Looking out for Number 1

The Thinker by Rodin

I hope I am wrong, but I am predicting a mean decade ahead, particularly here in the United States. Americans may be voting their bum out of office on November 2nd, hoping for real change or genuine bipartisanship, but at least through 2012 they will not get it. Political paralysis over the next couple of years is easy to predict, with a high probability that a Republican House of Representatives will try a reprieve of its 1995 government shutdown. The results of the 2010 census will encourage governors to draw congressional districts even more tightly to ensure even higher partisanship in Congress.

In addition, there are structural problems with our economy that are going to linger, particularly high unemployment. The “government is spending too much” mantra combined with businesses sitting on huge piles of cash but unwilling to use it to actually hire people simply means a prolonged period of high unemployment. And since Republicans in general will block spending on infrastructure and high tech investments, those jobs that will be created are mostly going to pay less. Add to this mess our massive foreclosure problem, wars in Afghanistan that will linger, massive climate change and the natural disasters that they will cause and it is hard for me to be optimistic about anything.

The Glenn Beck’s of the world would have me running to buy gold at inflated prices as a hedge against all this uncertainty and potential turmoil. The problem with gold is that it is not fungible. In any event, the world now runs on electronic currency. I am not worried about a currency collapse, but it’s clear that government is not going to look out for me, the little guy. And due to the Supreme Court’s incredibly bad Citizens United decision, we can expect even more extreme government by and for the corporation. Unless you are very agile and smart, you are going to be screwed.

Since I like prefer to live in the real world, I have been running “what if” scenarios with my financial future. I happen to be a federal employee who can retire in less than two years. Until recently, I assumed that I would never have to worry about my pension. It is as solid as the United States government and its sterling ability to print money, right? However, using Greece as an example, at some point if in the opinion of its creditors a state is insufficiently well managed, the creditors will show who is really in charge. In Greece, the effect has been a sudden reduction in the wealth of its citizens in general and government pensioners in particular.

While the social security system is fully solvent for at least twenty years, Medicare is not and Congress seems unwilling to do much more to make it more solvent. Larger structural issues remain to be solved but of course, there is nothing close to consensus on how to do this, and the situation will only get worse. It’s easy to see that even for a vested civil servant like myself, my pension may be on someone’s chopping block.

While I don’t see my pension going away altogether, I can see the federal government devolving into something like California. I can see mandatory cuts in pensions as well as many other programs in order to make creditors and Wall Street happy. How do you survive this new reality when the assumptions you made for your life plan change fundamentally?

Answer: not very well, as many unemployed and overleveraged Americans have discovered over the last few years. While I have escaped it through the virtue of steady employment, watching what has happened during the Great Recession to those caught in its vice is instructive. It has had me sending emails to my financial adviser, who all along has warned me that the solvency of some of my retirement benefits was questionable.

To some extent, I may worry too much. My wife and I are fortunate because we have mostly lived within our means. We do not carry a credit card balance. Our homeowner’s equity line of credit is now paid off as well. All our cars are paid off too, although we are dealing with the major expense of shepherding a daughter through college. It’s not today I am worried about. It’s my standard of living ten years or more from now when I am living on a fixed income that causes me concern. It’s when Uncle Sam’s creditors are forcing austerity and all that austerity means they are raiding my pension fund and scaling back my benefits. I think it is unlikely that my pension will disappear altogether. However, I do think it is prudent to assume a worst case of a 25% reduction in my pension, 10% reductions to my social security income and a lot higher premiums for health insurance. I am having my financial adviser run the numbers. What would my retired life look like? How can I mitigate now some of these potential serious financial consequences to my future?

Here’s the gist of what I am learning. You may want to take notes. I need to save as much as I can and pay off debt as fast as I can as well. For me, saving more is actually difficult to do. The federal Thrift Savings Plan is essentially a 401-K and I have maxed out my contributions into it. The one thing I can do is put money into an IRA as well, but that is limited to $5000 a year. I could save more as a financial cushion, but there are no tax benefits for doing so, and I must report interest as income.

The second thing I am learning is that I need to get out of debt. We are doing very well there, but we still have $85,000 for so left on the mortgage. This seems the wisest place for me to park any extra income. I have been chipping away at it the seventeen years we have been in the house, but need to be more aggressive. I am looking at strategies like applying all leftover income to paying off the principle on our mortgage.

So basically, to reduce our impact to any financial shocks, we need to be debt free as soon as possible, and save and invest as much money as possible. There are also other strategies that may seem not particularly patriotic. My financial adviser has had me move most of our funds into international stocks, where economies that are growing and the legislatures have more common sense. While Wall Street remains one of the few bright spots in our economy, investing too much money with Wall Street may be unwise, at least over the course of the next decade or so, because it will be buffeted by shocks to federal and state governments that seem likely to continue and exacerbate.

With luck, at some point, Democrats and Republicans will agree on a common path forward. It’s not hard to see what that future will be because it is likely to be laid out for us by events. Eventually we will all find that our lives will become more austere and we will be paying more in taxes. There is no way to escape this reality indefinitely, and no amount of vitriolic partisan clamoring otherwise can change it.

However, if our mortgage is paid off, we have a new real asset: our house. Washington Post financial columnist Michele Singletary made an excellent point recently: those of us who think having equity in our house means we are homeowners are fooling ourselves. We are homeowers, and our home as a permanent as our ability to keep sending mortgage payments every month. You are only a homeowner when the mortgage is paid off. Only then can you truly count your house as an asset and as part of your net worth.

We do own our investments free and clear. Properly managing that so it grows but does not lose value when we retire, that matters and is something we can control. Unfortunately, there are so many other variables that I cannot control. I can change those variables within my control and lessen my overall financial risks, and I can do that by saving like the Japanese, investing wisely and getting out of debt.

You are welcome to follow these strategies as well, which are sound and should be much more viable than buying gold from Goldline. I suspect many of you are younger, start with many more liabilities and have less in the way of income. In general, we all need to acquire the painful habit of living beneath our means to the extent we can and save or invest the difference. In addition, we need to become educated if we are not and continually keep our education relevant to the job market. The unemployment rate for college graduates even during these tough times is about five percent. It’s those with less education who are bearing the brunt of these times. Education in a decently paying field is the key, as well as mastering the social skills to get and retain these jobs.

It’s clear that no one is willing to look out for you anymore. Our safety net is collapsing. So much about the future is uncertain, but following these principles should greatly increase the odds that you will emerge with most of your standard of living intact.

Real Life 101, Lesson 12: The Basics of Investing

The Thinker by Rodin

This is the twelfth in an indeterminate series of entries that provides my “real world” lessons to young adults. It is my conviction that these lessons are rarely taught either at home or in the schools. For those who did not get them growing up you can get them from me for free. This is part of my way of giving back to the universe on the occasion of my 50th birthday.

Way back in Lesson 2, I covered the fundamentals of personal finance. I hope you used the intervening two and a half years to make yourself financially solvent. Good news: if you are not carrying a credit card debt, you are doing better than many Americans. Your net worth may hardly be in the positive numbers but at least it is positive. Even if you have student loans, providing it has helped you get a decent paying job, this is good debt.

You may be young but you might also have the feeling that old age is going to visit you someday. When it arrives, you know you would not prefer living in a cardboard box under a freeway. You know that to avoid this fate you need to start investing money now, although you might not have a whole lot to invest except for the spare change inside your sofa. Most likely you kind of resent having to save anything at all, but you know that like taking vitamins its one of these things that prudent people do. Where to start? Buy a share of Wal-Mart stock? Open a money market account? Buy gold on the assumption that its value will stay steady during inflationary times? There are an infinite number of choices and it’s so darn confusing!

