Asymmetrical Information - Megan McArdle

11.19.12

Ask the Blogger

You ask, we answer.

Dear Blogger:

At 35, I've done pretty well financially - good silicon valley job, enough income to meet my family's expenses, and by virtue of having been extremely frugal through my 20's, a $900k nest egg. My family had our first child this year, and I'm frequently asked about investing in 529 plans. My question is whether to take advantage of them or not. I don't expect higher education to look much like it does today in 18+ years (and I'd be very surprised if it was as expensive), so I'm weary of saving up a huge chunk of money in a plan that penalizes using that money for any other purpose. If higher education is free or nearly so online in 2032, which seems reasonable, this will turn out to have been a bad investment. My thought has been to save and invest normally in a taxable account, and just use that money and pay the capital gains for any amount that's necessary to educate our children. What do you think?  

Saving to Address Variable Education Risk  

Dear SAVER:  

It's a stumper, isn't it?  Your little bundle of joy will graduate into a world that we can't quite imagine right now.  If it looks like the one we're in, a 529 plan or an Educational Savings Account is probably a great idea, because the money to pay for college will accumulate without dividend or capital gains taxes.  On the other hand, the government doesn't want you using that money for anything else . . . so if  your kid is paying a $12.95 annual subscription to Coursera in 2032, you're going to have to pay a hefty penalty to recover what you invested in the 529.  And that's not the only thing that could go wrong.  Even if the education of the future remains expensive, if your kid gets a full ride scholarship somewhere, or if they just decide that they don't want to go to college, you are going to have to pay a hefty penalty to get that money back.  

It's also worth noting that 529 plans give you very little control over the investments in the account; the fund administrator chooses.  Fees are usually low, but getting locked in like that makes me uncomfortable.  ESAs give you more flexibility (and you can pay for more ancillaries, like computers), but I assume from your email that you make too much money to qualify.

On the other hand . . . capital gains.  If you don't use a tax-advantaged educational acount, taxes are going to take a 20% whack out of any money you save for college.  And that's if capital gains taxes don't rise, which I personally kind of doubt.  The government needs a gigantic amount of money to pay for all the entitlements we've promised.  Given the angry noises about Mitt Romney's tax returns, a higher capital gains tax seems like one obvious place that politicians are going to look.  

It comes down to a judgement: how certain are you that education will change (and change in a way that will make a 529 plan inappropriate?)  The Blogger can't tell you what to think about that; you have to look deep into your heart and ask whether you prefer the risk (certainty, I'd say) that capital gains rates will rise, or the risk that a 529 won't be much help paying for the kind of education that will be needed for the world of 2032.    On balance, I would probably use the tax free account, but I can see why you would decide not to.  

If you're really having trouble deciding, use this time-tested method suggested by a friend of mine: flip a coin. See what it says.  If you are possessed by the sudden urge to go two out of three, then hey, that's not really what you wanted to do.

But here's the really great news: it doesn't matter that much.  You're doing great financially, and however you choose to save, you're going to have more than enough to pay for whatever education your kid needs.  Decide what you're going to do, and then relax to the possibility that it may cost you money you can well afford to lose.    

Dear Blogger:  

My family of 3 (working mom, working dad, teenager)  does not have any health insurance and I see no feasible way of getting any. What is NOT having health insurance going to cost me once the new laws go into effect? Does it make any difference how much money you make as to what your penalty is or is it the same across the board for everyone?  Does it make any difference what state you live in ? I don't understand this whole exchanges thing and how it relates to penalties. I don't have a clue how to get any answers.  If it wasn't so stressful,  I would totally appreciate the irony of a law presumably trying to help people with their health that caused them to become worried sick.  

Worried Sick  

Dear Sick:

I can't answer your question precisely, because the answer is: no one knows yet.  The health care exchanges are being worked out now, it's not clear which states are expanding Medicaid and which are not, and the rules surrounding things like the individual mandate are still being finalized.  

