, I’m considering converting 70K from my TIAAF-CREF Traditional IRA into a Roth IRA, and paying taxes to do that that. I could then make my 7 grandchildren the beneficiaries and plan to not spend any of the Roth IRA myself unless I was desperate. I am 72 years old now, and my seven grandchildren range in age from 4 to 18. Could you make a spreadsheet to show me – and them – how nice that would be for them if I died at 90 and they received tax free income until they are all age 72 themselves?
Thanks, Julie from Massachusetts
Dear Julie,
Thanks for your question. You’ve highlighted one of the cool and little-discussed features of the Roth IRA, a potentially magical low-cost estate-planning tool for passing on tax-free income to young heirs.
The Roth IRA magic I’m about to describe happens because of three features unique to Roth IRAs.
First – unlike a traditional IRA – all withdrawals from an inherited Roth IRA are tax free to the beneficiary. Roth IRAs, we recall, require income taxes to be paid up front, either when a contribution is made, or in the case of Julie, when an existing Traditional IRA converts to a Roth IRA.
Second – also unlike a traditional IRA – you are not required to make any withdrawals from your Roth IRA in your own lifetime. If you can manage to survive without pulling out money from your Roth – as Julie referenced in her question – then you can leave that much more money for your heirs.
Third – heirs can withdraw money slowly enough from their inherited Roth IRA that their little nest egg can actually grow over time. The IRS has a schedule for inherited IRAs that shows how to calculate just how slowly money may be withdrawn.
By exactly how much money will the grandchildren benefit, and how does it all work?
Tax Free Inheritance!
The total value
I’ll take Julie’s example and run through the numbers, but let me hit you with the punch-line first:
Julie’s nest egg would produce nearly $1.2 million of tax free income for her grandchildren.
Here’s some fine print on that punchline: $1.2 Million of tax-free income assumes Julie starts with $70,000 next year; She dies at age 90; all of her grandchildren take only their minimum distributions until they turn 72; the accounts earn 6% per year; and each grandchild receives the total remaining value of their inherited Roth IRAs at age 72.
If I keep all of those above assumptions, except I dial down the annual return to a more conservative 3% return per year, her grandchildren receive $273,054 in total tax free income.
But what about the following?
If I dial up the annual return to a more optimistic 10% per year, her grandchildren would receive a total of $9.2 million in tax free income. 1
Now that I have your attention, how does the Roth IRA achieve this magic trick?
The magic happens over two phases, Julie’s life, and her grandchildren’s lives.
Julie’s Life
Traditional IRAs 2 require an owner to withdraw a portion of their retirement account as income every year after age 70.5. The IRS publishes a list for IRA owners age 70.5 and older about their required minimum distribution, roughly determined by the retiree’s expected remaining lifespan.
According to the IRS, A 72-year old like Julie would be required to divide the value of her IRA by 25.6 (the same divisor goes for all 72 year-olds), and take at least that amount out of her traditional IRA as income. 3
With a $70,000 Traditional IRA, Julie must withdraw at least $2,734.38 at age 72, (because that’s $70,000 divided by 25.6).
With a $70,000 Roth IRA, however, she is not required to withdraw anything.
If Julie is able to survive on rice and beans (and Social Security, and other savings) without drawing from her Roth IRA, the account will certainly grow for the next 18 years. At a 6% annual growth rate, her Roth IRA would reach $188,494 when she reaches age 90. At which point we assume each of 7 grandchildren inherits a Roth IRA worth $26,928 (because that’s $188,494 divided 7 ways).
The grandchildren’s lives
An inherited Roth IRA requires an heir to make minimum withdrawals, but in small amounts determined by the age of the heir. The minimum withdrawal amount is determined by the value of the Roth IRA divided by the expected lifespan of the heir.
The key here to the Roth IRA magic is that Julie’s grandchildren are relatively young, and the IRS allows young people with a long expected lifespan to withdraw money from inherited IRAs quite slowly.
So slowly, in fact, that each grandchild’s account is likely to grow over time, under reasonable annual return assumptions.
The eldest grandchild
Julie’s eldest grandchild, now age 18, would be aged 36 when Julie is 90. The grandchild could elect to take the inherited $26,928 all at once, but would be advised not to do so.
Instead, she should allow the account to grow over time, kicking off a growing amount of tax free income per year over the course of her lifetime.
At age 36, the eldest grandchild has an expected remaining life of 47.5 years, so could elect to take the minimum of tax free income of $555 (because that’s $26,928 divided by 47.5).
With that minimum withdrawal, assuming a 6% return, the account will grow each year. Withdrawals will increase each year as well, up to $4,136 when she is 72 years old, when the account will be worth $67,424.
The youngest grandchild
For the youngest grandchild, the deal is even sweeter. She would inherit $26,928 at age 23. Her original minimum withdrawal of tax free income would be $448 (that’s $26,928 divided by her expected remaining lifespan of 60.1 years). Minimum withdrawals would grow up to as much as $7,090 by age 72, at which point the account would be worth $109,903.
The younger the heir, the higher the potential for maximizing this Roth IRA magic, which can produce tax free income for life, long after the original retiree has passed.
