401k. Photo by urban_data. From the Flickr Creative Commons.

At this time of the year, many people are focused a bit more heavily on their finances in order to pay their taxes. Not a pleasant task, to be sure. While you are deep in this focus, anyway, however, why not take just a few extra moments to check in on your 401(k)?

I struggle with managing my 401(k) just like everyone else. It is a huge responsibility and I am still not sure I am doing it “right.” Since this is all we have for our retirement, however, we keep trying each year to get better, learn something new and try something different to improve.

One investor mindset rule I have learned that applies especially to the 401(k) is:

Past performance does not guarantee future success but history is an excellent teacher.

 
We can’t predict what is going to happen in the stock market each year but we can at least start to recognize possible patterns for when certain types of investments do better than others or when certain types of investments do badly.

Two things I learned from 2011 about my 401(k):

1) The best investment category of 2011: Bonds. If I could turn back time and put my 401(k) investments into 2011’s best performing mutual funds, I would have put my entire portfolio in bonds at the end of 2010. If I had done this, we would have sat on a positive return of anywhere from 2-7%. Instead, our portfolio return got hammered by losses in stocks, especially international stocks, which declined up to 19%. Ouch! Of course, this year, the story is likely to be completely different and bonds may or may not be the right choice for 2012.

2) Dollar cost averaging does work! We have 3 separate 401(k)s to track from current and past employers. When I compared the investments in the different accounts, I was surprised to discover that two of the 401(k)s shared one investment in common. I cross-checked to see if the common mutual fund performed exactly the same in both 401(k)s. Interestingly, the answer was mostly yes but the only difference was that one of the 401(k)s was actively being contributed to and the other was not. The portfolio with the active contributions performed one full percentage point higher! You hear all the time that you should be consistently buying into your stocks, mutual funds, etc. constantly rather than trying to time the market. This was the first time I saw with my own money at stake, how this really does pay off. In my head, I guess I assumed that the hard part is just saving up enough money to be able to retire. This experience taught me that even if you can save up enough money, once you hit retirement, you can’t just sit on a pile of cash and draw it down. You need to continue to be reinvesting and saving even in your retirement years to keep your portfolio’s return as high as possible.

Attached is a form I prepared that mimics the analysis I just did on my own 401(k) based on my 8 Tips for Organizing Your 401(k) from last year. If you like, fill it out for your own 401(k), put it in a file folder near your taxes and each year, prepare an update to file and see how you are progressing.

• 2012 401(k) Checkup

If you need more detailed instructions about the form, below are the key steps I took to fill it out:

1) 2011 Overall Performance.  Go online to your 401(k) plan’s website to access your 401(k) plan statements for December 31, 2010 and December 31, 2011. Fill in the top blocks of the worksheet for the total balance of your 401(k) for 12/31/10 and 12/31/11 and the amount of money you and/or your employer contributed to the plan in 2011. (If you have more than one plan, repeat for your other plans.)

*Note: if you do nothing else, it is a good idea to make sure you double-check you got the correct employer match to your plan in 2011. If you don’t even know what the amount of the match should have been, send an email to your HR department to ask. From experience, sometimes employers have computer glitches or make mistakes. Double-check to make sure and if there is something wrong, let your HR department know.

2) 2011 Return.  Calculate your annual return using a calculator or spreadsheet, using the formula:

2011 return = ((2011 balance/(2010 balance+Self Contributions + Employer Contributions))-1) *100%

3) Brightscope Rating.  Look up the Brightscope rating for your plan at brightscope.com and fill that in the last block of the top table.

4) Performance of Individual Mutual Funds.  The middle section of the worksheet is optional, but helpful to determine how individual investments within your plan are performing. Again, all you generally need to do is look at your statements for 12/31/10 and 12/31/11. Most 401(k) plans will categorize these investments for you as “Stable Value,” “Bonds,” “Large Cap” etc. In the middle blocks put in the name of each fund and calculate the return for each fund using the 2010 beginning balance, 2011 contributions and 2011 balance, the same way as described above for the overall plan. In the last box you can also go to Morningstar.com and look up the Morningstar rating for each fund. The Morningstar rating system generally gives a star rating for how the fund has performed over the last several years and sometimes a rating such as gold, silver or bronze for how Morningstar thinks it will perform in the future. Interestingly, these ratings don’t correspond exactly to how our funds performed but they are at least one objective guideline to take into consideration. Also, as Ramit Sethi notes in his book, underperforming funds often get closed down and transferred to new funds at the end of each year. You might want to note how many of your funds did this.

5) Look at the Long View.  The Retirement Goal Status box asks you to make a goal for how much you would like to live on (in today’s dollars) at retirement each year and how many years you estimate you will be in retirement. Plug these numbers into a calculator such as this one  to determine how much total money you will need by the time you retire. It will be a huge number but don’t be afraid of it, just write it down. Use the same calculator to figure out how much you will need to save each month to hit your target. Calculate one number using a generous return of 8% and another using a lesser return of about 5%.

6) 2012 Contributions.  Then write down how much you estimate you will actually contribute to your 401(k) based on your current paycheck deductions and your 2012 estimated employer match. If your number is nowhere near what the calculator indicates you will need to save this year, try not to panic. Understand that retirement saving is a long-term game. If you can’t hit your savings target this year, you just need to tack it in the back of your mind that you will have to put aside even more in the future to make up for it or adjust your eventual goal downward.

