P.S.: This is a big deal for all you index fund buyers too.

The Wall Street Journal ran a story earlier this week which made the case that price-to-earnings ratios don’t matter as much anymore. It’s a seductive argument. We’re in an age where a huge number of trades are made by quants, many of whom care more about stock market momentum than “boring” and traditional measures of value.

But ultimately, it seems hard to believe that the P/E ratio would become totally irrelevant in the way the authors and analysts in the story argue.

First, a quick definition. The P/E ratio is simply a stock’s price divided by its earnings. Depending on your preference, you can use a company’s last 12 months of earnings, its future 12 months of estimated earnings, the average of past years of earnings, and on and on.

I find it easiest to think of it in terms of yield. Just as your money market account yields a certain percentage every year (probably around 1% right now), a company regularly earns a certain amount of money for every dollar you have invested. Of course, company earnings are far less certain than that of a bank account, and that’s why investors require earnings yields—which is the inverse of the P/E—to be much higher than yields on safe investments like Treasury bonds and FDIC-insured accounts.

If you crack open a book on “how to invest”, the P/E is likely to be the explained in the first or second chapter.

Before we move on, if you just tend to dollar-cost average into index funds, like most personal finance blogs (including this one) suggest, you might wonder why this discussion even matters. The thing is, the central premise of buy-and-hold investing is that stock prices always move up over long periods of time. This should happen because earnings should rise over time, as the American economy continues to advance.

However, in a world where a P/E ratio doesn’t matter, by extension, earnings don’t matter either. Traders continually try to outguess each other rather than find good companies at cheap prices. You could say that more direct measures of value, like dividend yields, might become more important, but really the two are pretty similar—with the dividend yield, you just get to keep the earnings yourself.

Sure, P/Es are going down.

The article also spent a good deal of time on why P/E ratios might drop. That’s something I do think investors should worry about in the short term.

The market’s average P/E for the last couple hundred years had been about 15. However, over shorter periods, it has spent time at much higher and lower levels. At the end of the internet boom, it actually spent time in the 40s! During times of economic stress, like the 1980s and 1930s, it has gone into the single digits.

A few things influence their direction. The most simple is interest rates. Investors demand to be compensated for the risk stocks represent. So when risk-free Treasury bond rates go up, P/Es normally drop. Right now, Treasury bond rates are at historic lows. They have only one way to go—up.

But beyond that, investors can drive P/E ratios down when they perceive stocks to be more risky or feel their growth prospects are weaker. Those are both realities that most economists think we’ll be facing for a while.

No one factor should guide your decision to buy or sell.

If P/Es drop, even as the economy and earnings continue to recover, stock prices will stay the same or even drop. Such a period recent happened in the 1960s and 1970s.

Of course it turned out that when they hit those single-digit post Depression lows, it was an excellent time to buy stocks. It just took a decade or so for that to become clear.

And that might be the best takeaway for someone wondering why they should even care that these ratios might stay low for awhile. We’re used to our stock investments generally rising from year to year. Yes, the last ten years were a “lost decade”, but we didn’t really have to feel that until the market halved in 2008 and 2009.

This time around the market’s movements might be much more frustrating. It won’t go up. It won’t go down. It will just bounce around for years.

That means that even more so than during the last ten, you’re going to need patience. Owning stocks will pay off over the long run. The long run just be a long time coming.

In the end, the P/E must matter.

When you actively trade stocks, one of the easiest things to forget is that you’re buying and selling companies, not just meaningless pieces of paper.

In the short term, those pieces of companies can vary in value by huge amounts. One day Apple will have a P/E of 15, the next it will be 50.

That becomes especially easy with companies that aren’t yet paying a dividend. When a company reinvests all of its earnings, the only way you make money is if the stock price goes up.

If you look at investors like Warren Buffett, however, who truly are in it for the longterm, a company’s earnings will always matter. Because in the longterm, any mature company should end up paying a dividend to its investors.

That’s what makes the stock market different from a Ponzi scheme, and why the P/E will always matter.

You can’t keep a kid from his marshmallow.

Back in the ’60s, it was apparently O.K. to torture little kids. Just kidding, but one study came close.

Here’s the gist. Stanford economists took four-year olds one at a time and put them in a room with a single marshmallow sitting on a table. The experimenter told them that he had to leave for a short errand, but if they waited without eating the marshmallow, they would get an extra one upon his return.

Seventy percent of the kids caved, on average lasting 3 minutes before eating it. The rest of the kids were visibly frustrated as they tried to wait. Some turned away from the table so they wouldn’t see the marshmallow. Some covered their eyes. Decades later, the researchers asked the kids (now adults) for their SAT scores. The patient kids scored better.

Since then, the study’s been replicated a number of ways. But just a few years ago, scientists took it to a new level. To see exactly what was going on, they scanned testers’ brains while they weighed decisions to see what areas showed the most activity. Researchers from the National Bureau of Economic Research asked 14 participants to choose between receiving money at an earlier or later date. For example, they could take $27.10 today or $31.25 in a month. While they thought about what to take, they were put in an fMRI machine to see which regions of their brains were activated.

When they considered one of the immediate cash payments, their brains’ limbic system, which is generally stimulated in emotional situations, was active. On the other hand, the areas of the brain that control reason showed intense activity when they considered the far off payment.

When the emotional and rational parts of the brain square off, guess which one is liable to win?

Controlling impulses

Luckily, there’s a way to even the score. Earlier this year, scientists in Germany published a paper on a similar test. Similar questions about present or future rewards. Same fMRI machines to see which parts of the brain were being activated.

Except this time, the scientists asked the subjects to think about their future selves as they considered the future rewards. What will you do with the money? Where will you be living? What kind of job will you have? By making the subjects think ahead, their brains showed activity in locations of the brain normally associated with autobiography and emotion (in addition to the expected, rational areas).

What’s more, they became much more likely to choose the far-off, and rationally superior, offer.

Recently, some behavioral economists have floated a related idea to get workers to save more in their retirement accounts. Every time they open the account to see their balances, they see a digitally-altered photo of themselves in retirement. So a 27-year old would see an estimate of what he’d look like as a 65-year-old man. Maybe by making them think forward to that future self they’d be more willing to sacrifice his current wants for the guy in the photo.

And keep that blood sugar high

Another interesting finding: Being hungry makes you likely to opt for instant gratification.

