Your Own Personal Balance Sheet

Happy Thanksgiving everybody!  We hope your holiday was as filled with good food, family, friends, and involuntary naps (aka food comas) as our was.  We learned two things anecdotally this holiday season:

1. Gone are the days when being at your grandmother’s house in the middle of rural Maryland means you’re disconnected from everything; it does, however, mean that your cell data lasts approximately a day and a half.
   
2. The eye test at Best Buy on Black Friday indicated that people apparently have money to spend.  
   

They don’t necessarily know what they’re buying (yours truly having had to try and explain the difference between “Roku TV” and “Smart TV” to confused shoppers - apparently blue plaid flannel is close enough to the Best Buy employee uniform?), but they’re buying.  And the preliminary numbers back this up: apparently, American consumers spent over $6B on Thanksgiving/Black Friday, up 15% from last year.

That must be a good thing, right?  Yeah!  It is.  Probably.  Increased sales mean increased revenues for companies, which can be translated into higher (or at least supported) stock prices, even as profit margins have been falling over the last couple years.

More importantly to us, however, increased sales *should* indicate something about people having more disposable income, which is categorically a good thing.  We say *should* with little asterisk offsets because in this day and age one doesn’t have to have current disposable income to purchase something.  They could purchase it with debt (credit cards), and essentially borrow from future disposable income.

And, in point of fact, that is exactly what has been going on for the past several years.  Enjoy these charts  from the NY Federal Reserve (interactive up-to-date data available here, for anyone interested):

The general trend has continued through this year - total household debt is at all time highs now, and the main drivers of this are student loan debt (up 100% since 2009) and auto loan debt (up almost 60% since 2009).  This is not necessarily an issue in and of itself, given that the charts are in absolute dollars and not percentages.  However, real wage growth has been mostly nonexistent for most of the population, causing us to cast a moderate amount of side eye on that Black Friday shopping.

So.  What does your balance sheet look like?

In finance, there are two things you can look at to quickly get a snapshot of how financially healthy something or someone is (nb: despite Citizen’s United, we will always and forever refer to companies as “it” or “thing”).  They are the balance sheet and the cash flow statement.

Balance sheet: Fold a piece of paper in half.  To the left of the crease, write down the value of everything you have (your assets).  Retirement plans, savings accounts, cash hidden under the mattress, the value of your home, resale value of your car, your beanie babies collection, the 0.0346 bitcoin you bought last week...and to the right of the crease, write down the value of everything you owe (your liabilities).  Mortgage balance, student loans, credit card balances, personal IOU's.  The difference between the two sides is your net worth (or shareholder equity, if you are doing this for a company).  Ideally, this is a positive number that gets larger with time.

Cash flow statement: Don’t fold a piece of paper in half.  Start at the top of the paper and write down how much money comes in to your accounts every month (for purposes of this exercise, only include fairly regular things like job income, side hustle income, and dividends/interest.  Don’t include the penny you picked up on the street last week, we don’t care how shiny it was.)  Under that, write down line by line all the money that leaves your accounts every month: rent/mortgage, loan payments, gas, food, shopping, nights out, deposits to the under the mattress savings account, rounds of golf, everything.  Now, subtract all of that from the top number, and you get your cash flow.  Ideally, this is also a positive number.

Three things to remember:

• Positive cash flow will add to savings over time, causing your assets to go up and make your balance sheet stronger (higher net worth).
• Negative cash flow will force you to deplete savings over time, causing your assets to go down and make your balance sheet weaker (lower net worth).
• Think about assets as things that generate positive cash flow.  On the flip side, think about debt (liabilities) are things that tend to produce negative cash flow.

Good Debt vs. Bad Debt

All debt is a burden, and no debt is better than having debt.  However, that doesn’t mean that debt can’t be productive.  It just means that you should make sure it is.  Productive debt is debt that ultimately improves either your balance sheet or cash flow statement.  There’s no hard and fast rules for what type of debt qualifies as good or bad debt, it’s more about amount and purpose.

For example, buying a house (mortgage debt) is usually considered good debt. If you’re paying $2,000/month in rent and can buy a place with 3.5% down (FHA loan) such that your mortgage + mortgage insurance + taxes is going to cost you $1,600/month, well then that’s productive debt.  You have increased your cash flow by $400/month AND have a (likely) appreciating asset as well.

However, if you’re paying $2,000/month in rent and have $20,000 saved up for a down-payment, and think that therefore you can afford a $550,000 house (because 3.5% of $550k is $19,000), and so you buy the best $550,000 house you can find, well then you end up paying $2,500/month just on the mortgage itself, never mind property taxes and mortgage insurance and the like.  All of a sudden, that mortgage debt is now cash flow negative, and you are likely in a tight position.  That is not what we could consider good debt.

The other classic example of good debt in personal finance is student loans.  Taking on debt to increase your ability to make money down the road is good, or so the conventional wisdom goes.  To a certain extent, we agree (though it must be said there’s a special circle of debt hell reserved for student loans and the fact that they can’t be discharged in bankruptcy).  Taking on $250k in debt because you went through medical school and will immediately start with a six-figure salary?  Sure, that’s manageable.  Taking on $100k in debt because you went through Boston University (our own beloved alma mater, it should be noted) to major in something like...Classical Studies?  Yeah, those debt payments are probably swamping any cash flow you have from your...tour guide job?  Sorry, we don’t quite know what Classical Studies majors do in the real world.  Use grant money to write books?

Anyway, that kind of debt load is hugely prohibitive of actually starting to save money when you’re young and trying to start out on the right foot.  So the question of good or bad debt really has more to do with its actual impact on youbased on the particulars of the debt rather than the type of debt it is.  And the best way to assess that impact is to take a look at your balance sheet and cash flow statement.  Make it an annual activity this time of year, right alongside coming up with New Year’s Resolutions, and of course feel free to reach out to us if you have any questions going through it!

Other Year-End Housekeeping

Also this month, you are probably getting ready to wrap up open enrollment season for work benefits and/or marketplace healthcare.  A couple things to consider:

• Bump your 401(k) contribution up 1% or 2% for next year.
• Check in with your 401(k) investment allocations.  Are you comfortable with them for next year?
• If you’re on a high deductible health plan (at least $1,300 deductible for an individual plan/$2,600 for a family plan this year; $1,350/$2,700 next year), make sure you’re contributing to an HSA.
• Be sure to spend down any money left in your FSA, and consider switching that over to an HSA for next year if possible

If you find yourself with a nice year-end bonus and are looking for something to do with it, here are some considerations, in no particular order:

• Max out your 401(k) contributions
• Max out your HSA contributions
• Contribute to an IRA
• Pay down debt
• Invest it in a brokerage account
• Do some delayed Black Friday shopping.  Reward yourself for all the good financially sound decisions you’ve been making this year.
• Still unsure? Give us a call.