Lazy Man and Money

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.

Weird –> Rich + Happy

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When I was growing up, everyone strove to be “normal.” If you weren’t “normal”, you got beat-up or you didn’t get to hang out with the cool kids. It seems like being different is much more popular today. How else could you explain Lady Gaga’s success?

Or maybe I feel it is more popular because I’m not 13 any more.

About a year ago, I wrote about The Psychology of Love and Money. That is to say that I covered a YouTube clip that economic behavior psychology guy (certainly not his real title, but I’m going with it) Dr. Daniel Crosby had on the topic. The popular website Lifehacker saw the article and covered the video as well.

Today, I’m bringing another of his videos to you. The video was from a recent TEDx talk of Crosby’s titled “Can Being Weird make you Rich and Happy?”

Dr. Crosby wastes little time embarrassing himself with a weird picture of himself from his youth. It’s worth watching the video just for that to be honest.

He then breaks into the meat of the talk. If you want to beat the market, you have to be different and be right. If you invest the same, you’ll get what the market gets. If you are wrong, you’ll lose money. Crosby expands this into three principles:

1. Principled Defiance

The world needs people to stand up and be defiant and stand on their principles of what is just and true. He gives examples of Susan B. Anthony and Jackie Robinson standing up and rebelling to right a wrong.

2. Intelligent Risk

Crosby says that risk isn’t volatility as many economists might say. He asks if you’d find it “risky” if your portfolio rises 25%. Most people wouldn’t, but that would be volatile. Crosby then says that the real risk is in not reaching your goals giving this example, “… Not a single one of you would say, ‘Well, I have to eat cat food in retirement, but at least it was a smooth ride.'”

Crosby relates a story about a student so paralyzed with fear of opening acceptance letters (or regret letters) from colleges that she almost waited until past the deadline, ensuring her rejection. The lesson here: Sometimes we put so much effort into avoiding risk, we bring about the very thing we fear most.

3. Hidden Value

Crosby then invokes some people who have found hidden value and used it to succeed. Billy Beane, the GM of the Oakland Athletics who was made famous in Moneyball, found that value in things that other organizations didn’t and used it to be competitive in an organization that wasn’t able to pay players big money. Crosby cites the inventor of WhatsApp who sold his company to Facebook for $19 billion dollars years after Facebook rejected him for a job. Facebook missed the hidden value in the person and application the first time and it cost them a lot of money.

Bringing it All Together

At the end Crosby eschews his generic and unspecific goals of lose weight and make more money and replaces them with three really weird goals. I won’t spoil the fun, but the crowd can’t control their laughter (which ironically doesn’t bode well his second goal).

Being weird can definitely be rewarding. You don’t have to look any further than your own cupboard to see it. Zack Brown took a concept that occurs a million times a day, making potato salad, and put it on the crowd-funding website, Kickstarter. The result? Thousands of people contributed money and he might make six-figures simply making a potato salad.

So what are you doing weird? What are you doing to make your weirdness awesome.

P.S. I don’t know if you noticed the title of the article. See what I did there? (Hint: It’s not “normal.”)

Finding a Pattern Where There Isn’t One

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I was reading the new Money Magazine the other day and found the article on Warren Buffett very interesting. Unfortunately it was of the few articles that I found interesting. This is unusual for Money Magazine – I still consider it some of the best money I spend each month.

I love psychology and I think it greatly impacts how we invest. As humans we have a lot of strengths and weaknesses. When it comes to recognizing patterns, we are particularly good. Sometimes it is as if we are almost too good and want to find patterns when there aren’t any. I think we do this to try to make sense of a world that is full of random events (I apologize to the fate-believers, I’m just not with you.).

Turns out this belief in false patterns has a name: Apophenia. (I can’t decide if it sounds more like a Greek Goddess or a very short-lived Godfather character.) Sometimes it is called “patternicity” which I like a little better.

All of this shot into my brain when I saw this image in Money’s Buffett article:

Sometimes There is No Pattern
Click For Larger


I encourage you to click it for a larger version.

