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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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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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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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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Welcome once again to our continuing discussion of how your insane brain is costing you money.  You might think I’m exaggerating, but as we’ve seen already this week, there are a number of ways you brain doesn’t think entirely logically about money and investing.  One way that is particularly harmful to your investing and saving motivation is:

Hyperbolic Discounting

In its simplest form, hyperbolic discounting is an overemphasis of the old adage, ‘A bird in hand is worth two in the bush’.  When given the opportunity to have a relatively small amount now or delay our gratification for period of time and get a much higher amount of money, many people choose to take the smaller amount immediately.  The most commonly cited research (Green et al. 1994) shows that if people are given the choice between $50 today or $100 a year from now, most people will choose the $50 dollars today, in spite of the fact that the $100 will almost certainly still be worth more a year from now.

Interestingly, that same research found that if there was increased distance put between both rewards, if we are looking at the choice between $50 in five years or $100 in six years, most people will opt for the more financially beneficial option, choosing $100 in six years.  This is part of the ‘hyperbolic’ aspect of our mental process; there’s a much sharper drop off in perceived value in the near future (today vs. one year from now) than there is more distantly in the future (five vs. six years), even if the time period between the two events is the same.  (Besides showing the underlying false logic behind this process, it also illustrates a point we’ll use to make more logical decisions in the future.)

Hyperbolic Discounting Examples

-Most importantly for a blog about investing and saving, hyperbolic discounting causes people to value their current spending more than their future wealth.  As a result, given the choice between spending more today and investing more for tomorrow, most will opt for the former.

-Discounting future payments also causes people to opt for lump sum payments rather than defined periodic benefits, even if the defined benefits are much higher than the lump sum.  (I understand that there can be circumstances beyond the relative values of each type of payment that determine which method someone would prefer; this comment is more about people who look at $20,000 per year for 15 years vs. $100,000 immediately, and opt for the $100,000 without a reason other than it being a higher amount.)

-Opting to skip school or further training for an immediate job.  While it allows you to start earning money sooner, you’ll earn less over your lifetime than with more formal education; hyperbolic discounting of your future earnings potential strikes again.

Beating Hyperbolic Discounting

Remember how I told that when viewing the options several years in the future, people made the more logical choice?  That’s probably your greatest defense against hyperbolic discounting: put some distance between you and any of the options, so you don’t let the desire for immediate gratification overwhelm your common sense.  It might seem like a tough choice between spending money now and investing for the future, but imagine that you can’t use the money for a year; do you think you’ll still want to spend it?  If not, why do you want to spend it now?

Investing goes much the same way; it’s easy to rationalize putting it off until you’re older, or keeping the amount you invest as small as possible, but that leads to delays or avoidance of investing altogether.  Instead, try to take a longer term view, and look at what you could potentially have when it’s time to retire.  Would you rather have $1.9 million or $2.9 million in forty years?  (The difference between investing $4000 and $6000, respectively, and earning a 10% during that time period.)  How about choosing between $1.1 million and $2.9 million at retirement?  (The difference between starting to invest $6000 a year at 35 vs 25 years old, respectively.)  When you run some numbers to see your future net worth potential, it’s easier to see how relatively small sacrifices now can yield big returns in the future.

There, you know have a few mental tools to help you cope with hyperbolic discounting; the key is to try to repress the natural desire for immediate gratification and instead focus on the long term.  If you get skillful enough at doing so, you should be able to avoid the problems of hyperbolic discounting without any problem at all.

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Welcome to the second in our series of posts about the ways your mind makes it harder for you to manage money intelligently.  Yes, unfortunately the nature way that human minds work can be one of your biggest obstacles to success with your money, so this week, we’re going to uncover some of the biggest mistaken beliefs and do what we can to correct them.  Today, we’re looking at a belief that powers any number of poor bets in Vegas.

Gambler’s Fallacy

The gambler’s fallacy is when you assume that long term probabilities will hold in the short term.  More to the point, you would assume that because something statistically unlikely has just occurred, the laws of probability demand that the opposite result will occur now.  One easy example is if you flip a coin five times and every time it comes up as heads, you might then assume that the next flip should be tails; after all, it’s ‘due’ to come up heads, right?

People still gamble with pennies, right?

