Post #118

Part 5: Life Lessons that will help your finances (continued)

How Not to Get Cheated

I’ve talked about Dan Ariely and his book “Predictably Irrational”.  If you like his stuff, here’s the website: Predictably / Irrational.

I was dismayed that the results of one of his experiments proved that all people, if given the chance, will cheat a little bit.  That’s annoying to hear.  It means that if you own a company, you can pretty much count that your employees will steal pencils and little stuff like that, your customers will try to get more than they pay for, your lawyers will try to over bill you somewhat, and your vendors will try to take any advantage they can get.  It means that if you buy or sell a house, the real estate agents and the lawyers and the inspectors will all try to skin you a little bit.  Basically, every time you enter into a transaction with other people who are not close relatives (and even then, who knows) you will have to be wary about every aspect of the deal.

It’s too bad we can’t trust everyone a little bit more.

Luckily, when you investing in low cost index funds you don’t have to worry about being cheated.  There is no financial planner or agent involved, no lawyer has to write up a contract, the fund company is required to play by a written set or rules that are enforced by some regulator or other.  I’m sure there is some hanky panky at a few of these companies when they calculate their annual expense ratios, but the affect on your portfolio should be extremely small.  So my method of investing is fairly “cheat free” compared to buying stocks through a broker or using a money manager.

There is a way you can reduce the amount of cheating in other areas of your financial life.  It’s stupid, but it works.  Professor Ariely found that if he had his subjects write down the Ten Commandments, or write down their code of honor right before he tested their honesty, they did not cheat.  Because they were forced to state their religious or moral code right before their test, they did not cheat.

So the next time you use a lawyer, right before he does the work for you, have him write out that he is bound by whatever moral code lawyers are supposed to follow, or make him write out the ten commandments:

1. Thou shalt not overbill.
2. Thou shalt not charge for travel time.
3. Thou shalt not call your girlfriend and charge it to the client.
4. etc.etc.

This will make the lawyer less likely to cheat you.

The next time you see a doctor; have him write that he is bound by the Hippocratic Oath before he examines you.  This will ensure he doesn’t bill for a long visit when he really did an intermediate visit.  And he won’t refer you to a lab he secretly owns, that charges double the normal rate for blood work and other tests.

The next time you get your car serviced, have the mechanic write down the Ten Commandments, specifically, the one that says “Thou shalt not recommend a new transmission when all that is needed is a fluid change.”

You will save lots of money this way. 

I know it’s a stupid idea.  But it works.  There are probably other things you can do that are not as drastic.  Check out Professor Ariely’s website.  The 7/24/08 reader post about toilet paper is a practical application of how you can fix cheating problems by using the old noggin.

Post #116

Part 5: Life Lessons that will help your finances (continued)

Don’t Hang Out with People Who Are a Lot Richer Than You

If you are saving lots of money and investing wisely, you won’t be able to live like a king.  You understand that this will pay off in the long run.  But in the short run, you might feel envious of other people who have more money than you do.  They might be the people who live in the next town, or the people who moved into the fancy new development down the road, or the people you see on Access Hollywood who have big houses and are always going to parties and rehab.  Jealousy is a natural feeling.  In cavemen days, you could club them over the head and take their stuff.  But you can’t do that in today’s civilized society.

Let’s get a few things clear.  Not everyone gets jealous or envious.  Some people are happy with their lives and can hang out with anybody.  They don’t brag about their good fortune and they don’t envy anyone else.  These are the lucky ones.  Maybe they drink a special brand of chamomile tea.  Whatever it is, they don’t think twice about class distinctions.

Next thing to consider: The rest of us, who get twinges of envy from time to time, shouldn’t worry about people who are in the same financial boat as we are, but spend all their money on silly stuff.  These people are going to crash and burn when they hit retirement.  We shouldn’t envy them now, and we shouldn’t pity them later. 

Exception to the rule: If these people have a grandmother who is leaving them a few million when she kicks off, thus saving their proverbial bacon, you can go ahead and feel envious.  Maybe you can indulge in a daydream about how you were really born into their wealthy family, but were switched in the hospital with a poor kid from the Pine Barrens.  It’s been known to happen!