Researchers at the University of South Dakota told 65 college students not to eat the morning of an experiment. After bringing them in, they gave some of the students a sugary soda to drink. The others got a diet soda, with aspartame as a sweetener. The researchers also monitored the subjects’ glucose levels throughout the experiment.

Each of the college students was given a series of questions that weighed instant gratification against a future award. “Would you prefer $120 now or $450 in a month?” To make sure the students took the questions seriously, at the end, they rolled dice and were awarded one of the rewards they had chosen.

Here’s what they found: Before drinking the soda, both groups were just as likely to choose instant gratification. But after drinking the soda, the ones given the sugary stuff were much more likely than the other group to choose the delayed prizes.

The researchers think that the experiment links our desire for money with our primitive desire for food. When our blood sugar is low, our brain sends a signal that the body needs satisfaction now. While we’re most likely never at a loss for food, until it’s satisfied, it’s looking for a substitute.

Sounds like a good reason to make important decisions on a full stomach.

And the dangers of “Fake it ’til you make it”

We’ve all cheated in some way or another. Maybe you tricked your little sister into a bad trade at Monopoly. Maybe you copied an answer off the test next to you. Hopefully, those minor indiscretions never evolved into major betrayals at work or in relationships later on. But psychologists and economists have recently run a multitude of tests to help determine what makes us cheat and how to stop it.

The results are pretty surprising and, at times, counterintuitive. Our propensity to cheat doesn’t seem to have to do with getting caught. It doesn’t even seem to do with how much you gain by cheating. Instead, our sense of self and our peers heavily influence how honest we are.

Wearing a knock off makes you less honest.

I don’t wear knock-offs. Mainly that’s because I don’t wear expensive designer brands. Mainly that’s because I am a man. (Apologies to men who wear expensive designer brands. Blatant stereotyping, I know.)

It turns out that my avoidance of knock-off brands is a good thing. And all you people out there who think getting a knock-off makes you “frugal” might want to think twice, if a recent study by Duke professor Dan Ariely, and Harvard professors Francesca Gino and Michael Norton is to be believed. You might recognize Ariely as the author of Predictably Irrational and The Upside of Irrationality—two of the best known books in the pop economics field.

The researchers gave a group of women pairs of expensive Chloe sunglasses. They told half of the group that they were knock offs and the other half that they were real. In truth, they were all the real deal. While wearing the glasses, the testers performed a series of mathematical puzzles in a short amount of time. After the time was up, they were asked to grade themselves, but unbeknownst to them, the professors were monitoring their performance and how honest they were in the self-scoring.

Of the people who thought they were wearing authentic Chloe sunglasses, 30% cheated. But among the people who thought they wore fakes, a full 70% inflated their scores. The researchers found similar findings when asking them to perform other tasks. What’s more, when the researchers asked them to rate others on how often they thought various methods of cheating went on, the people who thought they were wearing fakes had a more cynical view.

Why do the ones who think they’re wearing fakes cheat more? Ariely & Co. think that the faking gets internalized. Those who wear fakes feel phony themselves, and thus are more apt to cheat and think others are cheaters. That’s quite a price to pay for being frugal, though I guess real frugalists wouldn’t care to fake designer duds.

We’re likely to cheat, but only a little.

In another Ariely study, 791 students were asked to take a series of tests and then grade themselves. They earned more money the more they got right.

Sadly, most students did cheat. But only five cheated the maximum amount possible. The others just gave themselves a little boost during the scoring. The results didn’t change no matter how high a chance the students had of getting “caught”. Whether they were asked to turn it into an instructor, just speak their answers to the instructor, or take the money from the jar themselves, the students cheated the same amount.

Tactics that did reduce cheating? Asking the testers before the experiment to write down as many of the Ten Commandments as they could remember or to read and sign an honor code.

Another surprising deterrent: Increasing the amount the students gained by cheating. If the student got an extra 10 or 50 cents for each “correct” question, cheating was high. But if they increased the reward to $2.50 or $5, cheating dropped to zero.

In my mind, this could indicate that the students didn’t really care about the money. They just didn’t want to look stupid. Increasing the financial rewards for cheating could have just made the students take the self-grading more seriously and outweigh their aversion to looking dumb. I wonder how the test would turn out without any financial incentive…but I digress.

You’re more likely to cheat if your peers do.

What if we throw one more wrench into the mix? In another version, Ariely had students from Carnegie Mellon and the University of Pittsburgh take the test. But he also hired an actor, who after just 30 seconds would stand up, say he answered all the questions correctly, and ask what he could do. The instructor would give him all the money and tell him he could go.

In other words, the students were witness to another supposed student who cheated in a very transparent way and got away with it. But how that affected their own honesty varied. If the actor was wearing a Carnegie Mellon sweatshirt, the University of Pittsburgh students would actually become more honest, having witnessed someone outside their peer group cheat. If the actor was wearing a University of Pittsburgh sweatshirt, the students would become less honest.

The message there: If you associate with cheaters, you’re more likely to become a cheater yourself.

Check out the video below to see Ariely talk about some of these experiments and others he’s run on cheating. The stuff on dishonesty begins at the 4:15 mark. It’s part of the TED series of talks, which I’m a huge fan of. I promise that the entire 15 minutes is worth watching.

Note to self: If you ever sign up to do tests in an academic study, you are never being tested on what you think the test is on. And there’s always someone watching.

And watch that basket.

As I don’t have a copy of Pudd’nhead Wilson, I don’t know the context. But Mark Twain once wrote that you should put all your eggs in one basket…and WATCH THAT BASKET.

You’re encouraged to diversify when you invest. A lot of employees sink more than half their 401(k) money into company stock—and then Enron show’s everyone why that was a bad idea. Even seemingly solid companies—banks, for example—can disappear overnight, but it’s much less likely that an entire index or basket of stocks will dramatically lose value.

Still, “watching the basket” is tempting. For one, it’s less to keep track of. If GE is one of five stocks you invest in, you’re going to know more about GE than you might about your own company. On the other hand, if GE is one of 20 stocks you own, you probably won’t know a heck of a lot about any of them.

But putting aside the benefits of focusing your knowledge, there are definite times when it doesn’t make sense to diversify, even if you planned to achieve it by buying one or two index funds. Here are a few of them.

The investment carries no risk.

The last few times I’ve touched on currencies and foreign bonds, I’ve had a few comments and e-mails asking about buying foreign government bonds. Even if the U.S. government up and disappeared, the argument goes, the government of, say, Australia would still be around to give your bond principal back.