Actually, as any statistician will tell you, it’s not.  Yes, over the long term (thousands or even millions of flips), the totals will be roughly evenly split, but within that series, there will be stretches where tails come up five, ten, twenty or even more times in a row, and similar stretches of heads.  You have no way of knowing if you are at the beginning of a much longer stretch or not; the only thing you know for certain is that there is an equal probability of getting heads or tails on any given flip.

Gambler’s Fallacy Examples

-Thinking that several red results in a row  in roulette means that black is due to come up, or vice versa.  The roulette ball doesn’t ‘remember’ previous results and ‘choose’ where to go next to look good statistically; every time, there’s the same possibility of getting a red as a black.

-Feeling that because your slots machine hasn’t paid out, it’s due to hit (and possibly to hit big) soon.  As with roulette, the slot machine (assuming it is fair and hasn’t been tampered with or altered in some way) doesn’t care whether the last five, fifty, or even five hundred spins have all paid out nothing; the chance that the next spin will pay out is exactly the same as it would be if the last results were all victories.

-Really, anytime you use the words ‘due’ or ’should’ in conjunction to something based entirely on chance, you’re appealing to the Gambler’s Fallacy.  Past results have no effect on future probabilities, outside of our own perceptions.

Beating the Gambler’s Fallacy

The easiest way to beat the Gambler’s Fallacy is simply not to gamble.  Not only will your wallet thank you for not taking out money when all the odds are against you, but you’ll never have to worry about making improperly considered bets because something is ‘due’ to happen.

If you do gamble, or engage in other activities based on probabilities, you best defense will be to learn and understand those probabilities.  If you know, for example, that there is a 6 in 36 chance of rolling a seven in craps, you won’t be surprised when that’s the most common result.  You also won’t be surprised if, due to the quirks of the dice, you see a few dozen rolls with no sevens, or a dozen sevens in a row.  Remember, the dice don’t know what’s been rolled, and have no need to stick with statistical probabilities in the short run.

That’s pretty much all there is too it; don’t let recent trends convince you that things need to change soon in order to restore the laws of probability.  Trust me, the laws of probability are not going to be worrying about you.

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Welcome to a week-long special about one of your greatest obstacles to financial success: your mind.  Unfortunately, many of the problems that we run into with money are caused by our minds; the current financial environment is not what our minds were designed to handle.  In the hopes of getting you to realize the logical flaws that plague our minds, we’re going to cover several of them this week, starting with one of the biggest, most prevalent ones:

Sunk Cost Fallacy

In a nut shell, the sunk cost fallacy is when you alter your behavior as a result of nonrecoverable money you have already spent. Unfortunately, the money you’ve spent is gone, and you can’t get those particular dollars back.  You have to do what you can to maximize your future enjoyment of your money, without regards to what expenses you had in the past.

Sunk Costs are like Sunken Boats; Usually Gone Forever

If we were completely rational beings, we would only be concerned about our future spending, not caring about what we spent in the past (at least, if there’s no possible way of getting that money back).  Alas, we humans are not that logical, and we ascribe value to what we spent already, regardless of what little effect it can have on our future financial situation.

Sunk Cost Fallacy Examples

-Spending more money to fix your current car than it would take to buy a new (or at least a good used car) car, because you’ve spent money fixing the car already.  (Side Note: I’ve nearly done this myself, spending more money than my car would be worth (I had bought it for $1000 several years before) to keep it running just a few more years, or more likely, months).

-Putting a nonrefundable down payment on an item at one store, before finding it somewhere else for lower cost (lower than the retail price minus the down payment).  If you opt for the less expensive item (which is the most economically sensible decision), then your down payment will be lost, an expense beyond the cost of the item.

-Holding a declining investment, while waiting for it to ‘break even’.  There are no guarantees in investing, and there’s no reason to think that your investment will necessarily come back, particularly to the fairly arbitrary point set when you bought it.  Investments don’t know how much you spent on them; good ones will increase in value and poor ones will decline, regardless of how much you spent to purchase them.

Beating the Sunk Cost Fallacy

The problem with the sunk cost fallacy is ascribing your past spending with equal weight to your future spending.  The best way to avoid falling into this trap is to re-evaluate your future spending while ignoring the money you’ve spent previously.  Ask yourself, ‘If I was making this purchase today, with no knowledge of what I’ve spent in the past, would I still make it?’  If it’s not worthwhile to make the purchase fresh, it’s not worth spending more money on it; chock up any down payments or previous expenses as the cost of doing business.

