Much has been made recently about the story of Grace Groner.  For good reason.  If you're unfamiliar, Ms. Groner died last week at the age of 100.  While working at Abbott Labs, she bought 3 shares of stock in 1935, reinvested the dividends, and lived within her means for the rest of her life.  That investment is now worth $7 million, which she has donated to her alma mater.

There are a couple of interesting story lines associated with this.  Most of them center on frugality and charity.  Again, deservedly so. This is a great lesson in both.  Although she doesn't perfectly fit the mold, Grace Groner's behavior would have made her a good subject for Thomas Stanley's The Millionaire Next Door series.

There are a couple of other vectors here that are interesting, though.  In his Wealth Report column, Robert Frank highlights one of them, which involves the power and risk of putting all one's eggs in one investing basket, especially when that basket belongs to your employer.  He points out that luck played a big role here.

In reality, though, if she had invested in the broader market, she would have enjoyed impressive returns as well.  But how impressive?  That is the story line that is most instructive, and it involves the power of compounding, which is coincidentally a favorite topic of this blog.

Let's look at some data.  In 1935, stocks were up 46.74%.  That's a nice way to launch a long-term investment.  The next year, the market was up 31.94%.  In other words, if Grace Groner would have invested in a broad stock index fund on January 1, 1935 (had they existed then), she would have almost doubled her money after two years!  Of course, the market is a volatile beast, and 1937's 35.34% drop was undoubtedly a good reminder.  Nonetheless, from 1935 through 2009, the average broad stock market return was 12.23%, according to the Federal Reserve's numbers.  What was Grace Groner's return?  By my calculation, it was just under 15.4%, with full reinvestment of dividends, etc.  That is what allowed Ms. Groner to donate $7 million to Lake Forest College.

But what about Robert Frank's assertion that luck played a huge role in her investing success?  How much would she have been able to donate to Lake Forest if she had instead been able to invest in the broad market for 75 years? $919,042.85!  In other words, the difference between a 12.2% and a 15.4% per year average return on a $180 investment for 75 years is more than $6 million and almost 87% of the final value of the investment.

That leads me back to two fundamental points:  1) the power of compounding cannot be overstated, and investing early is a huge advantage if one is hoping to build wealth, and consequently 2) finding inexpensive investment vehicles makes a huge difference, provided the associated returns are similar.  If Ms. Groner had paid 100 basis points, or 1%, for management of her Abbott investment, she would have ended up with a bit less than $3.8 million.

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On Saturday Warren Buffett released the Berkshire Hathaway annual report for 2009, accompanied by his customary shareholder letter.  It won’t hit mailboxes in printed form for a little while, but undoubtedly many people will read it online long before it gets to them.  I thought I’d dedicate a post or two to sharing what I see are some key points emanating from the brain of Buffett via his shareholder letter.  I’ve always felt this was an entertaining and informative read, and this year has not been a disappointment.  You might wonder why you should care what Warren Buffett thinks.  Like anybody else, he has made some good calls and has been off base about some things.  (I should point out that when he's wrong it's usually a matter of timing, and it happens much more infrequently than when he's right).  Regardless, through the companies he owns and the people he knows, he has an almost unequaled perspective on the American economy.  He also has a very rational view of the world, unencumbered by politics, and to a large degree, personal political ideology.  The engine of Berkshire is the insurance business.  They own banks and other financial services companies, as well as having major exposure to residential real estate.  The roots are based in basic, industrial companies.  In other words, Berkshire is directly exposed to pretty much all of the areas of the economy that have caused great concern over the past couple of years.  Although Buffett may be hands-off to a large degree in the operations of most of his businesses, he knows precisely what is going on in all of them.  The last obvious point in favor of lending credence to his views is simply that his investing performance has been unparalleled.  