It seems like this kind of argument comes from a general mistrust in the stability of the American government, which is pretty popular these days. Even China, one of the biggest foreign holders of Treasury bonds (with Japan), says it’s worried that the U.S. can’t sustain its debt levels.

But just because an investment isn’t as safe as it once was, doesn’t mean you should diversify away from it. Diversification only makes sense if adding the asset reduces your risk.

What can you add to Treasury bonds, FDIC-insured money market accounts, or CDs that would make your portfolio, as a whole, more safe? I can’t think of anything, and the solutions people have proposed carry their own, greater risks.

There’s nothing to show, for example, that holding foreign bonds of countries other than the U.S. would save you if the U.S. defaulted on its debt. In fact, the bonds of Australia, countries in the European Union, and Asia would probably be in big trouble as their own holdings of U.S. debt became worthless. What’s more, foreign bonds carry their own risks. Currency fluctuations happen constantly and could bring the bond’s value down at any time.

FDIC-insured products, like checking accounts, CDs, and money market accounts, fall into the same category, assuming you’re beneath the $250,000 FDIC limit for any one bank. Sure, the FDIC is underfunded. But that’s irrelevant. If the FDIC runs out of money, it’s going to be backed by the Treasury and Congress with every dime the U.S. government can mint.

Put simply, if you’re holding Treasury bonds to maturity or have money in FDIC-insured accounts, diversification gets you nothing. Just pick the account with the best combination of convenience and interest rates, and you’re done.

You need your money at a specific time.

If you’re like most investors, including me, you keep most, if not all, of the bond portion of your portfolio in bond mutual funds. That makes sense for those of us who are young to middle-aged. We’re saving for some obscure and far-off goal of retirement and don’t have an urgent need to get the money back.

But talk to someone a bit older, and you might find that they have most of their money in a bond ladder. of just ten or so bonds.

At first blush, you might think that’s really dumb. Instead of holding the vast universe of bonds included in something like the Vanguard Total Bond Market Index fund, they’re putting hundreds of thousands of dollars in the hands of just ten or so companies. Even though those companies might be seemingly strong, like GE or Anacott Steel, we all know that companies like GM and Ford once looked totally safe too, and look where that got us.

But the calculus of someone saving for a goal that’s soon to arrive is a bit different. You see, if you know you need a certain amount of money in exactly ten years, then a ten-year bond is a great way to get you there. A bond fund holds hundreds of bonds with different maturity dates. So its value is going to rise and fall with interest rates. You basically will never know with any certainty how much it’s going to be worth at any point in time.

On the other hand, an individual bond has an exact maturity date, and if you hold it until it matures, you don’t have to give a damn if interest rates double or halve while you hold it. As long as the company is still solvent, you’re going to get your money.

There are a couple caveats of course—the big one being that the company has to still be solvent. Companies can go through a lot over the course of a 10-year bond. Individual corporate bonds also only make sense for people with a lot of money to invest. Otherwise, you can end up paying a huge premium to what the bond would normally sell for.

But laddering Treasury bonds, and sometimes even municipal bonds, isn’t out of the reach for individual investors. For young people, it could make sense if you’re saving for a kid’s college expenses or a home downpayment. If you only have a little money to invest, you might forego the complexities of the bond market and just ladder CDs.

In the end, bond funds are great for diversifying you away from the risk a company will default, but do nothing to save you from interest rates rising (which make bond prices drop). And rising interest rates are a real, imminent threat to bonds right now.

Sometimes, you can’t diversify.

Ok, this doesn’t fit the topic as well, but let’s face it, sometimes you can’t diversify even though you want to. The classic example is your home. If you own an apartment in Manhattan, where the median home price is $900,000, you’ve probably got most of your wealth tied in one, 600-square-foot piece of real estate. The building or neighborhood could become unpopular. Wall Streeters could lose their jobs in droves again, tanking the local market. That’s not exactly what you call diversification.

Or the second, less classic, example: yourself. A 30-year old probably has more than $1 million-worth of earning power left in him, far eclipsing the $100,000 or so he or she’s saved already. But aside from taking on a second job, I can’t think of many ways he can protect himself from his industry failing or a debilitating injury with diversification. (He can protect himself with education or disability insurance.)

So diversify away, but only where it makes sense. And in the areas where you can’t—namely your home and your career—for the love of God, watch that basket.

Why it’s so hard to make money from the unpredictable

Today, the Wall Street Journal carried a story about how mom and pop investors can profit from “black swans”—those seemingly impossible events that, when they arrive, completely disrupt the investment landscape.

The term was made popular by Nassim Nicholas Taleb in The Black Swan a few years ago. Then, the financial crisis happened, and now, Taleb is one of those rare authors who would actually prefer to do fewer interviews and book promos than he does now.

Black swans are supposed to be inherently unpredictable. They’re the “unknown unknowns” of the investment world—extremely rare events that most consider impossible if not inconceivable. We all worry about tax reform, and then, boom, a few planes hit major American landmarks. (Which happened.) We all worry about Iran getting nuclear weapons, and then, boom, a nuclear power plant goes Chernobyl in Pennsylvania. (Seems improbable, but that’s the point.)

Once a black swan event happens, all of that other little stuff you normally care about as an investor—whether it be valuations, interest rates, or profit margins—ceases to matter, or at least matters much less. And as we discovered during the financial crisis, hitting a high-impact, improbable event results in almost all traditional asset classes losing value.

But in 2008, a hedge fund managed by one of Taleb’s collaborators didn’t lose money—in fact, it more than doubled. Today, mutual fund companies are opening their own funds, for investors who can’t afford a hedge fund, dedicated to protecting against or profiting from black swans. That’s not surprising. Mutual fund companies always come up with products after they would have been most useful. But now that these guys are around, do they ever make sense to invest in?

Predicting a black swan.

“Predicting” a black swan is an oxymoron. So how can investment strategies be tailored to do it? In his book, Taleb advocates putting the overwhelming majority of your assets in something extremely safe, such as Treasury bonds, and then taking a flier with the last 10%.

For example, after putting 90% of my portfolio into Treasuries, I might put the last 10% in a few biotech stocks. If one of them finds a cure to cancer—thereby hitting a positive black swan—I get rich, even though I had relatively little money invested in it. If they don’t, the worst I can lose is 10% of my portfolio.

More complicated strategies, used by some of the hedge funds that espouse Taleb’s strategies, involve buying out of the money put options.

Without getting into the strategy itself, basically the funds only make money if there are extreme market losses on whatever asset they buy the option on. Because the market thinks those events are unlikely, the options are very cheap. But over time, if the event never happens, a fund can slowly bleed to death as it waits in vain for luck to strike.