I can make it easy for you: start with your employer’s 401-K plan. Why? Start there because if your employer offers a 401-K plan they will often match your contributions up to a certain percent of your salary. In other words, it’s free money. It’s true that except in cases of dire emergencies you cannot take out the money before retirement, but you still get to invest more money than you can contribute. In short, you should contribute as much money as you possibly can into your 401-K or similar plan, particularly if you get matching contributions.

Start contributing today and never, ever stop until you are fully retired. This is the golden rule of investing: start early and contribute regularly. Do not contribute a fixed dollar amount. Contribute a percentage of your income automatically with every paycheck. Your income should naturally rise as you age so at the very least you want your contributions to rise proportionately. It is never to late to start investing but the multiplicative factor for starting early is mind-boggling. Starting early means that you have more time to invest and your money has more time to grow. Give until it hurts. Give until the financial pain is just short of excruciating. As your income goes up, try your best to put a greater percentage of your income into retirement funds as well. There is an additional piece of good news: the IRS pretends your salary is your actual salary less your 401-K contributions. In other words, you end up paying less in taxes because you “earn” less. The net effect is you have a little more money available to put into your 401-K than if the money was taxed up front.

If your employer does not offer a 401-K, or even if they do, you can still open an Individual Retirement Account (IRA). In 2009, you can contribute up to $4000 and write it off your taxes, at least if you place your money into a “traditional” IRA. You can also choose a Roth IRA. The difference with a Roth IRA is your contribution is not subtracted from your income for tax purposes: you pay the tax upfront but can withdraw it later tax-free. With a traditional IRA, you pay the taxes on the income much later when you retire for the privilege of paying fewer taxes now. If you can swing it, because younger people tend to earn a lot less than older workers, the Roth IRA is the better deal. As you age you might want to open a Traditional IRA because then you are likely to be taxed at a higher rate than you will as a retiree.

The general guidance for investing is tried and true and fairly well known. In the very long term, invest in stocks or stock funds as history shows that overall they will provide higher returns. In the medium term, buy bonds. In the short term, stick with savings, checking and money market accounts for their liquidity and safety.

What else should you save for? Many smart young people find plenty of incentive to save for their own digs. They would prefer being tied down by a mortgage instead of renting a U-Haul every few years and moving all their possessions. They also have expectations that if they own property, it will appreciate, and their net worth will grow. (The mortgage interest deduction is also a nice tax break, although you may find the cost of maintaining your home can eat up the tax break.) Obviously, you don’t invest this sort of money into retirement accounts. Where to put it depends on how long you think it will take you to buy some property. Most likely, you don’t want to put it into some sort of stock-oriented mutual fund because there is likely to be too much volatility in the stock by the time you need the money. The safest bets are savings and money market accounts, but they produce almost no interest. A good choice looking several years out would be a well-rated corporate bond fund. Also consider a fund that buys Ginnie Mae bonds. Ginnie Mae bonds actually help homebuyers like you buy houses. There is risk of losing money, but it is very small, along with decent potential of above average market returns.

Okay, you are thinking. Where do I buy these sorts of funds? In addition, which ones are good and which are bad? Unfortunately, there is a lot of smoke and mirrors among investment firms and brokerage houses, which they gleefully help create. Real return is hard to figure out, given that returns are rarely guaranteed and many funds charge fees to buy and sell funds. Many funds come with certain minimums and contribution requirements. Billions are spent to shape your perception that firms like Vanguard and T. Rowe Price are smart places to put your money. You would be right to be skeptical.

If you want, you can be your own broker. You can in theory send a check to places like Ginnie Mae or the U.S. Treasury and they will send you bond certificates back. This is too much hassle for most people. When in doubt I go to the most trusted and unbiased source I know: Consumer Reports. I think any smart consumer should subscribe to the magazine, but you can also spend a little money to get access to their online web site. Periodically they rate various categories of mutual funds. Their ratings are not necessarily sure things, but they are good, unbiased bets.

Ultimately what you need is a personal financial advisor. Most likely, that will have to wait until you have enough income to also afford a financial advisor. Banks and brokerage firms will want to sell you their financial advice. Be wary because most likely they put their bottom line ahead of yours. When I finally had enough money to get a personal financial advisor and I chose someone local who was listed on the National Association of Personal Financial Advisors web site. My personal financial advisor makes recommendations to me. I do the actual paperwork to make them happen. He never gets a cut of my earnings, only a flat fee for sound and unbiased advice.

Until that time comes, it is probably a sound strategy to be your own financial advisor. You can supplement your knowledge not just by reading my advice but also by reading some of the many popular books on investing available at your local bookstore. By following the established investing rules I outlined, you are likely to do nearly as well as the financially sophisticated anyhow. The truth is there is always risk in investment, as well as rewards, and no financial guru is always right, not even Warren Buffett. Some approaches will prove to be luckier than others in the short term, but time seems to even out the playing field. Sticking to traditional rules should serve you well until you have the time and money to get your own personal financial advisor.

Financial Winners and Losers

The Thinker by Rodin

For most of us the current recession, already the longest lasting recession since the Great Depression, is an unpleasant reality. 345,000 jobs were lost in May, which raised the official national unemployment rate to 9.4%, the highest in over a quarter century. While the trend is improving, this is still very bad. The Labor Department estimates 14.5 million Americans are unemployed. If you include the underemployed and those who gave up looking the unemployment rate is 16.4%. Many of us can look at our investments and find they are worth half of what they were before the recession started. Stock market indices reflect this trend. Meanwhile, real estate prices keep plummeting. Surplus homes abound, as financially distressed people walk away from their mortgages. All these statistics document that the economic pain is pervasive and widespread.

Yet despite all this pain, there are winners out there, many of whom are profiting from our pain and losses. Fahreed Zakaria, a Newsweek columnist, recently documented some of them. China’s Shanghai Index is up 45%. Brazil’s stock market is up 38%. Indonesia’s market is up 32%. Retail sales are 15% higher in China this year than they were a year ago. In India, car sales are up 4.2% compared with a year ago. All these countries are expected to grow this year while most of the rest of the world’s economies will contract. Learning why these countries are bucking trends is interesting. What it amounts to is that they are not overburdened by debt. Consequently, they have plenty of money to spend and invest. For cash rich countries like China, right now the world is a bargain. That is why they are buying foreign energy companies and purchasing mineral rights. The effect is to rapidly extend their influence across the world, simply because they own more of it.

Americans are belatedly discovering that not all forms of wealth are equal. The value of stocks and homes in particular are directly tied to the current state of the economy. When the economy tanks, they lose proportionate value. When the economy tanks severely, your house can have negative worth, flipping from an asset to a liability. Stocks too have little value if you need to sell them in a recession. Many Americans today feel compelled to sell their stocks, usually acquired through a 401-K plan, simply to survive. They do so in part because whatever meager savings they had acquired have been spent trying to hold on to their lifestyle. On the other hand, savings are more tangible as well as reliable. Perhaps that is why Americans are belatedly getting the religion: an old-fashioned savings account is good, not bad. Savings rates, which were at 0% before the recession are now at 5.7%. However, savings accounts do not offer a complete panacea either. The reason we bought stocks and houses in the first place is that inflation often ran ahead of on the marginal interest we might have earned on any savings.

Like the Chinese, Americans who find themselves cash rich in this recession now have an opportunity to shop for bargains. Our nation is now one big red light sale. With a few exceptions like health care, there are bargains everywhere, but particularly in housing, stocks and commodities. The smart Americans who kept their jobs and have sizeable stashes of cash should be scooping these bargains up.