One thing about the letter that is clear right off the bat is the fact that he felt the need to restate the basic tenets of owning Berkshire Hathaway.  The Berkshire Owner’s Manual is posted online on an ongoing basis.  Recently, however, Berkshire’s B shares have split 50 for 1 to facilitate the purchase of Burlington Northern, and there has been a huge influx of new shareholders.  For that reason, Buffett seems to give more attention than in most years to reiterating the overall philosophy of Berkshire Hathaway.   While it’s true that he reinforces basic concepts every year – and really every chance he gets -  this remains valuable information whether you’ve owned shares for several decades, or you are merely interested in learning from a great investor.

Perhaps the most universally interesting topic Buffett addressed was the state of residential real estate.  He may not typically be associated with this industry.  However, as he points out in the letter, Berkshire-owned MidAmerican Energy in turn owns HomeServices of America.  HomeServcies owns a broad collection of regional realty firms that combined make them the second largest real estate brokerage firm in the US.  Additionally, their website specifies that they are the “largest brokerage-owned settlement services (mortgage, title, escrow and insurance) provider in the United States.”  Berkshire also owns Clayton Homes, which has become the largest maker of modular and manufactured homes in the US.  This is all a long-winded way of saying that Buffett has a pretty good vantage point from which to view the problems and opportunities facing residential real estate.

First, some numbers.  Total industry output of manufactured homes has dropped from 382,000 in 1999 to 60,000 in 2009.  That has led to the bankruptcy of 1999’s top three manufacturers.  More generally, housing starts in the US have dropped to a fifty year low, at 554,000. (For some context on the trend of housing starts, see the chart at the bottom of this post.)

At last year’s annual meeting, Buffett talked at some length about the supply and demand dynamics in real estate, and how prices will start to pick up again when we work off the excess inventory that existed then in the system.  Typical, rational view of things, and of course he had the numbers at the tip of his tongue. 

The big news coming out of this discussion?  Warren Buffett believes that within the next “year or so” our housing problems should be largely behind us.  Of course, housing is overwhelmingly a local phenomenon, and there will be regions that continue to feel the effects of overbuilding well beyond 2011.  Furthermore, the upper end of the spectrum in many areas may still be years away from real recovery.  For instance, I recently saw data for the Phoenix area that indicated that inventory for homes under $400,000 was actually approaching neutral, meaning that it didn’t particularly favor buyers or sellers.  However, above $3m (I think…may have been $2m) there was enough inventory to serve buyers for over five years!  Note:  don’t hang your hat on these numbers as they are approximate and a couple of months old.  The point remains, though.

We may still be in for some bumps, but I suspect it’s comforting for most people to hear one of the most rational players in American business state that there’s light at the end of the tunnel.

Housing Start Data, courtesy of the US Census Bureau

I resisted reading The Millionaire Next Door for a long time, because the title led me to the assumption that it was a get-rich-quick tome.  I was very wrong about that, and I was disappointed that I waited so long.  I’ve now read the book twice.  To be precise, on both cases I listened to an audio version that I purchase from Audible.com, a favorite service of mine.  Far from being a book in the genre of Rich Dad, Poor Dad and its ilk, the book, written by Thomas J. Stanley, Ph.D. and William D. Danko, Ph.D, grew out of hard research they had performed about the affluent in America.

I should point out that a premise of the book seems to be that achieving millionaire status is an important goal and worthy of focus.  Not all readers would deem that a worthy goal.  Nonetheless, there are lessons in this book about financial comfort and independence that are universally applicable.  The impact of stress on our immune systems and overall health is undeniable.  An Ohio State University study has found that money-related stress had a stronger link to depression symptoms among breast cancer patients than even stress related to the recent death or illness of a loved one!  Living within our means is a sure way to reduce our stress, and that is the underlying message that I took from this book.

Before I go any further, I should stress that the book was originally published in 1996, and one million dollars went a bit further then.  We’ve had three significant shocks to the financial system in the interim!  Alas, the lessons still apply, even if some of the statistics are outdated.  In fact, applying the concepts in this book would have saved a lot of people some pain over the last couple of years.

