Building block – Financial picture

Another key element to having your life in order is to have a clear picture of your financial situation.  Jules helps a lot with all your physical assets like house (s), Car (s), Art, jewelry, furniture, etc..  Jules does net yet aggregate your financial bank account information.  This is the domain of Mint from Intuit (  Jules + Mint = Complete personal balance sheet

Note of caution:  this is a complicated topic and may take me some time to get all the way through it.
In an attempt to limit the scope of this discussion I’m going to aim my analysis, conclusions and recommendations at the age demographic of 35 to 70.  Doesn’t really narrow it down much, but enough to keep this Post short of novel length.

Lets start with some background
Previous way of thinking about how you go about planning for and funding retirement:

  1. Savings – Every month you try and put away some money into a safe vehicle called savings.  Typically you could expect a 5% to 6% risk free rate of return.  Slightly better than the current rate of inflation.
  2. Your primary home – You would buy a house, take out a 70% or 80% mortgage and over 30 years would pay off the mortgage, the house would appreciate in value 5% to 10% every year and when it came time to retire and live in a smaller much less expensive house you would pocket the full value of the house.  In 1970 you would have purchased a house for say $100K and in 2000 you would have sold it for $750K.  With the mortgage paid off the full $750K (Minus selling costs)  would all go to add to your savings.
  3. Social Security – You’ve been paying in all these years and you expect to paid back during your retirement years.
  4. Other pensions – You’ve been paying in all these years and you expect to be paid back during retirement.
  5. Possible windfall inheritance from older relatives.
  6. Possible financial support from your kids was never really considered in this generation of folks planning for retirement.

Major assumptions in place prior to 2000 that underpinned the thinking above:

  1. Stocks and Bonds would go up and down but over the long term would generate at least 9% annual returns.
  2. If you wanted to go completely risk free you could expect an annual return of 5% or 6%.
  3. House prices would always go up.  In a really bad year they might be flat.
  4. There would always be future generations of workers to continue to fund Social Security to insure it would be solvent.  Same applies to state pension funds like Calstrs and Calpers (in CA).
  5. Corporate pension funds were 100% secure and would always be funded.  After all that’s my money they’re just holding for me.
  6. Federal bonds were as good as gold.  No risk of default!  Other Government backs bonds were a close second.
  7. The fundamental belief in “the economic cycle” always worked in some form to get the country out of any recession it experienced.  The economic cycle theory essentially says when the economy gets into trouble (for whatever reason) it’s governments role to borrow money in today’s dollars, inject these dollars into the economy, rely on the recovered economy followed by inflation of those borrowed dollars to eventually pay back the debt borrowed in yesterdays dollars leaving the “inflation profit” to cover the real cost of rejuvenating the economy.  The only time this didn’t work was the great depression.  Fortunately for he economy World War II came along and bailed out that economy.

Okay, so what’s changed in the last 12 years since 2000?  Hmmm, let me think here for a moment…  Yes, you guessed it;  Everything!  Investing in the Equity markets has yielding nothing but many sleepless nights, the risk free rate of return is now 0% (maybe even negative), house prices have now fallen 5 years in a row, everyone now accepts Social Security will go bankrupt (the debate is only about when), Federal default on issued Bonds is a real possibility, no corporate pension fund is guaranteed to be there when you need it and the previously relied upon “Economic cycle” approach to fixing the economy has proven it won’t fix this one.

In fact if you now add up all the aggregate debt in the US alone (add Federal debt, state and municipal debt, private sector debt, unfunded entitlement programs, etc.) you get $56.6T, yes that’s Trillion!  See the following link for the details .  This is vs an economy that generates $15T in GDP annually.  That’s a debt to annual income of almost 4!  No economic cycle is going to bring this ratio back into a reasonable balance.  This problem will be with us for a long time.  Having said all this and clearly painted a pretty bleak picture I feel the solution is simple.  It’s the mirror image of what’s gotten us into this mess in the first place.  Again in my opinion, we collectively as a society have lived beyond our means increasingly ever since the end of World War II.  We’ve spent and spent, more and more, funded by borrowing against our homes, running up other debt on credit cards and student loans, all under the assumptions that house prices would continue rising, our income would rise and our savings would earn between 5% and 9% per year.  The mirror image of this is simply living within our means or below our means for a long time while we work our collective way out of this hole.  It’s that simple.  Our grandparents and great grandparents did why can’t we?

You don’t need to be 100% in agreement with my summary of the current situation to find value in the ideas that follow.  You only need to be partially in agreement.  If you think my summary assessment is all bunk and a few more QEs, interest rate twists, bailouts and tax hikes will solve everything then don’t bother to read on.  The framework I’m setting for the planning environment will be too far off from your own assumptions and frameworks for it to make sense.  If you do resonate with at least some of the framework established above read on.