Back to reality.  For those of us who tend toward jealousy, there’s a simple way to minimize the problem.  Hang out with people who have the same as, or less money than you do.  I go back to Dan Ariely’s book “Predictably Irrational”.  Chapter One of the book talks about relativity.  He gives an example of a class reunion where there is a big shot with lots of people around him.  If you become one of the hangers on, you will look poorer by comparison.  But if you move to a different part of the floor and talk with other schoolmates who are roughly in the same financial situation that you are in, you all will look pretty good in comparison to each other.

So if you want to improve your happiness, don’t hang out with the Joneses if they are richer than you are.  You will envy them and try to keep up with them.  This means you will spend more money than you should spend.  You will still be unhappy, because the Joneses, or someone who takes their place, will always have more than you.

Don’t watch the celebrities on Access Hollywood if you know it will just get you ticked off.  Watch reruns of Roseanne or My Name Is Earl, and you should feel better about yourself.

Of course, if your brother in law (or sister in law) makes more money than you do, and your spouse keeps reminding you of that fact, you may be stuck.  If you turn to Buddhism and follow the eightfold path you might achieve a higher state of consciousness.  Or you could run away from home and join the circus.

Post #115

Part 5: Life Lessons that will help your finances (continued)

Why RPI Graduates are Good Mate Material (from a Financial Viewpoint) I remember going to Skidmore College once each year with my fraternity buddies.  Our goal was to meet girls at the big Skidmore mixer.  At the time, RPI was almost all male and Skidmore was all female, so you think we’d have a pretty good chance of getting some nookie.  Skidmore invited men from other schools as well, Cornell, Union, and Dartmouth to name three of them.  In fact, I’m not sure that they actually invited anyone from RPI, I think we just kind of showed up. Anyway, since the last few posts have been about whom to marry and how “relativity” comes into play when people are making choices, I thought that our long ago futile efforts to land some Skidmore girls would serve as an excellent lesson. First of all, RPI men are great marriage material (financially speaking).  Except for Christie Brinkley’s ex-husband.  But he was an architect and he came from a money background, so there should be an asterisk next to his name.

Why are RPI men so great (financially speaking):

1. Primarily, we come from blue collar backgrounds.  We are not used to the finer things in life.  We don’t know the difference between a great wine and Chateau de Hudson River, so we’ll be happy with the Hudson River stuff.  In general, this means we won’t be big spenders.  We are perfect mates for people who want to accumulate lots of money.
   
2. We’re not going to cheat.  Actually, we will be so amazed that we found someone who loves us that we will be faithful like puppies.  If you have a happy (or even semi-happy), long lasting marriage you will wind up with more money than if you had a few nasty divorces along the way.
   
3. We’re not stupid.  We understand math, probability theory, and the power of compound interest.  This is a good asset if you plan to be putting your money into equities.  Note: I can’t guarantee this for the bio majors or the architects, but there’s not too many of those guys around anyway.
   
4. We’ll make decent money.  Engineers, physicists, mathematicians and scientists always do pretty well financially.  We won’t be the top earners, but we’ll be up there.

What more could you ask for?  Guys who earn decent salaries, are good at math, will be faithful husbands, and won’t spend a lot.

Anyway, here’s where relativity comes into play.  The Skidmore girls had a choice at their mixers.  They could talk to the pack of RPI guys.  Those were the ones wearing the farmer jeans and the high top converse sneakers.  They were quaffing their beer straight out of the pitcher because it was 50 cents for all the beer you could drink (we knew a good deal).  They tended to stammer when a girl tried to talk to them, and usually told Star Trek jokes.

Or, the Skiddies could talk to the guys from Union, Cornell and Dartmouth.  They were wearing suit jackets and little caps.  They had drinks with the little umbrellas sticking out.  They wore nice shoes and could carry on a conversation about politics or fashion.  Of course, the girls talked to these guy

I’m sure those other guys were all great people.  But let’s pretend that they were destined to grow up to be big spenders and serial womanizers.  There is no way the Skidmore girls could know that based on appearance.  They made their decision to talk to the other guys based on relativity and pheromones.  (RPI guys are notoriously short of pheromones, since most of us spent too much time in the Chem lab).

