Augmented Unemployment Report Leads to Augmented Balance Sheets

The world being circular, when you begin going in one direction you eventually come back to where you started. This circumnavigation also applies to words. Recently on Bloomberg radio I heard a cogent discussion of the impact of unemployment statistics on the domestic economy. The speakers very quickly blew past the Department of Labor’s official unemployment number of 6%+, focusing instead on what the department calls “an alternative measure of total unemployment.” This “augmented unemployment” statistic takes into consideration part time workers who want to work full time, those who have dropped out of looking for employment, and a portion of the “self employed” who would prefer to be on someone else’s payroll. This augmented number is over 11%, possibly 11.8% for November.

From the standpoint of an analyst or policy-maker, the difference between 6% and 11% is huge. Basing decisions upon misleading data can have serious consequences to a national economy or to an individual’s wealth.

In the investment world, we see something of a contrary relationship. Simplistic “value” investors often feel a stock is “cheap” relative to its book value as presented in balance sheets. A careful analysis of what makes up book value, particularly for a company that has grown by acquisitions, include a number of items generated by acquisitions such as the value of customer lists, an updated value of real estate (useful for an acquisition, but not for an acquirer) plus the remaining net difference between the price paid and all other assets which is labeled “goodwill.” This is not the first time that accounting rules and investment usage differs.

The accounting book value is measured against price to determine whether a stock or a market is currently attractive. On this basis, many investors believe much of today’s stock prices are attractive compared to history. Those of us who have grown up in the financial community prefer to rely on “tangible book value” which is lower than reported book. I often advocate reconstructing a balance sheet to determine true value under varying assumptions. Many accountants and investors have accepted that an augmented book value is more useful than a book value generated by hard assets.

Then why is it so difficult for wealthy individuals, particularly ultra high net worth (UHNW), to develop their own augmented personal balance sheet?

One of the elements of an augmented personal balance sheet would be what someone would pay for his/her home less the expenses of the sale, including taxes, less the cost of replacement living accommodations. This figure should be modified by the difference between the mortgage on the old dwelling and the new. Another example of an asset to be added to your balance sheet is the value of your business-related mailing lists. (If you do any significant amount of fund raising for any non-profit or political organization your personal mailing list could be quite valuable to another fund-raiser.) There are other assets that could and perhaps should be added, such as a portfolio of unexploited patents, sale of a brand name, current ownership of debt selling well below maturity value, etc. The augmented personal balance sheet should a complete list of actual and potential liabilities or commitments.

The augmented personal balance sheet can make the difference between an estate that accomplishes the grantor’s desires and one that produces just the opposite. In one specific example, a rather extensive list of specific dollar commitments to personal or charitable beneficiaries was designed both to meet those obligations and to reduce the residual estate so that a bunch of spoiled trust fund babies were not created. But, in this case, because little or no value was placed on various intellectual properties-patents, brand names or badly out dated valuations of real property, the residual estate was many times the expected amount, creating just the situation and resulting behavior pattern the grantor wanted to avoid.

The same result might occur if the grantor, while alive, used too small a valuation on his/her assets relative to liabilities and thus had reserves too large for future payments. This type of discussion and analysis should be done privately and often with other professional advisers present.

Traditionally when the Marines have landed their basic units; platoons, companies, battalions, regiments and divisions, are augmented with additional specialists and firepower. Thus, I am quite comfortable with the process of augmentation as it is often needed to accomplish the mission.

I discuss these principles in my book, Money Wise, and in my recent interview with Steve Forbes on Forbes.com's Intelligent Investing site. I hope you find it as interesting an experience as I did.

Joe the Plumber and his Personal Financials

Much has been written about Joe the Plumber and Joe’s concerns to maximize income in order to invest in his business. He correctly sees the need for capital to meet obligations to himself, his family, his business and/or some charity. If we could see his “personal balance sheet,” as advocated in my book Money Wise, we could also see his self-defined obligations to his retirement, to his wife Joy, and to the local hospital among other needs.

In recent meetings with the many charities that I am involved with, there is concern about the ability to accomplish their missions. They fear a number of pledges will not be fulfilled in full or on a timely basis. Their concerns are similar, but not identical, to our friend Joe’s worries.

Both arise due to the lack of financial clarity that comes from an understanding of one’s own personal financial condition but no understanding or sympathy for the party on the other side of their concern.

Based on past experience, people of limited to modest incomes continue to give to charities during periods of financial turmoil. Most continue to contribute each time they attend a religious service. They are using a “pay-as -you-go” strategy keyed off their current income. Historically there has been a very high level of predictability in these flows.

One of the major differences that occur as people move in stages from modest incomes to Ultra High Net Worth (UHNW), is that their lives can now be better described by a “personal balance sheet” than from an income statement. One of the ways to measure where you are in the path to becoming UHNW, is to understand how much of your charitable gift decisions are based on your income statement and how much on a “personal balance sheet.” While “The Good Book” requires tithing, or giving 10% away, few people in today’s world meet that standard. Single digit percentage allocations to charitable gifts are more the norm. Even in today’s crisis of confidence, I suspect that this pattern will continue when total annual giving is below $1,000 to $2,000 per year.

One of the many items to augment a personal balance sheet is a reserve for grants to charities. I am an advocate of a “funded reserve” with its own separate portfolio of investments, with the appropriate short term securities to meet current pledges and longer term instruments to meet longer horizon pledges, perhaps adjusted for inflation.

An augmented personal balance sheet depicts pledges as a liability with the same force on the grantor as any other debt. On the asset side, one of the portfolios is the funded reserve for grants. Much trickier is to measure the “psychic income” derived from feeling good by doing good. Perhaps this measurement can be a below-the-line addition to the combined financial and psychic income results for the year.

What should you, the grantor do in face of the current financial crisis of
confidence? You should first assure the charity in question that you recognize your obligation and you should determine if the organization is able to meet its minimum goals. Has the charity responded to the climate by cutting back expenditures and/or deferring spending?

For your part, deliver as much as possible to meet the charities’ short term absolute needs. An enormous lesson for both the individual grantor and the charity is that both need rainy day funds to cushion sharp, unexpected contractions similar to what we are passing through now. A reasonable starting point for these rainy day funds would be 10% of the expected annual funding, with an agreement to notify the other party when only 5% is left.

Both sides may have to put off work on the new Joseph and Joyce Wing of the local hospital while donors are forced to back to plumbing jobs, making the flow of cash work as well as it can until new supplies arrive.