Financial planning in the current reality:
As Einstein once said “make things as simple as possible, but no simpler”
It’s easy to over complicate financial planning but it’s also easy to over simplify it.  “What’s your number needed for retirement?” is way over simplifying it.  Giving up trying to figure it out yourself and going to “an expert” who will quickly explain to you how complicated it is and that only they can therefor manage it for you is the other end of the spectrum.  After trying all the available Retirement planning applications out there and determining they were all junk I recently decided to tackle this myself.  With the aid of Excel and a few other useful online tools I set off on the journey. The following is what I learned that I think the rest of you might find useful and interesting.

Start with the obvious:  Where are you now?
The first step is to build a simple high level current balance sheet for your family financial situation.  This is not hard but I continue to be amazed how many people have not done it and therefor really have very little sense for their current situation.  Don’t let the common excuses get in your way;  It takes too long, I really don’t want to know or I’m confident I’m just fine so why do the work to find out what I already know?  I contend that not truly knowing your current situation leads to vast amounts of hidden stress accelerators.  More on this later.  If you can’t generate at least the simplest balance sheet for your family financial situations you will never be confident enough in where you stand to put these stress accelerators to sleep for good.
The following are the steps to building your current balance sheet:

  1. List all the things you own worth at least $25K each.  Not what they’re worth (we’ll get to that next), just list them individually by name.  All bank accounts with at least $25K in value.  Don’t need to list the assets in the account just the account name.  401K accounts you might have left behind at various prior employers not yet rolled over.  Don’t include pension plans that pay out in the future over time.  These will be factored in later.  All real estate.  Cars, boats, anything that you can drive.  Collections; Art, wine, coins, etc.  Any loans you’ve made to friends or family directly that you expect them to pay it back.  Private investments you might have made directly in a business.  Think carefully.  Have you stored anything away in remote storage?  Is someone else using something that you own and have forgotten about?  Have you inherited anything you have forgotten about?  Don’t include anything you think you will inherit in the future (we’ll deal with that later as well).  Lastly, include the “other” assets which is anything else that falls below the $25K threshold.  Obviously, the number of items on this list is dependent on your family situation but it should not be a big long list.  Nor is accuracy down to the pennies important.  Just think of the “big” things.  If you need to move the $25K threshold up or down go ahead and do it to match your situation.  As a rule of thumb for deciding what threshold to use I suggest taking .002% of what you would roughly estimate your net worth to be without any analysis.  The point of the $25K threshold is to make this a high level process and save you bunches of time.  Trade off a little accuracy for lots of time saving.  Note if you lease anything you don’t actually own it so don’t list it.
  2. Next, next to each item estimate its value.  Bank accounts with assets priced to market this is easy.  Don’t worry about the individual assets in the account just list the value of the account next to the account name.  Estimate the value of each real estate holding.  Be realistic here.  We want the value of what you think someone would pay if you sold it today.  Use Zillow if you like but just for a frame of reference.  Don’t use what you paid for it.  Don’t use what you think it might be worth when you plan on selling it.  Don’t use what you wish it was worth.  Use what you really think someone would likely pay for it today!  Same goes for cars, boats, Pianos, etc.  Collections may be a bit trickier.  Make your best guess.  Don’t go look up every piece of art at Christies auction house.  Don’t look up every coin at Numismatic.  Don’t look up every bottle of wine at  Make your best guess but be realistic.
  3. Add it all up and see what you get.  This is the “Gross” value of all assets you own.
  4. Next, list all debt outstanding.  All mortgages, car loans, credit card debt, student loans, personal loans you might have with family members where you borrowed money from them and plan on paying it back.
  5. Now list the principal balance of each loan next to the name of the loan and add it all up.  This is your “Gross” liability total.
  6. Now list all your estimated transaction costs to sell each asset.  For real estate use 6% of the estimated value.  For collections use what you would estimate the sales commission to be if you sold through auction or however is considered the standard way of liquidating the type of collection you have.  Same goes for debt.  List any prepayment penalties you would incur if you paid off the loan today.
  7. Lastly, list any tax obligations you would expect to owe on appreciated assets.  This is very specific to your situation so I’m not going to try and give you a one size fits all formula.  Be realistic here.  This can have a very large impact on the final calculation.  If you’re carrying large accumulated loss carry forwards from previous tax filings apply them here to get a net tax figure.  Use current tax rates to figure this out.  Where tax rates are heading in the future we will deal with later.
  8. Now do the math.  Excel helps here.  Take the Gross Assets minus the Gross Liabilities, minus the transaction costs, minus the tax obligation (might be zero if you have enough accumulated loss carry forward credits, but can’t be negative).  See what you get.  This is your net worth as of this minute today.