7) Loan and Hardship Withdrawals.  Finally, in the last box, it is a good idea to check in to see what the loan and hardship withdrawal provisions are for your 401(k) just in case you should ever have to withdraw the money for an emergency. It is almost always a bad idea to have to take a loan or withdrawal from your 401(k) but if you are truly desperate, it is a resource available to you. The loan and withdrawal provisions are generally available online in the same place you access your 401(k) balance and other data.

I know this is a lot and overwhelming to some. If it is too much for you, perhaps do just the top box and set it aside. Or print out the form, print out your 12/30/2011 401(k) statement, put them in a file folder and make a note to do it next year.

How do you keep track of your 401(k)? Please share in the comments.

Ramit Sethi is a brilliant writer. When I first signed up for his free email list, I was both surprised and shocked at his communication style. He weaves in wonderful tips about finances, time management and other organizing-related topics, along with a dose of machismo, humor and personality.

At just 29 years old, he is one of the key voices of Generation Y and Fortune calls him “Generation Y’s personal finance adviser”.

I enjoy reading his emails but had never purchased his signature book, I Will Teach You To Be Rich. So, how could I resist when he pitched it in a recent e-mail like this:

Get my book for less than a Taco Bell Mexican Pizza

(The reference to the Taco Bell Mexican Pizza by the way refers to a touching story about how his immigrant mother refused to let him order the Mexican Pizza at Taco Bell when he was younger because it was one of the most expensive items on the menu.) You can download the e-book version of I Will Teach You to Be Rich at amazon.com for just $2.24 (for a limited time). As someone who always loves a bargain, this was my chance to see what Ramit’s book had to say.

I Will Teach You to Be Rich is primarily aimed at young college-age people but it has applications to a wide variety of people who are making a fresh start in managing their finances. I would consider my financial expertise to be more in the intermediate range so I didn’t find Chapters 1-5 on choosing credit cards, setting up bank accounts, opening a retirement savings account, creating a spending plan and automating your finances to be anything new. I have done these things already (although in a slightly different way than Ramit recommends) but the advice was sound and presented in an easy-to-understand and entertaining way. Below are some of my favorite quotes:

“After years of talking to young people about money, I have come to a couple of conclusions: First, I pretty much hate everyone. Second, I believe there are three categories of people: the As, the Bs, and the Cs. The As are already managing their money and want to optimize what they’re doing. The Bs, the largest group of people, are not doing anything but could be persuaded to change that if you figure out what motivates them. The Cs are an unwashed mass of people who are a lost cause.”

“The 85 Percent Solution: Getting started is more important than becoming an expert. Too many of us get overwhelmed thinking we need to manage our money perfectly, which leads us to do nothing at all. That’s why the easiest way to manage your money is to take it one step at a time—and not worry about being perfect. I’d rather act and get it 85 percent right than do nothing.”

“While other people spend many hours cutting coupons, growing food in their gardens to save on grocery bills, or being frugal with lattes, they’re failing to see the bigger picture. It’s fine to be frugal, but you should focus on spending time on the things that matter, the big wins.”

“. . . credit card companies, whom you should treat just slightly better than you would an armed militia coming after your younger sister.”

“Simple, long-term investing works. This idea gets nothing but yawns and rolling eyes during a conversation. But you need to make a decision: Do you want to sit around impressing others with your sexy vocabulary, or do you want to join me on my gold-lined throne as we’re fed grapes and fanned with palm fronds?”

“I hate budgeting. Budgeting is the worst word in the history of the world.”

“Try focusing on big wins that will make a large, measurable change. In fact, I focus on only one or two big wins each month: eating out, and buying books because I am a huge, huge dork.”

“Some people just seem to have a magical ability to manage money. They enrolled in their 401(k) years ago, they always know how much money they have, and they seem to relish tweaking their system to optimize it. Usually, these people are extremely annoying and unattractive. But that doesn’t mean we can’t learn something from them.”

“Nobody really cares about managing their money. Hell, I don’t even care. Get away from me, endless mailings from banks and investment accounts. (That’s the line I will use as a bedtime story to soothe my future children. I know, I know. My future wife is a lucky woman.)”

–Ramit Sethi, excerpts from  I Will Teach You to Be Rich

Chapters 6-8 address investing, asset allocation and other more sophisticated financial topics. I wasn’t expecting to learn very much here but I was pleasantly surprised. Although much of the information I knew intellectually, the way Ramit presented it with his own opinions and recommendations was new and refreshing. He even recommended a free Internet based tool for analyzing your investment portfolio that I had never heard of before and was a wonderful new way to look at my finances.

Chapter 9 is about living a “rich life,” in which Ramit takes on money issues like student loans, helping parents in debt, talking to your significant other about money, budgeting for a wedding, negotiating a better salary, and buying a home.

Overall, this book is a quick and entertaining read, packed full of great financial information. It would be a wonderful world if every student graduating high school or college received this book at graduation.

Since the financial world has undergone a lot of change in the last few years, there are just a few points that I wonder if Ramit might write differently today than when the book was first published in 2009.