Practically, for a mutual fund like the Pimco Global Multi-Asset fund, which the WSJ article cites as a black swan fund, you get a fund that charges a 1.41% expense ratio with a strategy that you’re not going to really understand. The managers say that their hedging strategies will limit your downside risk in any one year to 15%, but isn’t the whole point of a black swan event that you don’t know in what magnitude and in what way the swan will strike?

Lessons from the last black swan.

Which brings us to the event that rocketed thinkers like Taleb to prominence—the collapse of Lehman Bros. and the financial crisis. Between Lehman’s collapse and the March 9, 2009 market trough, the S&P 500 lost 46%. That’s pretty bad and really devastating to someone who needed that money soon and had most of their money in equities.

But your average retiree didn’t (or at least shouldn’t) have most of his money in stocks. Using the oft-used rule of thumb to put your age in bonds, a 65-year old would only have 35% of his money in stocks. Which means, his portfolio right now might be down 15% to 20% from that peak. Not good, but not devastating either.

Sure, another crisis is still possible, but it seems that crises of the most recent variety, which wipe out a large, but manageable, amount of wealth, are best dealt with after the fact rather than beforehand. If you happen to be the unlikely victim of a huge, unpredictable event, it’s much easier to reduce your spending, delay retirement, or take a part-time job than it is to try to run an investment strategy that will eliminate the bad event’s effect.

Take Peter Schiff, for example. His prediction of the 2008 financial crisis was dead on, but his clients lost 40% to 70% of their money.

Why? Schiff was right about the crisis, but wrong about its effect. He thought the dollar would lose its value and foreign stocks would stomp stocks here. Instead, the dollar soared, as investors poured into what they thought was the last safe investment out there, and his clients lost a ton of money. Of course, we’re not out of the woods yet, but Schiff’s mistake shows how hard it is to get bets on unlikely events correct.

So in my view, black swans are just something we have to live with. It would be nice to “beat them” by anticipating and profiting from them, but that’s probably impossible. It would also be nice to limit the downside risk of a black swan event, but there are so many ways in which such an event could affect you that limiting your downside is also probably impossible.

You can invest wholly in Treasury bonds, but what if the “black swan” is the dissolution of the American government? You could invest in gold. But what if the black swan is the discovery of a way to turn lead into gold?

As long as black swans—and their effects—can’t be anticipated, the best strategy is to remain flexible and quick to adapt when it occurs, not to try to predict the unpredictable.

Live happier, feel more relaxed, and restore your mental health.

Have you ever taken a two-week vacation, come back to work, and felt stressed before the next weekend arrived? Me too. And it wasn’t because the vacation was miserable. Quite the contrary.

Still, scientists and economists have long wondered why certain experiences that should leave us with lasting feelings of happiness and satisfaction wear off quickly and others stick with us for decades. You can’t get a better vacation by spending more money—jetting off longer distances to ritzier destinations. So what does maximize your vacation dollar and day?

Let’s get one obvious point out of the way. To enjoy a vacation, you have to take it. And too few of us do. According to Ipsos/Reuters, only 57% of Americans use all their vacation. Compare that to France, where workers get 37 days of vacation on average and 89% use all of it. We’re not the worst— South Koreans, Australians, South Africans and the Japanese are all even less likely to use their vacation time.

Not taking a vacation you’re entitled to is like leaving money on the table. Someone who makes $50,000 per year and doesn’t take the two-weeks he’s due is effectively taking a $2,000 pay cut. I hope doing the math would make him feel less bad about taking it.

Let’s say you’ve gotten over that though and are ready to plan the big escape. How can you make it the best you and your family could ask for?

Plan far in advance.

No, not because you can often get the best hotel rates and air fares that way—though that’s true too. Planning ahead gives you the psychic benefits of a vacation earlier, which results in a real increase in happiness even before you step on the plane.

A survey of 1,500 Netherlanders, which happened to catch 1,000 before vacations, found that their happiness markedly increased in the weeks leading up to their departure. A separate study found that the effect was particularly acute in the two weeks right before the vacation.

So while last minute junkets can be refreshing, keep in mind that the cost of your spontaneity is the two weeks-plus of anticipation that provides some, if not most, of your vacation enjoyment! Those same Dutchmen, after returning home, only took one week to return to their pre-vacation levels of mood, tension, energy, and satisfaction.

I’ve personally planned vacations more than a year in advance. And I tend to put reminders of it in places where I’ll run across them daily. I archive most of my Gmail messages, but the airplane itinerary will sit in the Inbox at the top of the list. I’ll have at least one guidebook sitting on a visible shelf. For one vacation, I actually had a sticker on a globe sitting next to the bed right up until we left.

Research each destination and activity thoroughly.

This is, in part, related to the “placebo effect” of expensive wine I wrote about a few months ago. If you’re told a wine is expensive or is going to taste great, when you actually put the glass to your lips, it will taste better, all else being equal.

Think about how you can apply that principle to a vacation. Instead of just doing a lot of research on Orlando and Disney World, put some time into researching the drive out there. Will you be driving through historic Seminole country? Figure out where you’ll stop for lunch beforehand and find reviews touting the food.

Again, this isn’t so much about making sure you have an interesting drive and eat good food—though that’s good too. It’s because adding that research, heightens the anticipation and primes your imagination to add value to each of those experiences. A grove of trees alongside a highway simply carries more meaning if you know that American Indian tribes used the land as a hunting ground a few hundred years ago.

Focus your dollars toward the end of the trip.

Economists and psychologists have studied something called the “peak-end rule” for about a decade now. It turns out, that our lasting memory of the experience—long after the experience has actually ended—is marked by the experience’s most intense moments and its final moments.

Daniel Kahneman and Donald Redelmeier tested colonoscopy patients and found that by lessening the pain at the very end of that rather painful experience, the patients had an overall higher satisfaction with the entire procedure.

So, a pleasant and relaxing vacation on the beach might not be the way to go—unless you find intensely pleasurable moments in there somewhere. Not going to expand on that.

It might even make sense to shorten your time away if it means you would be able to take part in an incredible experience that you really want to do. Five days at the beach, including a bout of hanggliding, will ultimately be more memorable and deliver more lasting happiness than seven days without any intense experience.

Break up the vacation with real life.

Finally, and especially if you’re taking a long vacation, it’s best to break up the vacation’s most pleasurable moments with “real life”—whether it be work, a boring drive, or pretty much anything a bit less pleasurable.

