Hey, teacher, give those kids a loan
Who should teach the young to live within their means? Young adults must take responsibility for their future wellbeing but they need not do it alone. Parents, schools, and governments have a role to play. Financial institutions can pitch in and help.
Taken together, home financing and retirement savings dominate retail financial services. The decades-long home-buying journey runs parallel to the retirement savings journey. A sizeable chunk of your earnings will disappear into both projects – month after month, year after year. Would it be weird to bundle those two amounts? Structured correctly, the way you finance and feather your nest could impact the size of your nest egg.
Number Twenty-one: The nest egg instinct
Keeping track of the coins jangling in your pocket used to be a practical lesson in budgeting. As kids, we would buy a bag of crisps and a fizzy drink by counting coins at the shop on the corner. Sometimes, lacking coins, you had to break a note. Then, that nice lady behind the counter would give you change, cheerfully adding up the total, coin by coin, starting with the value of the items provided and ending with the value of the note proffered.
Once you leave school, financial education is a different story. In our increasingly cashless society – contactless payment cards, buy-now-pay-later, and one-click checkout for online purchases – FinTech innovation can make spending easier and keeping track of your spending power harder. Throw in the reality of fluctuating incomes and the narrative gets murky quickly. Many people (young and not so young) don’t feel confident managing their money. It's time to go back to basics.
Are you sitting comfortably? Then we shall begin
Most of us will work until we retire, then eke out our twilight years with limited income and dwindling savings. If you take your first steps on the property ladder when young you're more likely to own outright before retirement. If you can, you'll repay the loan faster than scheduled to save money in the long run. Likewise, the sooner you start saving, the more you will have to live on later. And if you can top up your workplace pension all the better. However, that's a lot of numbers to keep track of. Paying rent while saving for a mortgage deposit is already brutal. Is it fanciful to expect the young to plan for their retirement decades in advance?
No. It's not. The grown-ups in the room (parents, schools, employers) should talk about these matters as part of a broader financial education curriculum. In a recent survey of kids, aged 15 to 18, some 72% said they wanted to learn more about money and finance. Financial services are chock full of little maths problems. Case studies about financial planning can bring dry mathematics alive. Compound interest, for example, is a concept that eludes many. Adjusting for changes in the cost of living is another.
Both concepts are required to make sense of financial strategies that play out from your teens to your dotage. Try telling a sixteen year old that they will be several hundred thousand pounds better off if they bought a place when young compared to renting for life. Most of them will want to know more.
Turning prophesy into profit
This article is not an attempt to cajole governments to change the syllabus, tweak the curriculum, or foist the burden onto teachers who are (quite likely) already stretched. Formal education is just the starting point. Any activity that helps develop the knowledge, skills, and attitudes people need can be called financial education. Counting coins is passé. Reading the fine print in a loan document can be instructive. But the fine print can also be daunting. Simplifying the basic contract would help. Designing an app with an intuitive user interface helps too.
Looking further ahead, banks are well placed to profit from helping the young deal with long-term financial planning. Mortgage banks could provide a framework for retirement planning that meshes with the long-term loan relationship.
Let the buyer beware
Banks take care to ensure borrowers don't over extend themselves. At the bottom of the ladder, steep deposits and low loan-to-income caps help protect home buyers from negative equity and the concomitant risk of losing their life's savings. Your mortgage broker is obliged to say that your home is at risk if you fail to keep up your payments.
So much for the downside. When it comes to the upside, banks feel little responsibility to help. They rarely point out that your retirement is at risk if you can't buy a home. Nor do they say that the risk of foreclosure when in a negative position is vanishingly rare. By comparison, renting in retirement is becoming increasingly common. Living for decades with no employment income is far more expensive than a mere mortgage foreclosure when you've got your peak earning years ahead of you. There's a lesson about probabilities buried in there struggling to get out. But, when it comes to giving guidance: downside good; upside bad.
Banks and brokers never talk about the profit you might make on your specific home or offer suggestions about how to maximise that amount. Caveat emptor, as they say in Latin. Or do you prefer ancient Greek? Socrates believed philosophers should debate ideas through spoken discourse. Writing, and the act of reading others’ work, will atrophy your memory, he opined. The same could be said of pocket calculators and other external aids. Banks provide quick and dirty mortgage calculators to help you get on the ladder but few provide comparable tools to evaluate the journey to the top.
We expect investment advisers to guide clients with great care when talking about a traditional retirement product. Banks have no equivalent duty. As you ascend, your stake grows because the debt outstanding falls. This equity is likely to dwarf your retirement savings and quantifying this amount is not rocket science. For example, given the absence of tax on capital gains for your principal private residence, strategies to maximise its value are tax neutral. Likewise, saving costs by reducing your mortgage repayments is indistinguishable from earning income tax-free. Finally, house prices routinely outpace inflation. The same cannot be said with certainty for your auto-enrollment pension contributions.
Taken together, plotting how to get to full ownership as quickly and cheaply as possible can add tens, if not hundreds of thousands of pounds to your retirement nest egg. Helping people think about retirement – when they're passing twenty, thirty, forty percent of their income through your balance sheet for decades – would be innovative but not complicated.
