Two Years Down, Many More to Go!

Credit: Stuart Miles

It’s hard to believe almost two years have passed since we dove into the personal finance world together with a crazy story about considering opportunity costs in terms of junior bacon cheeseburgers. I guess time flies when you're having fun. I have enjoyed 2MuchCents, and I hope you have as well. 2MuchCents.com will close out 2013 with almost 14,000 views spread over 14 countries! For that, I thank you.

A lot of bloggers start strong, but run out of ideas. I admit I have some spells where I battle writer’s cramp a bit more than I would like, but I’m definitely not afraid of topics drying up. Between your questions, your friends’ questions, your family members’ questions, new things I learn and experience, and never-ending changes and developments in this crazy world we live in, I think I could probably write forever. I already have plans in 2014 to post about why you need to save now as opposed to later, how you can keep as much of your family’s money in your family as possible, and why I think you should be a “contrary” investor. I also want to take a close look at index funds, offer some tips on buying a car, do another lighting round (where all I do is answer your questions), and write a short series on how I would advise someone to position themselves so they can retire early. (You’re not interested in retiring early are you?) Despite my plans and future posts already in progress, please know I get the most joy out of directly helping people like you by answering your questions; whether it gives me an opportunity to do a blog about your topic or not.

In case you missed any posts, the five most popular posts of the year were:

1. This Diamond Ring
2. It Happens
3. Last Call
4. The Homemaker Retirement Plan
5. All That Glitters Is Not Gold

I think one more blog post is worth mentioning, My Uncle’s Living Expenses, because I got a lot of in-person comments on that one. After mentioning it again, maybe I’ll get more!

Let me once again thank Mr. Andrew Davis for his tireless edits and content advice. I also need to thank my special lady, Mrs. Lindley Presley, for her continued encouragement, social media guidance, and grammatical expertise. I could not produce 2MuchCents without those two individuals.

Here’s to a healthy, happy, and financially successful 2014!

-Tom

My Uncle’s Living Expenses

Credit: Stuart Miles

Throughout the course of my blog, I have frequently suggested that you take the time to gather some data and take a good, hard look at the sources of your living expenses. The results of such an exercise might be shocking, concerning, enlightening, comforting, or something in-between. Whatever the results, today I thought we’d practice this exercise together as we take a look at my uncle’s living expenses.

Looking at the chart below, you can see that my uncle spends a significant amount of his money in several categories. Now all these numbers are rough, but it looks like around 21% goes to medical expenses, 20% goes toward paying off a note payable (he owes some people some money they gave him a long time ago), and 20% goes toward his security system. I can’t believe more than 60% of his expenses are allocated just to those three categories! Continuing on, I can see that he has some sort of debt, since he spends 6% of his total yearly expenses on interest payments. He also gives around 13% to charities or to people less fortunate than he is, so I guess that’s nice. He’s only spending 3% of his total expenditures on transportation, and only 2% on education. That seems a little low to me, but what do I know? Finally, I guess the other 15% is all meshed together into other, smaller categories of living expenses.

Now be nice to my uncle because I really do think he means well, but I also think he could benefit from looking at the sources of his living expenses as a whole a little more often. When I break down someone's living expenses like this I try to help them figure out where their money is going if they aren’t sure, I try to help them figure out where they can cut back if they need to cut back, and I try to figure out ways to improve their overall financial standing by addressing specific expense categories such as my uncle’s interest payments. As you might imagine, this process can be personal and painful, but it can also be eye-opening.

So if you were my uncle’s financial planner and you knew he was spending too much, what would you advise? Would you solely go after his debt? Would you tell him to cut back on his giving to charity? Would you have him try to cut back on his enormous medical, note payable, and security system expenses? I’m serious, what would you do?

By now, I hope you know I would never share my uncle’s financial information with you or anyone else I am not authorized to speak with. After all, always keeping my clients’ personal and financial information strictly confidential is part of my job. That being said, I was able to share the details of my uncle’s expenditures with you today because you’re related to him, too, and his expenses are a matter of public record. In other words, he’s my uncle, he's your uncle - he’s our Uncle Sam!