1) He makes mention that “you can make an average of about 8 percent in the stock market.” Now historically this is true (and hopefully it will continue to be true into the future) but anyone who has tried to make 8% in the stock market lately would probably advise that you ratchet that percentage down a few points for shorter-term planning purposes.

2) Using a credit union instead of a commercial bank is in a sidebar but probably would be in the main text if the book was written today.

3) There is no mention of choosing a bank based on the bank’s financial stability rating, which is becoming increasingly important today.  Yes, all banks are FDIC insured but that depends on the government keeping its financial house in order.

4) Like many personal finance writers, Ramit emphasizes that a huge benefit of the 401(k) is getting the employer match. Employer matches to 401(k)s and other retirement accounts have taken a hit in the economic crisis. Some have reduced the match, others have eliminated it entirely. But I agree that if you are lucky enough to still have a match, take full advantage of it!

5) Ramit likes to emphasize having an automated spending plan. Once you have a family costs can become much more unpredictable and expensive than when you are a single person or childless. I suppose I am waiting for Ramit to get married and have a family and write part 2 to this series and see if his advice differs then. I do automate our spending in many ways but can’t fully automate to the extent Ramit recommends. Still, the concept is a good one and if you can do it then you should!

6) Ramit likes Lifecycle funds in 401(k) plans. (If you don’t know what a Lifecycle fund, a.k.a. Target Date Retirement fund, is, it is the fund in your 401(k) that is labeled with a year close to your expected date of retirement, like 2020 or 2035 or 2040.) Suze Orman has a completely different take on these funds and hates them.  Following Ramit’s 85% solution, however, I think Ramit has a good argument that if you are not going to spend any time thinking about your 401(k) plan and your simplified choices in the 401(k) are: a) invest in cash b) choose one fund or c) use a lifecycle fund, going with the lifecycle fund is probably not a terrible choice. For a young investor, The Motley Fool tends to advise choosing the closest thing to an S&P 500 stock index fund, however, and some investors in this economic climate might choose cash. So, the Lifecycle funds might not always be the best choice for every situation. Anybody worried about this, however, could always follow the more detailed investing advice Ramit provides.

Bottom line: I would say I got incredible value for my $2.24. Ramit also provides some extra free downloads for those who buy the book that I have not yet watched but plan to. I would encourage anyone and particularly young investors or anyone who hasn’t found a finance guru they trust and like to give it a read. If you are only going to read one book about finance or investing this year, this is a good one!

Are you a Ramit Sethi fan?  How do you react to the excerpts above illustrating Ramit’s writing style?  Please share in the comments.

*I have no affiliation with Ramit Sethi other than being a fan and reader.

For March, I was tasked to make this lovely dessert which doesn’t take much time assuming you have ripe pears–which can be more of a feat than you can imagine! I bought mine a week in advance to ripen. Once ripe–the recipe is very simple and takes less than 20 minutes total to make.

You peel the pears, put them in a saucepan with 1c apple juice or the recipe calls for freshly-squeezed juice. I had regular OJ in my fridge so I used that.

Once that has simmered for 5 minutes, add 1 cup of raspberries and simmer an additional 5 minutes, all the time spooning the mixture over the pears. It is a very fresh-smelling concoction.

The serving recommendation for ultimate healthiness was with plain yogurt, as shown.

This is a dessert I would definitely use at a dinner party. You can’t pre-peel the pears–they’ll brown too quickly. But the peeling took very little time. It is a very tart dessert–the raspberries definitely overpowered the sweetness of the pear. It may have had a slightly different result with apple juice–and I think also pineapple juice would be lovely with this as well.

The yogurt’s creaminess definitely helps off-set the extreme tartness though. I do love sweet-tart combinations–they are among my favorite! So we also tried it with vanilla ice cream, which obviously has much more sugar and fat. I think it may appeal to a broader audience that way. But regardless–try this! It’s worth it–and it’s a welcome addition to my recipe collection!

"Taft finds tearing the budget a difficult task. Washington, D.C., Jan. 2. Senator Robert A. Taft, Republican of Ohio, found tearing the budget a difficult task as he told reporters at a press conference today that it would take at least two years to balance the budget" (1940). Photo by Harris & Ewing. From the Library of Congress Prints and Photographs Division

In the last post, we talked about the investing mindset of relating complex investments into simpler, more understandable ideas. We took the example of the federal government’s budget and scaled it down into the budget for a typical middle class family. I left you with the cliff-hanger of what would have to be done to get the federal government in a position to dig itself out of debt.

There is not one answer to this question. The number of possible remedies is really only limited by how you want to do the math. Anyone in a difficult situation like this could benefit from another investing mindset rule:

A good investor makes decisions first by numbers
and secondly by emotions.

So, where do we start with this problem?

Well, the first place we could start is to ask the family/government how it is spending its money. The latest government financial report provides this answer:

For simplicity, we will assume all of these expenses total $154,000. Scaling everything down we see the following breakdown.

