The Financial Beacon, Doug Carey
Every new year we see a list of “great financial tips” for the coming year from various media sources and pundits. Most of these lists contain somewhat generic information about saving more money or only buying things we need. This advice is fine, but I would rather discuss two very specific ideas that we rarely see brought up in the mainstream media.
Max out your Employee Stock Purchase Plan (ESPP)
Not everybody is fortunate enough to have access to an ESPP. But if you are, you likely have benefits that give you between a 10% and 15% discount on the lowest price of your company’s stock over a six-month period. Normally this is limited to a maximum of 10% of the employee’s annual salary. It turns out that the typical ESSP is the best investment deal you will likely ever find. The following example shows why:
- Lowest stock price during six-month period: $20
- Number of contributions from employee: 12 (one contribution from each paycheck during six month period)
- Dollar contribution per paycheck: $300
- Discount: 15%
- Discounted stock purchase price: $17
- Stock price at end of period: $20
When can the employee sell the stock?: At end of six-month period
A quick calculation of the total return from this plan gives us the following:
- Total contributions = $300 x 12 = $3600
- Number of shares owned at end of period: $3600 ÷ $17 = 211
- Total value of shares: 211 x $20 = $4220
- Total Return = ($4220 - $3600) ÷ $3600 = 17.22%
A 17.22% return sounds pretty good, especially since the stock price didn’t even go up during the period. But it turns out that the true annualized return is much better than this. In fact, it’s nearly 90%. Because the contributions were made over a six-month period, on average the money was only tied up for three months. Since there are four of these three-month periods in a year, the annualized return from this ESPP is (1 + 17.22%)4 – 1 = 88.8%! This is hard for some to believe, but this is the true annualized return. The return is even higher if the stock price goes up from its lowest point during the period. Compare this to the typical annual return of a money market fund, which is about 0.1% currently.
Given the incredible returns that ESPPs can deliver, it makes complete sense to contribute as much as the company will allow to the plan. Employees should absolutely max out the contributions to plans such as the one used in the example above. The return from ESPPs even beat the return from paying down auto loan debt or credit card debt and is certainly better than investing in the overall stock or bond market.
Be wary of student loans
Just last year the total amount of U.S. student loan debt surpassed credit card debt for the first time in history. There is now over $850 billion in student loan debt in this country. As tuition continues to climb, it is likely this figure will only go higher. Many parents and students alike look to student loans as one of the only ways they can afford college. But it is very important to understand one particularly nasty detail about these loans; they cannot be discharged in bankruptcy.
Nearly all debt can be restructured or even wiped out in a bankruptcy filing. Other types of debt, such as credit card debt, can even be walked away from without filing for bankruptcy at all. But student loans are different and the fact that they cannot be discharged in bankruptcy has led to years of headaches and stress for students and parents alike.
Part of the reason the law was written like this is because the federal government backs most student loans and it’s the federal government that wrote the bankruptcy law. To make matters worse, because the federal government is involved, the IRS can intercept any tax refund you might be entitled to until your school loans are paid off. Also, your wages can be garnished and you can be sued by both the government and any private lender that is involved. If somehow the borrower makes it through all of this without paying off the balance of the loans, the government will take social security benefits away from the defaulter until the loans are paid in full. Unlike most debt, the debt statute of limitations does not apply for federal student loans. They can pursue the borrower forever.
There is one small chance at a remedy if the borrower defaults on the loan. A student loan debtor can attempt to claim “undue hardship” and reduce the overall debt burden. But this process is expensive, time-consuming, and has a low success rate.
For both parents and students alike, it is of utmost importance to understand the terms of any loans the students might be taking on. There are certainly times when a student loan makes sense, but sometimes the potential problems they can cause are not worth the risk.