This probably seems counterintuitive. And frankly, even though I have no reason to doubt the science behind it, I find nothing more irritating than when work intrudes on my Sunday afternoon.

However, humans have this unfortunate tendency to adapt to all circumstances, whether they be positive or negative. You eventually get used to the crummy apartment with the leaking sink and dingy windows, but you also get used to the plush beach chairs and cool, tropical breezes. So just as your misery is deadened over time, so will your pleasure.

Maybe I’ll take my BlackBerry to Europe after all.

We’ve feared losses for 40 million years.

How hard is it to learn to be a good investor? I’ve written a lot about the behavioral quirks that cause us to make major mistakes when we put our money in stocks and bonds, even though we know that we’d do a lot better to make different decisions. Losses hurt more than gains feel good. Walking inside your boss’s office for a review actually triggers an adrenal response—you’re ready to sock your boss in the face or fly out the door as he tells you how well you’re filling out Excel spreadsheets.

Of course, none of these emotional and hormonal responses actually help you do anything. You know that having cold, sweaty hands isn’t going to help you explain your position to your boss effectively, in the same way you know that getting a free ice cream cone should make you just as happy as dropping one on the floor makes you sad. So why do we do it?

Monkeys fear losses too.

One of the unique traits of the human species is our use of money. If you’re a cattle rancher, you don’t have to drive 100 heads of steer to your Realtor’s office to buy a house. We’ve created a fungible, easily divisible medium of exchange that makes it much more convenient.

That old invention makes it that much harder to run economic or scientific tests to understand why we treat money the way we do. Animal testing—putting aside ethical issues—is much easier with medicines. The guinea pig was cured or it wasn’t. And after studying side effects for a while, we can move on to human testing.

But what if you could teach a monkey to value and use money? Then you could run all sorts of experiments to see how deep our ridiculously unprofitable predilections run.

M. Keith Chen, a behavioral economist at the Yale School of Management, has done just this. His community of Capuchin monkeys has learned to value coins. They can exchange coins for orange peels or apple slices. Chen can change the prices of the prizes every so often to see how the monkeys react.

In 2006, Chen ran experiments to see just how mad a monkey gets when prices go up versus how happy he gets when they drop. To do this, he faced the monkeys with two trainers, with different colored clothing. The first trainer would show a monkey two apple slices, but when the monkey traded in his token, he would either pay the monkey the promised two slices or just one—averaging out to 1.5 slices per payment.

The second trainer would show a monkey one slice. But when the monkey paid a token, he would either give the monkey the one, promised slice or would unexpectedly deliver two slices—again averaging out to 1.5 slices.

Rationally, the choice between the two trainers should have been a wash. But the monkeys preferred the trainer who gave them unexpected gains two-and-a-half times more than the one that gave them unexpected losses.

So, think you can get over loss aversion? Our ancestors might have felt this way for 40 million years. Good luck!

Monkeys also treat risk the same way we do.

Another fun monkey experiment: The capuchins were presented with two sets of trainers. In the first set, both trainers promised the monkeys one piece of food (by showing it to them).

But in fact, the first trainer always paid out two pieces, and the second trainer would pay out one piece half the time and three pieces half the time. Again, statistically, the trainers were a wash, but the monkeys preferred the one with the guaranteed, two-piece payment more than the risky guy.

In the second set, monkeys were always promised three pieces of food. But the first trainer would consistently pay out two pieces and the second trainer either paid out one piece or three pieces. In other words, the monkeys could take a guaranteed, one-piece loss or roll the dice (and risk losing two pieces). This time, the monkeys preferred to take the risk.

What do those experiments show? That when we have a choice between guaranteed gains or taking a risk for an even larger gain, we’d prefer the bird in the hand. But when we might take a guaranteed loss or can take a risk to possibly lose nothing, we’re willing to take the risk.

Monkeys overvalue what they own.

Why is it so hard to get a trade going in Monopoly? I noticed this especially when I was younger. After the board was bought up, the players would start to offer trades. Thing is, the offers would always be ridiculously lopsided. “I’ll trade you Boardwalk for North Carolina, Atlantic, Ventnor, and St. Charles.” And the response: “No way, I’ll give you Atlantic and $100 for Boardwalk.” And so on.

Economists calls this the “endowment effect.” We value things more if we own them. In one famous experiment, humans were asked to buy and sell coffee mugs. In each and every case, they wanted more for the mug than they, themselves, would be willing to pay for it.

Sadly, it doesn’t look like evolution has gotten us over this one either. Chen gave one group of his monkeys one kind of good and the other group another kind.

The monkeys preferred each type of good equally. So you would expect the monkeys to end up trading about half of the food with each other. Instead, almost no trades were conducted at all. “Yeah, I like apple slices as much as I like orange peels. But this is my orange peel.”

So next time you find yourself thinking you can overcome the behavioral biases that cause us to handle money so irrationally, think back to the monkeys. We’ve been fighting this for 40 million years. Think you’re going to be the one to overcome it?

Make more money without leaving a bad taste in your boss’s mouth.

Ready to make more money? As I’ve written before, getting a bigger salary matters more than your asset allocation. It matters more than avoiding ATM fees. Heck, it matters more than your savings rate. If you can get a 20% bump today, you put yourself on the path to a huge difference in wealth 20 years down the road.

And the benefits just multiply. As you negotiate for raises, you’ll get better at it. You’ll get better in other kinds of negotiations too. Worst case scenario: You get shot down. But that’s not any worse a position than you’re in now. If you don’t ask, the answer will always be “No.”

In part one, I explained why “now” is a great time to ask for a raise. The economic environment is bad, but not so much that you’ve lost all negotiating power.

However, let’s not abandon tact. Getting a raise is a lot different from negotiating a job offer. Before you start a new job, you can take an offer or walk, and presumably still have a salary at your old place. But when you ask for a raise, you’re putting at stake a carefully cultivated relationship that you’ll probably have to live with no matter what happens.

That changes the power dynamic a lot. The key to a successful wage negotiation is to get more money without making your manager unhappy. If you don’t get more money, you lose. But if you do get more money, and leave your boss feeling like he or she was forced into it, you still lose! He might grow resentful or doubt your respect for the company. If you threaten to walk, he might think you’re not dedicated and are just a mercenary looking for any chance to jump ship for more pay.

Walking this line, while still maintaining a position of power, is crucial.