There are a few fundamental concepts that I think are important.  Beyond that, I highly recommend getting this book (preferably at the library) and reading it closely.

The basic thrust of the book is that the average millionaire in the United States probably does not fit the profile that most people imagine when they think of millionaires.

What is wealthy?

The authors appropriately define wealth in terms of net worth rather than the number of expensive vehicles in the garage or the size of the house.  In 1996, they used a crude, absolute threshold of $1 million in net worth to be considered “wealthy”.  In today’s dollars, that translates to something close to $1.4 million.  However, they define a much more informative measure that describes how wealthy a person should be given his or her age and income level.  The formula is as follows:

Expected wealth = Age multiplied by pretax annual income (from all sources except inheritance), divided by ten

This is a much more useful measure, as it factors in standard of living.  To a significant degree, this metric captures whether or not an individual is living within his or her means.

PAWs and UAWs

The authors highlight two categories of savers:  Prodigious Accumulators of Wealth and Under Accumulators of Wealth, or PAWs and UAWs.  Accumulating wealth at a rate greater than at least 75% of the population qualifies an individual as a PAW, while doing so at a pace that is less than 25% puts one in the UAW group.  To make this more universal, they offer a simpler rule:  your net worth should be twice the level of expected wealth to be a PAW, while less than half of the expected net worth would place you in the UAW range.  So, if you’re 35 and making $100,000 per year, your expected wealth is $350,000.  If your net worth exceeds $700,000, you’re a PAW.  If it is less than $175,000, you fall into the UAW category.

This highlights another distinction called out by the authors:  balance sheet affluent vs. income statement affluent.  Examples abound of doctors and lawyers making over $500,000 per year while having little in the way of sustainable assets to show for it.  More impressive are the examples of individuals who make less than $100,000 per year in earned income, but can never work another day and be comfortable.  It’s all about living within your means.  (In fairness, many examples of the latter case lived well below their means).

They earned it

Another interesting point was that 80% of the wealthy in this study were first-generation millionaires.  They did not inherit wealth.  However, the country clubs of America are littered with inheritors who are quickly blowing through the cash their parents have left them, with no means of replenishing it.

That brings us to the concept of economic outpatient care.  This was much more of a black-and-white issue for me before I had children, but the statistics are still very powerful.  Adult children who had received any kind of financial assistance from their parents suffered for it.  The authors “found that the giving of such gifts is the single most significant factor that explains lack of productivity among the adult children of the affluent."  In eight of ten occupations held by children of the affluent, households that received regular gifts had lower net worth than those who did not.  Overall, such individuals had an average of 81% of the wealth of their non-receiving counterparts, although this was skewed upward by teachers, who apparently used the gifts they received to build additional wealth.  Receivers of EOC invest less and use more credit.  They come to depend on the gifts as supplements to their income, and proceed to live at a higher level.

The book offers a lot of data that is very eye-opening, and it clearly demonstrates that the average wealthy individual is not driving around in a Ferrari.  However, the takeaway ideas are pretty straightforward and common sensical.  That doesn't mean they're easy to apply, though.  Reading this book really reinforces that common sense.  Similarly, Thomas J. Stanley's latest book - Stop Acting Rich - doesn't really present radical new concepts beyond those of The Millionaire Next Door.  It does, however, reinforce the concepts in much the same way as its predecessor.  It, too, is worth reading several times.

I just read a somewhat provocative article by Liz Pulliam Weston entitled 4 Reasons we get ripped off, and I think you should read it, too.  It’s concise, but points to some actions that consumers can take to avoid falling prey to those who would take advantage of weakness, legal or illegal.

I’ll summarize the reasons here and provide my perspective.

Americans stink at math

No argument here, but this is pretty easily fixable.  The Department of Labor states that 58% of American adults cannot add 60 cents to $1.95 and calculate a 10% tip.  That is startling.  If you fall into this category, I recommend taking a remedial math class.  My guess is that elementary school students would fare a bit better in this survey, because they’re doing these kinds of calculations more frequently.

