Archives for January, 2010
31
Jan
Posted in Net Worth Update by Roger, the Amateur Financier |
Well, it’s the end of January already. Funny, I’m still having trouble remembering to put ’2010′ on my checks rather than ’2009′, and already the new year is more than 1/12th over. Is there anyway we can, as a society, call a redo and turn the clocks back to January 1st? I can’t be the only one who could use a whole new January just to get their act together.
Well, I suppose getting a replay on the year is very unlikely. I’ll just have to keep moving ahead, trying to get my finances in shape as best I can as I travel forward in time. While this year certainly gotten off to the best start, I have faith that things will improve in the near future. Call it optimism, call it faith, call it pure hope, but I have the feeling that February’s going to be a good month. If not, I’ll have to redouble my efforts into my time machine project.
Alright, enough of my optimism; it’s time to look at my finances:
So, not one of my best weeks; with the end of the month coming up, I’ve been spending quite a bit to cover various bills, which did not make the American Express happy. Add in investments falling (in spite of adding over four hundred dollars to my Roth IRA, my account showed a net loss this week), and it’s been a rough week. Still, my optimism remains intact. Come on February; I’m ready for a new month to come!
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30
Jan
Posted in Weekly Thoughts by Roger, the Amateur Financier |
Well, this weekend is turning out to be much more exciting than I was expecting. My post on the Ten Commandments of Credit Cards is up on Free Money Finance’s March Madness post that’s active as we speak. Feel free to pop over and check it out.
Of course, I find myself wishing I knew more about self promotion and advising, so I knew better ways to get the word out and promote myself. I’m hoping that if there are any readers who haven’t yet voted, this post could spur some action; ideally, you’ll want to vote for my article, but I’m honestly happy just to be included. All I can do is continue to write the best articles I can and hope they continue to impress others.
Speaking of articles that impressed others, here’s the list of the posts I really liked from last week:
Good Articles From Last Week
Would You Do Three Years in Prison for $20 Million? – An interesting question about an extreme version of the trade we all make, exchanging our time for money. Darwin summarizes the situation of a UBS banker who is serving a jail sentence for his role in fraud, but is likely eligible for a whistleblower reward in the tens of millions of dolars. I doubt I will ever be in a similar situation, but I’d be very, very tempted to make this kind of deal; it’s an amount of money that could easily change my life.
I Went on a Cash Diet…and It Worked! – I like to report good news; there’s too much bad news in the world already. Luckily, there is still some good news in the world: Mrs. Money decided to not use cash for the past few weeks, and has noticed a major improvement in her spending habits. I might have to try the same sort of thing with my credit cards; try as I might, it’s hard to keep my spending in check when I’m spending with credit cards.
A History of Investment Bubbles – A great look at some of the many (it’s amazing how many) investments bubbles that have occurred through history. My Life ROI does a great job of showing not only the where, when, and how of every bubble from tulips to real estate, but also provides some of the take home lessons from each. Remember, if you don’t learn from history, you’re doomed to repeat it. (Although, you can say much the same about most of your classes, really 
).
Tax Refunds Are Good For Most People – In what seems to be an ongoing quest to argue against every piece of popular investment wisdom, the Financial Samurai argues that getting a tax refund is a good thing for most people, as many people are better at using a lump sum of money properly (investing or paying off debt) rather than small amounts distributed over time. It’s an interesting argument, although I would make the counterargument that if you’re spending your time reading personal finance blogs, you probably have the discipline to save and invest throughout the year (or at least, set up an automatic saving/investment plan to do the heavy lifting for you).
Cutting Down On My Electric Bill – One of the pains of living in the snow belt is needing to have the heater on near constantly, just to keep your blood from freezing. Lulu gives some recommendations on how she cut her down on her electric bill, all good ideas for those of us who are freezing to death. If you are in the Southern Hemisphere and need to know how to cut down on your air conditioning bills, you’ll need to look elsewhere, though.
Seven Things You Must Do To Prepare for an Emergency – Lazy Man and Money provides a very solid list of things to have on hand in the event of an emergency. There’s not much more I can really add; hopefully, you’ll never find yourself in a situation where you need to use your emergency kit, but it’s excellent to have all this on hand, just in case.
