The Biden Administration’s student loan forgiveness program executive order would generate significant current and future liabilities for taxpayers, and cause college costs to soar.  Brian Wesbury, First Trust Advisors L.P.

Biden Administration announced a student loan forgiveness program in late August that is creating significant political and economic debate. And, the more economists and the public learn about the details of the pending Presidential executive order, the worse it looks and smells.

The executive order would generate huge costs and future liabilities for taxpayers, and cause college costs to soar, which already generates negative marginal value-added for both students and our country, writes Brian Wesbury, Chief Economist, First Trust Portfolios L.P.

The Biden Administration says the changes would cost $240 billion in the next ten years.  The Committee for a Responsible Federal Budget says $440 – 600 billion.  A budget model from Wharton says $1 trillion.  But even that $1 trillion figure might be way too low. The key factor driving the extraordinary costs is the cancellation of some student debt that already exists is only a small part of the policy change.

The much bigger change, and the one that the market has finally begun to absorb, is limiting future payments on debts to 5% of income, but only after the borrower’s income rises above roughly $30,000 per year.

For example, if someone makes $70,000 per year, then no matter how much they borrow they’re limited to paying $2,000 per year (5% of the extra $40,000).  After twenty years, any remaining debt would simply disappear.

The perverse incentives for the vast majority of students, choosing this “income-based repayment” system would be a no-brainer. And once they pick it, they wouldn’t care at all whether their college charges $35,000 per year (tuition, room, board, and fees), $85,000, or even $150,000.

In fact, students would have an incentive to pick the priciest college with the best amenities they could find and pay for it all with federal loan money, because their repayments are capped, states Wesbury.

Meanwhile, students would have the incentive to take out loans greater than what they need because they can turn the excess into cash for “living expenses.”  Then they could use it to buy crypto, throw parties, or pretty much anything else. The government would limit their future repayments.

And here’s what might be the worst part: colleges would have an incentive to enroll students even if they have horrible future job and earning prospects.  By enrolling people no matter how poorly prepared they are, a college can charge whatever they want and get huge checks from the federal government.  And the unprepared students won’t care because they really don’t have to pay it back.  In effect, colleges could create massive and perfectly legal money-laundering schemes.

Although, no one can be certain if the new proposal will be implemented fully.  But, if it is: college costs are poised to skyrocket and academia is courting a political backlash of enormous proportions. Meanwhile, the financial market is attempting to digest just how far from economic reality Washington politicians have become. The political allocation of capital is a sure recipe for economic disaster, states Wesbury.

And, don’t forget that a Presidential executive can be expediently reversed by the next president,quickly erasing the benefits of student loan debt forgiveness.

• Brian S. Wesbury – Chief Economist
• Robert Stein, CFA – Deputy Chief Economist

References:

1. Brian S. Wesbury and Robert Stein, Biden’s Student-Loan Fiasco, First Trust Economic Blog, August 29, 2022.   https://www.ftportfolios.com/blogs/EconBlog/2022/8/29/bidens-student-loan-fiasco

The Russell 2000 Index tracks the 2,000 smallest stocks (or companies) out of the 3,000 stocks in the Russell 3000 Index

The threat of recession, or even a significant economic slowdown alongside persistent decades high inflation, could prove to be a challenging investment environment, especially for investors in small cap companies and stocks.

The Russell 2000 has outperformed and has offered the strongest performance in all indexes both month-to-date and quarter-to-date according to WisdomTree data. The Russell 2000 Index is one of the most commonly watched indexes among investors, and it’s considered a benchmark for how smaller capitalized US companies are doing.

The Russell 2000 is a stock index that tracks the performance of 2,000 small-capitalization companies and often serves as a measure of the underlying health of the US economy.

It is comprised of the smallest companies included in the broader Russell 3000 Index, and is one of the most widely used benchmarks for funds that invest in small-cap stocks.

“Small-capitalization stocks tend to be more economically-sensitive and cyclical than large-capitalization stocks,” says Ari Wald, a technical analyst at Oppenheimer. “That is, they both rise and fall by a greater magnitude through the ups-and-downs of an economic cycle.”

The Russell 2000 represents around 97% of the investable US equity market. The Russell 2000 serves as a benchmark for small-cap funds and a barometer for the overall health of the US economy.

Note: It’s important to always keep in mind that owning a stock means buying a percentage of ownership in the company. In short, when you buy a stock, you’re buying a fraction of a company, and that fraction may pay dividends and provide you voting right privileges.

