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FAFSA Application Advice for College-Bound Kids: Apply Sooner Than Later

The good news for parents and their college-bound kids: The U.S. Department of Education’s Free Application for Federal Student Aid (FAFSA®) makes it relatively easy to apply for federal and state, and many institutions’ financial aid opportunities in a single session. This “one-stop shopping” certainly beats having to submit separate applications for each source of funding!

The catch? While you are generally required to submit your FAFSA application for the 2020–2021 academic year by June 30, 2020, you are permitted to do so any time after October 1, 2019. If you’re busy with a million other things – and who isn’t? – you might be tempted to let your application slide until, say, after the holidays. We caution against doing so. The sooner you apply for FAFSA after October 1, the more likely your efforts will pay off.

As reported recently by SavingforCollege.com publisher and VP of Research Mark Kantrowitz, “Students who file the FAFSA during the first three months tend to get twice as much grants, on average, as compared with students who file the FAFSA later.”

This caveat applies to the federal level on down. “While federal student loans and the Federal Pell Grant function like an entitlement, federal campus-based aid is more limited,” says Kantrowitz. For example, federal funds for work-study programs and other opportunities come from a single “pie,” which can end up being consumed before late-comers arrive at the table.

In addition, many states operate on a first come, first served basis. These states begin granting their awards after October 1, until the funds are gone. Other states have application cut-offs earlier than June 30, again warranting a timely FAFSA application to qualify for their funds.

In California, the FAFSA will open on Oct. 1, 2019, and the last day for students to submit the form is on June 30, 2021. This means that rising high school seniors who plan to begin college in 2020 should prepare to fill out the FAFSA starting this October. You can look up other states’ requirements here. Similarly, individual colleges may have earlier deadlines if you would like to be given “priority consideration” for their own financial aid funds.

In short, this is one window of opportunity worth leaping through as soon as it opens. To hit the ground running, you don’t even need to wait to obtain or renew your FSA ID, which will facilitate completing your FAFSA application as soon as October 1 arrives.

Before we wrap, we’ll add one more caveat from the Department of Education’s FAFSA application instructions. As the DOE emphasizes:

“One thing you don’t need for the FAFSA® form is money! The FAFSA form is FREE, so if a website or mobile app asks you to pay to fill it out, you’re not dealing with the official FAFSA site or the official myStudentAid app.”

In today’s climate of heightened security risks, that’s a critical point. Please let us know if you could use additional assistance as you plan for your own or your children’s higher education funding. Given the costs involved, a well-crafted strategy can pay for itself many times over.

September 17, 2019/by Matt Delaney

Financial Illiteracy’s High Cost

JDH Blog, Larry Swedroe, The BAM Alliance

by Larry Swedroe, Director of Research, 6/14/2018

It’s a great tragedy that despite its obvious importance to everyone, our educational system almost totally ignores the field of finance and investments. This is true unless you go to an undergraduate business school or pursue an MBA in finance.

Eighteenth-century English poet Thomas Gray wrote, “Where ignorance is bliss, Tis folly to be wise.” When it comes to investing, ignorance certainly is not bliss—it pays to be wise. Just ask investors who lost tens of billions of dollars in the Bernard Madoff scandal. Without a basic understanding of how capital markets work, there is no way individuals can make prudent investment decisions.

The sad fact is that surveys have shown fewer than half of U.S. workers have even attempted to estimate how much money they might need in retirement, and many older adults face significant retirement shortfalls. While educational achievement is strongly positively associated with wealth accumulation, research also has found financial literacy has an even stronger and larger effect on wealth.

Households that build up more net wealth may be better able to smooth consumption in retirement, and financial literacy enhances the likelihood people will contribute to their retirement savings. Compounding the problem of lower savings is evidence that less financially literate households experience lower risk-adjusted returns.

Financial Literacy Research

Milo Bianchi contributes to the literature on financial literacy with the study “Financial Literacy and Portfolio Dynamics,” which appeared in the April 2018 issue of The Journal of Finance.

Using data obtained from a large French financial institution, Bianchi observed portfolio choices in a widespread investment product called assurance vie, in which households allocate wealth between relatively safe and relatively risky funds—predefined bundles of bonds or stocks—and are able to rebalance their portfolios over time. Assurance vie contracts are prevalent in France, being the most common way households invest in the stock market.

Bianchi then combined this data with responses to a survey he conducted with the financial institution’s clients. The survey, which ranked investor sophistication levels on a scale between one and seven, allowed him to obtain a broader picture of clients’ financial activities outside the company and of their behavioral characteristics. While investments in assurance vie may not cover a household’s entire portfolio, they often represent a substantial portion of investors’ financial wealth.