The assurance I can give you is this: the health care plan is not supposed to penalize people for not buying health insurance because they can't afford it.  It is supposed to help those who can't afford it with subsidies.  And if it does end up penalizing a lot of hardworking families who simply do not have the money for health insurance in their family budget, that is going to cause a huge political uproar--big enough that I'm pretty sure Congress will quickly alter the law.  So don't stress out about this too much.  Whatever you think of the new health care law--and I was not a huge fan--it was not intended to whack families who can't afford to buy health insurance.  Try not to worry about this unless it actually becomes a problem. And as we get more specific information, Ask the Blogger will be revisiting this topic, so stay tuned.  

Dear Blogger: 

I'm a 32-year-old professional with a steady well-paying job and a hobby of building mobile and web applications for small businesses.  I've made a little bit of money working on these projects, but so far I've never given into the animal spirits enough to justify quitting my stable job.

What sorts of things do I have to think about if I was to quit and start a new company?  What will be the career implications if I fail?

I have a emergency fund that I could live off of for 6 months, if necessary, and a well-funded (for a 32-year-old) 401k.  I also have a wife and four children.  

Thanks,

Hesitant Entrepreneur  

Here's the bad news, Hesitant Entrepreneur: most small businesses fail.  Even startups headed by someone who has previously founded a startup, and has good funding, fail more often than they succeed.  Startups headed by folks who have never done this before fail at an even higher rate.  

Here's the good news: being your own boss is great, and startups are the economic engine of the United States.  If you have what it takes, it's a great life, and probably the only way you will get truly wealthy.  And even if you fail, it's unlikely to deliver a permanent career blow.

So, how to decide?  

Ask yourself some questions.  Like: do I actually want to run a business?  Do I want to sell, do accounting, and make sure we've ordered enough toner?  As an entrepreneur in the early stages, you'll be doing all those things. I've worked for several startups, and I loved the "Hey, kids, let's put on a show and raise enough money to save the community center!" spirit.  I also don't mind doing a bunch of different jobs--rather like it, in fact.  But I'd still never found my own business, because one of the things I learned from that experience is that I hate telling other people what to do, and while I'm actually good on a sales call, I absolutely dread making the kind of phone calls needed to set one up.

Look at your finances.  You need a good cash cushion, because your income will be variable and your expenses will not.  Do not view that emergency fund as your operating funds, or I guarantee that just as you plow the last of it into new inventory, your home furnace will die; you need money saved on top of that.  You also need basic insurance payments for life, disability and health insurance.  Many entrepreneurs are tempted to skip those items when cash flow gets tight.  Don't you be that idiot.  When you're a small business owner, there's no one to float you a couple of paychecks when you get sick.  

Did I mention that you'll be doing accounting?  Take an accounting course, if you haven't already.  The single biggest mistake that first-time entrepreneurs make is that they often can't even tell whether they're making money or not. 

Think hard about your risk appetite.  Every business goes through a period when the founder thinks that everything's going to hell and they've wasted valuable years on the stupidest idea ever.  Can you keep it together when that happens?  Or will you go wobbly under the stress?  There's no shame in saying "I don't want that much pressure on me".  

Also, seriously, I cannot stress the accounting thing enough.  You need to be able to tell whether you've got a business, or an expensive hobby.  

Luckily, you're in an extra-enviable position: you have started doing your business on the side.  That means you already know you have a product people want.  It also gives you time to grow the business and make some mistakes without feeling like you're one step away from disaster.  My advice is to keep your job and grow your business on the side until you can't--until making it bigger requires a full time you.  And at that point, you need to stop and assess: is the business making enough to cover a stripped-down set of expenses?  As mentioned above, those expenses need not include cable, but they do include basic insurance.  You have four children, and you need to make sure they're taken care of.  

If the business can support you and your kids at that point--or if you're so close that putting in a few more hours is obviously going to take you there--and if you're still loving it, then close your eyes and jump.  If it's not generating enough income to provide you a decent minimum lifestyle, then you stay put.  Doing it this way means that you're going to have to spend the next year pouring all your spare time into the business, which will be exhausting, if also exhilirating.  But it will be the thrill and exhaustion of riding a roller coaster, not the thrill and exhaustion of jumping off a cliff without knowing whether or not your safety harness works.  