Like most Americans, I do not have huge sums of readily available cash to invest. What amounts I do have I am tempted to invest in good undervalued stocks. Take General Electric. GE is perhaps the best-managed company on the planet, having sat on the Dow Jones Industrial Index since 1906. Its stock price actually slipped below $6 a share briefly in March, largely due to its financial subsidiary. It is currently trading at around $13 a share, but over the last decade, its price has been $30 to $40 a share. Shrewder investors than me may see red flags in owning GE stock, but I suspect it is a bargain. Likely, many other well-established companies out there can be purchased at a substantial discount too, only because the current economy substantially discounts their long-term worth. Their worth is discounted in part because people have to sell stocks to turn into cash to pay immediate expenses.

What lessons can we learn from this miserable experience so we do not repeat it? One may be a lesson I learned in 1988: unemployment sucks. I have remained fully employed since then because I have remained a civil servant. Private industry is certainly important, and in the short term often pays better than the public sector, but it is also inherently chancy. Having a steady paycheck during turbulent times is a great blessing. In my case, it is also a blessing to know there is little likelihood that I will be fired if the economy tanks further. As a civil servant, I will never be a millionaire. On the other hand, I should have steady employment. Moreover, when I retire I will have a pension to draw from, as well as social security and investment income from my 401-K. While I am unlikely to retire to a lavish estate in the Hamptons, neither am I likely to eat dog food in retirement. I am likely to have what now seems to be vanishing: a real retirement that should include occasional trips to exotic locations as well as good medical benefits, which are increasingly important as I age. I was not thinking about these things nearly thirty years ago when I first joined the civil service, but in the current economy, my decision looks smart. If you feel like a piñata from the last couple of years, perhaps it is time to consider some place other than private industry as a career, whether it is government service, a religious institution, a non-governmental agency or a nonprofit. There is no requirement that you have to spend your life in rough career waters.

Speaking of careers, if you have looked behind the unemployment numbers, the value of advanced education should now be clear. While people with bachelor or better degrees were affected by the recession, as usual they did better than those with just high school education. Where were the most jobs lost? Simply drive through the rust belt. Manufacturing took the biggest hit, and manufacturing jobs tend to require fewer skills. Also disproportionately affected were service related jobs that depend on the economy. When people have less money, they travel less, so we have lots of unemployed pilots, flight attendants and baggage handlers. When people have less money, they are not buying houses, which is why many realtors are working part time at best. With less money in circulation, there is less need for bankers, stockbrokers and securities dealers. The lesson: advanced education reduces risk of unemployment as well as usually pays better. Advanced education is needed not just because it pays better but because our world is more complicated. It needs increasingly more people with the advanced skills to manage and understand it.

I hope that some of us are learning to be thrifty. As someone raised from children of the depression, thrift came naturally to me. Apparently, it did not to many of my generation, because so many are overleveraged. The recession should teach us that many of the things we thought were necessities are luxuries. A family does not necessarily need two cars. My family survived on one car until I was out of the house. You don’t have to shop at Harris Teeter when a Shoppers Food Warehouse will do. You don’t need to buy shoes at Neiman Marcus; you can get a decent pair at Payless. If you are smart, you will funnel the difference into savings.

And speaking of savings, if you are rich enough to put in money for retirement but not rich enough to have at least six months of expenses in a savings account, perhaps you should at least be channeling some of that investment money into a savings account instead. In actuality, six months of living expenses is considered on the low side. You would be wiser just match your employer’s contribution into a 401-K (or perhaps put just 3% if they offer no match at all) and funnel the extra into high yield savings accounts. Unless your job is very secure, have the goal to accumulate at least 75% of your yearly expenses into a savings account.

By saving money instead of borrowing it, you make yourself more financially secure and you help turn the United States into a creditor nation again. Until 1978, we were the world’s largest creditor nation. Now we are the world’s largest debtor nation. The United States still has the world’s largest economy. These dynamics can be turned around, if we take time to learn from this recession. If we do it right, the next time a global recession rolls around we will be prospering like China and Indonesia instead.

A grave business

The Thinker by Rodin

Life is about living, right? So why spend any time at all planning for death? After all, there are few things more certain in life than death and taxes. Once you are dead, unless you are Jesus Christ, you can forget about coming back to life. The best use of my corpse will be pushing up some daisies somewhere.

Alas, my passing is of interest to my financial adviser. For the two years I have had him he has been pushing my wife and I to plan for being dead. These days though, just writing a will is not good enough. You need many documents, all of which are vital for keeping lawyers in Birkenstock and driving their Mercedes Benz. Apparently, in addition to a legally enforceable will, I need Power of Attorney statements, a trust until our daughter is old enough to spend her inheritance wisely and a life support directive. Death is apparently a very complicated thing, at least for those you leave behind.

Just because I am dead, I would not want to burden my loved ones, would I? Hmm, maybe I would. I mean, I do love my loved ones. That comes with the definition. However, from my jaundiced perspective, I have given more love to them in love than I have gotten back in return. Yeah, I know, it’s good to give more than you get. But isn’t the least they can do for me when I am departed to deal with a few inheritance squabbles and tax issues? Knowing my future deceased state, does it require an extra level of love while I am alive beyond which I have already borne out in my fifty-two years of devoted service?

How do I know that this world is real anyhow? It sure feels fleeting. Maybe nonexistence is real and life is surreal. Maybe I am like Neo in The Matrix and when I die, I wake up to find my life was just a wild dream. If life is a dream, why bother with the drudgery like wills and such? Why not just live in the moment and get as much enjoyment as you can from life?

Maybe that’s why I’ve dragged my feet on updating my will. The last one is nearly fifteen years old and was done by a friend, and just so my wife and I could feel comfortable going out of town without our daughter. Because it turns out that planning for your mortality is a complex business. Naturally, this being the United States of America, there is no simple way to make your wishes known. Instead, you need either pricey software or a good attorney or two, and likely both witnesses and a notary too.

Here is my idea of how it should be done: each state and/or county would have a web site. When you want to complete your will, you they would provide you with a way to legally authenticate yourself. You would go onto the web site and be presented with a standard will complete with a number of “most popular” checkboxes and open text fields. For 95% of us, this would work fine. Since I am married, if I die first, I want my wife to get all my stuff. The same is true with her. If we both died at the same time, our daughter would get the bulk of our estate. She’s no longer a minor, but if she were I should be able to fill in that part of the web form where I indicate who would be the custodian of our child, who would oversee the estate, and enter the disposition of important heirlooms. It should take a half an hour maximum, be all done electronically and remain on file in the county clerk’s office. It would be accessible if necessary so properly credentialed officials, like the doctor in the emergency room, could also get the information.

You can write some things in your will that will have no practical effect. For example, do you want your body buried or cremated? Where should your remains go or be placed? Should your body go to medical science? Wills are read weeks or months after the deceased passes, so it is best to tell your family your wishes on what to do with your corpse. Yet, the county could easily collect this information in a central database. Every five or ten years, say whenever you renew your driver’s license, you would be required to recertify your electronic will. All this strikes me as a perfectly logical way the government could become more citizen-centric.

However, because I suspect that my survivors will otherwise engrave, “The bastard didn’t even bother to leave a will” on my gravestone, I have much belatedly decided to work on all these death documents. I quickly discovered why I dragged my feet. They are expensive to get right, particularly if you have lots of money and assets. After all, you do not want your loved ones to deal with complex things like probate taxes. No, you want to create a trust instead and screw Uncle Sam. I called one of the more prominent firms around us and found out that a modest set of these documents cost in the $3000-$5000 range. How many of us has that kind of money to throw around?

