My dad taught me how to rig a mainsail, my college buddies taught me how to hold my Jim Beam, and my teachers taught me how to parse Chaucer. But somehow no one got around to helping me calculate compound interest or build a diversified portfolio. Arcane skills? Perhaps, but learning them is the best way to avoid spending your retirement years nibbling on Alpo.

Of course, people teach only what they know, and previous generations had less cause to study the finer points of finance, says Charles Farrell, a Denver-based investment advisor. Most men died within a few years of retirement; the rest squeaked by on pensions and Social Security. Today, employer pension plans are largely history and Social Security is endangered, leaving us to rely on our own savings during our waning years. And with life expectancies rising, we’d better be prepared to grow those savings and make them last. “This generation has to figure out how to afford to live off its investments for 20 to 30 years,” Farrell says. “It’s never been tried before.”

Ensuring your financial survival will require learning to be your own CFO. Herewith, seven skills to help begin your education.

FIGURING OUT YOUR NET WORTH: Would you start a diet without knowing your weight? Of course not. So begin your financial planning by determining your net worth. It’s assets minus liabilities, or what you own minus what you owe. Simple enough, but fewer than half of Americans can even approximate their net worth, says the Consumer Federation of America (CFA).

And if you’ve never stepped on a financial scale, it’s way too easy to binge on debt. “Too many people think they can afford a loan if they can make the minimum monthly payments,” says CFA executive director Stephen Brobeck. They might even feel fiscally fit because their bank accounts are growing each month. Meanwhile, every new debt dollar takes them further away from buying a home, funding a child’s education, or retiring with seven figures. Fortunately, software like Quicken and MSN Money and Web sites like Yodlee MoneyCenter can help you manage both sides of the balance sheet by tracking your net worth in real time. The calculator at can even help you project it into the future.

One warning about net worth: The equity in your home is an asset, but its value is subjective, and it’s not as useful in a pinch as cash or nonretirement investments. In general, you don’t want home equity making up more than half of your net worth.


RUNNING YOUR RATIOS: Smart stock investors use handy ratios (price divided by earnings, for example) to gauge the health of a company. Do the same for yourself. Farrell has devised three simple personal-finance ratios that can tell you quickly whether you’re on track for a secure retirement.

The ratios are built around Farrell’s belief that you should be investing or saving 12 percent of your pretax income each year. Then at retirement you’ll have saved enough to withdraw 60 percent of your preretirement income annually. What Social Security and pensions add on top of that is gravy.

GAUGING INTEREST: It’s an old saw in financial planning that some debt is good and some is bad. A loan to buy a home or attend school is good debt, because owning property or being educated tends to grow your wealth and the interest is tax deductible. Credit-card and auto-loan debt is “bad” because you’re buying stuff that loses value.

Don’t fall for this line. Today, millions of families could lose their homes because sleazy brokers convinced them to take out “good” loans on ludicrous terms. As for student loans, the interest is tax deductible only if you earn less than $70,000 a year. Plus, a growing share come from private lenders demanding double-digit interest rates. And school administrators don’t care whether that degree in culinary arts or sociology will translate into a job that pays you enough to fend off the debt collectors.

“It’s not as simple as good or bad debt,” Farrell says. “Your debt has to be kept in proportion to your income.”

While we’re blowing up conventional wisdom, here’s another bomb: It’s not always cheaper to pay off bad debt before good debt.


30-year mortgage, $250,000. Interest rate, 6.5%. Monthly payment, $1,580.


5-year car loan, $25,000. Interest rate, 8%. Monthly payment, $507.

Let’s say at the end of the first month you have an extra $1,000 to pay down the principal of one of the loans. Use it for the car loan and you’ll save $470 in interest over the life of the loan. Put it toward the mortgage, and because it’s a much bigger loan amount, you’ll save $5,890 over the life of the loan. One caveat: You see that savings only if you stay in the home long enough to pay off the loan. If you sell in 10 years, for example, you’ll save only $900 in interest.

Finally, always remember this: Paying off a 10 percent loan is like finding an investment with a guaranteed 10 percent re-turn and good luck finding an honest investment advisor who can promise that.

By Richard Sine

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