This economic downturn hasn’t been kind to a lot of people.  Jobs that haven’t been taken away from people have had their hours cut, their workload increased, or their cost of living allowances taken away.  Jobs that people used to be able to count on are on very fragile ground.

If this US Debt Clock is accurate, we’re getting a new person on the unemployment roster every 17 seconds now.

What can you count on in this economy?  I think the only thing that you can absolutely count on in this economy is that you can’t count on anything in this economy. Retirements have been upended by plummeting 401(k)s and IRAs.  Nest eggs have been cracked by crashing home values.  Many people, all of a sudden, won’t be able to retire.

It’s foolish to take anything for granted.  There’s far less within our control than we probably realize, and proposed solutions that aim to make things better will almost certainly just make them worse.

When you think about “preparing for the future,” think instead of “hedging against the future.”  How?

• Cushions, cushions. Bolster that emergency fund to buy time in the face of job loss.  Bolster your food supply in case price controls cause shortages.  (Price controls are another solution that will backfire.  Think gas station lines in the 1970s.)
• Diversify your investments. If you’re heavy in anything (or only have a couple of asset classes) look around some more.  And don’t forget to invest in yourself.
• Diversify your income streams. Only have one income stream?  Start working on another!  And then another.  Your one income stream can go bye-bye at any time.
• Retire into something rather than just retire. It would be great if one of your new income streams involves something you really enjoy, and can do well into the traditional retirement age.
• Take care of your health. I’ve recommitted to this. The less you need health care, the better, because it will be more expensive, and you’ll wait longer to get it.
• Pray.

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Sun’s Financial Diary reported that the 2010 contribution limit for 401(k) accounts will remain at $16,500.  The announcement came from the IRS Thursday.  There had been speculation that the contribution limit could be reduced in light of a decreasing CPI (and, indeed, the CPI is down from a year ago.)

Sun ends the post with a question:

Now that there won’t be any increase in contribution limit next year, it doesn’t seem to be a big deal for one year. However, it is a big deal in the long term for those who max out their contribution every year. Just consider this: How much will today’s $500 be worth 20 or 30 years from now?

(Presumably, had the limit been increased, it well could have been by $500, as previous increases had been in multiples of $500.)

The question becomes one of a tradeoff:  Someone who would contribute the maximum allowable by law can contribute only $16,500 rather than $17,000.  This means that $500 more of this person’s investment contributions will be taxable in 2010 than would be the case if the contribution limit had been raised.

The contribution limit gets a lot of attention.  I suppose it’s the piece of the 401(k) puzzle that’s easiest to grasp (after one understands the pre-tax contribution thing).  It’s the part of the legislation that is addressed regularly.  It’s the number that usually gets raised (”We can contribute more!  Hooray!”) except next year it won’t, and some folks — Sun among them — think this is a loss for people saving to retirement.

The question about how much extra income could have been gained by allowing that extra $500 to grow tax-deferred is insignificant.  Why?  Because the money (and accumulated interest and compounded dividends) will be taxed when it’s taken out.  Who knows what the tax rate will be in two or three decades?  Would you want to be taxed now, or taxed later?

Going a step further, the tax tables aren’t the only thing that can change.  Just about all of the rules governing these accounts can change. How will the rules change, and to what extent?  I have no idea, but just because they haven’t changed significantly over their lifetime doesn’t mean they won’t.

So don’t worry about not being able to contribute more to your 401(k).  But I do encourage you to think about whether you’re contributing too much to your 401(k) already.

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Over at the MBN Forums there was some discussion about a short video presentation called Drive Free, Retire Rich over at Dave Ramsey’s website.

The first part of the presentation (up through Slide 11) was very well put together, and showed perfectly the value of buying used over borrowing and buying new.  A synopsis of the first 11 slides:

1. Getting a loan and buying new is a bad way to buy a car because you pay for up to six years, the car loses a big chunk of its value the moment you drive it off the lot, and it’s not what it once was after a few years, but you’re still paying for it.
2. Instead, save up to buy an inexpensive used car, and pay yourself the car payment.
3. After 10 months, sell your used car for (close to) what you paid for it, and upgrade to a better used car using the proceeds and your saved money.
4. Rinse and repeat until you’re driving a pretty nice car, and saving what you would have spent on the car loan for an emergency fund, retirement, etc.

The presentation paints very broad strokes, but the premise is a viable solution to borrowing for a car.  It will be slowed by things like taxes, registration, repairs, etc., but there’s nothing wrong with the method at all.

Then, at the end of Slide 12, the video takes a right turn at Albuquerque and enters Fantasy Land:

At the end of six years, your $11,000 paid-for car has just about run its course.  It’s been great, but it’s time to upgrade.  But hey, that’s no problem:  You’ve got a mutual fund specifically earmarked as a car-replacement fund.  You know how much is sitting in that fund right now?  At the stock market average of twelve percent, you’d have about $32,000.