There is software you can buy, like WillMaker, but I remain a bit leery that it will not write the proper words or know precisely how to have forms properly notarized, witnessed and filed. So I did the next best thing, and shopped for a discount lawyer. It turns out that if you have to hire a lawyer, this is a good time. Many have been downsized and are scrambling for work, working from offices in their home. I found one via the user comments on Washington Consumers Checkbook. (Warning: you must subscribe to see the user comments, and they are not of much use if you live outside the Washington D.C. metropolitan area.) The lawyer even offered me a recession special: all the right documents done for a little under a grand. This still seemed like a lot of money, but it did not seem outrageous.

It turns out that what matters most is likely not the will itself, but various power of attorney statements and emergency medical directives. Do I want the plug pulled if three doctors agree that I am a goner but I cannot speak for myself? Who should speak for me when I cannot? Who can and should pay the bills or act when I cannot? Like most Americans, these obligations would fall to my spouse, but if she is not available, then who? For now, it seems safer to entrust this decision with a sibling. That may change as we age.

It will probably be money well spent, but in my deceased condition, it will mean nothing to me. We invited Carrie (the attorney) out to our house.  She told us much about the legal business of death and dying that we needed to know but about which we would have preferred to remain ignorant. We have been marking up drafts of documents she has cranked out, plodded through other verbose documents and keep trying to remember why we are doing this in the first place.

The good news is that when she is done we will have a set of PDF documents that we can easily update at any time, to name new executors and the like. We hope to have a final signing in our living room a week from Friday.

Dying is ordinarily a messy and depressing business, as is handling the estate of someone. Wills provide some comfort that the process may be less messy. As I discovered watching my mother decline, it is bound to be both messy and heartbreaking for those who go through it. Given these facts, much can and should be done to make it less onerous and expensive. With major economic crises underway, straightening out the business of death and dying is probably on no one’s radar. I hope someday someone will tackle it because the current process is unnecessarily complex and expensive, making it hard for the many who need these documents to acquire them. In the end, it is of most use to those who profit from it.

While death is inevitable, estate planning need not be the equivalent of rocket science. Instead, we could use the time and the money on worthier endeavors like enjoying the short life we were given.

Introducing the non-retirement retirement

The Thinker by Rodin

With stocks in some cases at half or less of their value of a year ago, many Americans are wondering if they will ever be able to afford to retire. To retire with a decent standard of living you generally need to have a number of financial ducks lined up. First, you depend on Social Security and Medicare benefits to provide basic subsistence and medical care. Second, if you are lucky enough to have an employer that actually provides a pension, you need to hope that the company does not go belly up before or during your retirement. Third, you have the value of anything in your 401-K or IRAs that you have squirreled away. Fourth, you may have some other savings or some sort of inheritance to draw from. Lastly, and really as a last resort, you may have equity in your house you can draw from, which perhaps you can draw from with a reverse mortgage. With enough of these assets, you can afford to retire when you hit a certain age. How many of us reaching retirement age can honestly say our financial ducks are lined up?

For many of you younger readers retirement may be an abstraction. You are probably far busier trying to hold on to your job and standard of living than to worry about something so far away as retirement. For us middle age Americans, retirement is on our horizon. For example, I am a civil servant who will soon be 52. In theory, I can retire at age 55 with thirty years of service, which will be in May 2012.

Will I retire and begin a life of leisure at 55? Probably not. If I did, certain other expenses would need to be trimmed. Even with my very generous government pension, I would get at best something like 60% of my government salary. However, I still will have bills to pay and I do not particularly want to reduce my lifestyle. Moreover, my mortgage will not be close to being paid off in 2012.

Without some substantial adjustments in my lifestyle, I cannot afford to really retire at 55. Since my investments like yours are in the toilet, it is unlikely I will be able to draw from them in a couple years. So I will still have that 40% gap in income to make up, at least until the mortgage gets paid off. Also, I have many more productive years ahead of me. I am a restless creature too. I simply do not have the constitution to “retire”, at least not at 57, the age when I currently plan to “retire” but when in reality I hope to simply start my next career.

I am betting though that many of you do not have these options. Your “pension” is probably anything in your 401K or IRA, which if you assess it at today’s value might make your heart skip. If you “retire”, your retirement home may be in a trailer park. It is also possible with today’s economy that your “retirement” will be involuntary and you will end up with a fraction of the benefits you were promised. So your “retirement” could simply mean getting one or more new jobs at a fraction of the wages you are used to, perhaps while also working more hours than you do right now. Even with all this, you may end up with a lower standard of living.

In short, for many in the fifty to 60 something age range, retirement, which used to seem almost tangible, is now off the table. We might as well pretend we are twenty or 30 somethings again. If this sounds like your situation, you will have one option: the non-retirement retirement. With this is a retirement you work as long as you are physically capable of working even after you “retire” by collecting social security benefits. You will be likely working at substandard wages perhaps making little more in real dollars than you did as a teenager. However, you will still have Social Security income to draw from and Medicare benefits to cover most of your medical expenses. The combination will not let you really retire, but it will keep you from having your standard of living drop through the floor.

Unless our new President Obama and Congress are able to fix things, and the macro-economic forces work in our favor for a change over the next few decades, “retirement” as our parents knew it may become a luxury most of us can no longer afford. In short, even though the Social Security system will survive the New Deal will have largely unraveled. Social Security and Medicare will provide seniors with a foundation for keeping their financial heads above water, but still not provide enough income to retire.

Many senior citizens are already dealing with this reality. Many retired to discover that they really could not afford to do so. Their actual cost of living exceeded their income and assets. For many, the new model looks like you retire when you absolutely, positively cannot earn money anymore. In other words, when you retire, you will have one foot in the nursing home.

Suppose you are fairly young and headstrong enough to think that you should be able to enjoy a real retirement someday, perhaps when you are in your mid sixties? What do you do? You can invest now while stocks are cheap and hope they will become nice juicy retirement assets by the time you retire. There is no guarantee here, of course, but stocks have tended to provide a higher returns over long periods than other forms of investment. You can also choose not to have children, or if you have children, have just one. (This is what my wife and I did, in part for economic reasons.) Children may be loveable and give purpose to your life, but they suck enormous amounts of money out of your wallet. In addition, you can spend your earning years living frugally while doing your best to climb the income ladder by having a well paying job and specialized skills. Perhaps these things, a resurgence of the American economy relative to the rest of the world, and a government that works for the people, will turn the dynamics around. My gut feeling is that we are sailing into very strong headwinds. We can tack as much as we want but moving forward is likely to be daunting.

For many of us, particularly those of us nearing retirement age, our retirement can be clearly envisioned and it is scary. The vision that we are seeing bears little resemblance to what we envisioned some decades back. The retirement our parents knew is dying from a combination of economic forces and bad government. We are likely to pay the price in an anxious non-retirement retirement.

Let us hope that President-Elect Obama and our new Congress can actually move us in the direction we need to go so we can really retire someday. I sure hope that a real retirement does not become something we lose in the 21st century.

Learn lessons today for the next recession

The Thinker by Rodin

Some years ago, I wrote about the fading middle class. Today, the recent hikes in oil prices appear to be driving a stake through the heart of many in the middle class. I can point you to scary NPR stories like this one. If you are not experiencing the uncomfortable feeling that your middle class lifestyle may be slipping away permanently, consider yourself lucky.

The middle class has been living on its margins for a long time. For years, an accounting was postponed. We postponed it by drawing equity out of our inflated home values and by putting more and more of our debt on plastic. Now the middle class is faced with a triple financial whammy: declining home prices, rising unemployment and rapidly escalating gas prices. For many families this means living very precariously.