2011 U.S. Government Scaled-Down Budget

Medicare/Medicaid: $37,000
Other: $35,420
Social Security: $32,000
Defense: $31,000
Interest on the Debt: $10,780
Military pensions:$7,700

When I play around with these numbers myself, treating the government like a family with a spending problem, I notice a couple of interesting things. First, if you try to start paying down our national debt at even a modest pace over 30-40 years, you necessarily have to start making cuts of about 50% to all existing government programs. Secondly, even if you increase taxes substantially just to cover paying down the debt and supporting all existing programs, there gets to be an effective limit at which you can no longer tax enough to support the existing programs. From my point of view, I don’t see how anyone can fix the U.S. government budget without both raising taxes and decreasing benefits.

Next, we can see what the experts in each of the political parties are proposing.

• Click to see a quick summary of proposals from three different viewpoints: the Tea Party, the latest Republican proposal and President Obama’s draft budget.

There are a million different ideas about how to get the country’s finances on a sustainable path. The one thing all parties seem to agree on is that things can’t keep going on the way they are. Something has to change. There are three key things I think we all need to remember about this budgeting process.

1) Regardless of the budget decisions ultimately made, the government has to get its currently dysfunctional financial and accounting systems organized.

The U.S. has made some terrible financial decisions over numerous years and has yet to fully account for all of these mistakes. Take for example, these shocking quotes from Comptroller Dodaro in the government’s latest financial report:

“Three major impediments continued to prevent us from rendering an opinion on the accrual-based consolidated financial statements: (1) serious financial management problems at the Department of Defense (DOD) that have prevented DOD’s financial statements from being auditable, (2) the federal government’s inability to adequately account for and reconcile intragovernmental activity and balances between federal entities, and (3) the federal government’s ineffective process for preparing the consolidated financial statements.”

“Based on our review of completed Material Differences Reports for fiscal year 2011, we continue to note that amounts reported by federal entity trading partners for certain intragovernmental accounts were not in agreement by significant amounts. We noted that a significant number of CFOs continue to cite differing accounting methodologies, accounting errors, and timing differences for material differences with their trading partners. Some CFOs indicated that they did not know the reason for the differences. In addition, some CFOs confirmed the balance or activity, however, differences continued to exist. Further, there continue to be hundreds of billions of dollars of unreconciled differences between the General Fund of the U.S. Government and federal entity trading partners related to appropriation and other intragovernmental transactions.” (emphasis added)

“As in previous years, Treasury did not have adequate systems and personnel to address the magnitude of the fiscal year 2011 financial reporting challenges it faced, such as control deficiencies in its process for preparing the consolidated financial statements noted above. We found that personnel at Treasury’s Financial Management Service had excessive workloads that required an extraordinary amount of effort and dedication to compile the consolidated financial statements. Further, there were not enough personnel with specialized financial reporting experience to help ensure reliable financial reporting by the reporting date. In addition, the federal government does not perform interim compilations at the governmentwide level, which leads to almost all of the compilation effort being performed during a condensed time period at the end of the year.”

If you are familiar with financial statements, you would know that these seemingly boring, technical quotes have massive implications. They are really shocking! CFOs typically sweat bullets over any notes to the financial statements that even hint that a company is mismanaging its money. These notes outright state that the government has “serious financial management problems,” “control deficiencies,” “hundreds of billions of dollars of unreconciled differences” and is “ineffective.” Also, the words “As in previous years” is put in front of a terrible statement about the Treasury Department’s lack of financial capability as though the Treasury Department thinks it is acceptable to continue not to address these problems. If a corporation issued financial statements anything like this, the company would probably be automatically delisted from the stock market and likely sued perhaps even with criminal charges. It really is that bad.

So, no matter which budget path we choose, we should at least have the integrity to admit to our bad choices and the intelligence to execute our complex choices and properly and fully account for whatever it is that we have done. This has to be a top priority for any political party.

When you look at the three proposals above, the Tea Party seems to say that they are going to address this problem by eliminating any complicated financial transactions by cutting the government down severely. Both the Republican and Democratic parties would do well to add a line item to their budgets for additional accounting and financial management personnel.

2) We have to make a decision about what to do with our debt.

The budget proposals from the three political parties make radically different choices when it comes to the national debt. If you are trying to relate the government’s finances to your own, this is where the biggest disconnect occurs. If you fail to pay your mortgage, credit card, etc. there are big consequences for you. If the government fails to pay, it doesn’t seem to matter at all. There is seemingly endless credit for the government.

The Tea Party’s proposal is kind of like declaring liquidation bankruptcy with regard to the debt and quickly strikes to erase the debt in 5 years while political will remains intact. While you can disagree with these tactics, it probably is true that if you really wanted to erase the debt, you would have to do it quickly. The Republicans take a less aggressive approach and start cutting spending slowly, starting to pay down the debt almost 30 years into the future and who knows when, if ever, it would be paid off in full. All you would need is one intervening war, economic crisis or other problem to throw that spending plan off. The Democrats also cut spending slowly but sadly don’t seem to ever start paying down the debt, even with large tax increases.

3) The government is most likely on a slow path toward relinquishing its role as guarantor, forcing us all to
live with more financial uncertainty.

It is almost certainly true that the government can only get its finances in shape when it can adequately predict and control costs. It is probably only a matter of time before the government follows the trend in private industry to convert open-ended obligations to fixed price, limited time commitments.