What freakin’ stock market averages 12%? That’s the ballsiest claim I’ve heard about the stock market.  It’s a full 5% higher than the real return of the S&P 500 from 1950 to 2008.  How they can say that with a straight face is beyond me.  What’s more, the video goes on to make calculations assuming that this rate will hold for forty years.  Sorry, there’s little chance of that happening, unless the 12% includes inflation.  Then I suppose it can happen, but if that’s the case, then the $5-million-plus the video claims we’ll have at the end of 40 years if we follow the plan won’t be enough to retire on.

Bottom line:  Buying an inexpensive used car, paying the car payment to yourself, and upgrading every year or so is a great way to get into a nice car that you actually own.

Just don’t count on a double-digit stock market for the next 40 years to pay for your retirement, too.  Please!

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This month’s Wired magazine (subscribe) had a review of a couple dozen rules for tech-savvy folks, and one of them dealt with the subject of hyperopia.  Hyperopia means “excessive farsightedness” and describes people who sacrifice today for gain tomorrow more than most people do.  The negative consequences of hyperopia are lots and lots of regrets; studies show that the  “doing the right thing” like giving up a party to put in a few extra hours of work in turns pretty quickly from self-congratulation to self-flagellation.

Saving as much income as possible in order to cover future needs can turn into hyperopia as well.  As Lazy Man and Money said in that article, it’s “not very fun” to be brown-bagging your lunch, drinking water, and staying home all the time just for the sake of building up the bank account “for someday.”  If the studies are to be believed, “someday” will likely be filled with a lot of empty memories and a lot of regret.  So, if one is to avoid this, the solution is easy:  spend money on fun stuff, today.

I know that sometimes I get concerned about not doing more family getaways to see The Mouse and wonder about what other things in life my family and I are missing.  But I also have a healthy fear of where things are going, and a few thousand dollars can go a long way to alleviating fear if invested correctly.  I’m certainly not so concerned that I want to put a vacation on credit, and I hope you’re not, either.  (Maybe it never crossed your mind.  Good for you!)

At the end of the day, there are more important things to do anyway, like building a legacy and fulfilling a calling.  Once those are clearly defined, working toward them is its own reward, and regret falls by the wayside.  Time, and money, that’s spent working toward the most important thing you can do is never wasted, but getting into debt usually postpones the time that you can start working on your calling.

The bottom line, then, is to figure out what are the most important things you want to accomplish with your life, count the cost, and begin working.  Then, the decisions you make about your time and money aren’t a matter of work vs. fun.  They’re a matter of unimportant vs. important, and hopefully there’s no regret involved in channeling resources toward important things instead of unimpostant things.

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“For which of you, intending to build a tower, does not sit down first and count the cost?” Luke 14:28

First off, Happy Independence Day to my American readers.  Happy July 4th to others.

Gary North’s Tip of the Week (subscribe for free in the upper right of this page) was on outsourcing.  He doesn’t plan to ever mow his lawn himself, because the net cost would be a loss.  He values what he can accomplish in those couple of hours higher than what it would cost him to have someone else mow his lawn.

The answer is easy for him because counting the cost for him is easy.  But what about for people who aren’t as productive now?  Do you outsource in that case?

Counting the cost is more complicated in this case.  Mowing your own lawn, making your own meals, clipping coupons, hitting yard sales, and the like are little money-saving things, but they all take time, which is irreplaceable.

Some questions that might be good to ask if the answer isn’t clear what to do:

• Do you have a clear vision where you’re going? If this is not the case, counting the cost really doesn’t have much meaning anyway.  No one can answer this except you.  Aside from just not having one, another indication of lack of clear vision is having a lot of projects that aren’t really going much of anywhere.  It is time to cut out the losers.
• Are you having trouble making your bills? If this is the case, then a good use of your time is making the money, and reducing expenses, to keep on top of your bills.  Not doing so has clear costs:  late fees, higher interest rates both for not making payments and as the result of a low credit rating.  If these things happen, they will postpone the grander legacy you have in mind.
• Are you in fair shape financially, but not good enough shape that you don’t really have to worry? This is where it gets trickier.  You can free up more time by paying to get things done that don’t directly contribute to your legacy.  The more of these activities you pay for, the more you can accomplish with the finite amount of time you’re given.  But, the more this costs — there’s the rub.  Do you sacrifice the appearance of present financial security to go full-bore at something great, or take up some of that time keeping a good financial cushion and work your legacy more slowly?  This brings about lots more questions, like whether your family is behind you, what other expenses or commitments are down the road, etc.  A silver lining to the recession, by the way, is that hiring out some activities now can be cheaper because business are hungrier for work now.