As the NPR story documents, some people are drawing from their IRAs just to pay their mortgages. The Washington Post reports today what I wrote about recently: the rapid extinction of the SUV. In some cases car owners are so anxious to ditch their SUVs that they sell them for less than they owe. This assumes of course that they can sell them at all. Gas prices have escalated so quickly that some people paying with credit can no longer pay at the pump. Many cards restrict at the pump purchases to $75 per transaction. Meanwhile, those of you who have a credit card debt, but have been responsibly making your payment every month, may be in for sticker shock. Many credit card interest rates are going up, even if your credit history is spotless. Someone has to make up for all those credit card defaults, so the cost is being pushed down to responsible borrowers. Oh, and by the way, interest rates in general are likely to go up, because The Fed is finally tackling inflation as the primary economic threat.

I hope that our economy is on a sound enough footing where we will experience just a mild recession, but that is looking more dubious. Stock markets reached bear territory today, and the price of oil shows no sign of falling. Perhaps the middle class can take some comfort in that many others are in far worse pain.

As I noted, this recession was probably preventable. I chastised our Congress for emulating its citizens by going so deeply into debt. Nevertheless, Americans are also at fault, spending way beyond our means. This has so many bad effects it is hard to know where to start. Perhaps the worst effect of all this deficit spending is that it pushes up the cost of oil. Since oil is traded in dollars, when the dollar is worth less, it makes oil disproportionately expensive. There is little we could do as a nation to restrain global demand, but had both government and its citizens lived within their means the dollar would not have dropped as much, which would have meant we would be less affected by the current oil shock.

There are compensations for our economic maladies. The rock bottom value of the dollar has made our goods and services a good buy, so our increased exports will help pull us out of recession. (However, the increased cost of transporting these goods may negate many of these benefits.) American productivity has also been amazing. It is infuriating that despite all our increased productivity, wages have been stagnant. The benefits of our increased productivity have gone disproportionately to the wealthy, who are also disproportionately enjoying lower capital gains taxes. In short, they are laughing all the way to the bank on your dime.

Proactive leadership, if it exists, can at least ease most economic hard times. Clearly there has been little evidence of it in Congress, which accounts for its rock bottom approval ratings. No spending of significance has been restrained. Just a few weeks ago by veto proof majorities Congress passed yet another bloated farm subsidies bill.

The Great Depression taught us the painful lesson that banks need to be regulated so they do not do stupid stuff and wipe out their customers’ assets. (This lesson was more recently reinforced in the 1980s during the Savings and Loan debacle.) We seem to have forgotten some other lessons from those Depression years. Then, as today, people lived beyond their means. While credit cards did not exist, brokerage credit abounded, and was used to purchase overvalued stocks with someone else’s money. In this recession, it is our overvalued houses, sold even to people with bad credit or who could not afford them, that triggered the downturn. We should have learned our lesson in 1929.

In short, most economic calamities are self-inflicted. They result from either absent-minded government and/or absent-minded people.

In case you have not noticed, Occam’s Razor has tried to be something of a prophet. Granted, foreseeing the current economic mess was not that hard, I just chose to do something about it. Back in 2004, I purchased a hybrid. A year ago, we installed new energy efficient windows and compact fluorescent lights. I began biking to work. I hired a financial planner. I lived within my means and did not carry a credit card debt. I downsized my life compared to that of my financially distressed neighbors who are now trying to sell their overvalued McMansions and SUVs. I kept a low debt-to-earnings ratio.

Sure, I have financial concerns, but I know that my family will weather this economic downturn. Long ago, I made sure that we were ready to quickly batten down our financial hatches. So many of us though gave nary a thought to our financial comeuppance, living way beyond our means. It is not the least bit surprising that now that an economic storm is upon us that these people are suffering disproportionately. I know my ship’s hull is dry. It appears though that many of my neighbors are busy bailing water.

Should I chastise my fellow human beings? Or should I say that they were just being optimistic? Optimism is generally considered good, but sometimes it can be a foolish trap. Optimism has to be based on something tangible. When it is not, optimism degrades into foolishness. Certainly, it is not possible to be completely prepared for all life’s possible financial hits. If I were to lose my job, I would be in tight straits too, although I am fortunate to have a financial cushion where I could ride out my unemployment for a while. Only the very wealthy can protect themselves against all financial risks. Most of us though through the exercise of intelligence and by living modestly can weather most financial storms.

If you are one of the unfortunates caught in this financial storm, you have my sympathy. I hope you learn a lesson when good times reemerge, as they must eventually. Try to avoid the urge to resume your former lifestyle. Scale it back, even if you feel flush. Apply the difference to building long-term assets and an economic safety net. I doubt anyone going through financial pain today wishes they had overextended themselves, now that the storm is here. The reality is that when these storms occur, it is the financially savvy who profit from the detritus. Money, like matter and energy, does not disappear. It simply moves from one place to another. OPEC countries are clearly profiting. It is likely that by being prudent I will be a bit ahead of everyone else when this storm ends. If you were caught in this one, you should have a goal to end up ahead too when the next one happens.

Riding recession’s wave

The Thinker by Rodin

As we headed for a recession? Are we in the midst of one now and just do not know it? Do I know? Heck, no. Even our best economists do not know. Most likely by the time it is declared official, some six months to a year after it begins, we will be out of it, or climbing our way out.

There is little doubt that recessions hurt. On a personal level, many people lose their jobs and that pain extends to all aspects of their lives. Those of us watching our financial portfolios get upset and nervous when we see the value of our assets decline. Many of us are already stretched to the limit and up to our eyeballs in credit card debt. Our house, if we have one, has provided us the equity we needed to confront life’s little financial emergencies. With declining home prices. for many of us our home equity is tapped out. Moreover, since the average credit card debt exceeds $3000 per credit card holder, taking on more credit card debt looks unwise, particularly at 18% annual percentage rates.

Then there is the problem lenders are having valuing their assets. With so many financial institutions holding bad debt in the form of dubious mortgage backed securities, they are unsure exactly what assets they have and how much they are worth. Without knowing what their assets are worth, it is harder to loan out money. Those of us with dubious credit histories are likely to find there are no lenders who will lend us money.

A recession should serve as a warning notice to those of us in debt. It is hard enough during flush times to live on borrowed money. During a recession, it can become impossible. There are stories locally like this one where otherwise normal people find that their fragile financial cards quickly tumble when the economy turns and end up homeless. Granted, even in flush times it is hard to build financial wealth if you carry a large amount of unsecured debt. Economic factors and job markets are always finicky meaning your hot profession may turn out in a few years to be worthless. During flush times, it is possible to get out of credit card debt and build reserves of cash. These assets may not get you through the next recession unscathed, but you are more likely to emerge less battered and bruised. Spending habits, like eating habits, can be devilishly hard to change. A recession though can give many of us the fortitude to make painful short-term choices for a long-term benefit.

Then there are others like me for whom a recession is in some ways good news. No job is guaranteed but I am fortunate to be a well-paid civil servant. Most likely, I will have a steady income throughout this recession. However, even if I were not in such a situation, many people in the private sector do fine during recessions. Their jobs are in relatively high demand, or they possess some important institutional knowledge that lessens their likelihood of unemployment.

You can usually tell which groups will be unduly affected by a recession. These are the same groups whose jobs are tenuous even in good times. Autoworkers, for example, tend to be among the first in the unemployment lines. The financial sector is taking a whack this time around, which is not surprising because of the debt crisis. Any industry that depends on discretionary spending is vulnerable. Those planning a career would be wise to keep these factors in mind.