The author’s final database incorporated portfolio information at a monthly frequency for 511 of the financial institution’s clients over the period September 2002 to April 2011. On average, the assets it covered were approximately 50% of a household’s financial wealth.

Following is a summary of his findings:

Financial literacy correlated with demographic variables; in particular, education and wealth.
Financial literacy was negatively correlated with being female—a gender gap that had been observed in prior studies.
An additional unit of financial literacy was associated with a 3.5% increase in the probability of holding stocks.
More literate households experienced higher portfolio returns.
Controlling for various measures of portfolio risk, the most literate households experienced yearly returns approximately 0.5% higher than the least literate households, relative to an average return of 4.2%. These magnitudes were in line with those found in a recent study of Dutch households.
There was no evidence that, overall, households with higher financial literacy choose riskier portfolios. Instead, their risk exposure varies systematically with market conditions, allocating more to risky assets when they have higher expected returns. A 1% increase in the expected excess return of risky funds was associated with a 2% increase in the risky share for each unit of financial literacy.
Decomposing the observed changes in the risky share over time into active changes due to portfolio rebalancing and passive changes induced by differential returns to risky versus riskless funds, Bianchi found that passive changes were relatively more important for less sophisticated households. For the least sophisticated households, passive changes accounted for 64% of the total change in the risky share over 12 months. For the most sophisticated households, by contrast, passive changes accounted for 30%. This demonstrates that households with lower financial literacy display greater portfolio inertia. More educated, older and female investors display lower levels of inertia.
More literate households were more likely to act as contrarians. Rebalancing, they tended to move their wealth toward funds that had experienced relatively lower returns in the past.
The returns more sophisticated households actually experienced tended to exceed the returns they would have earned without rebalancing their portfolios. More sophisticated households were more likely to buy funds that provided higher returns than the funds they sold.

Conclusion

Findings such as these demonstrate that financial illiteracy is costly. The fact that our educational system has failed to provide much of the public with what I would consider even a basic level of financial literacy certainly is a tragedy. (The research shows this is not a U.S.-only problem.) But perhaps the bigger tragedy is that so many apparently would rather watch some reality TV show than “invest” the time and effort to become financially literate.

I have now authored or co-authored 16 books on investing, presenting the evidence from academic research. This has been my way of trying to reduce financial illiteracy and help prevent investors from being sheared by the wolves of Wall Street. Others, such as John Bogle and William Bernstein, have written outstanding books on the principles of prudent investing.

The only problem is that the sales of Harlequin romance novels (not that there is anything wrong with them) are far greater than the sales of books on modern portfolio theory and efficient markets, providing one explanation for why investors continue to use nonfiduciaries as their advisors and adopt active management strategies—strategies with a high likelihood of failure.

The bottom line is that the greatest investment you can make, and the one with the highest expected return, is an investment in your own financial literacy. Remember, if you think the price of financial education is too high, just try the price of ignorance.

This commentary originally appeared June 4 on ETF.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

June 20, 2018/by Matt Delaney

The Risk and Return Implications of ESG

JDH Blog, Larry Swedroe, The BAM Alliance

by Larry Swedroe, Director of Research, 6/11/2018

Environmental, social and governance (ESG) investment strategies—along with the narrower category of socially responsible investing (SRI)—have gained quite a bit of traction in portfolio management in recent years.

In 2016, funds based on such strategies managed about $9 trillion in assets from an overall investment pool of $40 trillion in the United States, according to data from US SIF. In addition, the organization’s 2016 survey of sustainable investment assets found that in the U.S., climate change was the most significant environmental factor influencing asset allocations.

Value Play In ‘Sin’ Stocks?

While ESG investing continues to gain in popularity, economic theory suggests that if a large enough proportion of investors chooses to avoid “sin” businesses, the share prices of such companies will be depressed. They will have a higher cost of capital because they will trade at a lower price-to earnings (P/E) ratio.

Thus, they would offer higher expected returns (which some investors may view as compensation for the emotional “cost” of exposure to what they consider offensive companies).

Academic research has confirmed that the evidence supports the theory.

Higher Fees OK

Interestingly, Arno Riedl and Paul Smeets, authors of the study “Why Do Investors Hold Socially Responsible Mutual Funds?”, which appears in the December 2017 issue of The Journal of Finance, found that investors are willing to pay significantly higher management fees on SRI funds than on conventional funds, and that a majority of them expect such funds to underperform relative to conventional funds.