Why do I tell you this story?  If you care about your financial well being, your decision about whom to marry should not be based on pheromones and relativity.  Look past the physical and think about your future mate from a financial viewpoint.  Will you be able to grow old together and have a secure retirement?  It doesn’t sound too romantic, but life is tough.  This is a very important decision, especially if you want to have children.  You need romance and love, but you also need security. 

Remember, you can get a slightly nerdy guy to dress nice and talk about art, but you can’t get a handsome, smooth talking deadbeat to turn into a model citizen.

Post #114

Part 5: Life Lessons that will help your finances (continued)

More Marketing Tricks

Don’t Always Select The Middle Choice

In Dan Ariely’s book “Predictably Irrational”, I learned that humans don’t know what they want unless they can compare it to something else.  Sales people and store owners know this, and use it to manipulate us into buying the stuff they want us to buy.  When I go to a camera store looking for a high end camera, the salesman may have one he wants to sell me, because he makes more money or he has a lot of this model in stock.  So he’ll show me a camera that’s more expensive and has more features than the one he wants to sell me.  Then he’ll show me a cheaper one with not as many features.  Finally he’ll show me the one in the middle.  He pretty much knows this is the one I am likely to buy.  Even if there is no salesman, you will see the cameras on a shelf displayed so there is a high end one, a cheaper one, and a middle priced camera, which is the one the retailer really wants people to purchase.

The way to save money on this deal is to do a little research before you get to the store.  If you know what you want before you go in, it will be harder for them to try to sway you.  And buy your stuff at a place where you know the profit margin is reasonable.

Magazine Subscriptions

This happened to my daughter.  You get a free magazine for a three month trial period.  They automatically renew the subscription for a full year at the going rate when the trial period is up.  They send you a bill. Inertia is at work here.  They figure you will take the easy way out and pay the bill rather than yell at them and cancel the subscription.  If you gave them your credit card number when you first signed up for the “free” subscription, they will just bill the credit card for the next year without telling you.  Sometimes, the free offer comes from the credit card company, so they already have your number!  Double inertia is at work in this case.  You will probably pay the credit card bill without even realizing that the “free” subscription just turned into a more costly one year subscription.  You have to be really careful with these wily marketing people.  It’s OK to take a free offer.  Pay attention so they don’t pull this trick on you when the trial period is over.

If you decide to order a magazine the best way to pay for the subscription is with a check.  They can’t sneak the renewal past you.  They need to send you a bill for the second year, and this gives you a much better chance to cancel the subscription if you don’t want that magazine any more.

Post #113

Part 5: Life Lessons that will help your finances (continued)

How Marketers Try to Manipulate You!

Here are a few tidbits about how marketers are always trying to get you to spend more money than you should.  If you know these tricks ahead of time, you can avoid being taken to the cleaners.  You’ll have more money to invest.

Don’t Buy The Second Cheapest Wine On The Menu At A Nice Restaurant. 

Restaurant owners know how to push our buttons.  The second cheapest wine on the menu is actually the wine that they paid the least for.  They know you will skip the cheapest wine so you don’t look like a complete loser to your table guests.  You’ll pick the second cheapest wine.  They make more money with this selection, and the people in the kitchen are laughing at you.  What you do is, select the cheapest wine on the menu and tell your table guests that you are splurging on a really good bottle.  Why?  People’s expectations influence their taste.  If they think they are drinking a good wine, it will taste better to them!!  Check out this link if you think I’m a lying dog!  Price Influences Wine Taste

You Will Spend More At A Restaurant That Has At Least One High Priced Entrée!

If your local Bistro has a $41 Entrée of stuffed Veal Chops with blah, blah, blah, you will likely spend more on your meal even if you don’t order the $41 dish.  Why?  Apparently, silly people that we are, we are more likely to order the second highest priced meal.  So the restaurateur makes sure his second most expensive item is overpriced, which ensures that he will make a larger markup when you order this dish.  How do you avoid overpaying?  Buy something less expensive than the second most expensive entree.

Post #110
Part 4:  Good Advice, Bad Advice, and News About Investment People (continued)

Summary:  What have we learned so far?

This is the end of Part 4, which deals with good advice and bad advice that you will be given by the “experts”.  This portion of the blog could have gone forever, as there are tons of people giving advice, most of it bad.

So what have we learned so far?