Happy cost counting!  Here’s to moving in the right direction.  Half the year is ahead of us!

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Liz Pulliam Weston wrote a nice article recently describing nine money priorities.  She lists them from top priority on down:

1. Pay your bills
2. Save $500
3. Start saving for retirement
4. Pay off “toxic” debt
5. Bolster your emergency fund
6. Check out long-term disability insurance
7. Enhance your retirement savings
8. Start saving for college
9. Save for spectacular expenses

I emphasized #3 and #4 because she thinks that starting to save for retirement edges out paying off debt.  Sensing backlash, she defends this position:

You may be surprised to see retirement so high on the list. Surely your credit card debt and your kids’ college educations are more important.

Except they’re not. You have only so many working years to set aside enough cash to last you for the rest of your life, and any delay in getting started will cost you big time. Waiting just five years to begin can reduce your total nest egg by as much as 30%.

Retiring (or not retiring) is about money, not about age.  If you reach age 55 (or 65, or 75, or 80) and don’t have enough money to support yourself, you won’t be able to retire.  Fill out an application to hand out yellow smiley stickers while you wear a blue vest.  Socking away money at 8% annual return (ha!) does you absolutely no good if you’re paying 17.99% APR on a credit card.  If the interest you’re paying out is outstripping the interest and dividends and appreciation you’re getting with your investments, you’re falling behind.  Filling up a leaky bucket just means you’ll be thirsty later.

There are a couple of instances when it might pay to follow this advice:

• You get a match with your 401(k). If you contribute to your 401(k) only to the point for which you get a maximum match from your employer, then this might offset putting off your debt repayment.  It’s free money.  But if your employer doesn’t match your contribution, forget contributing until your consumer debt is paid off.
• You have low fixed-rate mortgage debt. This debt is a good inflation hedge.  Gosh, if you have a rate under 5%, you’re golden.  Pay that one off slowly, and put what you want into retirement savings.  If there’s a chance that your rate will increase, pay it off ASAP before funding retirement.

Otherwise, I really don’t seen the merit of saving for retirement until you get rid of the high-APR debt.  But maybe it’s a psychology thing.

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This morning in Sunday school someone threw out that a substantial fraction of Americans have a lottery win comprising their retirement plans.  (”How did we get to talking about gambling in Sunday school?” you might ask.  It was just a chance discussion, that’s all.)

I just shook my head at that statistic.  I figured it wasn’t far from the truth, but looked around a little bit to verify.  This three-year-old article over at the Motley Fool cites a survey survey by the Opinion Research Corporation for the Consumer Federation of America that found about one-quarter of those surveyed thought that winning the lottery was the most practical way to amass $200,000 or more.  (Here is a summary of the survey.)

Since I’m a math-oriented guy, I thought it’d be neat to figure out the return on “investing” in Powerball® tickets.  Tickets cost $1 each.  The odds of winning different prizes, plus the average payout for each prize, are as follows (PB = red Powerball, W = white ball):

The five white ball + red Powerball win is the Jackpot. This varies from week to week and I calculated the payout by taking the sum of the cash payouts for all the Jackpots in 2008 (a little over half a billion dollars) and dividing by 104 (two drawings per week).  The payout is about 20 cents for each dollars’ worth of tickets bought, or a return of minus 80%.  (Add a few percent perhaps if you take the annuity.)

The loss gets a little bit less if you chip in an extra buck per ticket to get the Multiplier.  Each week the Multiplier is 2, 3, 4, or 5; the chance of each multiplier showing up is 25%.  If a winning ticket is a Multiplier ticket, then the payouts (except the Jackpot) will be multiplied by the Multiplier.  These tickets cost twice as much, but the average Multiplier is 3.5, which means that the payout of the first eight prizes is multiplied by 1.75.  This ends up being a loss of “only” 67%.

Ok, that’s pretty a bad return, as one should expect: the average lottery player should get taken for a ride.  But how did the Standard and Poor’s 500 Index do last year?  It was pretty bad, too.

The S&P was 1,411.63 on January 4th, 2008.  It was 931.80 on January 2nd, 2009, a loss of 34%.

So, investing in the S&P 500 was (on average) better than putting an equivalent amount of money into Powerball tickets.  But certainly our investments can aspire to better things than just outperforming the lottery, can’t they?

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This Michelle Singletary column on the Washington Post website has answers to a few readers’ questions regarding debt and debt reduction.  The first question outlines a situation that stings a bit.  Here’s a summary:

• Husband has less construction work coming in; takes lesser-paying jobs to bring in something.
• Couple cuts budget but is still short $250/month, which is depleting their savings.
• She contributes to her 401(k) only enough to get match from employer.
• Question: Give up the free money to shore up the shortfall?