Now it’s time to go on and do the analysis needed for you to know whether to feel good about this number or concerned about this number.  If you don’t plan on doing the following analysis don’t bother doing the former.  The emotional reaction or feeling you have when you see the results of your net worth analysis can be very dangerous if the following context is not added to it.  As I am, all of you are faced with almost daily decisions as to “can I afford X?”  The answer to this question is often wrought with emotion because we really don’t know the answer definitively.  The answer is usually “well I don’t really know” or “it depends”.  Conflict between family members arrises most often when one person has one emotional feeling towards the answer to this question and another family member feels very differently.  Neither feeling is based on any math, just emotion.  Just a gut feeling so to speak.  One family member may be saying to themselves “look at the life style we lead, of course we can afford to donate $5,000 to the school fund raiser”  and the other family member can easily be saying to themselves “if you only knew what I know about the future economy, the likelihood our kids will find jobs, etc.”.  With no real scenario analysis to fall back to this discussion becomes emotionally charged very quickly and leads to another major stress accelerator.  When considering bigger issues like buying a new house, can we afford private college?, loaning someone money, etc. the level of emotional charge ramps up even more and can lead to big problems.
There are three basic technical approaches you can take when preparing your balance sheet;  Paper, pencil and calculator, Excel or Mint.  Mint is a free online service offered by Intuit (they bought the company a few years ago) which allows you to enter in manually all your assets and liabilities or allows you to enter the login and password information for all your accounts and it will automatically retrieve the needed information consolidate it all and give you a balance sheet report.  In most cases a combination of login and password info to your online accounts plus some annual entry of other assets you hold will be required.  Mint can be found at .  I was able to completely replicate my Excel method in Mint with about 3 hours of work.  Yes, only I would take the time to do both.  In fact both will be needed to complete the process as the Mint retirement planner is no better than any other one out there.  Useless.

The analysis of how your finical life may play out:
Income side of the equation:

  1. Step 1 – Future salary income.  By the time you have reached this age demographic you have a pretty good sense for your potential to earn money going forward.  When you’re 21 you have no idea.  But when you’re between 35 and 70 you have a pretty good idea of your earning potential.  Using Excel, simply estimate between you and your spouse how much you expect to earn for the remaining years you expect to work.  If you expect to retire but remain active and collecting some income, taper it off over some number of years as you hit the “retirement” age.  Focus on Gross earnings.  We’ll deal with taxes later.  Include all sources of earned income.  You may have a primary job and some consulting on the side or board positions on the side.  Include these all in your summary.  Use big round numbers.  don’t get caught up in trying to be really precise each year.  If the final analysis does not yield the outcome you might be dreaming of you will come back here and extend the retirement date or in some cases maybe move it up (this didn’t happen to me).
  2. Step 2 – Other sources of income/gain.  Estimate the other sources of income/gain each year looking out until you turn 90 (or whatever age you feel you will live to).  This includes any source not related to your job.  These are sources that are presumed to continue  past your retirement point.  These can include investment income (Bond coupon payments or Stock dividends), investment appreciation (I would caution against using any assumption more than a few % points here), rental profits, etc.  We’ll treat anticipated inheritance proceeds later.
  3. Step 3 – Social security and other pension income.  You get these reports every year.  They tell you exactly what you can expect in annual payments based on when you retire. Plug the numbers in.  We’ll deal with the “discount factor ” later.  The “Discount ” factor is the likelihood you’ll actually receive all or some portion of this money.
Taxes on Ordinary income
  1. Lets just assume 50%.  In the highest tax bracket that’s a pretty good assumption for now when you add federal, state and local income taxes.  Might be a little big but not by much depending on what state and city you live in.  Your guess is as good as mine where this rate will go in the future.  I can tell you with great confidence it’s not going down anytime soon.
  2. As you will see I assume little to no income from traditional capital gains sources so no need to distinguish between ordinary and capital gains rates.  I hope this is not the case and we do start to see ways to make money from investments held over the long term but lets leave that as upside to our planning process.

Ordinary Expense side of the equation:

  1. Credit Card expenses.
  2. Primary Checking account expenses – These of course include electronic checks and other forms of ePayments.  I hope by now none of you are writing more than a couple actual physical checks each month.
  3. Expenses paid out of other bank accounts – Maybe some direct debit mortgage payments.  Hopefully most things you actually pay for are done through either the credit card (s) or primary checking account.  You may not keep a big balance in your primary checking account and may make large payments out of a separate account.  Maybe tuition payments, car purchase etc.  I would suggest in the future you minimize this approach and make all payments out of either the Credit card or one single checking account.  You can easily transfer funds instantly between accounts so this approach does not sacrifice any interest potential or create any unnecessary risk.  This makes life much easier when it comes to really understanding how much you’re spending.
  4. Add them all up making sure you don’t double count any checks written to pay off the credit card balance each month or funds transferred from one account to another.  All major banks allow you to easily do this online.  Don’t get into the bottom up detail of what you spent money on just work with the totals for now.  Try and do this for the last couple years so you factor out some “onetime” unusual type expenditures that may bias your ability to extrapolate into the future.
  5. Now that steps #1 to #4 have given you good sense for your expense rate currently it’s now time to estimate it going forward.  Don’t get into the minutia.  Stay high level.  Depending on where you land in the 35 to 70 age range you will either be ramping this up then flat then down or you may be running flat for a while then down or you may be ramping it down as we speak.  I have no real specific guidance here.  age 52 is the midpoint between 35 and 70.  I’m 53 and my wife is 49.  Our kids are 21, 18, 16, 13 so we’re still looking at running flat to slightly up for a few more years before any ramp down begins.  Think about your own situation and apply growth percentages from the top down.  Don’t try and get into each specific expense line item and ramp it up or down.  Look at the big ones.  Look at the family payroll (the kids) particularly education expense.  If you have financial responsibility for other relatives factor that situation in at the high level.  Look at your costliest major hobbies.  Are they flat, ramping up, ramping down?

Extraordinary Income and Expense items:

  1. On the income side.  Do you expect any windfall inheritance income?  When and how much (after any applicable taxes).  (Special note:  I plan on covering wills trusts and estate planning in a separate post next week).  do you expect any other income not covered by the ordinary income section above?  Any known gifts coming in?  Do you expect to win the lottery?
  2. On the expense side.  Do you plan on any regular or one time gifts to relatives or friends?  Between you and your spouse you can gift $26K each year to each or your children (or anyone else for that matter) tax free.  do you do this?  do you plan on doing it?  For how long?  Do you plan on helping your kids with their first house, car or wedding?  anything else you are planning on that will cost you significant money that is not considered in the ordinary expense category?

Completing the Income statement:
Now you just combine your income minus taxes, minus your expenses (both ordinary and Extraordinary) looking out until you retire, and  then to when you turn 90 (or whatever age you care to insert) and you will see how much cash you will generate between now and then or how much you will burn.  Add or subtract this to your current net worth balance sheet amount and you can see roughly where you will stand at retirement and 90 years old.  I urge you not to initially make it any more complicated than this.  Remember the Einstein quote.  Being the anal perfectionist and self proclaimed master of “finishing” things, I’ve taken it much further and built a spreadsheet that allows me to vary all sorts of assumptions about investment return, rates of inflation, probability of kids living at home post college graduation, grand kids needing some help, major unexpected illness in family, family business bankruptcy, etc, etc.  It works for me.  It’s an ugly spreadsheet requiring a lot of manual entry to keep it working but it works for me.  I’ve also extended the cash flow concept to planning for when we will sell certain assets and buy others and how this impacts real cash flow.  I’ve added a mechanism for varying tax rates and distinguishing capital gains from ordinary income.  Again, a level of detail not many of you will likely have the patience or time for doing.
Back to the simple version.  Just take your current net worth (liquid and illiquid) add or subtract your annual net income (income minus expenses) each year until you reach your target age and see where your net worth would stand then.  Obviously you make a bunch of assumptions along the way but none the less you get a pretty good  practical picture of where your heading.  Then you can decide with some real analysis behind it how you feel about it.  Should you be making any changes and if so how can they effect the goal.
The following are some questions I found myself asking  along the way:

  1. How much is really enough when I reach 90?  Why?
  2. What sort of lifestyle do we really want to have once the kids are on their own?
  3. What sort of reserve do we need to be truly comfortable we’ve got the major “unknowns” covered.  Here I’m talking about the unexpected medical expense or other financial tragedy that strikes unexpectedly
  4. What or who do I want to provide for with my residual estate?  Money left when I’m gone.
  5. What causes do I care about that we might want to devote significant financial resources to while we’re still around?
  6. To improve my financial picture would I rather work longer or live at a lower standard of living?  Whatever you do don’t go down the road of making riskier investments hoping for the free ride.  Don’t bet on winning the lottery.
  7. What range of “doomsday” scenarios would I be able to survive?  How would I define “survive” in the doomsday outcome?  I try not to think about this one much.

So what’s the bottom line to all this in summary?  In my opinion, not having an analytical framework to help answer the question “Am I comfortable with my financial future?” leaves one to go entirely on gut instinct and emotion.  For those of you who have been reading Thinking Fast and Slow  this is all System 1 based thinking.  On any given day based on how you feel that day you’re answer to this question will swing all over the map.  This leads to increased and unnecessary anxiety, stress and relationship tensions.  I’m not saying it’s “wrong” to have gut feelings about one’s financial condition but it must be followed up with System 2 level thinking to maintain perspective and sanity.  This is  particularly important in today’s rapidly changing and complex world.  Yes, I’ve gone to an extreme many of you think is nuts but some form of this analysis is needed by everyone.