In Part 1, I listed the Ten Commandments for Creating Wealth.  The important commandments are: try to make lots of money so you can save a lot, start investing early in life, save at least 20% of your gross annual income, and invest in a diversified basket of low cost index funds.

In Part 2, I talked about your career because the more successful your career, the more money you will earn.  I also talked about the various retirement plans available to you.

In Part 3, I talked about everything you need to do to set up your financial life and start investing.

The next part of the blog will deal with “Life Lessons”.  Financially speaking, there are two or three really big mistakes and lots of small mistakes that you can make in that will wind up hurting your financial future.  I’m not talking about mistakes such as burning your neighbor’s house down because he makes fun of your lawn.  Most people don’t make those kinds of mistakes, and the ones that will do something like this probably don’t read my blog.  No, I’m talking about other mistakes, such as marrying an idiot, getting divorced, and going without health insurance to save a few bucks.  Things like that.  Hopefully you will read these posts and say to yourself “He’s got a point.  I better not max out my Home Equity Loan and sink the money into the Vanguard Emerging Market Fund.  It might be too risky.”

Post #109
Part 4:  Good Advice, Bad Advice, and News About Investment People (continued)

Target Date Funds Revisited – Good or Bad Advice?

Here’s an article to check out:

After Losses, Target-Date Funds Draw Scrutiny

In Posts 23 and 39 I talked about using the Vanguard Target Retirement 2050 Fund as a one fund answer if you are way too busy to even think about looking at your portfolio for ten minutes a year.  Was this a bad recommendation? 

No.

If not, then why is Vanguard mentioned in this article?

Vanguard is guilty of having 52% of the Target Retirement 2010 Fund portfolio in equities in 2008.  Consequently, they got pasted with a 21% loss as a result.  Other funds, offered by Wells Fargo and Deutsche Bank, had more bonds in their funds with the same target year.  Those funds suffered lower losses.  I guess the author of the article is implying that the Target 2010 funds should have had much lower levels of stocks in their portfolios, because retirees want safety.  The author mentions that those who buy target date funds are usually the investors who are the least informed.  In other words, the buyers thought they were buying something that was very safe, and found out that having 52% of your money in equities could lead to a big loss.

Vanguard doesn’t have excessive fees.  The annual expense ratio of the 2010 fund is .19%, which is minuscule.  So you can’t fault them there.

Vanguard has 11% of the fund portfolio in foreign stocks, which isn’t excessive.

Vanguard uses the Total Bond Market II fund and Treasury Inflation Protected Securities for the bond portion of the portfolio in the 2010 fund.  This is not a risky bond portfolio.

Just to put things into perspective, this fund has been around for less than 5 years.  It has a three year annualized loss of .4%, which ranks it in the top 24% of all funds in this category.  This means that 76% of the Target 2010 funds did worse.  But I agree that it is a big shock for some old guy who doesn’t know much about stocks to lose 21% a few years before he retires. 

So I’m all for the regulators forcing the fund companies to disclose the exact composition of their target date portfolios before they sell them.  Personally, when I retire, I would prefer a fund that is 50/50 stocks to bonds, rather than 10/90.  But many people won’t, and they should know what they are buying.

Now, let’s get back to the fund I recommended, the Vanguard Target Date Fund 2050.  If you re-read posts 23 and 39, you will see that I don’t recommend it unless you are so strapped for time that you cannot devote a few minutes a year to maintaining a portfolio with more funds.  

For those of you who are in that position, it’s a much better choice than most of the other Target Date 2050 Funds.  Low fees (expense ratio of .19%) and reasonable asset allocation for young people (10% bonds, 72% US stocks and 18% foreign stocks).  It gets more conservative as you get older, so that within seven years of 2050, the fund’s asset allocation will resemble the Vanguard Target Retirement Income Fund. (66% bonds, 24% US stocks and 10% foreign stocks). 

How did this fund do in 2008?  It lost 34%.  That’s a big loss, but it’s not unexpected.  After all, 90% of the fund holdings are equities.

Let’s look at how the fund held up compared to its peer group.  The fund has been around for less than five years.  It has a three year annualized return of -2.58%.  This return is ranked in the top 1% of all funds in its category.   

So I’m good with my recommendation.