We don't recognize sociopaths

This reason is kind of depressing and little bit scary, but undoubtedly true.  In fact, I am not sure it is only  sociopaths about whom we should be concerned.  An even bigger concern for me is the number of salespeople who do not act in the best interest of their customers but feel that is the standard way of doing business.  Sometimes the lines are not so clear.  When you buy a car, the salesperson receives a commission, and it’s entirely appropriate for her to be compensated for her effort.  How much compensation is okay?  That’s a blurry line, but too often the answer is “as much as possible”.

In my business, the norm is probably to not act in the best interest of the client.  Most financial “advisors” are simply salespeople who are not obligated to act in their clients' best interests.  In this case, my recommendation – self-serving though it may seem – is to work with an advisor who is a fiduciary and thus is legally required to act in the best interest of the client.

In general, try to understand how a salesperson is compensated and what his or her incentives are.  Do they make more money pushing certain products over others?  Is it obvious what your total cost will be?  If any of this is unclear, ask!  Furthermore, before making a purchase of consequence, develop a plan and stick to it, including a budget for the purchase.  It is much harder to be persuaded to go beyond what makes sense when you’ve established firm boundaries.

Bait-and-switch capitalism is now the norm

This is definitely a problem.  I think it’s important to try to find alternatives whenever possible, including cancelling your service in favor of a more transparent one.  Most importantly, ask about the total cost up front.  You still may get a lie in response (back to the sociopath concern), but at least that will become obvious pretty quickly after the fact and you can take steps to rectify the situation then.

Half the police force has disappeared

There is a lot of debate in our society about the appropriateness of new legislation and the size of government. Certainly, the legislative framework in several areas is imperfect. Nonetheless, I think effective enforcement is a more important consideration at this stage.

A recent article in the Personal Finance section of the Wall Street Journal talks about the math of clipping coupons.  I think there are a couple of of important points here.  One is that a knowledgeable (and aggressive) consumer can save a lot more money than is probably obvious to most people, because most people don't walk through the calculation of how much they're actually saving.

The second critical point is that savings are rarely considered from an after-tax perspective.  Despite Ben Franklin's assertion, a penny saved in this case is really not the equivalent of a penny earned.  Setting aside the peculiarities of our income tax code for the sake of simplicity, consumers in the 33% tax bracket must actually earn an additional 50 cents for every dollar they save.  Saving $20 at the grocery store each week really allows you to forego an additonal $30 in earnings that would have been required to spend that $20.  In other words, consumes tend to undervalue the impact of the amount they're saving.

Interestingly, more often than not my wife and I find that the coupons we're prepared to use at the grocery store do not save us enough to match the cost of the equivalent store-brand product, so we do not end up using the coupons.  Nonetheless, the article raises valid arguments about how to go about determining if a "frugality initiative" makes sense for you.

As we approach the time of year during which high school seniors finalize their college plans, I thought I'd offer a post detailing some scholarships that are either exclusive to or particularly valuable for twins and triplets.  Paying for college is a burden known to most parents, but it's particularly taxing to those who have multiple kids going away to school at the same time.  Please note that I've done some research on each of the scholarships listed, but I am certain there are more out there.  I will post more as I become aware of them, but please feel to use the Contact page on the main Foothills Financial Planning site to send me a note with any information that might be helpful to others.

Note that these are not in any special order, although I am starting with my alma mater. 

Kelley School of Business, Indiana University

The Kelley School offers the Layton Frazier McKinley Scholarship established by his brother, Lewis E. McKinley.  The preference is that the recipient is a twin, especially an identical twin.

George Washington University

Although not specific to multiples, George Washington University offers a 50% discount for siblings, which would obviously be beneficial for twins and triplets. 

Wilson College - Chambersburg, PA

The all-female Wilson College offers the Twins and Triplets scholarship, which provides a 45% discount on tuition as long as all students remain enrolled full-time.  