I don’t want to wade into the ballyhooing of politics, but I do think some of you might find the pie graph above a little more interesting now that you know it was from a CNN report covering the United States government’s 2011 fiscal year. Switch out my uncle’s “medical expenses” for Medicare, Medicaid, and some children’s health insurance programs, my uncle’s “note payable” for Social Security, my uncle's "security system" for defense spending and international assistance, and my uncle's "charity" for safety net programs, and our government’s living expense picture should become a little more clear. It could just be me, but I imagine clamoring for more military spending or more health insurance versus spending more on education, for example, might give people pause when they look at the government’s federal budget as a whole, and keep them from getting so caught up in an impassioned speech or a fiery, late afternoon news show.

You may have caught on to my ploy from the very beginning, but I hope some of you are a little surprised and maybe even flabbergasted. Sure, take a look at Uncle Sam’s spending and reflect quietly on the sources of expenditures for our country if you’ve never done that before, but let me reiterate that the main purpose of this post was to demonstrate to you the true value and potential impact that looking at your living expenses as whole can offer.

I don’t claim to always have the answers for your budget, and certainly not Uncle Sam’s, but if you take the time to figure out the sources of your living expenses and look at their relative percentages, I bet we could get off to a really good start!

-Tom

The Fiscal Cliff

Credit: papaiga2008

In recent weeks, there have been a lot of people talking about a little something called the “Fiscal Cliff.” Some people seem to be worrying a great deal about it; other people don’t think it’s that big of a deal. I’ve had several friends and readers of this blog ask me about it, so today I thought we’d take a look at this so-called “Fiscal Cliff” our country is scheduled to fall off of on January 1, 2013.

The “Fiscal Cliff” gets its name because of the tremendous tax increases and spending cuts that are currently scheduled to happen all at the same time: the beginning of 2013. Some compare the immediate effect of these substantial tax increases and large spending cuts to jumping off a cliff. Personally, I think it's a better comparison to imagine yourself sitting by the side of a tranquil pool watching a hippopotamus on the diving board that is going to jump when the clock strikes midnight on New Year’s Eve.

This hippopotamus is made up of tax increases and spending cuts. The scheduled tax increases include:

• The end of the Bush tax cuts (if you are in the 10% tax bracket, you’ll be in the 15% tax bracket, if you are in the 25% tax bracket, you’ll be in the 28% tax bracket, if you are in the 28% tax bracket, you’ll be in the 31% tax bracket, if you are in the 33% tax bracket, you’ll be in the 36% tax bracket, and if you are in the 35% tax bracket, you’ll be in the 39.6% tax bracket),
• The end of the 2% 2011 and 2012 payroll tax cut,
• Sharp adjustments in the estate tax rate from 35% to 55% and in the estate/lifetime exemption amounts from $5.12 million to $1 million,
• The end of the distinction between ordinary dividends (now taxed at your ordinary income tax rate) and qualified dividends (now taxed at 15%), and
• The end of the special tax rate on long-term capital gains for investments you've held for more than a year (now taxed at 15%, scheduled to be 20%).

The second part of the hippopotamus is the automatic spending cuts that are scheduled to take place because Congress failed to reach a debt-reduction deal in August of 2011. These cuts will eliminate $1.2 trillion in projected federal spending over ten years, with about half the cuts coming from the defense budget and about half the cuts coming from other government programs like education, air travel safety, and food inspection. Discretionary spending limits are also supposed to be formally capped.

Before we talk about how we get the hippo off the diving board, let’s take a minute to figure out how the hippo got there in the first place. From an economist’s standpoint, when a country’s economy is slowing, or not growing at a fast enough pace, its government can do two things to try to encourage growth: cut taxes and/or spend more. The theory behind cutting taxes is that individuals will have more money to spend in the economy if they owe less in taxes, which will stimulate the economy. The theory behind the government investing more money into the economy is that the increased spending will lead to more jobs, more products, and new growth that will get the economy moving again, and eventually the revenue generated will be worth the government’s initial investment. Our government has tried both of these option in recent years, and people will argue over the results, but either way, less tax revenue and more government spending has caused our national debt to skyrocket.

The funny (or not-so-funny) thing about the “Fiscal Cliff” is that our leaders purposefully scheduled these tax cuts to expire eventually and knew our government could not sustain its recent spending sprees when they provided stimulus. They were trying to do what they could to get our slowly-growing economy going again, but they really can’t afford to try much longer. What I mean, is that the hippopotamus represents the conundrum our government now faces: if they keep the tax cuts and keep on spending, our national debt could turn into a national security issue, but if they allow taxes to return to their previous norms and cut their spending, our economy could slow or even contract.