Ms. Singletary’s answer is yes, do this until the employment situation improves, even though it hurts to give up the free money.

I have to agree with this.  I’d go for one more round of cost-cutting before throwing in the towel, or cut as much as I could but just reduce my contribution so that I’d still get some of the match, but yeah, money more or less locked away in a 401(k) doesn’t do much good when the credit card balances start going up.

I think this would especially hurt someone who had been doing the right thing and taking advantage of matching money from their employer.  Plenty of people just let this money float right by them down the drain each and every paycheck.  (Just to set the record straight: I’m not completely sold on maxing out 401(k) contributions, but getting as much as you can out of your employer in matching money is usually a good idea.)

Keeping your income streams flowing is key, just as doing little money-saving things.  Investing should be used with excess funds, and if there are no excess funds, then there should be no investing, for retirement or otherwise.  And if there’s debt to be reduced, then this is even a stronger reason for not investing.

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Pretty much any good personal finance resource you run across will talk about this:

Spend less than you earn.  All this means is that your expenses (everything that leaves your wallet) are less than your income (everything that enters your wallet).

If you’re spending more than you bring in, you’ll have to borrow the difference.  Each month, interest must be paid on the amount borrowed.  If you continue to spend more than you bring in, the amount owed to the people who lent you the money will increase, and the payments back to the lender will increase as well.  Eventually, so much of your income will be dedicated to repayment of debt that there will be nothing left over to live on, and you’ll be forced into bankruptcy.  You may be able to borrow again eventually, but the interest rates will be much higher.  For a while, you may not be extended credit at all.

Is it clear that this is not a good thing to do?

On the other hand, if you’re spending less than you bring in, you’ll be saving the difference.  These savings can be used for an emergency fund.  They can be used to buy a car.  They can be used for a down-payment on a house, for college expenses, and for retirement expenses.  By living within your means, you can make your money work for you, rather than the other way around.  The larger the percentage of your income that you save, the bigger your savings will end up being, and the more conservative you can be with your investments.

If this sounds really straightforward, it is.  However, straightforward doesn’t necessarily mean easy or even fun.  Not only must you not spend the money initially, you may need to put it in a strong piggy bank in order to continue not spending it.  Spending less than you earn consistently means having lots of financial discipline, monitoring your expenses and adjusting your budget, putting small windfalls or stimulus checks to work rather than blowing them, and resisting the temptation to borrow in order to look rich.  If you’re married, it means being on the same page with where things are headed.

If it were easy, everyone would be doing it, and the would be a lot fewer people in danger of working at a job they don’t like until the day they die.

I mentioned in the introductory post to this series that one main reason I’m writing these posts is to remind myself of solid personal finance, so I hope to be able to learn from my own advice occasionally.   My biggest shortfall remains that I don’t budget and monitor our expenses carefully enough.  As a result, some expenses slip through the cracks and bigger expenses occasionally blind-side us, making things a little tighter than they usually have to be for a few weeks.  Part of this too was adjusting first to marriage, and then to having a daughter; spending less than we earn is more difficult than it was before these things happened.

Financial independence rests more on living within one’s means than it does with bringing in a big salary.  A big salary makes it much easier to save, but it doesn’t guarantee it.  Even the wealthy have to live within their means or they will soon not be wealthy.

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I was chatting with one of the members of my credit union’s supervisory committee after our meeting today.  We had just talked with the CEO about the ongoing banking bailouts, buyouts, and other assorted taxpayer deficit bonanzas, and we all recounted stories of investments becoming worthless amidst company bankruptcy.

Then my friend’s tone shifted, and he said that his frugality was among the best return on investment he’s gotten.  Let’s look at a few aspects of this:

• He kept a job for many years and has a pension.  This by itself isn’t frugality — and many fewer people have pensions waiting in the wings now — but the analogy can be made for making regular contributions to retirement accounts.
• He drives a 25-year-old car.  He’s just to the point of absolutely needing another one.  "It’s only after five or ten years that a car will ’start paying you’" because the cost of ownership tends to be less after a while than it is at the beginning.
• He has lived in inexpensive housing.
• He eats in a lot.  Eating in restaurants is usually much more expensive than preparing food at home.
• When he does eat out he makes the entree stretch for two meals.  It usually can.
• He’s sensitive to prices on utilities like phone and Internet.
• He cuts his own hair.

He had suffered his own share of investment losses but spending less than he’s earned — and being used to a lifestyle that continues to let him spend less than he’s bringing in — is what lets my friend do as he wishes with his time in his retirement.

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