In the most optimistic scenario, if markets return over the next 100 years at the rate they have in the past 100 years (a key “if”) Julie’s conversion of her relatively modest $70K Traditional IRA into a Roth IRA would produce close to $10 million in future tax free income for her grandchildren.
Incidentally, even though past performance is not indicative of future results, the S&P500 (including reinvestment of dividends) has earned 11.7% over the past 40 years. ↩
Just like other retirement accounts such as 401Ks and 403bs ↩
As a retiree ages and her remaining lifetime shortens, the IRS requires the retiree to divide by a smaller number, leading to higher distributions. A 90 year old must divide her traditional IRA account value by 11.4 for example, so would have to take out a minimum of $6,140 on a $70,000 account (because that’s $70,000 divided by 11.4). ↩
“If a family was sending their child to college this fall, AND they were fully able to pay cash (from an educational tax deferred plan) what would their monthly contributions look like for the previous eighteen years?
Assumptions – gross household income in 2014 is $100,000, and was steady but average 2% less each previous year.
Total annual expense $40,000 year one (includes living expenses). Expense increases by 3% each year.
Student earns degree in 4 years. Returns would track S&P 500 (or other index) to keep it simple.
18 years ago, this disciplined family started socking away $X each month in preparation?”–Todd R.
Todd, Thanks for the good question.
We could calculate this a few different ways, some easy and some complex.
I’ll start with the easy.
Simplest answer: $4,990 per year, or approximately $416/month.
Let me break down this simplest calculation to show the assumptions underlying it.
I assume each contribution is made on the first day of the year, and each contribution enjoys a full years’ growth at the assumed rate of return.
I assume the family makes 18 years’ worth of contributions to an education fund, starting in the year of the child’s birth and continuing non-stop through matriculation at college. I assume the family continues to fund the same amount in years 19, 20, 21 and 22, but that money does not get any return on investment. It just goes toward expenses.
I assume the costs of college, in years 19, 20, 21 and 22 are $40,000, $41,200, $42,436, and $43,709, respectively, reflecting the annual 3% rise listed in your scenario.
I assume a steady, 5% return on investment, every year, year in and year out, for 18 years.
I’ve ignored the income portion of your scenario for the moment.
After this I’ll update with other ways to answer the question, but I think this is a reasonable first approximation.
One concluding, scary, thought: NOBODY I know is saving $416 per month, from the month of their child’s birth.
Andrew, in Baltimore, writes in with a sure-fire way to earn 1%, risk-free, for 10 seconds of ‘work.’
I’m almost afraid to let out his secret, as mobs will soon descend on the City of Baltimore’ inner harbor Aquarium to attempt to reproduce this sure-fire money-making process.
But, I owe it to Bankers Anonymous readers to try to enrich them as well.
(Be sure to sign up for my daily newsletter for similar wealth-building tricks. For just $999.99 per month, you can learn all the techniques. Up next month: Bitcoins.)
Dear Bankers Anonymous,
I am a long-time reader, first-time letter writer. I’d like to get your advice regarding a great wealth-creation opportunity that I stumbled upon.
While at the National Aquarium in Baltimore, my son asked me for a penny to put into one of those souvenir penny press machines. Conveniently, next to the penny press machine, there is a change machine. However, this is a not a typical change machine. In this particular change machine, you receive 4 quarters and one shiny penny for each dollar bill you insert. The penny is free!
The original intended use for Andrew’s serendipitously discovered ‘perpetual money machine.’
This may not sound like much, but it amounts to a risk-free 1% return for 10 seconds of “work.” I immediately realized that there was a tremendous opportunity here. I returned the next day with $200 in crisp bills.
After just 30 minutes I was able to able to convert the 200 ones into 800 quarters and 200 pennies- $202.
I realized that I could repeat this process for the remaining 8 hours that the aquarium was open and walk out with more than $234! In order to do so, I just needed to convert my $202 in change ($201 after I bought a Fresca) back into one dollar bills. Unfortunately, changing the coins back into bills was not easy to do at the aquarium. The cashier at the gift shop seemed unhappy when I gave her my coins and asked for 201 one dollar bills. Her manager explained that “We’re not a bank.”
(Of course not! What bank would pay 1% every half hour! Duh!)
Eventually, we agreed that I could use the change machine but that the gift shop or cafeteria would not change my coins for bills. I am unable to lug 50 pounds of coins around, especially because just 30 minutes of the repetitive motion of inserting the one dollar bill into the machine exacerbated my carpal tunnel syndrome in my wrist. Another alternative is that I could purchase one of these machines for my home.
Note: Not the actual Fresca bought by reader Andrew with his newly-made riches
I have a few questions for you:
1) In consideration of the above challenges, how could I scale this operation up?
2) Perhaps I should try this same strategy, but with bitcoins?
3) What are bitcoins?
Thanks, Andrew
Dear Andrew in Baltimore,
This is the most brilliant money-making strategy of all time. As an initial investment to scale-up your strategy, I have ordered from China 50 of these special “extra-penny” change machines for my basement. I’m going to set them up to work constantly in parallel, churning out 1% return on my dollars every few seconds, relentlessly. Those bitcoin miners haven’t seen anything like this!
A version of this post ran in the 