Almost no private company makes these kinds of commitments any more. For example, companies found that promising employees pensions was too difficult to manage and required too much to be set aside in savings to guarantee payments so pension plans were converted to 401(k)’s. Likewise, we now have private health insurance programs that cap lifetime spending at a certain dollar amount. The government is really the only entity that operates without these constraints.

This is probably the biggest philosophical difference between the competing proposals. The Tea Party and the Republican Party force the government to operate like a private company. Open-ended programs like Medicaid would be converted to block grants to the states of limited dollar value. Once the money runs out each year, it is gone and people would have to do without unless private charity steps in. Likewise, converting Social Security to private accounts would do the same thing. Instead of your “Social Security pension” you would get the 401(k), which could be better or could be worse depending on how your investments perform. Converting people from Medicare to private health insurance will almost certainly result in dollar caps on care. The Democratic party maintains existing, unlimited systems but sadly, does not seem to have a sustainable way to afford them, even with significant, larger tax increases.

Worldwide, we are seeing many countries come to terms with the end of guaranteed programs. It requires us all to accept that the buffer on life’s uncertainty is gone. We could starve. We might have to make life-altering consequences about our health. We certainly have to take more responsibility to save, to make connections with other people who could help us, to maintain our diet and exercise and to do all sorts of other difficult things.

We can at least take comfort knowing that the future might not be dim, just different. After all, is there that much difference between having a Social Security 401(k) where the value goes up and down with the stock market or a guaranteed Social Security pension that gets cut 25% (or perhaps more) when the government runs out of money?

It is a good exercise in focused, logical investing discipline to look at each of these budget proposals and create your own game plan assuming any one of these strategies is enacted. How would they impact you?

When it comes to your own money, the same rational, numbers first, approach is essential. Money is complicated. It invites emotion. Money is the access key to all sorts of wonderful and essential things. Money is also the reminder of bad decisions or painful decisions we keep putting off.

The government’s budget struggle really has so many parallels to our individual lives. How do we plan for the future? How do we strike the balance between getting exciting things we want and covering the cost of boring, basic essentials like food, clothing and shelter. How do we do the day to day accounting necessary to make good decisions?

Do you struggle with maintaining rational thought when it comes to issues of money? What do you think of the pending budget proposals? Please share in the comments.

Green donuts for St. Patrick's Day. Life is sweet!

This month’s investing theme is certainly about bringing more green into your life. As a reminder that green is sometimes about money but more often about the people we love, I wanted to share these pictures from our early St. Patrick’s Day celebration (following the preschool calendar).

A great day to be a strawberry blonde.

...or a blonde with hints of red.

Green eyes. The best green to wear on St. Patrick's Day.

Green boots and green legs.

An impish grin.

A lucky smile.

And a great time to be "green" at life too.

 Sláinte!

Happy St. Patrick’s Day!

 
**As a side note relating this to organizing, I have written before about my shopping weakness for holiday outfits for my children.  I am happy to report that I was able to restrain myself and spend only $4.50 on St. Patrick’s Day attire (two $1 hair bows and a clearance pair of striped socks at $2.50). All the rest was scavenged from our existing closets.

Simplified diagram of the federal budgeting process from "A Citizen's Guide to the Federal Budget" 1999

Probably one of the biggest deterrents to learning about investing is that the learning curve is extremely steep for the beginning investor. There are so many different types of investments, so many different industries, so many types of analyses and calculations. Many people take one look at this situation, feel so completely helpless and overwhelmed and just give up. They don’t open their 401(k) statement or read a prospectus or even borrow a book from the library. They just hope for the best, do a little here and there, and take comfort knowing that safety nets like Social Security are out there to help.

Unfortunately, the reality for most of us is that we can’t rely on this ostrich-like strategy any more. We have to know what we are doing, even if that means confronting a lot of bad news or having to change.

If we want an example of this, Americans can look to our own federal government. We all know that for many, many, many years, the government’s finances have been a mess. But how many of us have any idea how bad they are or exactly what it will take to fix the situation?

I didn’t feel like I really understood any of this discussion—except in the broadest of terms. So, I recalled another investing mindset rule that has served me well:
 

Restate a complex investing scenario into something you do understand.

 
In the next couple of posts, we will organize information on the U.S. government’s finances in a couple of different ways. It is my hope that this information will help us all to become better investors of our own money and also better stewards of the nation’s finances as well.

Gene Dodaro, Comptroller General of the United States. Photo from the GAO website.

First of all, how do we even begin looking at the government’s finances? Fortunately, for us, this is already someone else’s job. Whose job? Gene L. Dodaro, Comptroller General of the United States. Mr. Dodaro’s biography indicates he has a bachelor’s degree in accounting as well as 30 years of experience at the Government Accounting Office.  Mr. Dodaro is accompanied in this work by Robert F. Dacey, Chief Accountant, who is an accountant and lawyer and a recognized authority in accounting circles.

Last year, Mr. Dodaro and Mr. Dacey were involved in producing a document called Fiscal Year 2011 Financial Report of the United States Government, which is in many ways similar to a 10-K issued by a publicly traded corporation.

Auditing the finances of the federal government is a completely daunting task because of the sheer size of the government. Where to begin? First, they narrow down “the government” to a list of 35 of the most important agencies.

The 35 Government Agencies Included in the U.S. Government’s Fiscal Year Report

While this is a huge list, I am sure there are probably other agencies not listed here. For whatever reason, those other agencies are not included in the fiscal year report.