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29
Jan
Posted in Your Mind and Your Money by Roger, the Amateur Financier |
It’s the end of the week, and that means the last in the series of mental mistakes we make with our money. If you’ve been reading all week (good for you if you have!), you’ve probably noticed that many of these mental flaws seem to stem from the same basic problem: your brain is bad at predicting the future. You save everything in the hope that it will go up in value or make unrealistic assumptions about future odds. Well, buckle up, because we’ve got one more irrationality to deal with:
Irrational Escalation of Commitment
You escalate your commitment when you continue to devote time and money to a course of action as a result of previous commitments. If you’ve ever tried to climb a mountain (or attempted to reach some other physical or mental peak) and pushed yourself to go a bit further ‘because I’ve already come all this way’, you’ve escalated your commitment to a goal. Such escalation becomes irrational when the rewards from completing your goal would come nowhere near to covering the expenses you’ve paid to complete the goal. A business plan that’s already cost more than it could possibly recuperate but is continued anyway is an example of irrational escalation of commitment.
Escalator, Escalating... Get it?
If all of these sounds rather similar to the sunk cost fallacy, you’re onto something; irrational escalation of commitment frequently results when people (or organizations of people like businesses and governments) refuse to see or acknowledge that the money they’ve spent already is sunk, and the insistence that increased expenditures are needed to justify the initial spending. It becomes an endless spiral of spending more and more to justify previous, sunken costs. Speaking of which…
Irrational Escalation of Commitment Examples
-The most commonly cited example of irrational escalation of commitment is the dollar auction. The short version is this: a professor offers to give the highest bidder in the class one dollar. There’s a catch, though: not only will the highest bidder have to pay out his bid to get the dollar, but the second highest bidder will have to pay his bid as well, without receiving anything. The bidding starts low, at one cent, and quickly increases, until someone bids one dollar. That should be the end; after that, people are paying more than the dollar is actually worth with each bid, so the bidding should end.
But, because of the rules of auction, the second highest bidder also has to pay, and so he has the incentive to bid even higher; if he wins with a bid of $1.01 rather than losing with a bid of $0.99, he’ll only have to pay one cent rather than ninety-nine. The dollar bidder has the same motivation; if she wins the auction, she’ll have to pay less than if she comes in second place. With this seemingly logical thought behind them, they can (assuming the professor allows them to continue) bid the price of the dollar up to many, many multiples of its actual value, only stopping when one bidder runs out of money to make progressively higher bids or the professor calls the auction off. With each bid, the bidders were doing what would optimize their financial interest, but the overall process could, assuming the professor forces them to pay up, end up costing each of them far more than the value of the prize they’re seeking.
-As mentioned already, anytime a manager opts to continue a project after spending more money than it could possibly recuperate, it’s an example of irrational escalation of commitment. It might be done to save face or even the manager’s job, but for the company as a whole the process is wasteful and counterproductive.
-Many forms of ‘Keeping Up with the Jones’ can be considered a type of irrational escalation of commitment; as with the dollar auction, even if you ‘win’ and have a more impressive car, lawn, or house, you have still ended up spending more than you could possibly hope to recuperate by selling (assuming there’s even a market for your improvements; last I checked, there’s not too much demand for used lawn ornaments).
Beating Irrational Escalation of Commitment
Well, if you ever find yourself in an economics class and the professor wants you to bid on a dollar bill, just don’t do it! For the more real-life examples, always keep the potential goal in mind, and aim to keep your costs well under the potential rewards. If you’re trying to compete in a costume contest to win a $100 grand prize, the cost of your costume(s) should be less than $90 or so; otherwise, even if you do win, you won’t have much to show for it.
Also, be sure to recognize when your costs are sunk, and have the willingness to walk away. Yes, maybe devoting just a little bit more money to your so-far failed project will enable it to be a success, but it still won’t bring back the money you’ve already spent. More likely, any attempts to justify that spending will just lead to increased spending in the future, with no increase in rewards.
The key to stopping irrational escalation of commitment is to attempt to be as rational as possible, and look forward to the potential rewards rather than behind to the (sunk) costs you’ve already paid. Remember, you can’t change the past, but you can do things differently in the future!