I have good news for those who have always wanted to own a home, but could not afford one. Perhaps housing prices have not hit bottom yet, but if you have saved enough money for a traditional down payment and have a decent credit history, now is the time to buy. Not only are house prices down but mortgage rates are down as well. There are plenty of houses on the market to choose from now, so you are likely to find that dream house at an affordable price. You should be actively looking around.

Ironically, if you have ready cash, recessions are also a great time to buy most products or services. Businesses everywhere are anxious to cut deals because often they are just trying to stay in business. If you have the money for rather expensive things like getting the roof fixed or replacing the siding on your house, now is the time to get this work done at a discount. You will also help stimulate the economy by keeping people employed.

If you are invested in stocks, bonds and mutual funds, while you may be feeling nervous about the value of your assets, there is also a flip side. Many funds are a great bargain during a recession. Granted there are exceptions and I am certainly no stock analyst but you may find terrific buys out there. Presumably, you are in the market for the long haul. Profit is made by buying low and selling high. Consequently, this is the right time to buy.

It may not be fair but when some part of the economy suffers someone else profits. Recessions tend to happen because people, corporations and governments do foolish things. That certainly is true this time. Mortgage brokers created packages of bad mortgage debt. They sold them under false pretenses to investment firms that should have known better. In addition, our foolish federal government spent the last seven years spending like a drunken sailor on shore leave. Moreover, people in general ignored macro trends like global warming.

Very few of us will be the Donald Trumps of the world. Most of us though can distinguish between speculation, which usually throws away good money, and investments, which allows good money to grow prudently. Prudence and moderation are virtues, not just personally, but financially as well. People ride out and even prosper during recessions by exercising prudence in good and bad times. They do not live beyond their means. Saving money is their highest financial priority. They do not do foolish things with their lives or their money. Their lives may look boring. They may have a Subaru in their driveway instead of a BMW or Lexus. They may be sending their kids to public schools even though they can afford to send them to private schools. They may be buying clothes at Target instead of Nieman Marcus. They may live in a rambler rather than a McMansion. These are the sorts of people likely to live to see their golden years, and have plenty of money to enjoy those years.

If the pain of this economic downturn bites you, you do have my sympathy because I have been there a few times too. I was fortunate enough to learn my lesson early. While I am aware of the pain that recessions cause many people, I also know that recessions are a temporary phenomenon. Eventually conditions change, markets adapt to new realities and prosperity reemerges. While I cannot stop a recession, with some prudence and a little bit of luck I can not only ride recession’s wave, but also soar above the recovery’s crest when it happens.

So can you.

Real Life 101, Lesson 2: Personal Finance Basics

The Thinker by Rodin

This is the second in an indeterminate series of entries that provides my “real world” lessons to young adults. It is my conviction that these lessons are rarely taught either at home or in the schools. For those who did not get them growing up you can get them from me for free. This is part of my way of giving back to the universe on the occasion of my 50th birthday. It is my hope that at least some of you reading this will benefit from my experience and save yourself a lot of unnecessary anguish.

When I was growing up managing money was straightforward. If you were just starting out it was almost impossible to get a credit card. Consequently, you lived within your means, no matter how modest they were.

Now managing money is much more complicated. Unfortunately, it is a good bet that you graduated high school without a money management class. Credit card companies spend millions trolling for financial fools willing to get themselves deeply in debt. They especially target young people, and try to make your indebtedness to them a lifelong habit. It appears that many Americans and young people in particular now see money as wholly abstract. As long as your ATM card works or your credit card is not over its spending limit, you assume your head is above water. Personal debt has become as abstract as the National Debt.

If this is what you think, you are sadly mistaken. Debt matters and the kind of debt you carry matters even more. Carrying debt costs you dearly and limits what you can do with our own money. Your goal should be not to be one of the millions of Americans with a negative net worth. Your goal should be to get out of debt entirely and start accumulating both a reserve of cash and a supply of assets that exceeds your debts. What you will get are financial resiliency and peace of mind. You want to be one of the financial winners in life, not one of the many losers out there always struggling under a crushing load of debt. If a real financial crisis hits, like a banking crisis or the need for an expensive operation not covered by insurance, these people will end up as financial road kill. You should not aspire to be one of the unfortunate.

Having no debt is ideal, but impractical. Credit card debt, like any debt that is unsecured is bad debt. Any debt that does not help you work yourself up the food chain is also bad debt. Consequently, student loans are probably good debt, providing you use the money to study earnestly in a program that will provide you with a good and steady income in future years.

All your expenses can be placed into three categories based on decreasing priority: things you need, things that will enhance your long-term financial solvency, and things you want. You need food, housing and a way to get to and from work. You may aspire to be a college graduate or a truck driver. Money spent here is your second priority because it enhances your long-term solvency. The latest Xbox game station may be something you think you need for your happiness. Do not delude yourself. It is something you want. You can live without it. If after satisfying the first two priorities there is money left over, go and buy something off your want list, providing you can pay for it without going into further debt.

You might say, “But I need high speed internet so I can respond to emails for job searches.” Sorry. It is convenient to you to have high-speed internet, but it is not a need. You can go to most public libraries and use their internet service for free. Similarly, you do not need a car. You can walk, bike, join a carpool or take public transportation. You might even be able to work from home. If you live in the middle of nowhere you can move to some place closer in. People survive without cars all the time and so can you. I used public transportation for years until I could afford a car. Similarly, you may think you need your own apartment. However, you could also find a roommate, take a room in a group house or even live in your parents’ spare bedroom if they will let you.

Granted this sort of life will not necessarily be fun. However painful what you are doing is in the short term, always keep in mind that it is a sound long-term strategy that has been proven effective over millennium. It means that you are living within your means. It means that you are positioning yourself for your long-term prosperity.

After seeing where your money goes, the next step is to make sure money goes where it needs to go first. This involves the prosaic but vital exercise of making and sticking to a budget. If you have more expenses than income, you either need to cut expenses, increase income or do both. Creating a budget is not rocket science. If need be you can do it with a pen and paper, as most generations until now have done it. Any spreadsheet can be used to create a budget. If you cannot afford Microsoft Excel, download the free OpenOffice suite, or use Google’s free spreadsheet tool.

For years, I would end up going “ouch” whenever that big bill arrived. I did not necessarily have all the cash on hand when, for example, the auto insurance bill arrived. Eventually I figured out that if I escrowed equal parts of the money I needed every month I would have all the money on hand when I needed it and I would not be so anxious. You can use the same strategy. My criteria is that any bill paid less often than monthly and which will be for more than $250 when it arrives I will escrow for in advance. I divided up one of my bank accounts into a number of imaginary accounts, one for each of these major expenses. For example, I pay $765.18 a year for homeowner’s insurance. That is $63.77 a month. Therefore, every month I put $63.77 into that account. I expect the bill in 4 months, so I have paid 8 months into the account so far and have accumulated $510.16 in it. When the bill comes due, I have the money to pay it in full. In addition to known bills, I also escrow for anticipated major expenses. For example, I put $250 a month into a car savings account. It is there to act as a down payment for future car purchases, as well as to pay for any major car repair bills that come up. I have a similar account for major repairs. This generally means that I do not need to touch savings when I have to install a new roof or put in a new air conditioner.

To use an escrow system you first need a pile of cash that you can subdivide this way. If you have no pile of cash because you are making payments on your credit card instead, work to get its balance down to a zero balance as fast as possible. You can use a debt calculator to figure out how much money to pay every month to get rid of a credit card balance. For example if you have $8000 in credit card debt and are being charged 15% interest and want to pay it off in 2 years, you can use an online debt calculator like this one. Pay $383.10 a month over two years and you will pay off the debt.