This image shows that if you simply invested evenly in all ticker symbols starting with the letters W-A-R-R-E-N, you would have handily whopped the S&P 500 over the 20 years.

The article explains why this has worked over the 20 years. Smaller companies have done better than larger ones and investing them equally gives them a greater weighing than the S&P 500. The S&P 500 consists of larger companies and doesn’t have the small companies at all.

If someone didn’t know any better, they might say, “Hey this is clearly a pattern showing you how to beat the market.” Hopefully we are smart enough to know that there really isn’t anything special with ticker symbols starting with the letters that spell W-A-R-R-E-N.

This reminds me a little of the funny website spurious correlations that helps us understand correlation does not imply causation. My favorite chart on that website is the correlation of divorce rate in Maine to the US Per capita consumption of margarine.

However, what happens in a scenario where the pattern isn’t so arbitrary? I think that’s where things get difficult for a lot of people, professionals included. If the chart didn’t use the ticker symbol gimmick and instead with something like return on small companies when equally weighed, it presumably (from the article’s explanation) would show a similar trouncing of the S&P 500 over the last 20 years. That would lead one to believe that such investing is the clearly the way to go. There’s no kooky red flag to tell us, “This pattern is crazy.” It’s hard to determine what is causation and what is correlation in a complex system like the stock market.

What does this all mean? I wish I had a super conclusion to wrap it all together. Unfortunately, I do not. What I do have is the thought that diversification is even more important than I thought it was.

It’s Not About Big Wins vs. Small Wins

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I was just reading Ramit Sethi’s post of 7 things I learned from 9 years of I Will Teach You To Be Rich. I love when people boil down years of hard work to a few simple ideas.

I love it more when brilliant people like Ramit does it.

What I don’t enjoy is when they assume their way is the only way and take arrogance to an epic level in an attempt to support it. Sometimes I think he takes lessons from Judge Judy on how to be annoying. For some, that’s their schtick and it works for them… so good enough.

He has a few things that he focuses on, but for the most part he’s against frugality. Vehemently against it. Here are a few quotes from the article:

“… She does online sales, and she made a rule for herself that each time she does a monthly webinar, she takes 5% of sales and spends them, guilt-free, on anything she wants.

I love this!

A $2,000 bag? Get it.”

“It’s easy to talk about cutting back on lattes, disabling the oven light to save $0.03 over 2 years, and never ordering appetizers. Great! You’ll save $11,000 in 30 years and hate your self every day of your life.”

“None of us wants to live like a penny pincher. Do you really want to know how to make your own laundry detergent and save $0.32/year? Who wants to live like that?”

I’ll be the first one to tell you that you should figure out what your time is worth and make judgments appropriate to that. I’ve been saying that for years. The people making their own laundry detergent are saving a lot more than 32 cents a year and it ends up costing them just a few minutes of time. Many have done a simple calculation and determined that it is worth their time.

I have yet to ever hear anyone suggest that they disable their oven light. Though a frugal blogger has shown that using the oven saves you a couple cents in reducing the number of times you open your oven door. Saving 32 cents a year or disabling an oven light to save 2 cents a year is ridiculous.

As for getting the $2,000 handbag… well if that’s just 5% of your monthly webinar sales, it’s somewhat reasonable. Just know that person’s webinar sales is $40,000 a month or $480,000 a year. If you make less than that, you are going to need to save up for it or violate the 5% spending rule. What percentage of people do you think reading the post make $480,000 a year? Far, far fewer than 1% right? Maybe .0001% since he has a wide readership. So why focus on an edge case that’s irrelevant to almost all his readers.

However, the other examples, skipping appetizers and the daily lattes are simply smart thinking in my opinion. Restaurants in general give you tons of food, more calories than most people should eat in a sitting (from a health standpoint). So why add more food and expense to that? Plus if you are going to add more food clearly the wise choice would be a dessert at the end, right?

The lattes are another thing as well. It’s not complicated math to add up how $3 lattes (roughly the price of one at McDonalds, plus some tax) adds up to around $1000 a year. Consider for a minute that 64% of Americans don’t have $1,000 in savings. A single latte-free year, would more than double the savings savings of most Americans.

What are you going “hate your self every day of your life” more for? Not having a morning latte or being on the brink of a financial disaster. Only you can answer that question, but I’d pick the later.

Ramit then goes on to make a case for a few big wins:

Or… you could focus on the 5-10 Big Wins in life and never have to worry about ordering your morning coffee: Investing early. Negotiating your salary. Starting a side business. Finding a Dream Job. Optimizing your credit. And a few others.

You can listen to the experts who tell you to keep a budget and cut back on lattes. The truth?

  1. They don’t even do this
  2. Why don’t they ever talk about Big Wins like earning more? Answer: They don’t know how.

I love the big wins as much as the next guy. They are a big portion of what I highlight in my post about fixing your finances. Many of the things he highlighted are no-brainers. No personal finance blogger or guru is advising people to have bad credit or wait as long as possible to invest. They aren’t going to tell you get a terrible job or just “suck it up” if you are underpaid.

It isn’t about big wins vs. small wins, because it isn’t an either-or situation. You can do both. If you are smart about it, you can use the small wins to help you fund the big wins such as starting a side-business or investing early.

Do the experts cut back on the lattes? It depends on your definition of experts. If you are talking about David Bach who has sold millions of books on the topic, maybe not. However, he doesn’t have to now that he’s sold millions of books. When you sell millions of books, you won’t have to either. If you are talking about personal finance bloggers who (mostly) just trying to get by like every other average Joe… yes these “experts” (their level of expertise varies of course) tend to skip the lattes.

Do the experts never talk about big wins? Well considering the examples of big wins Ramit listed (Investing early, negotiating your salary, starting a side business, finding a dream job, optimizing your credit), I’d say darn close to 100% of experts talk about at least some of them. And certainly the experts know how to invest early and get good credit. This stuff isn’t rocket science.

The rest of the article is actually pretty good with some solid advice. Ramit loves to talk about the psychology behind money and this is helpful. It’s particularly helpful in understanding why he’d be against frugality… he can’t sell his “premium-priced” (his words, not mine) courses to those people. I think he believes it is better to mock them, so they don’t waste his time… which is fair because, again, he’s doing extremely well with his schtick.

The article made me chuckle in another way. In one sentence, he says, “That means it’s ‘free’ to try all the free ebooks, the $7 online courses, the ‘guru’ webinars… but ultimately, we start to realize we’re wasting our most valuable resource of all: time.” Let’s look at two things and ask “what saves someone more time?” Is it:

1. Skipping the lines at the $3 latte shop and making your coffee at home.
2. Taking Ramit’s Earn 1K class.

I’ll go with option #1. (For full disclosure, Ramit’s Earn 1K class is about earning $1,000 a month. Still, there’s a lot of time involved in taking the class… and then even more time involved in implementing the results. I’m not saying that you shouldn’t start your own side business, but let’s not dismiss the value of how frugality can save you time and money.)

The Psychology of Love and Money

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A little while ago, I got an email from a Dr. Daniel Crosby who works at IncBlot Organizational Psychology (seems like he runs the company, I couldn’t tell for sure). How long was a little while ago? I remember when I got it, because it was the day my son was born. Little Man is over 9 months old now. I am a heel and should have covered this before now.

The email caught my attention. I get a little bit of a kick when a doctor sends me an email that starts with “Hey Lazy…” (I know I brought that on myself.) I get a lot of requests from people to highlight whatever it is they are working on with my readers. I’d say that over 99% of it is junk or nothing very special. However, Dr. Crosby’s work was different. It was a TEDx talk. If you aren’t familiar with TED, I don’t know how you found my website. However, Wikipedia gives a good introduction. I’d describe as a bunch of brilliant people imparting their best wisdom on the world… and you get to watch it free!

I hesitated to embed the video here just because it’s over 18 minutes long. I understand your time is valuable. I found this more entertaining and informative than almost everything on television today. In case you didn’t get it from the title of the article, the video is about the psychology of money. As you might guess, people don’t always act rationally to money. (If they did, this video would be very boring.) The video covers some of the irrational ways we act. I don’t know if there are official terms for psychological phenomena that Dr. Crosby talks about, but I’ll cover a few after the video:

The talk focuses on four specific psychological pheneomena, but I’ll outline the whole thing here to make it easy for you. One of the great things about the talk that I overlooked the first time (I was focused on the money) is that he compares the irrational behavior that people have with love with money.

  • I Can Change Them
    • We Feel We Can Change Lotto Odds – In love, people often have a bias towards fixing someone (for lack of a better term). We feel we can change them. When it comes to money, we are the same way. In a $100 lottery with 50 tickets people are willing to pay nearly $2.00 for a ticket that is choosen for them (as you might expect). However, if they are given the chance to choose the ticket, they’ll pay almost $9. We think we can change the odds. (I asked Crosby for a citation of this and he said believed it was from Langer 1974 in the Journal of Personality and Social Psychology.)
    • We Over-Invest in What We Know – We think our experience with the company or product is going to lift the stock price. He cites the Facebook IPO and how Facebook warned us about the financial problems with the company.
    • We Invest in companies we work for… even when we don’t significantly matter to that company’s success. The example cited is the person who works for Coke and invests in the company. You aren’t likely to change Coke unless you are meeting with the C-level executives on a fairly regular basis.
  • This Time It’s Different – The example here is that Liz Taylor believed this each of the numerous times she got married. In terms of money, the phenomena is called New Era Thinking. He cites the tulip bubble in the Netherlands in the 1630s where people would pay 10x the yearly pay of a skilled guilder for a single tulip bulb. Dr. Crosby says that it’s easy to dismiss this kind of thing as antiquated thinking, but it comes up recently with the tech bubble and he cites eToys when it was valued more than Toys R Us when it very little sales and no profit.
  • Prince Charming Bias – A high-impact, low-probability event will come sweep us off our feet and make all our romantic or financial problems disappear. He points out the stories of Cinderella, Snow White, and Sleeping Beauty. Only Sleeping Beauty’s Prince has a real name. It’s not important to the story for the other princes to have names, we know what they stand for which is what matters. Dr. Crosby compares this to the lottery. The people who play the lottery are the ones who typically can least afford to. Those with masters and Ph. D. are the least likely to play. He cites that you are 9 times more likely to be crushed by your television than to win the lottery, but you’d never bet on such a thing. If you do win the lottery, be careful what you wish for, because there is a good chance that you’ll gain weight, not be happier, and broke in five years.
  • Just Can’t Quit You Bias – Breaking up with a partner is terrible (this isn’t exactly news). We have same problem with money. The gambler can’t quit the table, because he can’t stand being a loser. A person buying a stock that loses money tends to ride on it to the bottom, because they can’t stand a sure loss.

I had a few thoughts while listening to this presentation. When Dr. Crosby was talking about Facebook, I recall that I bought some at $26 and some more at $19 because I realize that a number of people have a “Can’t Quite You Bias” with the company. (At those prices, I found the valuation fair. I sold off most of my ownership at $33 at locked in some gains.) His response was that at some price Facebook makes sense, just not $38. (I agree.)

I also thought that the eToys vs. Toys R Us was an interesting comparison. What if it was Amazon vs. Barnes and Noble? Ebay vs. Sotheby’s? His response was that eToys had a lot more vapor surrounding it. I remember Amazon being referred to for years as Amazon.org, because they never made a profit. He agreed that breakthrough companies do indeed change the game. The problem is figuring out what these are. Seems like Netflix has been up and down that roller coaster a number of times.

In the end, these biases are certainly worth acknowledging. It reminds me a lot of the article I wrote about why people buy into MLM health products that appear to be nothing more than snake oil.