In other words, investors understand there is a price (in the form of lower expected returns) for expressing their social values, and are willing to pay it.

Impact On Risk?

Jeff Dunn, Shaun Fitzgibbons and Lukasz Pomorski of AQR Capital Management contribute to the literature concerning ESG investing with their February 2017 study, “Assessing Risk through Environmental, Social and Governance Exposures.”

While other studies focused on the impact of ESG/SRI investing on returns, the authors’ focus was on the risk side of the strategy. Just as it is logical to expect that investors shunning certain stocks should lead to those stocks having higher future returns, it is also logical to hypothesize that companies neglecting to manage their ESG exposures may be exposed to higher risk (a wider range of potential outcomes) than their more ESG-focused counterparts.

Risk Of ESG Neglect

The authors used the MSCI ESG database (often referred to as intangible value assessment, or IVA, data) and Barra risk models to determine whether there was any link between the two. The IVA methodology covers a large cross section of companies around the world (more than 5,000 companies as of December 2015 accounting for 97% of the market cap of the MSCI World Index) and assesses how much each company is exposed, and how well it manages its exposure, to a range of environmental, social and governance issues affecting its industry.

Dunn, Fitzgibbons and Pomorski employed the Barra GEM2L risk model to determine forward-looking (ex-ante) risk estimates. Specifically, a stock’s returns are assumed to be driven by a combination of its loadings on systematic risk factors and by firm-specific “idiosyncratic” effects, which are assumed to be uncorrelated across assets. The authors’ sample period is January 2007 to December 2015.

Following is a summary of their findings:

ESG exposures are informative about the risks of individual firms. This finding is robust to a wide variety of controls and various stock universes (U.S., developed and emerging markets).
Stocks with the worst ESG exposures have total and stock-specific volatility up to 10-15% higher, and betas up to 3% higher, than stocks with the best ESG exposures.
ESG scores may help forecast future changes to risk estimates from a traditional risk model. Controlling for contemporaneous risk model estimates, poor ESG exposures predict increased future statistical risks. The magnitude of the effect was relatively modest: A deterioration of ESG score from the 75th to the 25th percentile is associated with about a 1% increase in risk. While this increase might seem small, it may simply reflect the fact that ESG captures risks that are long-run in nature and that may not materialize in the short-to-medium term.
Across the three dimensions of ESG investing, the social and governance pillars show the strongest correlation to risk. The environmental pillar is only insignificantly related to the various risk measures.
Stocks in the first (worst) quintile of ESG scores had greater earnings volatility and were less profitable than stocks in the fifth (best) quintile. They also had more exposure to the value factor. Furthermore, they had lower Ohlson scores (a measure of default risk). Additionally, they were smaller companies. Each of these findings is related to risk and highly statistically significant. Stocks in the first quintile also had more exposure to the momentum factor than stocks in the fifth quintile. This also was statistically significant.
Consistent with theory and prior research, stocks in the first quintile of ESG scores earned 1.8% higher returns than stocks in the fifth quintile. However, while certainly economically significant, this difference was not statistically different from zero at the 5% confidence level (t-stat of 1.2). (Note that this lack of statistical significance could be due to the limitation of the short period covered by the study.) The higher returns might be a premium that investors earn for the displeasure of holding such stocks, possibly as compensation for the additional risks (such as greater earnings volatility, less profitability and greater default risk) these stocks exhibit.

What Risk Exposures Convey

Dunn, Fitzgibbons and Pomorski concluded: “ESG exposures convey information about risk that is not captured by traditional statistical risk models.”

They added: “While the effect is modest in magnitude, it is consistent with ESG exposures conveying some information about risk that is not captured by traditional statistical risk models. Overall, our findings suggest that ESG may have a role in investment portfolios that extends beyond ethical considerations, particularly for investors interested in tilting toward safer stocks. ESG exposures may inform investors about the riskiness of the securities in a way that is complementary to what is captured by traditional statistical risk models.”

The authors included this note of caution: “It would be surprising if ESG were a first-order driver of a stock’s risk beyond what is already captured in a well-constructed statistical risk model. ESG may convey information about, say, the likelihood of a governance scandal, but such a scandal may not materialize for the average company over a relatively short horizon we study here. Moreover, ESG exposures are fairly persistent and stocks with poor ESG profile tend to be poor ESG also in the future.”

The bottom line is that, while ESG investors seem likely to be sacrificing some returns to express their social preferences through their investments, it also seems likely there may be some offsetting benefit, though it may be marginal, in the form of reduced portfolio risk.

This commentary originally appeared May 29 on ETF.com

June 6, 2018/by Matt Delaney