Triggered by Debt
Vol #95: August 26th, 2022
Trigger warning: this post contains a discussion about student loans.
Earlier this week President Biden announced his plan to cancel $10,000 and in some cases up to $20,000 worth of student debt. This lightening rod of policy has received criticism from every possible angle.
I won’t bore you with any more opinions about why it’s irresponsible, inadequate, or inflationary. Let’s look at this through the lens of a trader, where the only thing that matters are the numbers, and what the plan should be going forward.
One of the hardest things about trading (and life) is mastering your emotions. Everything gets doubly sensitive when money is on the line, and our brains start playing tricks on us.
The magnitude of the loss or gain is important to assess impartially. Portfolio construction doesn’t care how $10,000 feels, it cares about compound annual growth rates.
The overall size of this student loan relief package is estimated to be about $300 billion. Those are big numbers, and thousands of times bigger than most people are used to dealing with, so it’s easy to get sticker shock.
We’re so innumerate with large numbers, there’s a meme that recycles itself regularly on Twitter where people incorrectly divide a large number by the population of the US to suggest that such and such expenditure would have been better used to give every American $1M.
To put $300B in context, the PPP loan program forgave loans worth more than three times that amount. The IRS estimates there is an annual shortfall of tax collection of approximately $1T. There’s a lot of money sloshing around Washington.
The only way to become a better investor is to know exactly what your exposures are. If you’re investing 5% of your net worth in crypto, it’s really painful to see the market get cut by more than half. But in the grand scheme of things, a 3% drawdown in your overall net worth should be within your risk tolerance if you’re investing in digital assets.
The same thing goes for the positive side. It’s fun to pick stock winners, and see a pet project succeed. I’m a big fan of the play account, because it keeps you interested and sharp about how to manage the entire portfolio. But while buying 100 shares of a $5 stock and watching it jump 50% makes you feel like Warren Buffet, it only covers one nice dinner after taxes. Don’t let that winner shift your spending mindset.
The student loan numbers also matter on an individual level. The average student loan is a little less than $40k. Knocking 25% off this amount seems meaningful. But for an average term of 10 years, assuming an 8% interest rate, this is only cutting the interest payments in half - the student still pays a 25% premium on their education because they had to borrow money.
For graduate school students, private loans, and larger balances this number becomes increasingly less significant. There is still a massive amount of student debt left out there, and the cost of higher education is trending in the wrong direction.
Unfortunately the magic of compound interest is a very powerful force against borrowers here. The massive amounts of interest that builds up on these loans turns them into an ever growing albatross. $10k buys a lot of Doge coin, but it barely puts a dent in most people’s interest costs.
Once you’ve put the cost in terms of dollars and cents, there’s still an emotional element that feels charged. This dates back to the playground, and is as insidious as it is disruptive. “That’s not fair.”
Fair in the trading world is no different than the life lessons of kindergarten. There are going to be times when unfair things happen against you, and times when unfair things happen for you. Sometimes you get the hand out, sometimes you get backhanded.
In the world of pit trading, where and how you were positioned on the physical trading floor mattered. With potentially dozens of your competitors standing around jockeying for orders, being heard mattered. Brokers would come in with juicy trade morsels, and conveniently allocate the prime cuts to the guys at the front of the pit they knew best, and happened to share regular steak dinners with.
When orderflow moved upstairs, the traders remaining on the floor were scraping to carve out a slice of the pre-negotiated trades that by rule had to cross through their pits. Was it fair that the best orders always happened to go by when you were in the bathroom? Is a broker honoring their fiduciary duty by sending a decoy order to one pit so they can quietly trade a premium order uninterrupted?
Whether any of that is fair, is a complicated question. It sure feels a bit icky, but the more outraged you get about it, the more likely you are to bungle your next trade and cut off your nose to spite your face. Make yourself heard, continue to work the ref, move on.
If you’re outraged by the political and economic policies of the ruling party, the best thing you can do is vote. Most of your outrage is probably better channeled elsewhere.
Another important trading lesson here is to look at this debt relief through a Bayesian perspective. Does this change anything going forward? What new information should we include into our decision making process?
As discussed a bit above, a $10,000 discount on college tuition is unfortunately relatively minor given the costs of college these days. Public universities are averaging almost $50k for four years, and private universities are more than three times that amount, with many even higher.
Now that we’ve opened the flood gates for $10k giveaways, should that nudge more people to go to college? This probably shouldn’t be the item that pushes you over the fence.
If you’re saving for your children’s college through a 529 plan, should this cause you to reduce your contributions? We can certainly hope that the cost of higher education comes down, but the trend is not our friend here. I hope my 401(k) earns 10% a year, but I’m only budgeting for half that.
What about investors who are not necessarily looking to spend on college, but thinking about the overall impact of this on inflation and asset prices? The markets are a massive soup of factors, and this is barely a tweaking of the spice level. It’s more meaningful individually to focus on your savings and expenditures.
If there is one piece of light hearted (not financial advice) that I appreciated in this cacophony of instant opinions, it’s this:
