Behavioral Finance: Good or Bad

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A couple of weeks ago I asked Are Roth 401(k)s and Roth TSPs Better? in response to an article in Money Magazine. I attempted to give an answer in part 2 the following day.

The argument was complex and worth reviewing those posts for more detail, here's the shortest version I give. Because many people simply put a percentage of their salary (say 6%) in a retirement account, it is better to got with a Roth 401(k) over a traditional one... you'll end up with more money in most scenarios.

Mathematically, I still don't fully grasp it. However, at the time it was explained to me, it made sense.

The reason it turns out better is "behavioral finance." Investopedia explains behavioral finance as:

"According to conventional financial theory, the world and its participants are, for the most part, rational 'wealth maximizers'. However, there are many instances where emotion and psychology influence our decisions, causing us to behave in unpredictable or irrational ways.

Behavioral finance is a relatively new field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions."

Maybe that definition isn't exactly fitting of the situation, but it seemed like the idea was to tell people to go with Roth 401(k) because in general circumstances it will turn out better.

I've never been a fan of such financial generalizations. At the time, I cited people who give the advice, "Cut up all credit cards." It makes me cringe because I use credit cards to save thousands of dollars a year and never pay a finance charge. I also don't spend more money, because it is "less painful" then spending cash. To me it is exactly the same.

On one hand, I want to say this behavioral finance stuff is terrible. Instead let's just educate people so that they can be ideal "wealth maximizers" (love that term). If we show people how to make great financial decisions, they'll be better served in the long run.

On the other hand, I want to say, behavioral finance could be useful. It's easy for me as someone who blogs about personal finance on a daily basis to say, "let's teach people." However, I think there are a lot of people who are ummm, well too Lazy (in the bad sense), to learn. Maybe they are preoccupied with some of life's other problems. So for those people, maybe just telling them what to do is the right thing?

You may be able to tell that I'm leaning towards behavioral finance being bad. I think people should learn all they can about how their money works from a mathematical view. It's okay to point out the psychological pitfalls, but I don't think that should be the horse that pulls the wagon.

What do you say? Let me know in the comments.

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Finances, Psychology

Last updated on September 14, 2014.

Car Dealerships are Rip-offs…

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... but we already knew that right? Or maybe we all didn't.

I'm not writing about buying a new car (that article might be tomorrow), but I'm writing about getting a car repaired. As I mentioned yesterday, my car broke down earlier this week. It's a ten year old Jeep, so it's not of tremendous value and it's been having more breakdowns of late. Since I have a Jeep dealership near the house, I decided to bring it by and get it looked at.

They called back and told me it would be $1000 to fix. I asked what was wrong and they said the cooling fan was broken and it needed new spark plugs. I thanked them and proceeded to hang-up and call my local mechanic. Over the phone they said it would probably be $400, but in person today I think it might even be cheaper than that.

Saving $600 (or more) on a phone call? Eat your heart out Geico.

I shouldn't say that every car dealership is a rip-off when it comes to repair, but that's been my experience and this just cemented that. What's your experience with car dealerships? Let me know in the comments.

(Since this article was so extremely short, I'm going to give you a bonus related article. I'm breaking the blogging rules today.)

To Donate or Not to Donate

Before we got the diagnosis that it was a reasonable fix, my wife was thinking of donating it to Kars 4 Kids. She called them and they said they'd be able to give a tax write-off of whatever they sell it for after their costs for fixing it, but that it would be at least $500. If they were able to sell it for $4000 (below Kelly Blue Book), but used the dealership's $1000 quote to fix it, we'd get a tax write-off of around $3000.

Assuming a 25% tax bracket (just to make things easy) that's a value of around $750 in our pockets. Alternatively, we'll put $400 into fixing it up and try to sell it on our own for $4500 (still under Kelly Blue Book) making a profit of a little over $4000.

I'm all for helping out kids, but that's a huge difference. The $4000 will make a few payments on the new car. Let's hope it works out as planned.

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Posted on October 29, 2013.

Ignore Your Personal Finance Guru

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This couple that I'm friends with related an interesting story to me the other day. They decided that their current bank no longer suited their needs and it was time to try a new bank. Sometimes, and this is one of those times, switching to a new bank isn't exactly easy. In the middle of this process, bills came due, so they use money from other other accounts to pay them. This created a little bit of chaos with their budget. One of them figured, "Well, we aren't spending money haphazardly, once the bank accounts get settled, we'll be able to transfer money to the right places and right the budget." The other one was a little more concerned about the budget. However, that argument started with, "Well, Suze Orman says..."

I can't remember if the ensuing argument made sense or not. I believe I was too busy actually putting my face in my palm, but the details are foggy. (The other half of my brain thought, "There's definitely a post to be written here.") Whenever I hear someone bring up a "[personal finance guru] says..." my soul starts to cry. I just gives me the feeling that they are memorizing some points and not really learning them, or thinking for themselves. That can be a dangerous thing because even personal finance gurus make mistakes.

Before I go any further, I want to make something clear. I'm not intending to put these gurus down to make me look better. Their personal finance knowledge far surpasses mine. Any regular reader knows that I do not claim to be an expert. If I tried for the next 80 years I couldn't be the experts the following people are. In short, they are awesome, and I am scum. :-)

I thought I'd take a few minutes and detail some of the issues that I have with personal finance gurus:

Suze Orman

Since she was the first person mentioned, I thought it would make since start with Ms. Orman. I have watched her syndicated show about a dozen times. Often she takes calls where people ask if they can afford to buy some luxury item. It's extremely rare for Suze to say, "Yeah, go ahead and get it." I'm waiting for the person who makes $3 million a year to ask to buy a gumball and get rejected as an outlandish request. I'm also fairly convinced that you could make Jack Bauer give up any and all secret information by putting him in a room with Suze Orman and Judge Judy. That is if they aren't actually the same person in a disguise. Come to think of it, I've never seen them in the same place at the same time, have you?

David Bach

I could write up a paragraph, but Kimberly Palmer of US News has done all the work for me. She makes a point that David Bach's famous (and copyrighted) Latte Factor... the faulty math and the psychology behind it.

Dave Ramsey

He's almost exclusively focused on getting out of debt. There's little for the person who wants to learn how to be wealthy. Also, ago 5 years ago, Five Cent Nickel pointed out that Dave Ramsey is bad at math. It's true... Dave Ramsey is more about the psychology of getting out of debt than the math about the best way to do it. To further complicate things, Dave Ramsey brings religion into personal finance, which doesn't necessarily lead to better financial management.

Jean Chatzky

No one can find a downside to Mrs. Chatzky. She's perfect in just about every way. Well, at least I thought that until I got email from her publicist that she wanted to promote her website. She was willing to answer 5 questions from Lazy Man and Money readers... except that when I presented the questions, the answers never came. I tried to repeated get in touch with her publicist to no available. The egg on my face matched my shirt quite nicely. And I'm not the least bit bitter :-).

There are probalby a few more personal finance gurus, I could throw under the bus, but I hope I conveyed the major point I was hoping to... No personal finance guru is perfect. There's enough gray area in math, psychology, and other factors that make all information open to some interpretation. They are great for learning the concepts of personal finance, but you should probably adapt them to your own situation.

In the case of the switching of the bank accounts, I went with the friend who said that the budget would be straightened out when the bank accounts are. They still have access to all the money, so I consider it a short hiccup in the personal finance of the couple. It happens... hug it out over a latte.

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Posted on September 3, 2010.

What if You were Required to Share your Finances?

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My friend, Kosmo at The Casual Observer clued me into a Associated Press article about Norway opening up their country's tax records. The belief by the Norwegian government is that transparency is the best policy. That transparency comes in the form of releasing a "skatteliste" or "tax list" to the media.

I realize that other cultures have other customs that may seem strange, but imagine this in the United States for a minute. Can you imagine all the privacy advocates in an uproar? (Note: I think I'd be roaring the loudest.) Critics claim that the list creates quite the ruckus in the country. For instance, instead of hearing "My dad can beat up your dad" in the school yard, there's the "My dad makes more money than your dad." I guess children grow up fast in Norway, because I didn't think about money and how much my parents made back then. There's also the fact that robbers can now calculate the highest return for their thieving effort.

For me personally, part of this concept struck very close to home. A few jobs ago, someone found a disk with the complete company's payroll information. This quickly circulated around the company through private email accounts. When it got around to me, I was surprised to see that the person who spent half the day asking me questions was making 20% more than me. She also only worked 4 days a week. I know she was a favorite of the managers, but I still thought that was excessive considering I had more experience. In fact, I hinted at the experience as one of my earlier posts on this site.

In a transparent Norwegian-tax world, I would not have been underpaid that long as I would be able to make an easy case for a raise based on knowing what my peers make (and my managers knowing that I know what they make). So maybe this is a good thing for Norway as it can ensure that people get paid more fairly. What's your take?

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Last updated on August 1, 2011.

Your Financial Football Team

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I have mentioned in the past that I'm a huge fan of professional football. My wife calls this Sunday my biggest holiday - and she's right. Your personal finances have a lot more in common with a football team than you might think. Let's take it position by position starting at the top:

billbelichick.jpgHead Coach - The head coach is responsible for evaluating the players and coming up with a game plan each week. You are the head coach in your finances. It's up to you to develop your financial game plan. Investment options are your players. You choose how to use them. If you fail in planning or misuse your investment options, you aren't likely to be successful.

tombrady.jpgQuarterback - The quarterback the leader of the team directing the action on the field. He works closely with the head coach to execute the game plan. A plan is nothing without action and execution. In your financial game plan, it's not enough to just have a plan, you need to follow through an execute on that plan.

randymoss.jpgWide Receivers - If you are going to win the game you need to score. This year the New England Patriots showed that wide receivers can be the cornerstone of a potent offense. It's not surprising to see them get 10-15 yards at a time. The problem is that sometimes their performance is inconsistent. If the timing or execution is off and there is no gain and the whole offense stalls. In your investment portfolio wide receivers are the mutual funds and stock portions of your portfolio. You might gain 10-15% one year and 0% the next. However, on average you they bring in some of the best gains.

Running Backs - The running backs are the opposite of the wide receivers. They very rarely run for 15 yards at a time. However, they also rarely get stopped for zero yards. They very consistently gain 3-4 yards. In your financial plan, running backs are like bonds or your high interest savings accounts.

patriotsdefense.jpgDefense - The defense of the football tries to stop the other team from scoring. Another way to look at it is that you don't want to see all the hard work from the offense go to waste.

vincewilfork.jpgLineman and Linebackers - The front seven of the defense are the big players trying to stop the offense from short gains. In your financial life, this is being frugal and saving money. If you can stop the small loses everyday you'll do well even if you don't have record setting offense.

asantesamuel.jpgCorner Backs - The defensive backs play defense against the other team's wide receivers. They are out to make big gains against you. You run up against these guys whenever you make a big purchase, like a house or a car. It's easy to pay a few extra thousand dollars completely negating your offense.

rodneyharrison.jpgSafeties - Every once in awhile the opposing team makes an outstanding play putting your defense in jeopardy. The safeties are the last line of the defense. In your financial life, insurance performs the work of the safeties. You may think you have everything covered, but there are some expected surprises that sneak into everyone's lives.

marquisehill.jpgFor completeness, I should mention that Jim at Blueprint for Financial Prosperity also has an article comparing personal finance and football. At the end of the article he makes a great observation that life is more than personal finance or football. It with this that I dedicate my last picture to Marquise Hill. While Sean Taylor's death created shock waves around the NFL, Marquise Hill's went almost entirely unnoticed by the media. He will be remembered for two things, helping residents rebuild their homes after Hurricane Katrina, and giving his life to save his friend's. His team will not forget and are playing for him this Sunday.

Photo Credits:
Michekinn:Bill Belichick
Stussy5555:Tom Brady
Italian Freedom Fighter:Randy Moss
ClimbingKevin:Laurence Maroney
FLC:Patriots Defense
DLHPhotos:Vincent Wilfork
glenntoby:Asante Samuel
laingphoto:Rodney Harrison Hill

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Posted on January 31, 2008.

Health Scare and Some Financial Questions?

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Yesterday, in a post on Lazy Man and Health, I introduced you to the Travelin' Man. You might be familiar with him because he comments fairly frequently. Unfortunately, his doctor says that he might have bladder cancer. He sent a few bloggers an e-mail, asking a few financial questions. I'll take a shot of answering them here...

Each bullet point is a question from him, and my responses are directly below that:

  • Should I alter contributions to my 403b? I get a match of 100% up to 5% of salary. I currently contribute 10%.
    LM: I'd suggest dropping that down to 5% to pick up the match.
  • Should I divert more of my paycheck earmarked for investment into a high-yield savings account, at least for the short-term?
    LM: I think that's a smart idea.
  • Of the money I already have invested, do I need to consider re-allocating my assets to a less risky portfolio (Hey, I am young - it is almost all stocks - and weighted heavily to international ~35% or so)?
    LM: I might add a few bonds to the portfolio, maybe make it around 20%. If it were me I'd still keep about 35% of the remaining 80% in international funds. I think there's more risk in relying on the US with a vast majority of your money.
  • I don't have a will or living directive written. Is there a process that I need to follow?
    LM: I'd look to create a living will online. It looks like it could be free. Read the commments, there are probably a couple of other things in there as well.
  • I am single with no dependents - how would that alter your way of thinking versus being married with a few kids to take care of?
    LM: Well if I was married with children, I would definitely be looking at my life insurance to make sure that they'll be cared for. Unfortunatly, this might not be an option with a health scare. In some ways you are better off - not having to worry about their survival if you are unable to provide for them. In other ways you are worse off, not having their support at a time like this.
  • My employer is very generous with paid leave, and I have about 400 hours of sick time accrued. How important is it to manage that time versus looking at things like short-term disability (pays about 2/3), or is that even an option?
    LM: I think the doctors and/or treatment will dictate this one. If you are phsyically able to work in the short term, then I'd do that. When you are not able to work try to determine if it's just going to be for one day or if it's going to be a couple of weeks. Your doctor should be able to help you.
  • Given the likelihood of remission, but possibly having to deal with this again in the future, how would you alter choosing health insurance packages? Would something like AFLAC be beneficial during the next sign-up period?
    LM: This answer depends almost entirely on the health packages offered to you. There are a ton of online articles comparing HMOs and PPOs and do either any justice in this space would be impossible.
  • At 35 years old, is it too early to start thinking about long-term care insurance (again, single with no dependents)?
    LM: I don't think it's ever too early to "think about" anything. Definitely educate yourself and run the numbers. I'm almost thinking that it's a good idea, but I don't know if long-term care insurance rise with your current condition - like life insurance. If it does rise and it rises too much, then it's not valuable. It's going to be something that you have to take on a case-by-case basis.
  • While my credit is not stellar, I have made great strides to improve it (the only outstanding debt I have right now is my mortgage and student loans - the total of which is about $45k). Are there any "best ways" to handle in the impending medical expenses?
    LM: I'm going to assume your health insurance willl help you know what is and what isn't covered. That's going the first obvious start. The other idea I had was look to see if your employer offers some kind of health savings plan where you save money for health expenses tax-free.
  • Are there any other spending or saving habits that you would adjust?
    LM: Honestly, I would probably start to save a little less for the long term and try to pack in some fun now. Sometimes something like this will give you the kick in the pants to do something you've always wanted to do.

Obviously health comes first, but what you suggest to the Travelin' Man?

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Posted on June 28, 2007.

Can You Save Too Much In An Emergency Fund?

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Ben at Money Smart Life has brought together a few different bloggers to answer the question "Can You Save Too Much In An Emergency Fund?" I was one of the bloggers responding. For me, an emergency fund of $1 is too much lost in opportunity costs.

In day 2 of the series, Ben asks "Can you be too conservative with your emergency fund?" I don't give my thoughts on that specific question, but I'd say that you really can't be too conservative. The money has to be as liquid as possible and for that to be the case, you really don't want any volatility.

In day 3, Sun's Financial Dairy gives his detailed emergency fund. So stop on by, there's a lot of good emergency fund talk going on at Money Smart Life.

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Posted on April 26, 2007.

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