After they go through the books of all these agencies, they produce the fiscal year report letting us know how the government spent its money. For the past several years, these financial results have been terrible, reflecting huge deficits.

The U.S. government’s finances are in the trillions of dollars. The concept of a trillion is just too much for most of us to grasp. For example, I could tell you this true but brief summary of the government’s 2011 financial picture:

2011 U.S. Government Financial Summary

Income: $2.4 trillion
Expenses: $3.7 trillion
Deficit: $1.3 trillion

Since my own finances do not involve trillions of dollars, I don’t really know how to process this information. But when I took these same numbers and scaled them down proportionately to reflect a middle class family’s income, they looked like this:

2011 U.S. Government Financial Summary Scaled Down to a Middle Class Family’s Income

Income: $100,000
Expenses: $154,000
Deficit: $54,000

Now, the situation still looks bad but it is finally relatable. Imagine for a moment that our hypothetical family had a year where they had to replace the roof on their home, had some sort of medical catastrophe and had to buy a new car. The family could easily overspend their income doing these things, and probably paid for them by taking out a home equity line of credit, car loan and credit card debt. It was a tough year for our country last year and you could say that the complex transactions conducted by the government were similar to these family challenges.

If this were an isolated incident, the government, like the family, might heave a sigh of relief that it made it through the year and then start constricting expenses to be able to afford all of our newfound debt. Unfortunately, the government has been doing this type of spending every year for a long period of time. There is always some emergency we haven’t budgeted for, some exciting new thing we want to build or buy, some expense that we wouldn’t dream of letting go. So, the government, like some families, just keeps charging and charging, tiding things over for one more year.

What does the government’s net worth look like now? Below is a chart from the most recent financial report for the government:

Again, these numbers are so astoundingly large that they defy comprehension.  A net “worth” of -$15 trillion dollars?  If we relate them down to something we can understand, like a house and mortgage, we get something like this:

 2011 Government Assets and Liabilities Related to the Average Middle-Class Family

Assets (House):  $113,000

Debt Securities and Pensions (Mortgage): $665,000

Other (Credit Card Debt/Car Loans, etc.): $63,600

Net Worth: -$615,600

As you can see, the government is incredibly leveraged.  The typical family in this situation would most likely declare bankruptcy and start over.   Just the $63,600 in credit card debt would be enough to push most families to the brink.

We know (hope) that bankruptcy isn’t an option for our government, so what can be done about this terrible situation?  In my next post, I will talk about that in context of another investing mindset rule.

In the meantime, I ask you to think about an investment you don’t understand and try to relate it to something that you do.  In my case, the investments that confuse me the most are the mutual funds in our 401(k) plans.  Over the past year, I have been trying to track the investments on a quarterly basis and equate them as closely as I can to traditional stocks.  I also try to simplify all the complex data into simple questions like “If I add up the beginning balance plus all contributions in this investment, is the current value of the investment more, less or the same compared to what I started with?”  “Which investment made the most money?  Which made the least?” “What asset category is this investment in?”  I still can’t make the accounting numbers work out exactly for these mutual funds (for reasons I still don’t understand) but I feel a little more empowered to deal with these funds and at least have a framework to get started.

Have you used a relational mindset to help you make more sense of your money?  Please share in the comments.

"Vocational Printing. Math. class. See 4168. Location: Fall River, Massachusetts." (1916) Photo by Lewis W. Hine. From the Library of Congress Prints and Photographs Division.

As a homeschooling mom, I am in the middle of teaching my daughter about the intricacies of addition and subtraction of simple numbers. She is starting to realize that math takes effort. Sometimes she looks at a complicated problem and just takes a wild guess. I have to stop her and say, “No, you don’t have to guess. You know how to figure this out.”

As I learn about investing, the same advice applies to me. One of the investing mindsets I have had to adopt is:
 

Good investors are always open to learning math
and calculation methods.

 
I know some readers are groaning at this point. They don’t like math or think they are terrible at math or some other rationale. But if you want to learn how to invest, you must learn math. It is not optional.

As an example of how we take wild guesses as inexperienced investors, we might be filling out a savings calculator and it might say, “Enter your estimated rate of return.” “I have no idea,” we might think. Then we might remember reading something about how the stock market averages around 8% each year so we put in 8%.

I read an article recently by Jason Zweig of The Wall Street Journal titled “Are Pension Forecasts Way Too Sunny?” that challenges us not to guess on these return calculations and tells us to figure it out. In the article, Mr. Zweig says that pension managers used to forecast around 12-16% returns. Now, after many difficult years in the stock market the managers have revised their return estimates to around 8%.

But Mr. Zweig argues that this is still an unrealistic guess and that “you [would have to be] a better stock picker than Warren Buffett” to pull this off. When I read this, I was surprised but his explanation was rooted in easy-to-understand math.

His example:

You want to earn 8% per year and your portfolio is 50% in bonds and 50% in stocks. Bonds are currently earning about 2.2% per year.

His calculation: 50% * 2.2% = 1.1% estimated contributions from bonds to the portfolio

If you want to earn 8% per year, your stocks must contribute at least 6.9%. To a naïve investor like me, this doesn’t sound impossible. But though more math, Mr. Zweig demonstrates that it is unrealistic.