No [bleep], Sherlock
From the bank's perspective, the rate at which your equity grows depends on unknowable future house prices and choices open to a customer who might refinance at any time. The bank's reluctance to discuss the future is understandable but why make it so hard to calculate how quickly the debt will fall – something well within their gift to explain? Banks will talk about it in the abstract but get squirrely on the specifics.
In the early days, your payments are "mainly interest..."
As much as we admire the ancient Greeks, things have moved on. Talking in non-specific ways about money is not enough. People need help with the arithmetic. The future is unknowable, but it is not chaotic. Planning how to live within your means is a nested series of mathematical challenges. Banks can design services with tips and techniques for budgeting and saving built-in. The variables and operands can be laid out and discussed within normal historical ranges. The equations themselves involve a GCSE level of comprehension. Banks could lob in the odd multiple choice test to ensure the customer is paying attention. There are no prizes for solving problems by counting on your fingers and toes, using an abacus, or fathoming the mysteries of the slide rule.
Pilgrim's progress
Our daysrent® purchase plans are designed with mathematical precision and elucidation in mind.
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Bad grammar makes me [sic]
From a planning point of view, your projected Progress Percentage is the number of points you will have banked at the point of sale, divided by the number of points required to complete the purchase plan.
Note the future perfect tense deployed in the expression "points you will have banked..." This means that if you decide you want to sell 2,500 days into the contract, you know in advance that your Progress Percentage will be 25% once you have banked 2,500 points. The numerator in the Progress Percentage will remain unchanged as time passes but your intention to stay for 2,500 days only becomes "perfect" in the future when you get there, unless, of course, you decide you'd like to stay a year longer, in which case, you need to add 365 daysrent® to the numerator.
OK. It's more complicated than that. You first need to know that the numerator is the number that appears above the vinculum in arithmetic notation, but you get my point. High finance involves a lot of GCSE level maths.
Different ways of marking time
We calculate ratios using points because temporal duration can be expressed in many ways but some make mathematical formulae inelegant. In the old money, 2,500 points is six years, ten months, and four days and 10,000 points is twenty-seven years, four months, and seventeen days. Suddenly, it's not immediately obvious that one divided by the other gives you a Progress Percentage of 25%.
Since today is Tuesday the 18th of June, 2,500 days from now the date will be Thursday 24 April in 2031 which will be one quarter of the way between today and Sunday the fifth of November 2051 – the date you will instantly recognise as Full Ownership day because it's twenty-seven years, four months and seventeen days from now. With me so far?
And, if you are (say) twenty-eight years old at present, you will be thirty-five, or thereabouts in 2,500 days, which is one quarter of the way between today and the year you turn fifty-six, which you will instantly recognise as the age you will attain when you stop paying rent forever.
Different ways to speed things up
Things get interesting if you buy FastTrack points along the way. These points serve to shorten the pathway to ownership such that if (for example) you buy two hundred FastTrack points, your Progress Percentage will rise from 25%. The numerator stays fixed but the denominator falls.
In a prior article in this series [Number Nineteen: What's the point?] I described the exchange rate between daysrent® and FastTrack points. There's more to it than I can do justice to in a single article but, suffice it to say, if you receive more than one FastTrack point for each daysrent® point you pay in advance, you benefit from inflation-adjusted compound interest. Or, I should say, a compounded yield because your monthly contributions in a purchase plan are not (strictly speaking) a repayment of principal and interest.
The simplicity of the contract empowers the buyer to think through scenarios using calculation tools that gamify the process. We can tell the buyer that half way through the contract her share of the value of her home will be at least half. We can say things like, the longer you stay, the greater your share and we can give precise percentages of a thing of unknown future value using simple ratios.
Now we can multiply your FastTrack-adjusted Progress Percentage by the projected future value of your home.
Six FastTrack points will cost you one daysrent®
That's an elegant way to say that you will make six times your money irrespective of inflation as long as your home rises in line with inflation over the next however many years.
As years pass you will know whether your home is rising (or falling) faster than inflation. As you approach the day of sale, the tracking error shrinks and the accuracy of your planned exit value will grow over time. Slowly, ever slowly, the wisdom of ploughing money into FastTrack points will become clearer – at least for those that care about retirement savings.
We, Pathway, get to re-invest those FastTrack points for decades. That's how this planning malarky feeds our revenue model. As noted above, banks are well-placed to profit and this need not be at the expense of their customer.
That's a wrap
Remember that future perfect tense when thinking about owning a rapidly accreting asset outright prior to retirement. Think of the amount you generally pay for decades of financial advice and then the value of a built-in scenario planning tool will become apparent in the present tense.
We will dive further into the many ways to include future house price movements in the scenario planning process. Not today, but soon. Suffice it to say that if (a) your stake in the value of your home rises by at least 2.5% per annum (b) you can influence that percentage by buying FastTrack points and (c) the underlying property price is likely to rise in line with the economy on a generational timescale, the net result of compounding of these three effects for decades is very sensitive to assumptions about the future. By net I mean you have to subtract the value of the FastTrack points purchased, obviously. You can put your slide rule down now. 😉
As ever, #fintechinnovation begins at home.
Ike Udechuku | Cofounder | CEO | The Pathway Club