Pay attention. Planning matters.

By Don Kuehn

Last January crude oil sold for $55 a barrel. No serious person at the time would have predicted $100+ oil just a year later. And high oil prices trickle down into all aspects of the economy, not just the cost of operating your car or heating your home.

You can conserve and recycle, bunch errands, eliminate unnecessary trips to save gas and turn down the thermostat. But the best defense for soaring prices is good budgeting and relentless saving. Surveys have shown that the people able to cope with economic surprises are not those with the highest incomes, but the ones who have the greatest financial literacy.

People who have attended financial seminars, for example, had a net worth 20 percent greater than those who were complacent about money matters, according to "Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education," a survey by Annamaria Lusardi of Dartmouth College and the Harvard Business School, and Olivia S. Mitchell, director of the Pension Research Council of the Wharton School at the University of Pennsylvania (see a sample of the questions). Part of the increase can be attributed to motivation—those who had attended seminars were more apt to want to save and invest. But mostly those who know the most about how financial markets work do a better job of weathering the swings of the markets.

Lusardi and Mitchell found that those who were literate in financial matters (see sample questions below) and who self-identified as doing "a lot" of retirement preparation had a median net worth of $200,000 compared with $84,000 for those who planned "hardly at all."

"Our review reveals that many households are unfamiliar with even the most basic economic concepts needed to make saving and investment decisions," the authors said in their 2007 study. "Such financial illiteracy is widespread: The young and older people in the United States and other countries appear woefully underinformed about basic financial concepts [like compounded interest and percentages], with serious implications for saving, retirement planning, mortgages and other decisions."

As corporate America shifts more and more of the burden for funding retirement to ordinary citizens, economists are asking questions like these two:

• How do you get people who never have money left over at the end of the month to save even 5 percent of their income for their future?
• How can people who have little or no knowledge of investing in stocks and bonds increase the returns they get on the money they save?

Just about the time you set your sights on a financial goal, it seems someone raises the bar. Inflation pushes it out of reach, or an emergency bites you in the budget. Part of the problem is caused by national and global events over which you have little control—like oil prices or the crisis in the home mortgage industry.

The dollar has fallen to new lows—a good thing for U.S. companies that want to sell their goods overseas, not so good for you and me. Because oil is priced in dollars, a falling greenback means higher prices at the wellhead and at the pump. The cost of heating a home with oil this year is expected to rise an average of $379—unless it gets really cold this winter.

One reason for the falling dollar is the penchant of the Federal Reserve to lower interest rates in a bailout of Wall Street fat cats who made bad bets on risky mortgage loans. In turn, lower interest makes U.S. Treasury bonds less attractive to foreign investors who then take their money elsewhere in search of better returns. Not much you can do about that.

But there are plenty of things you can control, and debt and spending are the biggest among them. In a review of 401(k) shareholders, John Ameriks, a senior investment analyst at Vanguard, found that how much income a household had was less an indicator of retirement savings than how much the family actually spent.

Ameriks found that those who were on track toward a comfortable retirement had a median income of $69,000 and median assets of $200,000. That compared with a cohort having an annual income of $83,000 (17 percent higher) who had saved just $38,000 toward retirement.

He also found that those who actively managed a household budget were more likely to have built greater wealth than those who didn't—budgets being the best way to keep a rein on runaway spending.

Employing a few simple, proven techniques like paying yourself first (in a Roth or traditional IRA), dollar cost averaging your investments and maxing out any available contributory retirement plans at work can put you on the road to financial stability.

Research has shown that to build wealth, it's not what you invest in, but that you invest, and that you do so regularly whether the markets are up or down at the moment. A core fund, such as a low-cost, no-load S&P 500 Index fund from one of the major families of mutual funds makes a solid base from which to start building a portfolio. After you're ready for diversification, branch out to international, bond or perhaps sector funds and ETFs (exchange-traded funds).

After you have had some success investing your own money and watching it grow over time, you will want to investigate all of your options.

Remember, too, that after inertia, inflation is your worst enemy. You simply must get started, and you have to be invested in the stock market to keep your money growing at a pace faster than inflation. Savings accounts, interest-plus checking, money markets and U.S. Savings Bonds just won't cut it.

I recently saw an estimate that a couple retiring today needs a reserve of $215,000 in their nest egg just to cover medical costs in retirement. Medicare and Medicare Part D (prescription drug coverage) will not pay for all of your healthcare needs. Health costs have been rising at a much faster clip than general inflation. So, by the time you retire it could easily mean a quarter of a million dollars or more just to pay for healthcare.

If you are a parent wrestling with the choice of adding to your child's 529 college savings plan or putting more into your IRA or 403(b) account, go for the retirement account every time. Your kid can earn a scholarship to go to college, but there are no scholarships available to help you get through retirement. That one's on you. It's your money.

Don Kuehn is a retired AFT senior national representative. For specific advice relative to your personal situation, consult competent legal, tax or financial counsel. Comments and questions can be sent to dkuehn60@yahoo.com.

Sophisticated Financial Literacy Questions

In their survey, "Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education," Annamaria Lusardi and Olivia S. Mitchell asked people some simple and some sophisticated questions to gauge their financial literacy. Here is a sample of the more sophisticated questions. How would you do?

1. Function of Stock Market
Which of the following statements describes the main function of the stock market?
a. The stock market helps to predict stock earnings.
b. The stock market results in an increase in the price of stocks.
c. The stock market brings people who want to buy stocks together with those who want to sell stocks.
d. None of the above.
e. Don't know/refused to answer.

2. Knowledge of Mutual Funds
Which of the following statements is correct?
a. Once one invests in a mutual fund, one cannot withdraw the money in the first year.
b. Mutual funds can invest in several assets—for example, invest in both stocks and bonds. c. Mutual funds pay a guaranteed rate of return which depends on their past performance.
d. None of the above.
e. Don't know/refused to answer.

3. Relation Between Interest Rates and Bond Prices
If the interest rate falls, what should happen to bond prices?
a. Rise.
b. Fall.
c. Stay the same.
d. None of the above.
e. Don't know/refused to answer.

4. Safer: Company Stock or Mutual Fund
True or false? Buying a company stock usually provides a safer return than a stock mutual fund.
a. True.
b. False.
c. Don't know/refused to answer.

5. Riskier: Stocks or Bonds
True or false? Stocks are normally riskier than bonds.
a. True.
b. False.
c. Don't know/refused to answer.

6. Long Period Returns
Considering a long time period (for example, 10 or 20 years), which asset normally gives the highest return?
a. Savings accounts.
b. Bonds.
c. Stocks.
d. Don't know/refused to answer.

7. Highest Fluctuations
Normally, which asset displays the highest fluctuations over time?
a. Savings accounts.
b. Bonds.
c. Stocks.
d. Don't know/refused to answer.

8. Risk Diversification
When an investor spreads his money among different assets, does the risk of losing money:
a. Increase?
b. Decrease?
c. Stay the same?
d. Don't know/refused to answer.

From "Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education," by Annamaria Lusardi and Olivia S. Mitchell. Used with permission.

Answers: 1.c; 2. b; 3. a; 4. b; 5.a; 6. c; 7. c; 8. b.