The “Fiscal Cliff’ is the scenario where Congress does nothing and allows the scheduled tax increases and spending cuts to occur. Essentially, the hippo jumps on New Year’s Eve. Sure, the impact on the economy could be dramatic, but I truly believe the tax increases and spending decreases need to happen to fix our national debt problem. If Congress does nothing and the hippo jumps, it is surgery by chainsaw, so to speak, but it is surgery we need. Some politicians, economists, and people are actually rooting for this to happen.

If Congress does act, other scenarios such as “Fiscal Ramps,” “Fiscal Ladders,” and “Fiscal Ledges” are out there. Under these proposals, some of the tax increases and spending cuts will go into effect, but not all fully or all at once. The theory is that these options would begin to address our national debt issues, but could avoid a possibly huge negative splash in our still slowly-growing economy. Under these scenarios, the hippo is essentially off the diving board and gently getting in the shallow end. Some politicians, economists, and people are actually rooting for this to happen.

I, nor anyone else, know what Congress is going to do (or not do), but I do know our national debt situation is as serious of an issue as our still slowly-growing economy. I don’t know what the short-term impact will be if the “Fiscal Cliff” scenario plays out, but I do know it will finally address some of our nation’s long-term concerns. The short-term impact will be less severe if a slower-instituted series of fiscal reforms is adopted in the next few weeks, but I don’t know how well it will address our nation’s long-term budget deficit. I do, however, believe that the longer Congress and our leaders remain indecisive, the more volatile markets, businesses, and individuals will become with anticipation.

So, how do I tell you all of this and still sleep? Easy - NyQuil. Seriously though, the important thing to remember is that, even if a hippopotamus jumps into a pool, the water will eventually settle. No matter how, if our country takes steps to reform its budget and lower our national debt, our country and our economy will be stronger in the long-term. As an investor and an American, I’m more interested in the long-term.

-Tom

Financial Advice From 1796

Credit: FreeDigitalPhotos.net

Leader of the Constitutional Convention, the commander of the Continental Army, and the first American president, George Washington is considered by many to be one of our nation’s greatest heroes, renowned for his character and leadership. In his 1796 Farewell Address, Washington masterfully articulated his reasons for not seeking a third term of the presidency and offered an eloquent argument for the importance of patriotism and protecting liberty. He also offered some prudent financial advice in a portion of the speech penned as “Warnings of a Parting Friend.” I believe these points still hold true, and I thought I'd share some of them with you today.

Quote #1: “And there being constant danger of excess, the effort ought to be by force… to mitigate and assuage it. A fire not to be quenched, it demands a uniform vigilance to prevent its bursting into a flame, lest, instead of warming, it should consume.”

Washington seems to be speaking about the danger of political parties, departments within the government, and individuals who try to seek more power and riches for themselves. He indicates that the spirit of always wanting more is good to a certain extent (a fire not to be quenched); however, if not vigilantly watched or kept in check and balanced, it could destroy (consume). This lesson can still apply to both personal and government spending and the importance of living within our means.

Quote #2: “As a very important source of strength and security, cherish public credit. One method of preserving it is to use it as sparingly as possible…, but remembering also that timely disbursements to prepare for danger frequently prevent much greater disbursements to repel it...”

Washington appears to be emphasizing how important having good credit is. He was advising the nation and its citizens to be careful how often they use credit and for what purpose. Washington also seems to acknowledge that for a prudent purpose, credit could and maybe even should be used if the benefit ensures stability and offers a hedge against potential risks. These important financial lessons should jump out of history books and into our personal and government spending habits!

Quote #3: “…avoid likewise the accumulation of debt, not only by shunning occasions of expense, but by vigorous exertion in time of peace to discharge the debts which unavoidable wars may have occasioned, not ungenerously throwing upon posterity the burden which we ourselves ought to bear. … You should practically bear in mind that towards the payment of debts there must be revenue…”

Washington warns against going into debt unless the expense is absolutely necessary. In today’s times, many people incur debt to go to school, to purchase a car, or to buy a home, but that does not necessarily mean you should go into debt if you don’t have to. Washington also points out that debt incurred during hard times should be repaid during times of peace and prosperity; if not, the debt will likely not get paid off. (He has definitely been right about that on a national level!) On an individual level, the takeaway is to consider paying off debt when you have extra cash available, and ideally to pay it off sooner rather than later.