But before we get into the actual conversation, let’s do a quick review of where power comes from in a negotiation. According to a rather famous power framework, there are five kinds, listed here in no particular order:

1. Reward power: You have this when you can help your boss’s cause, and he knows it.

2. Coercive power: You have this when you can hurt your boss, and he knows it.

3. Expert power: You have this when your boss thinks you have some sort of special knowledge or expertise.

4. Legitimate power: You have this when your boss thinks you have the law on your side in influencing him.

5. Referent power: You have this when your boss likes you, thinks you can make him happy, or gets some sort of other pleasure from having you around.

I’ve seen and heard of all types being used in a raise negotiation, but as you can guess, flexing some of those muscles is not ideal.

Take legitimate power, for example. Sure, if you have a good case of being discriminated against because of your race or gender, you can probably get your boss or boss’s boss to increase your salary. Or how about coercive power? Walk up to your boss with a competing job offer, and he’s threatened with losing a valued employee and the thousands of dollars and hundreds of man hours that come with recruiting someone new.

But using either of these is a mistake. In the first instance, while totally a strong reason to ask for a raise, you’re still left at a workplace that apparently has biased coworkers—now who have additional reasons to resent you. In the second, you’re left with a boss who will forever remember the time you coerced him into giving you a raise. Guess who’s getting the ax once it’s time to cut expenses.

So when it’s time to ask for a raise, you’re best served by focusing on the three remaining ways of exerting influence: showing how you can help your company, displaying unique expertise or attributes that are impossible to replace, and generally, being a decent guy or gal to work with. Let’s tackle all three.

Setting the stage.

In part one, I went over how to decide when to ask. In short, you want to have just finished a great, memorable accomplishment, but also be in a time of the year when your boss actually has the power to grant a raise.

Assuming you’re in such a blessed position, set an appointment with your boss during a time of the week or month when he or she is facing the least stress and time pressure. You don’t want him to have an easy excuse to wait until a project closes or a report is put together. Hopefully, he should be able to get on the phone that evening or the next day with HR or the relevant office to get a raise approved.

Don’t just waltz into his office and ambush him with a request—ask for 30 minutes at least a day or two ahead of time, and if asked, say you’d like to talk about your performance on your last couple projects. A smart boss will know exactly where this conversation will go.

Get all your research on salaries in your field together. Type up a single page of bullet points you want to mention, noting your past accomplishments with measurable ways you’ve added to the bottom line and bring two copies (only give it to him if he asks). Remember to bring a notebook.

It’s important to have at least a general idea of where the conversation might go before you walk into the office. Is he going to mention budget issues? Is he going to mention the nice raise you got last year? How likely is it that he gives you the most dreaded response in raise negotiations possible? (More on that later, but hint: The dreaded response isn’t “No.”)

Practice how you’ll respond to each of his doubts. Sure, times are tough, but you’ve greatly helped the company’s budget woes by shaving 10% off project expenses this year. Yes, you got a raise last year, and you’re thankful, but since then, you’ve increased your sales lead production by 20%.

Ready for an uncomfortable, yet extremely profitable, conversation? Let’s walk into the office.

Remind your boss that he likes you.

Well-liked employees get raises. It’s as simple as that. Of course, your performance matters the most. But deep down—on a much deeper level than the part of the brain that’s concerned with company performance—your boss is attuned to the psychic rewards you give him with your respect, loyalty, and friendship.

The first part of your talk will probably contain the moments with the highest tension, when your boss is waiting for you to begin what he’s probably convinced himself will be an uncomfortable conversation. So it’s critical to get the tone right from the outset. You’re not in his office because you think he’s slighted you (even if you do actually think that). You’re in his office because you have a challenge that, together, you can both overcome.

“But wait,” you object, “aren’t we adversaries?” There’s no doubt that you are. You want more money. Your boss wants to keep costs low. But projecting an image that you don’t view him as the bad guy changes the conversation from “who will win” to “how can we win together.”

Researchers from Cornell and Cal State-Long Beach have found that bargainers who view a negotiation to be a threat are more likely to be hard-nosed and less likely to be creative than those who see it as a “challenge”.

The challenge, in this case, is that you’re a kick-ass employee who is concerned that you’re not being compensated for your awesome contributions to the company. So as you start to slide from the small talk to the crux of the issue, make sure you say things such as “There’s one problem I was hoping we could solve together” or “Something’s concerning me and I was hoping you could help me think through it”. You don’t want to use language like “You’re underpaying me” or “My results aren’t being appreciated.” That automatically sets an adversarial tone, and even if you win, in the long-run, you lose your boss’s good will.

Bringing out your evidence

As you (hopefully) did when you first got offered your job, follow your boss’s lead. Ask him how he or she thinks you’re doing or how you did on that last, amazing project. Let him make the case for a raise for you.

Assuming he or she “forgets” one or two major accomplishments, reference your list to give the high-impact, measurable goals you accomplished and detailed earlier. Make sure you give the team as a whole respect too—you don’t want to make a group effort seem like it was solely your individual accomplishment. That’ll just make your boss skeptical.

Whatever you do, don’t make it personal. You don’t want a raise because your rent just went up. You want a raise because you’re contributing more to the company. You’re not upset at your boss for not appreciating your effort. You’re showing your boss a way he can keep one of his top performers happy.

Your boss will see that you’re reading from a list and might ask for a copy. And it’s extremely important you give it to him (or that he write down your accomplishments). Because even though you’re trying to convince your boss to give you a raise, you’re also helping him build a case to his boss that his payroll budget should be increased to accomodate you.

Don’t bring out the PayScale or GlassDoor data you discovered. At least, not yet. That sets the tone that you’re threatening to leave and can put your boss on the defensive.

Time to get down to the numbers.

“And that’s why, I’d like you to consider raising my pay,” you finish breathlessly. Congratulations, you’re in the midst of a heart-pounding conversation that will be more important to your earning power than any other you have over the next 12 months. Just being in this position is more than most of your colleagues can probably say.

What now? For one, let your boss speak first. Let him propose how much the raise should be. He might come up with a figure that’s even higher than what you hoped for.

But let’s say, he doesn’t. Step one: Don’t fall into the trap of anchoring bias. Anchoring is our tendency to rely on an initial piece of information given (“How about a 3% raise?”) to make subsequent decisions and guesses. “Oh crap,” you might think. “If he’s thinking 3%, maybe I should only ask for 6%.” Bam. All your research that says you should really be looking for a 15% to 20% bump goes out the window.