This argument applies with investing costs.  The cost of buying your investments can be considered sunk; if the investment declines, you have no way of getting your investment back.  You need to evaluate your investments on the basis of where they stand currently and where they will go in the future.  If the investment is declining, particularly if it is an investment like individual stocks that can go to zero, you need to ask yourself if you genuinely believe the investment will rise in the future.  Evaluate your investments as if you are putting in new money today, even if you aren’t, so you aren’t considering costs that are already sunk in your decisions.

As with any logical problem, it’s easy to fall into the sunk cost fallacy; our minds are designed to work in ways that aren’t conducive to our long term financial future.  You’re going to need to make some effort to avoid it.  Remember that money that’s been spent cannot be recovered in many cases, and as a result, shouldn’t factor into your future financial decisions.  While you shouldn’t forget the past, you should be sure to keep it in perspective, and not allow your past decisions to dictate future, less than ideal actions.

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Well, I made a mistake this past one, one that could cost me a pretty penny.  I didn’t pay my American Express bill on time this month.  Unfortunately, with all the trouble I had with getting unemployment benefits, I didn’t schedule a payment for Amex when it closed for December, and didn’t think to double check this month.  I realized my mistake this Saturday (when the payment was due on Thursday), paid the bill, and had the payment credited to my account.

Well, today, I re-checked my account, and I was both charged a fee, and credited an equal amount to my account.  I’m not entirely sure what happened; I was expecting (and prepared to pay) a fee because of my mistake, but perhaps because it was my first time failing to pay on time and because I corrected the situation within two days, they gave me a pass this time.  If so, I’m thankful, and will have to try even harder to prevent this event in the future.

In either event, I’m taking the initiative and setting up automatic payments for my credit cards (and will see if I can do so with my student loans, as well).  I’m also making notes on my net worth table to keep track of which automated payments are scheduled to be paid, so I can add any other payments that are needed.  So, with all that in mind, let’s see where my finances stand this month:

It was a bad week for my investments, which got hammered.  That went a long way to dragging my net worth down, but hopefully the markets will pick back up soon.  Until next week, here’s to an increasing net worth (and no stupid credit card mistakes) for everyone reading!

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Ah, Robert Kiyosaki.  So many contradictory thoughts come to mind when I think of you and the books you’ve authored.  On one hand, you were the first personal finance writer who really caused me to stop and re-evaluate how I was using my money, and for that I thank you.  On the other hand, much of your advice, particularly in your first book Rich Dad, Poor Dad, seems highly inappropriate for me at best, and downright dangerous for most people at worst.

Given those two considerably different views, I had to make a serious effort to read your second book, Cashflow Quadrant, with an open mind.  I did my best to judge it not based on my opinion of you, your critics, and even your first book, but rather the merits and demerits of the book itself.  Is it a must read for all would be investors, or something that most everyone can skip?  Let’s read on:

Overview

The book starts by introducing the Cashflow Quadrant(TM), an illustration of the four primary ways to earn money.  It’s shaped like a plus sign, with four letters in each corner, separated by the plus’s cross bars.  In the upper left, there’s an E (for employee), the lower left has an S (for self-employed), the upper right has a B (for business owner), and the lower right has an I (for investor).  (Look over at the cover of the book; you should be able to make it out.) Much of the rest of the book refers back to this diagram at one point or another, so having a good understanding of it is important.  In fact, before the introduction ends, Kiyosaki notes that his ‘Poor Dad’ (his biological father) always recommended he stick to the left side of the quadrant (the E and S side) while his ‘Rich Dad’ (his friend’s father, who gave him advice on how to become rich) suggested that he should focus on the right side (the B and I side).  The first chapter begins to introduce the idea of the four quadrants in more detail, as well as noting that it’s possible to be rich or poor in any one of them.

The second chapter starts to introduce the differences between the four groups.  According to Kiyosaki, E group employees desire security, the S group of self-employed people wants to do it themselves, B group business persons want to be surrounded by those who can help them build and grow their businesses, and investors in the I group use money to make money.  There’s a few side discussions in the chapter clarifying his definitions and expanding where he suggests people who wish to be wealthy should focus their attention (in the B and I quadrants).

The third chapter covers why people choose security over freedom.  Kiyosaki discusses how many people will, as they increase their salary at work or in their small business, spend more and start to borrow even more, leading to a cycle of ever increasing debt even as their income is rising.  He also covers some patterns of the rich (moving from the S quadrant to the I quadrant by investing their earnings, for example) and the not so rich (continually changing E quadrant jobs).  The fourth chapter covers the three types of business systems that Kiyosaki recommends; traditional C-corporations, franchises, and network marketing.  He goes into some detail about each type of system, giving particular recommendations to network marketing.

