Money Listens

Have you heard of the 80/20 Principle?  It’s a great, quick, down and dirty way to live.  You can use it in absolutely any situation.  It works 80% of the time, and the 20% of the time it doesn’t work, it doesn’t really matter whether it works or not.  Here are some situations where I find it incredibly useful in my daily life:

1.   Meal Planning.  Kids like 80% of the food available in the world, but only 20% of what you cook.

2.  Time Management.  80% of your time is spent avoiding what you could do with the other 20%.

3.  Cleaning.  It takes 80% of your time to clean it, but only 20% of your time to mess it up.

4.   Cell Phones.  80% of your time is spent talking to the 20% of the people you don’t want to talk to.

5.   Stuff.  You use 20% of your stuff 80% of the time.  (This is actually a valid example of the 80/20 principle).

6.  Cable/Satellite.  You watch 20% of the channels 80% of the time.  (I’m guessing at this one, because I don’t have cable or satellite).

7.  Food.  80% of your calories come from 20% of the food you eat, mostly Frosted Flakes and chocolate.

8.  Starbucks.   80% of your drink is 20% froth.

9.   Babies.  80% of all girl babies are named Emily.  The other 20% have names that are spelled funny.

10.  Money.  Save 20% and spend 80%.

Don’t know much about history

Don’t know much biology

Don’t know much about a science book

Don’t know much about the French I took

Sam Cooke wrote the song “Wonderful World” in 1960.  Go ahead, take a minute and hum along.  I’ll wait.

How much do you remember about your history or biology classes?  Maybe it doesn’t make much difference.  Did you even have a class in finance or money management?  I never did.  Does it really matter if we know much about finance?

Last week I wrote that we’re basically on our own when it comes to managing our money. How do we know if we’re OK on our own?  How much do we really need to know?  A Dartmouth economics professor, Annamaria Lusardi,  has developed a simple test to determine if you’re financially literate.  Don’t worry, it’s only 3 questions and nobody has to know your score.

Here are the questions:

1) Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
a) More than $102
b) Exactly $102
c) Less than $102
d) Do not know

2) Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account?
a) More than today
b) Exactly the same as today
c) Less than today
d) Do not know

3) Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.”
a) True
b) False
c) Do not know

If you answered all 3 questions correctly, congratulations, you are financially literate.  If you missed 1 or more, or didn’t know, you need some more financial education.  Even if you answered all 3 correctly, you need to keep learning to stay one step ahead of all the traps the banks and credit card companies are setting up for you.  Just keep reading this blog.

The answers?  A) More than $102,   C) Less than today, and   B)False

Read more about financial illiteracy at the Freakonomics blog from the New York Times.

The stark truth about managing our money these days is that we are mostly on our own.

This was the first line of a column in the New York Times a few months ago and it has stuck with me.

In our parents’ days, managing money was easy.  My mom and dad had  one checking account and one savings account.  Later in life they had a credit card, but used it mainly for traveling.  If they wanted to buy something and didn’t have enough in the checking account, they saved up for it.  My mom put clothes on “lay away,” and even had a “Christmas Club.”  That’s a savings account for Christmas.  My mom would put in $25 a month.  Usually, she would get a calendar or some small promo item in January.  You couldn’t touch the money until November.  At that time you got your shopping money, with interest, and a Christmas tree ornament.

When my mom got a credit card, that took the place of the Christmas Club.  Unfortunately, it was backwards.  She would charge the presents, then spend the next few months paying them off.  Instead of earning interest, she had to pay interest to the credit card company.  Which way sounds like the better deal?

Mom and dad never got into debt or had trouble managing money.  At that time there were no sub-prime or zero down mortgages.  The banks made sure people didn’t buy more house than they could afford.  Everyone had a down payment and a fixed rate on their mortgage.  If you didn’t have the cash, you didn’t buy it.  And nobody had a house over 2,000 sq. ft.

Retirement was also simple.  My dad worked for the U.S. Dept. of Agriculture his entire career.  Who does that anymore?  He got a pension when he retired, and my mom got survivor benefits when he died.  Plus, he got health insurance during retirement.  And social security.  Retirement planning?  There was no such thing.  Maybe for rich people that owned their own business, but not for ordinary people.

College planning?  If your parents couldn’t pay, you worked your way through.  Maybe you took out a $1,000 loan.  No college student had a new car.  Or a credit card.  I was 27 years old before I got my first credit card.

Those were the good old days.  At least when it came to managing money.  Today we are on our own.  I heard someone say it’s as if you’re sick and go to the doctor and your doctor hands you the x-rays, blood work, and lab results, and says “here you go, you’re pretty smart, I’m sure you’ll figure out what to do.“  We feel lost and out of our league.  It’s all so complicated, this money stuff.