Dear Blogger:  

I graduated with a BA in political science from a good liberal arts school in New England in 2011, and I've been working in Boston since then in a job with no real career track (read: I took what I could get).  I didn't want to jump right into graduate school after college--I wanted to work for a few years, pay off some debt, build up some savings, and know that I was making a responsible graduate school choice.

I think I've been successfully scared away from two of my post-grad ideas.  It seems getting a Ph.D. in poli. sci. would not be a particularly good idea, since the academic job market is very weak and has it's own peculiarities.  Law school doesn't look like a good choice either--that is a lot of debt for shaky job opportunities.  In each case, I could probably get into good programs-- if I had to guess, I could probably get into a top 30 or top 40 law school--but after watching my girlfriend and her classmates struggle to find jobs after graduation, I'm very hesitant to pursue a J.D.

Which leaves me with something of a middle choice: masters programs.  I'm very interested in pursuing an MPP--it seems most of those policy-related jobs that used to be available to smart BAs now require a law degree or an MPP.  I've been looking at a few programs, and most of them seem to focus on building real job skills, not just emptying my pockets for two years.  But I'm still hesitant to take the leap--what do you think youngsters like me should consider before taking the plunge into graduate programs, especially ones without the well-known career tracks like law school or medical school?

Graduate Requiring Another Degree  

Dear Grad:

Believe it or not, I've been where you are more than once.  I spent my very early 20's kicking around various jobs, including a couple of startups and a job as a secretary at a non-profit.  Eventually I ended up as a technology consultant, and a couple of years after that, i had the epiphany that I didn't like technology as much as the other technology consultants.  That's when I decided to get an MBA.  Three years later, I graduated from Booth into a weak job market, and the consulting firm I'd signed on with rewarded my decision by promptly going out of business.  

What I have learned from a decade of slowly and painfully paying off high five-figure student debt on a salary considerably lower than I expected when I got my MBA, is that you should think long and hard before you try to solve a career crisis by going back to school.  As it happens, I enjoyed my degree, and ended up using my coursework more than many of my classmates.  On the other hand, I also spent much of my thirties dining on thins like "Ramen and Cheez-Doodle surprise"--the surprise being that you're 32 and still have to eat ramen because you can't afford, y'know, meat.  

The MPP is a less expensive degree, but it's still pretty pricey.  And the jobs for which it qualifies you are often at government agencies, not known for their over-generous pay or rapid career advancement.  I know people who have gone to high-ranked programs and ended up spending years toiling in the underpaid bowels of a state agency.  The schools will highlight their successful graduates with glamorous-sounding federal positions, but understand that unless you go to Harvard, that is not necessarily the norm.  

You are doing the responsibel thing by saving a little money and taking some time to really think hard about this decision.  So: bravo! The best advice I can give you is first, to understand what sort of job you want, and are likely to get, before you go.  And second, to pay very close attention to the ranking of your school within your field of graduate study.  Yale has the number one law school, and an MBA program with a so-so reputation.  People often erroneously assume that a top-ranked school in a field they know well must mean that all the programs are good.  But even a school like Yale has some notso-hotso graduate programs.

When you do this research, do not ask the schools, who will shamelessly lie to you while waving the resumes of their three recent grads who got awesome-sounding jobs (working for their uncle).  Find some employers you would like to work for, and ask them where they recruit from.  Find out what sort of people they hire.  Then see if you can do what it takes to become that sort of person.  

As someone who has been there twice, Grad, let me reassure you of one thing: even if grad school turns out not to be the panacea you're looking for, you will eventually figure something out.  Your dead-end job feels like forever to you because you haven't been in the job market for very long.  Those of us who have been working for longer have noticed that shockingly few of our acquaintances are still doing data entry or driving a fork lift twenty years later.  As long as you're actively looking for the next thing, and talking to employers about how you might become the worker they want, you will eventually figure out what you're good at, and find a better job.  If you can do it without racking up a great deal of student loan debt, so much the better.

Ask the Blogger appears Mondays.  You can email your questions to mcmeganmoney@gmail.com