The fifth chapter covers the seven levels of investors, from level 0 (those who have nothing to invest) to level 4 (the long-term investor, who invests primarily in mutual funds) to level 5 (sophisticated investors who can make their own investments) and finally to level 6 (capitalists, who create investments like businesses and sell them to the market).  He ends with a note that you have to become good at being a level 4 investor before you can go on to level 5 or 6.  The first section of the book ends with a chapter advising you to see money with your mind, since it is just a concept.

The second part of the book is about ‘Bringing Out the Best in You’.  Kiyosaki starts with a chapter encouraging the reader to be who they want to be.  The eighth chapter covers how to become rich, focusing on changing your mental attitude toward money and becoming rich.  He spends quite a bit of time covering various emotional and mental hang ups many people have, attempting to dispel them.

The ninth chapter goes over some of the heroes and villains of past financial crises (and rather astutely notes that Alan Greenspan would become a villain in a financial downturn).  He covers some more advantages to using real estate to invest and starting corporations, mainly the tax advantages inherit in both.  The chapter ends with a sidebar, reminding readers to stay up to date on tax law and use the rules to their advantage.

The tenth chapter kicks off the last section of the book, on thinking like a B or I individual.  This chapter covers taking baby steps learning to think like a rich person, gradually re-educating yourself to think in terms of the possibilities for businesses or other investments that are out there.

The last seven chapters of the book are organized as seven steps to finding your financial fast track.  Step 1 is to mind your own business, learning about your financial situation and developing a plan to become wealthier.  Step 2 is taking control of your cash flow, determining where you money comes from and goes.  It ends with a pretty solid, if ambitious, plan for paying off your credit debt each month.  Step 3 is knowing the difference between risk and risky, the difference between make intelligent investments and never doing any investing.

Step 4 is to decide which type of investor to be, one who knows nothing, one who seeks ready solutions, or one who seeks problems to try to fix.  Step 5 is on seeking mentors, who could be anyone from good role models you want to follow to spiritual role models who can inspire you.  Step 6 is all about turning disappointment into strength, learning from the mistakes you’ll inevitably make.  Step 7 i about having faith; in this case, faith that you can accomplish your financial goals.  The book ends with a table comparing the Broke Masses, Successful Middle Class Investors, and the Rich on a number of features, from investment vehicles to the resources they use.

Pros

-Easy to Read: Kiyosaki is definitely good at creating a compelling narrative, and this book is no exception.  You should have no problem reading and following along with the points he makes, as well as the diagrams he shares.  The book is pretty easy for anyone to pick up and read.

-Actionable Advice: Particularly in the last set of seven chapters, Kiyosaki lays out a number of simple, easy to follow steps that make it possible to become wealthy using his methods.  Particularly compared to Rich Dad, Poor Dad, having real, workable advice is a good step in the right direction.

-More Inclusive Perspective: Again, compared to his first book, Cashflow Quadrant does much more to acknowledge alternate view points on wealth and money.  Kiyosaki notes that people in all four quadrants can become rich, for example, and also points out that most of the millionaires in the US would be considered level 4 investors on his scale.  All of this makes it much easier to get something out of the book, even if you don’t follow all his advice.

Cons

-…But Not Completely Unbiased: While not as bad as the first book, Kiyosaki still doesn’t show an excess of respect for those in E and S quadrants.  Some of his comments do have justification (the relatively high taxes paid on earned income, for example), but many of them are unfounded, attributing traits of fear or perfectionism onto those who are self-employed or work for someone else.

-Selective Emphasis of Risk: Kiyosaki is perfectly happy to discuss risk… the risk of not investing according to his principles.  What he mentions only in passing is that doing the high profit potential deals he emphasizes does have the risk that many, if not most, will fail.  Unfortunately, even when acknowledging such possible failures, there’s no mention of how to prevent or recover from them; the idea of insurance or an emergency fund never comes up.

-Denigration of Education: A continuing theme in Kiyosaki’s writing is the relative unimportance of education.  From calling his highly educated father ‘Poor Dad’ to maintaining that street smarts are much more important to success than book smarts to sharing a list of anti-education quotations in the middle of a chapter (sent to him by Poor Dad, no less), he has no fondness for education, and seems to delight in denigrating it.