So, what do we do?  Even if your doctor prescribes treatment, it’s up to you to follow  through.  To stay healthy you have to monitor what you eat and how much you exercise, take your medicine, and listen to your body.  You have to develop good habits and give up bad habits.  You’ll probably read up on whatever area you need help on, and ask friends for advice.

Money-wise, it’s pretty much the same thing.  Even if you have a financial planner, you still have to implement the plan, work on a budget, check the fine print on your IRA, and read up on the various types of checking and savings accounts.   But a multitude of resources are available to you that weren’t available to your parents.  Take advantage of the internet, the library, and your own bank. Take a class and read some books.  Talk with your friends.  Maybe you’ve gotten into debt or made some less than stellar investment choices.  There are so many resources to help you turn things around– to develop  good saving habits.  Though you’re on your own, you’re not alone.

When I took Dave Ramsey’s Financial Peace Class he had one lesson on investments.  He was careful to explain that he was not an investment expert.  Most of his advice concerned saving regularly and putting money away in IRAs and 401(k)s.  But several times he said that his investments in “good quality growth mutual funds” were returning 15% annually, and you, too, should expect that.  Probably at the time he wrote that lesson, which was during a very good stock market run, he was getting those returns.

Today, he might admit to being a victim of what’s called recency bias.  That means you look into your crystal ball and see recent events continuing into the future.  The most recent events carry more weight than those in the more distant past.

This happened to me in one of my first jobs.  I had a very good month; a difficult project finally came together, and my numbers were really high.  My annual performance review was the next week and I was expecting a great review.  But my manager didn’t just focus on the last month.  The 11 months before that weren’t so good, and the one good month probably kept me from being fired.  Recency bias caused me to be overconfident.  The next year I learned about another force called reversion to the mean.  An extreme event is temporary and the next event is likely to be closer to the average performance.  My extremely good month was followed by several more mediocre ones.  I didn’t last much longer in that job.

Reversion to the mean also explains why Manu Ginobili can have a very poor performance in one game and his teammates are confident he will have a very good game the next day.  If his average is 19 points per game, and he only scores 6 one night, he likely will revert to the mean and score 19 the next night.

What does this have to do with your investments?  It means that you can use the long-term averages for different types of investments to forecast the return of your particular portfolio.  If you have a diversified portfolio of  U.S. stocks, international stocks, and bonds, you can estimate the return for each category. You won’t be susceptible to recency bias and assume that a particular investment will always be going up (or going down.)  You won’t sell your bonds and buy foreign stocks if the internationals have an up year. And you’ll realize that if one part of your portfolio has done extremely poorly, it will probably revert to the mean and perform as expected the next few years.   And after what we’ve experienced so far this year, any reversion to the mean will be welcome.

Next to our home and cars, food is the biggest bite out of our budgets.  Since we’re always going to the grocery store, we’re always complaining about how much food costs.  Just how much is reasonable to spend on food anyway?  When in doubt, the IRS has the answer.  Yes, that Internal Revenue Service.

If you’re delinquent on your taxes and want to work out a payment plan, the IRS will allow you amounts to spend on various necessary items, then the rest you pay back to them. The IRS allows a family of 4 to spend $752 per month on food and another $74 on household supplies, which are laundry and cleaning products and paper goods. This is a whopping $826 per month.  This is for all food, including eating out.  (We hope if you’re  behind in your taxes that you hold down the restaurant visits).

Are the IRS numbers in line with what Americans really spend?  Fortunately for us, the U.S. Bureau of Labor Statistics stays on top of this stuff.  The “average” family income in 2006 was $43,799, after taxes.  For a family of 4 people, $552 per month was spent on at home food and household supplies.  This included laundry and cleaning products, but not pet food, shampoo or drugs.   If you have 2 dogs and 2 teenage girls and include dog food and “health and beauty aids” in your grocery budget, this number can go way up.  Believe me, I know.

Low income families, the bottom 20%, with $9,969 yearly income spent $331 per month for 4 people. That’s somewhere in the neighborhood of 20% of income on food.

The top 20%, with the highest income of $141,738 spent $1,097 per month.  Think raspberries in January and wild halibut.  Or imagine doing all your grocery shopping at Whole Foods.

The bottom line?  American families spend between $331 and $1,097 for food and household supplies.  The national average is 9.9% of income.

Your costs could vary.  A lot.

So, how much should we spend?  You have to decide that on your own.  If you’re into organic and natural foods you’re going to spend more.  If you buy a lot of convenience foods or have teenage boys, you’re going to spend much more.  If you shop around the store’s perimeter and buy mainly fresh fruits and vegetables in season and what’s on sale, you’ll be about average.  Or not.

See the statistics for yourself at these websites:

http://www.irs.gov/businesses/small/article/0,,id=104627,00.html

http://www.irs.gov/businesses/small/article/0,,id=104627,00.html

http://www.bls.gov/cex/2006/Standard/quintile.pdf

When I was I kid I loved going shopping for school supplies.  Holding the list, checking off the items– it was one of the few times I got to make choices of my own. Did I want a blue pencil box this year?  The highlight was the lunch box.  Snoopy and Woodstock were fun, but would I be cooler with Charlie’s Angels?  I felt sorry for some of my friends.  Their moms would confiscate the supplies until the first day of school.  I was allowed to unpack them in my room.  I would cut the scissors out of the plastic, write my name on all the notebooks, and organize everything in one shoebox.  It was amazing that I had my own Elmer’s glue, my own Scotch tape, and one dozen brand new Ticonderoga pencils.

I have no idea how much my mom spent on school supplies.  We really didn’t buy much.  But I remember what I spent for my 3 kids two years ago– $108.00.  I remember because it was a big shock.  And it wasn’t everything they “needed,” some items we couldn’t find at that store.  Since then I’ve looked for ways to save on school supplies.

You’re not going to believe this, but the “back to school” ads hit in Sunday’s newspaper.  It’s barely the middle of summer, but all the gardening supplies have been cleared out, and the shelves are stocked with paper, notebooks, and highlighters in a hundred different colors.

Here are some tips for keeping costs down.

1.  Look around the house.  Did you save the scissors or rulers from last year?  Do an inventory of any supplies that can be used again this year.  Check those off the list.  You did download the list from your school’s website, didn’t you?

2.  Don’t let the kids go shopping with you.  If you do, they’ll talk you into the $2.00 neon plastic ruler instead of the $.49 one.  If you’re like me and have fond memories that you want your kids to enjoy also, buy most of the stuff yourself and let them choose a lunchbox or pencil case.  Remember that our kids go shopping much more and buying school supplies isn’t as big a deal as it once was.

3.  Pick up items every week that are on special at the grocery store.  Most stores have crayons one week and glue the next.  And buy extra if you know that your kids always need more after Christmas.  If you do a lot of art projects, get as many bottles of glue as you can.  They won’t be this cheap again until next year.

4.  Find a store that has spiral notebooks for $.10 and buy 2 or 3 dozen.  Your kids will complain because everyone else has Batman or Narnia on their spirals.  But they can decorate the front covers with markers and stickers.  And you’ll have enough to last the entire year.  If you like using them for journals and to-do lists, buy a few more for yourself.

5.  Buy at least 6 poster boards per child.  You know how your kid tells you at dinner that he’s got a poster project on recycling due the next day?  He wants you to drive him to Walgreens to get a poster board.   You suggest that since it’s about recycling he should tape some brown paper bags together and use that for a “poster.”  Now you don’t have to have that conversation, you’ll have plenty of poster boards stashed in the back of your closet.  If you really go through them, Sam’s Club online has a package of 25 for $8.88, including shipping.

6.   Stock up on what your kids use the most.  If you have elementary age kids, they will devour markers and crayons.  High school kids need vast quantities of index cards and mechanical pencils.  Everyone seems to need folders.  They are so inexpensive at this time, buy 2 or 3 dozen.  Make sure they have prongs.  You might want the plastic ones if you kids are hard on paper folders.  If you have the storage space, stock up when you find a good price; you can use the items for more than one year.

7.  Don’t buy inferior quality items.  Some of the dollar stores have pens that barely write and pencils with erasers that don’t erase.  Stick with name brand items unless you’ve used a brand before and are satisfied with the quality.  I’m partial to the Dixon Ticonderoga pencils, they are a pleasure to use and really help young kids with writing.

8.  If you need office supplies for yourself, buy those at this time of year.  Most stores have “dorm room” collections with great prices on desk lamps and organizers.  But don’t buy them unless you need them and were planning to buy them.  Some of these items can make great birthday or Christmas presents.

9.  If you start shopping now, you will be able to buy school supplies at your normal shopping trips.  Just pick up whatever items are on sale that week.  It isn’t worth going all over town to several stores, but over the course of the next few weeks most of the items you need will be on sale at places you regularly shop.  You can plan a trip to a store like Office Max for the other items on your list when they have a good sale.

10.  If you kids must have a particular binder or item that is more than you want to pay, tell them you will give them the cost of the plain item and they can add their own money to make up the difference.

Buy some extra supplies and drop them off at your child’s school.  There are always kids that don’t have school supplies.  Isn’t that one of the reasons we want to save money, so we can afford to share with others?

For all the cows you’ve loved before…

Friday, July 11, 2008 is Cow Appreciation Day.  Anyone who dresses like a cow gets a free Combo Meal.  Go for breakfast, lunch, or dinner.  Or all three.  Even if you’re not up for a full body costume, just wear a mask or spots and get a free sandwich.

It’s time to say thank you to all those cows who do so much for us all year long.  Where would breakfast cereal be without cows?  Today is their special day.  And it can be yours, too, with a little creativity. And did you know Chick-fil-A has some of the best cole slaw?  But the waffle fries are my favorite.

Visit Chick-fil-A’s website for tips on making your own cow costume.  And this could be you:

High school is over, college is next.  Your freshman has her sheets and towels, mini-fridge, panini maker, first aid kit, shower caddy, and about 350 lbs. of “must-have” stuff.She’s registered for classes, signed up for orientation, sent her roommate 500 text messages, and has “class of 2012″ on her Facebook.  (Let’s hope she will graduate in four years.)What else is on the college to-do list?  How about money stuff?  She’s going to be using money in college and needs to tell it where to go and what to do.

1.  Bank Account

Where is she going to bank?  She has a checking account and ATM/Debit Card with a local bank.  She needs to open a checking account at a national bank with a location at home as well as a location within walking/biking distance of college.  Most banks have no-fee student checking accounts.  Find out about ATM fees and overdraft charges.   A parent can be a joint holder in order to regularly transfer an allowance, or in a time of emergency.  Make sure she knows how to balance a checkbook and stuff like how long it takes her paycheck to clear after she deposits it.

2.  Credit Card

She will be bombarded with offers to open credit card accounts.  Make her swear not to do this.  Her ATM/Debit Card will be branded with VISA or MASTERCARD, and will be all she needs.

3.   Paperwork

She needs a filing system with folders and a place to keep them. Go ahead and make some now.  Even if most statements and bills are online, there’s still plenty of paper around.  Especially financial aid forms and notices from the school.  Does she know what types of paper she must keep?  What about receipts and warranties?  She also needs to keep her social security card, passport, test scores, health records, payroll stubs, and important papers somewhere.   And under the bed doesn’t count.  Not only does she need to keep the stuff filed, she needs to fill out the forms herself.  And write the tuition check.  And tell her she gets to fill out her own tax return next year.

4.  Spending Plan

She needs a plan for how much money she can spend on eating out, recreation, clothes, Starbucks, gifts.  You get the idea.  If this sounds like a budget,  a rose by any other name. . .   How much will the parents contribute and how much will she be responsible for?  And she needs to keep track of her spending.  Quicken or a spiral notebook will get the job done.  She needs to know that you will “audit her books” at Christmas break.  And you don’t mean textbooks.

5.  Maintance

She needs to know how to take care of her stuff.  If she has a car, what will she be responsible for?  She needs to know how to run the anti-virus programs and backup the data on her computer.  She needs to know to keep passwords safe.  And do laundry.  Ruining clothes is expensive.  She needs to pay her bills on time.

6.  Student Loans

If she is taking out loans she needs to understand the terms, especially what the repayment amount will be.  She must be careful to keep up with the forms and limit her loans to the bare minimum necessary for school.  Loans can get out of hand in a hurry.  She can check out this video on how college students struggle with money management.  http://www.youtube.com/watch?v=JOt3Apl7qBA

7.  Privacy

Does she know not to give out her account numbers or passwords?  Does she have a basic idea about identity theft and scams?  Tell her not to lend money to friends.  And don’t borrow any, either.

8.  Back Up

Tell her you’ll be there for any problems.  Money listens and parents can listen, too.

Investing has its own rules.  When we try to play investing by the rules we’ve always used to run our lives, it doesn’t work.  One of the reasons we’re lousy investors is because we follow the rule “You get what you pay for.”  When you’re buying a car, a computer, or dark chocolate, you generally do get what you pay for.  The more you pay, the better the product.  But not when it comes to investments. You can’t tell whether a financial product is the best one just because it costs more.  In fact, often the opposite is true.

Another maxim we live by is “If you don’t know how to do something, hire an expert.”  In practice, it’s much harder than it sounds.  Just who is an expert?  We’ve all had trouble finding a car mechanic or a plumber we can trust and depend on. How in the world can we find a financial planner?  (Be on the lookout for a future post on how to find a financial planner.)

Listen to your gut.  Trust your instincts. You usually know what is right.  Sure you do.  If you’re playing Clue, you might have a hunch that it’s Colonel Mustard in the Lounge with the Wrench.  So what if you’re wrong.  You’re out of the game and go get another Pepsi.  Are you going to risk your life savings on a hunch?  Okay, I think most of us have this one down.  We don’t rely on hunches.  We don’t guess.  We actually do some research and make the best decision we can.

If Dogbert recommends Index Funds, what are you waiting for?

These cartoons are from Scott Adams’ Dilbert website.  Check it out at www.dilbert.com.  And please don’t mention the words “copyright infringement.”