4 Keys to a Solid Financial and Retirement Plan

Before getting too far into the new year, it's important to develop a realistic record of where you ended 2011 and how your financial situation changed during the year. You'd think everyone would already know where they stand, but such financial self-awareness is the exception.

Building such a record takes time and effort. Creating an annual report of your finances, however, can provide an invaluable record that only you can assemble. Done properly, it should illuminate your future, paving the way to important financial decisions and helping you make smarter choices.

[See 50 Ways to Improve Your Finances in 2012.]

Planning efforts are helped by a predictable future, and we've been spared some of the crisis headlines and volatile markets that we saw last year. Also, 2012 is off to a much better start than most experts thought just a few weeks ago. The U.S. economy and jobs outlook are stronger than expected. Stocks are back to prerecession levels. Even Europe is lurching its way to patchwork debt-crisis agreements, which seem likely to help the region avoid big loan defaults and bank failures that could harm the United States.

We also know that interest rates and inflation should remain low for some time. When calculating investment returns, it makes sense to target modest annual gains of 3 to 5 percent. Retirees have gotten 3.6 percent increases in Social Security income due to the program's annual cost-of-living adjustment. Medicare costs for seniors are closer to being under control than they've been in many years.

There will be very disturbing debates in Congress about the need to cut Medicare, Medicaid, and even Social Security. But any changes in these programs should have, at most, a minimal effect on plans for anyone within 10 years of retirement.

With this backdrop, consider four sections for your annual report: income, expenses, investments, and other assets. Much of this work can be a natural companion to the work you already do to file your income taxes. Even if someone else does your tax returns, you probably need to assemble the W-2s, 1099s, brokerage statements, and other documents that tell the story of what you earned and what you spent in 2011. If this is the first year you've done an annual report, you'll also need to pull the same documents for year-end 2010 so you can do year-over-year comparisons. But you should have all the major documents readily at hand from last year's tax returns.

[See Investors Scramble as Fed Extends Low-Rate Policy.]

Income. This is not the taxable income number from your W-2 and other income statements that will be entered on your tax return. It should represent the annual value of your paychecks plus any other dollars that were actually provided to you as cash in hand. It would not include earnings on investments unless you cashed in the investments and converted them to cash. How much cash did your family unit (you, spouse, dependents, etc.) receive that was available to be spent or saved? How does this total in 2011 compare with 2010?

Expenses. Tracking what you spent in 2011 is the single biggest component in building your annual report. It's also the most valuable. Spending categories might include groceries, domestic (household goods, clothing, grooming), home maintenance, car (gasoline, maintenance and repairs, payments), utilities, home mortgage, entertainment (movies, meals, periodicals, sundries, cash withdrawals, and similar discretionary spending items), charity, healthcare, travel, insurance (you can include auto insurance here or under cars), educational spending, and taxes. Use online banking and credit card statements to generate as much of your expense report as possible.

Investments. Include changes in all of your investment accounts as of the end of the year. This review also should be part of a broader assessment of your investments. And, yes, you should do this more often than once a year. Look at all your investments, including active retirement accounts.

If you have an approach to diversifying your investments (and you should), review it and make sure this is still your approach. Then look at the changed values of your holdings and make sure to adjust your portfolio so your holdings meet your diversification objectives. Include CDs and any cash balances in bank and brokerage accounts as well. Add them all up and see how they fared at the end of 2011 compared with year-end 2010.

[See Make a Housing Plan for Retirement.]

While you're at it, spend some time to determine how much money you paid other people to handle your investments and retirement plans in the form of trading fees, management advisory fees, and account servicing fees. If you own mutual funds, you'll need to look at their prospectuses to find some of the fee information. If you have a 401(k) through work, your employer should be able to help you find out about fees as well. There are big variations in fees among mutual funds and investment firms. Because most retirement funds are invested for 30 or 40 years, paying smaller annual fees will save you many thousands of dollars.

Other Assets. What nonfinancial assets do you own that you could sell and convert to cash? This won't take long, and it needs to be done. If you own your own home, how much money would you clear if you had to sell it? You won't know this for certain unless you put your home up for sale. But you can get a good idea. If you live in a large city where real estate values are closely monitored, you should be able to get a good idea of how housing values have changed over time. Also, what's your home's appraised value for property taxes? Did it change last year because of weakness in housing values? What did homes like yours sell for during 2011? Such comparable sales figures are available from local multiple listing services and real estate agents. Many newspapers publish home sales prices and keep this information on their websites.

What's the resale value of your car(s)? There are online tools to provide this information. Do you own other tangible assets that have cash values--a boat, jewelry, antiques, and the like? Total their cumulative cash resale value as of the end of 2011. If you can, compare it with the year-end 2010 values. If you can't, it's still good to know what your assets would bring on the market. And you can see next year how much their value has changed.

After you've done your first report, annual updates don't take much time. Over the years, these reports will also give you a solid idea of the financial costs of how you live. As you approach your retirement years, you will have a good basis for determining how much money you will need to spend and whether your retirement income will support this lifestyle.

The hardest part of doing your annual report? Getting started.

Twitter: @PhilMoeller

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