His calculation: 50% * 13.8% = 6.9% estimated contributions from stocks to the portfolio

In order for the portfolio to earn 6.9% from stocks, the stock portion of the portfolio needs to be earning at least 13.8% per year. The pension plan being overseen by Berkshire Hathaway is estimating a return of around 7.1% with about 30% in bonds (i.e. Mr. Buffett thinks he can earn about 9.2% on his stocks). Stocks in general have averaged 3.9% – 8% over the last 20 years. So, the portfolio managers estimating 8% with a 50/50 mix would more realistically estimate a 5.7% return (if they assume they can equal Mr. Buffett’s stockpicking talent).

The lesson: when it comes to your own portfolio, use a reasonable rate of return based on math:

For example, a typical investment portfolio for a younger person is 90% stocks and 10% bonds. If you use Mr. Zweig’s formula, you come up with:

90% *(3.9% – 8%) = range of 3.5% – 7.2% return from stocks

10% * 2.2% = 0.22% return from bonds

Total estimated portfolio return = 3.72% – 7.42%

So, if you are estimating how much you might earn on your investments in this “aggressive” portfolio, you might guess somewhere in the middle, say around 5.5%. As you can see, this is far less than 8%. These calculations could change each year based on changes in the stock and bond market so you will have to recalculate periodically but you don’t have to just give a wild guess. I will have to update my own planning accordingly.

Was the above example as eye-opening to you as it was for me? What other simple math formulas do you rely on to steer your investments in the right direction? Please share in the comments.

I have been enjoying the sunshine streaming in my windows each morning as I wake and sadly, this weekend that may go away. It’s daylight saving time this weekend. Time to turn those clocks forward one hour tomorrow night and start Sunday morning one hour earlier. Early birds must love this time of year but night owls like myself are going to be off-kilter for a few weeks.

Also, fair warning that there are now:

40

days left for Americans to file their tax returns for 2011. The tax deadline this year is:

Tuesday, April 17, 2012

 
You might want to consult my Tax Preparation Tips.

Also, you might consider doing the following to make your tax preparation next year a little easier:

Ruly Tax Organizing Tip
As you input your various sources of 2011 income, expenses, deductions, etc. make a list of what documents you need to complete your return and put it into a folder called “Taxes 2012.” Next year when January 1 rolls around and you start receiving various tax documents, you can check off the list to see what you have and what is missing.

"A skeptical but timid parent goes to ask why the board ... " Illustration by Thomas Fogarty (1922). From the Library of Congress Prints and Photographs Division.

In the polarized environment of the current financial status of the U.S. government and the current elections, I have been surprised by the alarmist nature of news stories on both sides of the political spectrum regarding budgeting issues. The two news stories below are representative:

Our county is in the beginning phases of negotiating next year’s budget, which may include cuts to the local school system. A recent news story had the headline: “Expenses cause ruckus in Spotsylvania: School Board Upset by Mileage reimbursement Policy After Seeing Former Chairman’s Bill“. While certainly no one wants fraud, waste or abuse, the article goes on to detail that the largest charge being complained about was $319.59 and all the charges in question totaled $932.37. These charges were in full compliance with the School Board’s expense policies and seem absolutely trivial to me (in the context of normal business expenses).  The story, however, was representative of the fear of many in the school system that someone is out to take advantage of them at every turn.

On the other side, I received an email recently with this headline, “Government Will Seize Gold.” The article went on to detail one investor’s view that policies enacted by the federal government in 1933 when the U.S. dollar was still based on the gold standard will be revived. While, I suppose in theory, the government could do this, it seems so far from likely that I can’t imagine being concerned about it. Wouldn’t you expect that before the U.S. government went around seizing gold from people they would just raise taxes? Still, it is representative of the fear among wealthy individuals that all their hard-earned money will be taken away at a moment’s notice.

These stories remind me of another investing mindset strategy:

Maintain a healthy skepticism about all things.

 
All lawyers are taught to be skeptical of everything all the time. Lawyers always rain on the parade and point out the loopholes and downsides in any plan. It’s part of their job. Businesspeople tend to go to the extremes. When things are good, businesspeople tend to want to overemphasize the positive. When things are bad, the skepticism increases and tends to lean more toward paranoia. Donald Trump, in particular has written before about his ever-watchfulness in this area.

I would point to the article below as an example of healthy skepticism:

• “Jim Rogers: Government ‘Always’ Lies, Tweaks Inflation and Jobless Data,” Newsmax, December 6, 2011.

It is probably true that there are many ways to present government data on inflation and joblessness. While the word “lies” may be an exaggeration, “shenanigans” might come to mind. To be a good investor, you need to think about the motivation of whomever prepared the data and whether there is a legal, but biased way that it could be presented. Understanding this will help you make better decisions for yourself.

When it comes to healthy skepticism, however, it probably does not help matters that we have seen so much fraud and abuse in so many areas of government and in business as well. These stories from The Washington Post saddened me because they highlighted how easy it is to manipulate public trust and how difficult it is to get caught:

• $8 million in Prince William County IT contracts over 4 years were awarded to a company associated with the head of the IT department who was steering the business to the company and helping submit fake counter-bids.
• $20 million was overcharged on IT contracts for the Army Corps of Engineers with the complicity of the government officers overseeing the contracts. The Washington Post described it, “an audacious four-year swindle that prosecutors have called ‘one of the most brazen’ in federal contracting history.”