In truth, you should meet whatever your boss says with a look of disappointment. Career coach Jack Chapman calls such a tactic “The Flinch”. Here’s a video of him demonstrating it:

When I first saw this video (thanks Get Rich Slowly!), I thought it was the most awkward thing I had ever seen. You repeat the salary or raise offer slowly, and then just sit silently, while your employer is left to surmise your extreme disappoint at what he thought was a generous offer.

But it turns out, Chapman’s on to something. You see, in tests of negotiation tactics, professors from the University of Pennsylvania and Ben Gurion found that expressions of anger and disappointment immediately make the other party in the negotiation more likely to make concessions and raise their offers. Not sure about you, but I’d keep it professional and hold off on the anger. That leaves the appearance of disappointment as one way to turn the odds in your favor.

Your goal in the ultimate offer will be to push as close to the top of that salary range you discovered at GlassDoor as you can. Pull out that research if your boss seems to be clueless as to what the market for people with your skill set is.

If you win a raise, awesome. Make sure you get information on timing, and recap the meeting in an e-mail when you get back to your desk.

But what if you don’t get an immediate yes? I’m willing to bet that if you’re a top performer, your boss won’t say “No.” Instead you’ll get the most dreaded response in the history of raise negotiations…

“Yes, I agree you deserve a raise. No, I can’t give it to you now.”

Could any response be more cruel? Your research worked. You made your case well. Your boss agrees. And yet, he or she cops out and defers to budget or timing issues to put your well-deserved raise on semi-permanent hiatus.

To me, this is even worse than “No.” If you get a “No,” you can naturally ask how you can change the answer into “Yes.” What metrics does he want you to achieve? What does an employee who deserves a raise look like? When can we revisit the discussion?

But either through genuine budget issues or a desire not to hurt your feelings, your boss has punted. What now?

This has happened to me before. In fact, I was foolish enough to leave the meeting feeling really good about how it went. My boss thinks I should be promoted! And I did get promoted…five months later.

Step number one: Ask for a specific timeline for the raise. If not now, when? As in “The Flinch”, the key emotion for you to project is disappointment, not happiness that your boss apparently acknowledges your worth.

Whatever timeline he proposes, make him feel that your raise needs to be addressed more urgently. Ask, “Is there any way we can make it happen sooner?” or “Is there any way I can help you with HR or payroll to process things more quickly?” Don’t come to the point of threatening to leave, but such questions will automatically make your boss dream of situations where his top employee starts fishing around for a new job.

And finally, ask to revisit the issue at least a month before whatever timeframe your boss gives you. The last thing you want to happen is to remind him of your discussion in six months, only to have him say that he’ll “start the paperwork” or some other nonsense that takes even more time. Make sure to document the conversation in an e-mail.

Of course, if the boss’s promises never materialize, it might be time to walk. You could come back with another offer for leverage—a prime example of “coercive power”—but even if he caves, that’s liable to sour your relationship.

Whatever the outcome, you at least gave it a shot, which is more than 3/4 of employees can say in this economic environment. And just having the practice will pay dividends. I can’t remember where I read it originally, but when it comes to dealing with awkwardness, there’s one piece of advice I live by: Your success directly correlates to the number of uncomfortable conversations you’re willing to have.

This post was an Editor’s Pick at the Carnival of Personal Finance at Live Real, Now. Thanks Jason!

Why it’s dumb to just be “happy to have a job”

Standing still is not a career plan. Here’s how to turn the final months of the Great Recession into an opportunity to bolster your salary by 10% or more.

Oh yes, the job market is bad. You probably know someone who’s looking for a job right now. I know several, and many of these professionals have started to apply for temporary jobs in retail—folding clothes and working registers—and still haven’t gotten a bite. That’s enough to make anyone want to hunker down and just pray that the suits on the top floor don’t look your way.

That’s a big mistake. If there’s one thing I want you to take away from this post, it’s that there’s great power in taking five minutes to put yourself in someone else’s shoes. It’s such a basic concept, but no one does it. What are your boss’s greatest worries? What does he or she talk to his spouse about after getting home? What do good and bad days at the office look like for him?

Do that now, and you might find it’s not the worst time to ask for a raise after all. Why? Well, first it’s important to understand that it costs a lot to replace someone. According to the Employment Policy Foundation, it costs somewhere between $6,500 to $18,000 to replace an employee, depending on the industry. When you talk to human resources managers, they often talk in multiples of salary. Hard to find employees, like registered nurses in rural areas, can easily cost 150% of a base salary, from costs to hire a search firm, lost productivity costs, paying temporary workers, and so on.

In the meantime, HR managers are very worried about turnover right now. They’ve come to grips with the fact that many employees felt shafted during the downturn, and many are already starting to voluntarily leave for other jobs. Sorting through 1,000 applications for one position isn’t as fun as you might think.

With employee retention top of mind, that leaves you in a better bargaining position than 9.5% unemployment would imply. No matter if you think you’re getting paid fairly or not, asking for a raise is a conversation everyone should have regularly, if for no other reason than to keep your career in motion.

In this two-part series, I’ll explain how to prepare for that conversation and then how to have it, based on actual conversations with raise-givers and, in part two, on behavioral research into what negotiating tactics actually work, without leaving a bad taste in your boss’s mouth.

See where you stand.

Especially if you took a job during the downturn, there’s a good chance your employer took advantage of the weak job market to pay you less than what he might have a few years ago. Although companies are reinstating raises, they’re going to be less than 3% according to a recent survey.

At that rate, if you were brought in at $40,000 for a job that would normally pay $45,000, it’ll take four years to reach what your colleagues get paid today, putting yourself on the path for a long-term hit in wealth, simply because you picked an unlucky year to get a job.

If we were talking two decades ago, I’d give you this trick. Find a few work colleagues who feel they’re underpaid and have everyone write their salaries on a slip of paper. Put them into a hat, mix ‘em around, and lay them out on the table. You’ll quickly see where your salary falls, without anyone getting embarrassed about being poorly paid.

Luckily today, we don’t even have to do that. Some popular salary websites, like PayScale.com, are useful in getting you a general idea of the market for particular skills. But I’ve found GlassDoor to be more useful. If you work at a large company, you’ll be able to see the actual salaries of coworkers who have anonymously put their salaries into the system. That makes for a more accurate comparison, since companies aren’t always uniform in the titles they give to people doing the same job.