Washington was a truly legendary leader, and in his Farewell Address I believe he was speaking to the nation as a whole and to its people as individuals. I also believe Washington’s advice is as timely and true in 2012 as it was in 1796. With such powerful and still-applicable words, it’s no wonder why reading Washington’s Farewell Address has been an annual tradition in the U.S. Senate since 1896. And remember, we know Washington’s words must be true because he could not tell a lie!

-Tom

To the Moon and Back, Twice

Credit: FreeDigitalPhotos.net

Want to hear something frightening? If someone were to stack the U.S. government’s debt in $1,000 bills, it would be almost 67 miles high. Want to hear something even more frightening? That was a fact during Ronald Reagan’s presidency in 1981! As of 2011, that stack would be more than 900 miles tall!

If that didn’t connect with you, I can also tell you that our national debt could buy 3,824,812,630 Super Bowl tickets, 58,000,000 homes at an average price of a little over $240,000, or all of the country’s 400 largest companies based on market capitalization. If I’m still not breaking through, I ask you to look at the moon tonight and try to fathom that our national debt in $1 bills could reach the moon and back, twice.

Now that I have your attention, I want to briefly discuss our national debt. Some economists, pundits, and politicians would have you believe that the U.S. could be imminently facing an economic Armageddon. Some would have you believe the national debt is not a big deal, and it could actually be a good thing. Well, which is it? 

Before we decide, let’s briefly consider federal government debt. In simple terms, a government deficit, or debt, arises when the government needs money to pay for a program or project that exceeds tax revenue. The government can address this deficit by increasing tax revenue, printing more money, or by issuing bonds. Increasing tax revenue requires politicians to increase taxes, and that is not always popular. Printing more money is an impractical, short-term fix because, though it allows the government to pay for the program or project, it will devalue the currency and cause inflation, as everyone suddenly has more money. The unpopularity and consequences of the previous options are why most federal governments in the world prefer to issue and sell bonds. By issuing bonds, the government is able to fund its programs and projects with money borrowed from bondholders in return for promising to pay the bondholders back in the future (with a little interest).

If you’ve had your television on in the past decade, you probably know that most nations have government debt. This is because during economic downturns tax revenue falls, and when there are natural disasters, wars, or new entitlement programs, government expenses rise. Theoretically, during times of economic prosperity and peace, there should be government surpluses, and over the long term, government budgets should stay in balance. As you probably know, that has not been the case for the U.S. and many other countries.

For those who firmly believe we should always have a balanced budget, I would ask you to consider why a person is willing to take out a student loan to go to college or why a company is willing to spend substantial amounts on research and development for a new product. Going into debt for the potential of higher earnings or for the potential development of a new or improved product that will yield huge profits is not such a bad idea. Similarly, when the government goes into debt for infrastructure, technology, education, and other programs that promise a better and brighter tomorrow, it is also not a bad idea. It’s those wars, social programs, and other controversial geo-political expenditures that only have an immediate impact with little or no future potential for cultural, social, or financial gain that get governments into fiscal trouble.

The real issue with our national debt is sustainability. Just like people will be financially okay as long as they can make interest payments on their loans and eventually pay down the principal as their earnings and income increase, a government will be okay as long as it can make interest payments on its debt and eventually pay down the principal as the country’s gross domestic product (GDP) grows. In short, our national debt is sustainable as long as GDP grows faster. If you look at the three charts below, you will see our national debt from 1792-2011, our GDP from 1792-2011, and our national debt as a percentage of GDP from 1792-2011. If you are like me, you will have two takeaways and one conclusion:

Takeaway #1: Our national debt has never been higher.

Takeaway #2: Our gross domestic product has never been higher.

Conclusion: Since our national debt is growing faster than our GDP, I would say our national debt is currently not sustainable. However, our country’s financial situation was more precarious right after World War II than it is right now.

How much debt is okay? I don’t know and neither do any of the economists, pundits, or politicians! All I do know is that our country is operating at an unsustainable rate of incurring debt. I believe it is okay to not have a strictly balanced budget as long as the extra spending is used for projects and programs that offer the potential for a future return that exceeds the current expense. I also believe that our policymakers should look to the 1950s as a guide, and they should cut our current spending and increase tax revenues until our GDP is once again growing faster than our national debt. At least then, our debt will become sustainable again. Then, going forward, our policymakers must create and stick to budgets that allow our country to start paying down our national debt principal so that our financial position can stabilize and improve. Similar to how people should never max out their credit if at all possible, our government needs to return to a financial position where it could comfortably sustain additional debt so our nation is ready when the next economic downturn, national security issue, or natural disaster arises.

-Tom