I suspect you will find that when you pay off a debt that you will feel like a weight has been lifted off your shoulders. While you are paying off the debt, you will have the satisfaction of seeing your finance charges and outstanding balance drop lower every month. When finally paid off, there will be no more finance charges ever. You can use the money on other priorities. $383.10 a month can buy a lot of Xboxes.

I plan to offer more financial guidance for you to ponder will be coming up in future entries.

Adventures in Financial Planning

The Thinker by Rodin

If you have been wondering why I have not been blogging this week it is because real life has been keeping me busy. Some weeks there simply is not time to blog. This was one of those weeks.

Many things have distracted me. There is my job, of course, which more than fills the daylight hours. There was my wonderful daughter’s seventeenth birthday, part one of which we celebrated last night. In addition, a sister was in town this week. We got together for dinner in Tyson’s Corner, discussed family news and politics. You cannot put two of my siblings in the same room without politics coming up.

We both shared the same shameful and sick feelings. We were grasping how to articulate them. What comes out are not so much words as an inchoate primal scream. We cannot believe that our Congress has given President Bush permission to torture people and limit the rights of enemy combatants. Congress approved a law so broad that it appears that the president could declare me an enemy combatant and indefinitely detain me. We can only hope these unconstitutional laws are quickly overturned by the courts. It boggles my mind that our Congress could discard the tradition of Habeas Corpus that goes back to the Magna Carta. As if these outrages were not enough, the House of Representatives approved a bill that lets President Bush conduct widespread government eavesdropping. The Senate will likely follow along, after the recess. The congress believes that these actions will show they are tough on terrorists and consequently will help them retain control of Congress. What is does to those of us who are politically awake is make us wet our pants. One diarist on DailyKos put it accurately when he wrote an obituary for our country. I hope after all the wreckage from the last five years that America has finally woken up. We will know in about a month after the midterm elections. In any event, I cannot fully articulate my feelings about these events right now; just express my abject horror, and my disgust at our president and our Congress. I cannot even absolve my own party, which should have filibustered this bill in the Senate, but did not.

While the bizarre and surreal actions in Washington have occupied my forebrain, ordinary life still goes on. I have also been planning for my father’s 80th birthday, which we celebrate next week. My family is still getting to know our cat Arthur Dent better. We spent part of each day is spent coaxing him out of hiding, petting him and giving him tummy rubs. Then there have been the illnesses. Our daughter brought home some nasty cold from school, promptly gave it to me, and I passed it on to my wife. My wife is the only one who still has cold symptoms. Her voice sounds like gravel and she spends much of her waking hours coughing and chugging expectorant. In addition, my side business of installing modifications to phpBB has gotten more active. I have been working with a very assertive client who has been uncovering many hitherto undiscovered bugs in my Digest and Smartfeed modifications and naturally wants me to fix them.

Finally, and perhaps most importantly, there is the slow Chinese water torture of implementing our financial plan. I am discovering why I have procrastinated on our family’s financial planning all these years. To put it mildly, it is a pain in the tuckus to implement our financial plan. I can see why many choose to outsource the whole business to a trusted broker. Jerry, my financial planner, says I am in the worst of it right now. He has made things as simple as possible, by doing things like providing many of the forms I need and having one of his employees fill them out. Once this load of work is behind us, he assures us that we are in for a long period of smooth sailing. The hard part is changing course. We may trim our sails once a year during our annual review. I cannot wait to get to that stage because right now I am up to my armpits in forms and phone calls. I am discovering that it will take months to make this course correction.

My wife has two 401-Ks that have sat dormant for the last few years. It should be routine to roll them over into someone else’s plan. Alas, it is anything but. Instead, there is a plethora of confusing and poorly documented hoops to jump through. Each company that manages 401-K or IRAs has its own bizarre procedures for rolling money in and out. Prudential Retirement, for example, holds one of my wife’s 401Ks. They require a spousal notification form. That is fine if only a signature were needed but no, it has to be notarized, which means I have to find a notary and arrange a time when we are both available to have the form notarized. One plan simply requires that I give authorization on the receiving institution’s forms. Another insists on sending us their special forms. They must be returned before they will accept a transfer request from the receiving institution. Setting up receiving accounts is not necessarily straightforward either. Vanguard, for example, requires a minimum investment in each kind of fund (usually $3000). One fund, their Energy Fund, requires a minimum of $25,000. In addition, you must set up a money market account with at least $2500 in it in order to move funds around.

Working through just one of these rollover issues is enough to trigger a migraine. I have discovered that financial institutions are not necessarily anxious to part with your money. They seem to put up lots of hoops just to see if you have the patience to jump through them. The details on how to do these things are not necessarily on their web sites. Therefore, you have to call them on the phone, decipher their financial speak, then call back the receiving institutions, and ask more questions. The whole process feels medieval and is both frustrating and aggravating.

My wife used to work for USAA Insurance. The only way to get a rollover of her 401K going is to access their employee only web site. That requires an ID and PIN. Maybe she knew once upon a time but long ago forgot. So now, we are waiting for snail mail to arrive with a new PIN to get that process going.

Then there are the non-retirement assets to shuffle. Closing two funds with USAA was actually straightforward. I just logged on and pressed a few buttons. Money instantly shuffled into my money market account. Great. I opened my money market checkbook to write a check to the new institution only to discover I had just used the last check. I now have to wait 4-6 business days to get new checks.

Altogether, I have to move five funds in four institutions and place them into eight funds maintained by five institutions. Three of them are retirement accounts, which have to go through a rollover process to avoid withdrawal penalties. Other existing funds, which I was told to keep, required some minor tweaking. Changing contribution and reallocations for my Thrift Savings Plan took only a few minutes and were done conveniently online.

My wife made all this more challenging. She hates anything to do with money management. It required coaxing her to do things she really, really hates, like speak to retirement fund specialists. This is just one of the reasons why I keep the books. She can be challenged just holding to her receipts. Fortunately, she has a process for that now: she stuffs them into her wallet. I typically sort through them once a week or so. So getting her on the phone with those holding her 401Ks and talking through issues like IRA rollovers was challenging. Often I had to initiate the call, conference her in, get her permission to let me talk to them, and then get the answers I needed.

Once our money is shuffled around, other issues loom. Life insurance is one of them. Next year when I turn 50, my term life insurance costs will nearly double to about $800 a year. Jerry says that I need to keep the life insurance through age 60. He has sources that offer much better deals but work only through financial planners. One gave him a quote for about $500 a year for ten years. That is great, because it means I will save at least $3000. Of course, to save the money I have to go through an obtrusive physical examination and then wait 60 days or so. That process needs to start now, because I turn 50 in February.

I am keeping a notebook of things I need to do. The list keeps expanding. It took about three weeks, but we finally returned the papers for our home equity loan to the credit union. Second trustee endorsement statements first had to be added to our homeowner’s insurance. Much, much notarizing was needed. We made one appointment with a notary, but missed one place where we needed a notary’s signature. This required finding another notary while working it around my wife’s illness.

The recommended umbrella insurance policy arrived, but the bill has not, at least not yet. I have not even begun to think about updating our will. Jerry has some lawyers he can recommend. Setting up a special IRA for my wife was straightforward, but required a $2000 initial investment. That money had to come from somewhere. Fortunately, last month was a three-paycheck month.