Eastern Michigan University

The Furlotte Twins Scholarship is available at Eastern Michigan, in the amount of $571.

Lake Erie College

Lake Erie calls its Twins Scholarship a full tuition scholarship, although it is split 50/50 between twins.  Nonetheless, Buy One Get One Free is a pretty good deal when it comes to a college education.

Appalachian State University – Boone, NC

Appalachian State offers the Misti Dawn Triplet Memorial Scholarship, which doesn’t appear to have formal criteria beyond a North Carolina state residency requirement, but presumably being a triplet would help.

Sterling College 

I have read that Sterling College in Kansas offers a scholarship for twins, but I have not been able to verify that.

Twins Days Festival in Twinsburg, OH

Scholarships are awarded each year at the Twins Days Festivals.  Awardees are repeat festival-goers.

There are many local clubs and organizations dedicated to parents of multiples, and they sometimes offer scholarships.  By their nature, the sums may not be as substantial as what is provided by the schools themselves, but every little bit counts.  One very noble offering comes from the Illinois Organization of Mothers of Twins Club, Inc., which offers $100 and $300 scholarhips to several parents of multiples who are furthering their education.

A common, folksy investing maxim is to invest in good companies that you understand.  It's not a bad place to start, but as this Bloomberg article on Apple's valuation underscores, the downside is that such companies may have prices that are assuming perfection.  If that perfection doesn't happen, the stock price may be in trouble.  Even if they hit the targets, the likelihood that the investment will grow at a rate greater than the overall market is often low.

Note that this is not a commentary on Apple specifically, or whether or not I agree with the author.  The point is that investing - particularly in individual companies - cannot be done in a vacuum.  The quality of the company is not necessarily correlated with the quality of the investment.  What really matters is how the market values the company.  There are good companies and mediocre ones that make good investments.  The same is true of bad investments.

As part of "Jump-Start Your Retirement Planning Days", Kevin O'Reilly is teaming up with Kiplinger Personal Finance and The National Association of Personal Financial Advisors to provide free advice to consumers. See the press release and learn more here:http://tinyurl.com/FFP-Napfa.

More about Kiplinger:http://kiplinger.com
More about NAPFA:http://www.napfa.org

Some quick facts from Bankrate.com's 2009 Checking Study:

• NSF (nonsufficient fund) fees rose to a record high for the 11th straight year.  In other words...don't bounce checks!

• Another new high:  monthly service charges on interest-bearing checking accounts that fall below minimum balances.  This is a good reason to use a checking account for transactions, and a savings account or similar vehicle for earning interest. It's still pretty easy to find free non-interest bearing checking accounts, and the miniumum opening balances tend to be low.

• Online bank accounts require higher opening balances, but lower minimum balances to avoid fees, and the fees are lower.  They also pay considerably higher rates of interest on interest-bearing accounts (.69% vs. .12% average in 2009).  These accounts are a good option for the tech-savvy (or simply tech-unafraid).

• The average ATM fee increased 12.6% to $2.22; this was under $1 in 1998.

• The average fee for "foreign" ATM usage dropped from $1.46 to $1.32, as some banks dropped these fees altogether.  It is a no-brainer to use your own bank's ATM if it is at all possible.

As the federal government and media have made clear in recent months, banks make a considerable amount of money from fees.  Theoretically, retail banks accept deposits and pay a relatively low rate of interest, then turn around and lend that money at a higher rate.  That spread is their profit.  That's a bit simplistic, but banks - especially the big ones - don't typically operate that way anymore.  They do make money on the spread, but fees are a big part of their profits.  When you see big jumps in averages fees from year to year, rest assured that their expenses are not increasing at the same rate.  That's pure profit, at your expense.  Check out these tips from Bankrate to avoid paying fees on your checking account.

View a summary of the 2009 Checking Study at http://www.bankrate.com/finance/checking/2009-checking-study.aspx.