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28
Jan
Posted in Your Mind and Your Money by Roger, the Amateur Financier |
By this point in our little exploration of your inner mind, you might be getting a little upset. After all, we’ve seen that you (or at least, your unconscious mind) base decisions on money that’s already gone, overestimate how quickly statistical deviations will be corrected, and over-discount future money; with all of that to contend with, how much more can your brain possibly mess up your financial plans? Well…
Disposition Effect
You know that relative who saves just about everything, keeping not only the normal mementos of friends and family (things like old report cards and artwork from children), but hangs on to everything, no matter how useless it seems to everyone else? That’s the disposition effect at work; the nature of people to hold onto something rather selling and acknowledging how little it is actually worth. Regardless of how likely it is that we will ever use a particular item again, our minds are more at ease if we hold onto it forever, just in case.
A sunny disposition is helpful, but completely unrelated to the disposition effect
It’s the same with investments; people have a tendency to hold onto investments that have fallen in price, regardless of how unlikely it is that they will ever recover in value, rather than selling and acknowledging the loss. Of course, the inverse is true, and can be just as damaging: we’re more eager to sell when our investments are up, regardless of how much further up they might go. Combine the two effects, and you have the recipe for sub-par investment results regardless of how the market actually performs.
Disposition Effect Examples
-The pile/filing cabinet/room that many people have, filled with instruction manuals for objects that have long since been replaced, tax returns spanning the last several decades, and every receipt we’ve ever received. If we were really honest (and yes, I’m as bad as anyone about this), we’d come right out and admit that we could throw most of this stuff out and never even know it was gone, but part of our mind finds comfort in knowing that it is there.
-Self-Storage places, where you can pay by the month to stow some of your excess stuff. The entire business model is designed on the assumption that you are willing to pay each month so that you can get stuff out of your house, but still want to be able to retrieve it at any time. The convenience is almost certainly not worth the expense.
-As mentioned before, the willingness of investors to hold onto their losers and cut their winners short is also an example of the disposition effect at work. While doing so may make you feel better (you can crow about the stocks you had that shot up while pretending the ones that declined can still increase), you’re doing the exact opposite of what you should be, investment-wise; holding the stocks that rise and getting rid of those that fall.
Beating the Disposition Effect
Beating the disposition effect is basically an issue of mind over matter. You should know, in the rational part of your mind, that the chance of benefiting by holding onto many of your possessions is very low; unless your attic is filled with rare artwork or your basement holds pristine baseball cards from the thirties, most of your stuff is only as valuable as the use you can get out of it. If you aren’t using it, particularly if it’s just taking up space in your house, dorm room, or apartment, you’ll likely be better off selling it for money with which you can purchase something you WILL use. (Or better yet, why not invest the sales proceeds so you’ll have more money in the future?)
The simplest solution is to go through your possessions on a regular basis, figure out which you need and don’t need, and get rid of what you don’t need (selling it, throwing it away, trading it with someone else, whatever strikes your fancy, as long as it gets the item out of your living area). If you’re a pack rat like me, it’s going to be tough, but it’ll be worth it to make your living space more, well, livable.
I’m not going to try to set out a precise definition of what exactly falls into the category of ‘needed’; you are going to have to give some thought as to what you consider necessary and unnecessary in your life and work from there. For me, I would include regular use items (like my clothes and computer), seasonal items (holiday decorations and the like), mementos (things like report cards or art work I did as a child), and collectibles (so I have a category for my manga, really) as my ‘needed’ items, and everything else would be fair game to sell or trash, from books I haven’t read in years (which have no emotional value attached) to most of the DVDs I’ve accumulated in the past.
For investments, that same type of discipline will pay off. Know when you make the initial purchase how you’re going to respond if the price goes down (Sell it when it drops a certain percentage? Buy more when it dips lower?) and if the price goes up (Sell it when it gains a certain amount? Wait to see how high it goes, selling when it starts to dip from its peak?). Even the best laid investment plan won’t always increase in value, but if you make a plan for what to do in any event (and more importantly, you STICK to your plan), you’ll be much better in the long run.
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