On the bright side, it seems the government is taking seriously the mission to restore public trust.

• “Pentagon builds auditing army as budget shrinks,” The Washington Post, February 26, 2012

but it’s not always easy ferretting out fraud and it’s expensive too:

• “Slow start for Medicare’s new fraud-busting computer disappoints lawmakers,” The Washington Post, February 23, 2012.

So, in the meantime, we can tell ourselves that it is probably true that someone somewhere is taking advantage of the system (and our respective interests) but hopefully far more people are playing by the rules, paying their fair share and have the interests of the greater good at heart. When it comes to our individual actions, we have to do our best to ignore what someone else may have done to cheat the system, since justice has a way of coming around to those folks eventually, and focus on what is the just action for ourselves and for others at that moment. At the very least, we will be able to sleep well at night.

What news stories have caught your eye recently as examples of paranoia, fraud or abuse? How do you balance this information with your own thoughts? Please share in the comments.

Please indulge me in a post that is really just a treat for my Dad’s birthday (and any other male or racing fans that happen to read my blog).

I recently received a press release from Akrapovič, a Slovenian maker of high performance exhaust systems for racecars and motorcycles. I have no idea why they sent it to me. Perhaps it was because I did an organizing theme on cars and driving once.

First, off, here is one example of the ϋber cool nature of their business, which, not unimportantly, involves creating the sound of speed:

For those like me who know nothing about racing, I am going to reorganize Akrapovic’s press release into a series of questions and teach us something about organization as well.

Tell us about Akrapovič

Akrapovič, the leading manufacturer of premium performance exhaust systems for motorcycles and cars, has a history of racing success. Throughout its 21 years of business, Akrapovič has partnered more than 60 World Champions.

What is your latest project?

After supplying the exhaust systems for Audi Sport since 2009, Akrapovič will become an official Audi Sport partner for the first time in the 2012 season.

For 2012, the inaugural year of the newly-formed FIA World Endurance Championship, Audi Sport will be going full out to secure the championship title with Akrapovič as one of their partners – and net a hat trick of wins at the prestigious Le Mans race along the way.

. . .

“A wealth of engineering experience and the very latest technology goes into every exhaust we make. The fact Audi has chosen Akrapovič once again reflects the performance levels of our products and manufacturing skills of the entire Akrapovič team.

“We’re proud to be working with Audi again and are confident this dynamic duo will make be a force to be reckoned with during the FIA World Endurance Championship.”

Side question to Wikipedia: What is Le Mans?

“The 24 Hours of Le Mans (French: 24 Heures du Mans) is the world’s oldest sports car race in endurance racing, held annually since 1923 near the town of Le Mans, France. Commonly known as the Grand Prix of Endurance and Efficiency, race teams have to balance speed against the cars’ ability to run for 24 hours without sustaining mechanical damage to the car and manage the cars’ consumables, primarily fuel, tyres and braking materials. The endurance of the drivers is likewise tested as drivers frequently spend stints of over two hours behind the wheel before stopping in the pits and allowing a relief driver to take over the driving duties. Drivers then grab what food and rest they can before returning to drive another stint. Today it is mandated that three drivers share each competing vehicle.”

–”24 Hours of Le Mans,” Wikipedia.

Side question to Audi: Can you show us an example from last year’s race?

What innovative technology are you planning for the 2012 race?

Audi’s new R18 e-tron quattro and the R18 ultra endurance weapons are indeed a beautiful creation loaded with unparalleled technology – technology that typifies the German manufacturer’s famed slogan ‘Vorsprung durch Technik’. (Side question to Google translator: What? “Progress through Technology”) Of course, being a partner to Audi sport, this means Akrapovič had to bring its technical development and manufacturing experience to the fore with a specially designed Akrapovič exhaust system.

Crafted from a specialised titanium alloy, the high-performance system is 40 percent lighter than a stainless steel equivalent to further enhance the performance and handling of the Audi R18s. The special alloy material also has outstanding heat-resistant properties and durability – both crucial in the punishing field of endurance racing. The system is then tuned to the race car´s engine to enable it to use its full performance arsenal.

How do you organize the design process when building a high-performance racecar?

The Akrapovič exhaust used on the Audi R18 e-tron quattro and the Audi R18 ultra is created by Akrapovič engineers working with their peers at Audi Sport right from the initial design phase, through to production, on to testing and, finally, race support. This stringent process is similar to that used to create the Akrapovič range of aftermarket exhausts – available for selected Audi models and other high performance brands.

Uros Rosa, Akrapovič Technical Director said: “After being involved in two successive victories in the 24 hour Le Mans with Audi Sport, we’re aiming to build on our success in 2012. Our exhaust has been crafted to meet and surpass incredibly high demands of endurance racing. We’ve worked with Audi every step of the way to develop a system which is perfectly suited to the car’s performance’’

So cool, eh? The 2012 24 Hours of Le Mans race will be held July 6-8, 2012. Best wishes to Audi and Akrapovič!

Happy Birthday, Dad!