Conclusions

Overall, I liked Cashflow Quadrant much better than Rich Dad, Poor Dad.  Yes, there are still flaws; it under-emphasizes risk and devalues formal education.  But it’s a much more practicable book, with specific suggestions for those trying to follow Kiyosaki’s advice, as well as including some advice for those who aren’t ready for his particular brand of investing.  It’s a decent beginning investing book; even if you didn’t really care for Rich Dad, Poor Dad, it might have some points worth knowing.

• Book Review: The Automatic Millionaire
• Book Review: Eat The Rich
• Book Review: Jim Cramer's Real Money

• What if I didn't drive my car everyday?
• rich mom, poor mom
• Do you appreciate what you have?

It just never seems to end, these holidays where we have to exchange gifts with our loved ones.  Don’t get me wrong, I like giving gifts, particularly to my fiancee, and I’ve been known to give gifts with no occasion behind the giving at all.  But it’s different when the gift is expected, all but required, as on Christmas or the upcoming Valentine’s Day.

Yes, Valentine’s Day.  My fiancee called me this afternoon to let me know that she’s purchased a gift for me for Valentine’s Day, meaning that I need to get on the ball and find her a gift as well.  The fact that a celebration of love and the life of a Catholic saint has turned into a major gift giving holiday just seems a little bit wrong, as does the fact that relationships can rise or fall based on what’s purchased and received February 14th.  I’m all for the abolishing of Valentine’s as a holiday…if I could only get my fiancee to agree.

Oh, well, perhaps next year.  For now, it’s time to consider some of the good posts this past week:

Posts The Amateur Financier Liked This Week:

Be Sloth and Don’t Roth! – A contrarian post from the Financial Samurai that challenges one of the most commonly held pieces of personal finance advice, that a Roth IRA is better than a traditional one.  The arguments he presents, as well as the discussion that developed in the comments, debate the argument back and forth, with one of the best arguments being one that I reviewed earlier this week (the part about marginal tax rates).  If you’ve been considering Roth accounts a retirement slam dunk, please have a read so you aren’t (unpleasantly) surprised come retirement.

How to Help Haiti – Given that Haiti is still in the news for all the wrong reasons (aftershocks and continuing problems getting people and supplies where they need to go), Baker’s advice on how to help Haiti and its people in their time of need seems quite timely.  Be sure to read the suggestions he and the commentators have on giving, and give to the worthy causes trying to help Haiti.

It’s More Environmentally Friendly to Pay With Plastic – An intriguing thought, especially since I have an interest in environmentalism as well as personal finance.  If you need an excuse to switch from using cash to using a credit card (or debit, if you prefer not to even risk building up credit card debt), consider Mrs. Money’s argument that using cash creates a lot of waste (in its creation, shipping, use and eventual destruction) that comes nowhere near the pollution generated from creating a plastic card.  Reasonable and logical, as far as it goes; just make sure you use your plastic wisely (especially with a credit card), and everything should be alright.

Maximize Strengths or Minimize Weaknesses? – There’s only so much time we can put into improving ourselves, so Lazy Man and Money asks, do we try to build up our greatest abilities or decrease the problems we have?  Personally, I think there are personal skills that are useful no matter what you do (like good personal finance and time management), where you should minimize your weaknesses, and specific skills useful for your job or other source of money (like being good at chemical testing, to use me as an example), where you can probably, but not always, make yourself more valuable by maximizing your strengths.

Invest? Borrow? Why Not Both? – Frank Curmudgeon wonders about the human psychology quirks that cause us to discount debt until we pull money from savings to pay it off.  It’s one of the many parts of being human and dealing with money that make little sense, and yet they still persist.  Personally, I think we just aren’t built to understand concepts more nebulous than ‘I have two coconuts, enough to last for two days’ in the course of evolution, but that’s just my view.

Where The Amateur Financier Was Featured This Week

The Carnival of Money Stories hosted by Funny About Money featured my article Fifteen Things to Tell a Younger Me (which is likely going to go down as one of my favorite articles this year)

• Weekly Thoughts: Happy Grundsow Day
• Weekly Thoughts: Christmastime is Here!
• Gift Card Smack Down!

• Other money carnivals this week
• Unbroke: What You Need to Know About Money
• Last Minute Gifts For The Frugals On Your List