Stocks are a way to build wealth.

References:

1. https://www.businessinsider.com/personal-finance/russell-2000-index
2. https://www.cnbc.com/2018/04/03/when-you-buy-stock-heres-what-you-actually-own.html

“For the individual investor, investing in low-cost, tax efficient, broad-based, capitalization-weighted index funds is still the best way to build an investment portfolio.” ~ Burton G. Malkiel, author “A Random Walk Down Wall Street”

Index funds serve investors far better than expensive, tax inefficient, actively managed funds, argues Burton G. Malkiel, author ” A Random Walk Down Wall Street”. By holding a portfolio of all stocks on the market, in the proportion to their relative size or capitalization, the investor would be guaranteed to realize market return.

Index funds generally provide higher net returns for investors than actively managed funds that try to beat the market. “You are much better off not buying individual stocks, but buying an index fund,” Malkiel wrote. When investors talk about “beating the market,” they mean getting returns — over time — that are higher than what the broader market achieves.

Malkiel believes investors are generally better off to buy-and-hold rather than trying to chase particular strategies or make short-term moves. One of the best ways to cut down on both trading costs and capital gains taxes is simply to invest for the long-term. Do your research and buy into stocks slowly so you get comfortable with them. Hold them for decades.

But, if you’re inclined to invest in individual stocks, what follows are Malkiel’s Rules for picking quality stocks

1. Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years.

Malkiel says although it is a difficult job to do, picking stocks whose earnings grow should be the main objective of investors.

“Consistent growth not only increases the earnings and dividends of the company but may also increase the multiple that the market is willing to pay for those earnings. Thus, the purchaser of a stock whose earnings begin to grow rapidly has a potential double benefit—both the earnings and the multiple may increase,” he says.

2. Never pay more for a stock than can reasonably be justified by a firm foundation of value.

Malkiel says investors can roughly gauge when a stock seems to be reasonably priced so they can look at the market price-earnings multiple before making an investment decision.

“Buy stocks selling at multiples in line with, or not very much above, this ratio. Look for growth situations that the market has not already recognized by bidding the stock’s multiple to a large premium. If the growth actually takes place, you will often get a double bonus—both the earnings and the price-earnings multiple can rise,” he says.

Malkiel says investors should be cautious of stocks with very high multiples as many years of growth is already discounted in their prices.

“If earnings decline rather than grow, you can get double trouble—the multiple will drop along with the earnings. Buy stocks whose P/Es are low relative to their growth prospects. If you can be even reasonably accurate in picking companies that do indeed enjoy above-average growth, you will be rewarded with above average returns,” he said.

3. It helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air.

Malkiel says investors are emotional human beings driven by greed, gambling instinct, hope, and fear in their stock market decisions. This is why successful investing demands both intellectual and psychological sharpness.

“The key to success is being where other investors will be, several months before they get there. So ask yourself whether the story about your stock is one that is likely to catch the fancy of the crowd. Can the story generate contagious dreams? Is it a story on which investors can build castles in the air—but castles in the air that really rest on a firm foundation?,” he says.

4. Trade as little as possible.

Malkiel says frequent switching accomplishes nothing but subsidizing the broker and increasing tax burden when investors do realize gains.

“I do not say, “Never sell a stock on which you have a gain.” The circumstances that led you to buy the stock may change, and, especially when it gets to tulip time in the market, many of your successful growth stocks may become overweight in your portfolio,” he says.

Hence, Malkiel says picking individual stocks is a fascinating game and investors should tilt the odds in their favor while protecting themselves from the excessive risk involved in high-multiple stocks.

The odds of anyone consistently beating the markets are very low. Therefore, the recommended strategy includes index funds as the core of your portfolio follow by picking stocks with the money you can afford to put at somewhat greater risk.

While “beating the market” is a pursuit that can lead you to substantially grow your wealth, it’s not healthy to make it the cornerstone of your life. Investing should serve a bigger purpose in your life — like achieving financial independence, helping to send your kids to college, or whatever else matters to you. When you have a nest egg to do that, it’s entirely possible that it’s time to stop focusing on “beating the market” and turn your attention elsewhere.

References:

1. Burton G. Malkiel, A Random Walk Down Wall Street, W. W. Norton & Company, New York, 2015, pp. 261-262.
2. https://economictimes.indiatimes.com/markets/stocks/news/burton-malkiels-rules-to-pick-quality-stocks-avoid-irrational-decisions/articleshow/91850408.cms