I figure it will be several more weeks of aggravating phone calls and filling out dense legal forms before we succeed in transferring all our assets. Dotting all the I’s and crossing the T’s with items like life insurance policies and wills will take longer. Once these assets are in place, then I need to set up regular contributions for many funds. I am hoping somewhere around the start of 2007 all this will be behind us and all we need to do is trim those sails once a year. For it will take many margaritas under some palm tree in the Caribbean to make up for this aggravation.

The Plan

The Thinker by Rodin

“Investment is an effort, which should be successful, to prevent a lot of money from becoming a little.”

Fred Schwed Jr.
“Where are the Customer’s Yachts?”, 1940
From the preface to our financial plan

Back in February, after attending a retirement seminar I became uncomfortably financially awake. As a result, my wife and I decided to spend some money making sure that we were not going to be eating dog food in our retirement. The result finally arrived yesterday: a detailed financial plan for the second half of our lives. I thought I would share some of the insights in our financial plan. While the strategies recommended were tuned for our particular situation, many of them might apply in your particular case. In the process of putting together a financial plan, I learned to become specific about my hazy goals for the future. I also learned a lot from the planner on what to do and what not to do when planning for the future. You may find this valuable also.

Please understand that I am not the typical case. I am a career federal civil servant, grade GS-14, which is one stop below the top rung in the general schedule. I also have more than twenty years of federal employment. I am blessed with steady employment, plus pension and health benefits that many in the private sector no longer have. I start out with a good financial base.

Let me say a bit about our financial planner. Jerry lives locally and makes his living from a combination of financial planning and financial planning evangelism. (I met him at a retirement seminar.) He is a member of the National Association of Personal Financial Advisors. While not every NAPFA member is necessarily competent, I do feel better for hiring a NAPFA affiliate. First, since he is a member I know he is not trying to sell me securities for which he has a personal interest. NAPFA members are fee-only advisors. Nor does he buy or trade securities for me. In short, he has no incentive to work against my interests. This, plus the financial acumen that I lack, were my two essential qualifications for a personal financial adviser. While I can balance my checkbook, my eyes glaze over when I try to competently select from the thousands of stocks, bonds and securities out there. I cannot begin to make an informed judgment on whether one security is better than another is. I have neither the aptitude nor the interest to become financially savvy like Warren Buffet.

The good news is that our financial strategy to date has been good. It has not been great, but at least it has been good. Our net worth is approaching a million dollars. With many families, the bulk of their net worth is in their house. If the market goes down much of their net worth disappears. With over $400K in investment and retirement assets, our financial base is somewhat insulated from housing price fluctuations. In addition, since our only major liability is our mortgage (down to about $120K) we have an excellent net worth. I was fortunate to learn prudent money management basics from my father. Having practiced it for more than twenty years, this strategy alone has proven very valuable. If you can live within your means, not carry a credit card balance and escrow to pay for most major expenses and bills, you will naturally move you toward the top tier of financially stable families. You win simply because the vast majority of Americans cannot discipline their financial lives. Many of these families are awash in debt.

After we told Jerry our risk tolerance (moderate), he looked for appropriate securities. His strategy was to put us into funds that were less likely to be turbulent but had consistently beaten the market. Since I am a federal employee, he told me to continue to invest in their version of a 401-K, the Thrift Savings Plan. However, he recommended that I shift 50% of my assets and allocations into the “G” (government bond) fund. This would ensure the bulk of my retirement assets would grow but would be insulated from market shocks. He also recommended putting 25% into the “F” (fixed non-governmental bonds) fund and 25% into the “S” (Small Cap) fund. I was a bit surprised by this advice, since it meant getting out of the “C” (Commercial) fund, the blue chips, in other words. He does not see adequate future growth coming from blue chip funds.

My wife has two 401Ks from previous employers. For her funds, he recommended rolling over the money into a Vanguard Fund Group IRA. For one fund he recommended 40% be placed in their energy fund, 20% in the commercial real estate fund, and 40% in their global equity fund. Jerry believes that the United States, due to deficit spending, has overextended its credit and it is likely to show up soon as a financial shock or at the very least, in the form of higher taxes in the form of capital gains.

He also had this interesting and very sober statement:

“It is difficult to predict how much Social Security will provide you when you retire given the questionable long-term status of this program. Consequently, we advise you to keep your own retirement savings contributions at the maximum level throughout the remainder of your professional work careers.”

Since Jerry believes the bulk of growth in the future will come from overseas where governments know how to live within their means, he believes we should invest strongly in quality overseas mutual funds. For her other 401K, he suggested my wife place $30,000 in Vanguard’s health care fund, and the rest in the global equity fund. He is convinced that with the retirement of the baby boomers the demand for health care services will only increase. Putting her money into a company like Vanguard also offers a lot of flexibility to move funds around in the future, since they manage hundreds of funds.

I have a small IRA left over from days when I thought I needed one. His recommendation was to move it from my Wells Fargo Discovery Fund into a CGM Focus Fund. Since my wife is currently in a part time job with no benefits, he recommended that we set up an IRA for her and put the maximum of $4000 a year into it. He recommends the Bridgeway Small Cap Value Fund IRA.

He says to “hold” a number of our existing accounts and funds. He says to keep the savings bonds and spend them first when our daughter goes to college. He also said to hold the USAA Income and Money Market Funds and to keep contributing to them. As for my USAA Growth Fund, he said USAA does much better with their bond funds than their stock funds. He recommended moving this money into a Mairs & Powers Growth Fund instead. He said my USAA S&P 500 Fund needed to go too. He does not like index funds and the S&P 500 in particular has been underperforming the market. He suggests putting it in the T. Rowe Price Real Estate Fund instead.

Our financial plan came in a thick binder full of charts and statistics. He used Morningstar Research to select funds and showed us all the ratings and rankings and the rationale that he used. He even ran Monte Carlo simulations on our plan. He priced everything in today’s dollars, so I could quantify the information. He erred on the side of caution, assumed a 4.5% inflation factor and 8%-9% in annual earnings.

He also looked at other aspects of our financial life. He recommended I maintain a $500K term life insurance policy until I reach age 60. That way in case I died, my wife could pay off the mortgage. He also strongly pushed me to get an umbrella insurance liability policy. It would cover expenses in the event that I or some member of my family was sued. He said skip the long-term care insurance until I was 64 and a half years old. My federal disability insurance is adequate and he saw no need for my wife to buy separate insurance, since at the moment her income is not crucial. He directed us to check our homeowner’s insurance to make sure we had sufficient replacement coverage. Moreover, should we need to pay for major expenses he strongly suggested we open a Home Equity Line of Credit. With the HELOC, should unforeseen expenses arise, we would not have to sell any of our investment assets. In addition, interest on a HELOC is tax deductible. Meanwhile, he recommended that we keep paying off the additional principle on our mortgage every month, but try to pay an extra $200 a month, rather than the $50 – $75 extra I had been paying. The goal is that when both my wife and I truly retire (for I plan to work part time after I retire from the federal government) we should be mortgage free. In addition, we need to update our will, maintain durable power of attorney statements and create advanced life support directives.

If we follow his plan then when I retire from the federal government at age 57 he believes we will have $115,000 in annual retirement income. This assumes I take a part time job paying $32,000 a year through age 63. When we “retire-retire” (no more part time employment) assuming a solvent social security system then there is a 100% probability of having $134,000 a year in after tax dollars per year, a 75% chance of having $146,000 a year and a “most likely” (average of the two) of $140,000 in retirement income.

All this is conditional, of course, on following the financial plan, a solvent social security system and his reasonable assumptions on inflation and fund growths.

Included in this scenario is $60,000 to pay for a round the world cruise that I asked for.

Barring nuclear war, I guess we will not be eating dog food.

Continue reading “The Plan”