If you find yourself at the top of the salary range given by one of those tools, that’s great! But don’t rule out asking for a raise anyway. This is just an exercise to see how much of an increase could be achieved. Someone who sees they are at the bottom of the salary range has a better chance of getting a large increase than someone at the top.

Do a self assessment.

Everyone thinks they deserve a raise. Few people can prove it.

First, forget all of the reasons why you want a raise—they don’t matter. A raise negotiation isn’t personal. It’s not about your car payments or rising rent. You need to show your boss why he has a reason to give you a raise.

So, start putting together a list of reasons. You might, for example, regularly deliver programming assignments a week ahead of schedule, allowing your team to deliver products more quickly. If you’re in sales, maybe you convert prospects at an above average rate. Anything you write down should be central to your job or to your boss’s job. Ultimately, he probably has a boss to please too.

It doesn’t matter if you run the party planning committee. Honestly, unless you’re unionized, it also probably doesn’t matter if you’re spending extra hours at work. Your boss, and your boss’s boss, will need reasons to give you a raise that are central to their bottom line.

Some good examples of reasons for a raise:

1. The project I led came in 10% under budget.

2. Since I took charge of business development, we’ve acquired five new customers, one of which is on track to generate 20% of our revenue this year.

3. I’m developing our people. Since being put on my team, Sally and Jim have increased their sales performance by 25%.

And some bad examples:

1. I do just as much work as John, yet he gets paid $5,000 per year more.

2. I’m the first one here in the morning and the last one to leave. (If you don’t have results to show for it, the immediate question becomes, why does it take you so long to do your job?)

3. I haven’t gotten a raise in two years.

Hopefully, you have good reasons. If you don’t, you should still have this conversation with your boss, but more on that in part two.

Finding the best time to ask

You’ve probably heard that the best time is right after you get congratulated for a major accomplishment. This is only partially true. If you work for a big corporation, your boss might not have flexibility in the middle of the year to move money around.

So when will he? Get familiar with your company’s budgeting process to find an optimum time. If your company is like most, the fiscal year will begin in January or July.

Performance reviews are when your boss doles out whatever raises were determined by that earlier, budgeting process. And since raises are averaging just a few percentage points, it might not be an ideal time to ask for one. First, depending on the company, it’s likely the raises are already working their way through the payroll system by the time you hear about them. But second, giving an extra point or two to you means he or she has to take a point away from someone else. Not ideal.

Another great time to ask is after someone in your department leaves. As HR and your boss try to determine what salary they’ll give to whomever they hire as a replacement, you’ll have room to maneuver and take some away from that salary for yourself.

But honestly, the best time to ask for a raise is nearly always going to be “now” unless your company has just experienced something overly negative. Because even if you can’t get the raise at that meeting, it at least puts it on the table for when your boss has more flexibility.

Ok, ready for an uncomfortable conversation? Trust me, earning 10% to 20% more is going to be worth it. Here’s part two, which will walk you through the actual negotiation.

Not that any of them are all that great.

The hot air balloon above is inflating. Get it? Get it?! Sorry. I’m tired.

There are only so many ways our government can eliminate the deficit and eventually pay off its gigantic debt. The least painful—and the one federal officials were desperately hoping for when they enacted the stimulus—is to grow the economy. With the economy growing, they get more tax revenues without having to change any laws.

Two, less optimum solutions are to raise taxes or spend less. Both of those make voters angry. Spending cuts sound good until you realize it means your kid’s classroom goes from 25 students to 30 students. Raising taxes never plays well, even when you purport to target the highest-income households.

That leaves inflation. No politician has to vote for it. It’s hard for rivals to point to interest rates and say, “Congressman Smith did this!” Inflation is simply the easiest way to pay off the deficit without alienating your constituents. Yeah, it’s weak, but when push comes to shove, you’ve got to believe inflation is going to rise before Congress successfully balances the budget.

So where does that leave you? And what can you do to make sure a devaluing dollar doesn’t decimate your portfolio? And for that matter, how can you stop Pop from excessive alliteration?

The myth of stocks as inflation-fighter.

One of the most common arguments in favor of investing in stocks is that they keep your portfolio from being silently eaten away by inflation. For your retirement money to keep its earning power, the yarn goes, you need assets whose returns will outpace inflation. Stocks are one, good answer.

Except they aren’t. In fact, stocks tend to do terrible when inflation is high. Take a look at this chart from Martin Capital Advisors.

In times of rapid inflation (the gray boxes), the S&P 500 (the green line) tended to drop, sometimes by a huge amount.

The point is, while stocks will probably outpace inflation over the long-term, holding stocks as a short-term panacea to what you might think is a coming bout of major inflation doesn’t make sense. Indeed, it seems misleading that the two issues ever got combined. Yes, inflation is an enemy to your portfolio. Yes, stocks—even at a conservative 5% growth rate—outpace the average inflation rate of about 3% over the longterm. But the two aren’t built to counteract each other.

What about commodities?

It would seem that commodities—such as oil, natural gas, and, I don’t know, timber—would be better inflation hedges. After all, if prices go up, the prices on the raw goods we need to make things should go up, too. The problem, of course, is that a ton of things, in addition to inflation expectations, influence commodities prices. Let’s take oil for example. This chart is from Inflation Data:

You’ll notice that the 1979 high for oil (in 2010 dollars) wasn’t topped again until 2008. Of course, inflation didn’t go down over that long time period. Quite the contrary. There were just a few hurricanes and a couple major oil crises that jostled the price of oil around, even as inflation made its inevitable climb upward.

Other commodities face similar circumstances. But even if they didn’t, keep in mind: Commodities reflect inflation expectations. So if you’re thinking about buying some oil ETFs right now in expectation of high inflation, you’re already late to the game. Even if inflation does rise rapidly, if it doesn’t keep up with the lofty inflation expectations the market has set for it, commodity prices could still drop.

And I’m tempted to skip gold, but what the hell…

Not that some reasonable people aren’t making arguments for gold investments. It’s just I feel like it’s unfair to keep beating up on this one. One last chart, also from Inflation Data:

Similar to the oil chart, you’ll see that even though the price of gold, currently at about $1,200 an ounce, has surged this year, it’s still nowhere close to the $2,251 peak it reached in 1980 in today’s dollars.

If anything, gold is a crisis hedge. If the U.S. government collapsed and the world collectively decided to revert to a medieval trading system in which precious metals of limited industrial use became the currency du jour, then gold might be a good investment. When I write about this, a common counterattack is to say that the dollar itself only has value by fiat (i.e., because the U.S. government says it does).

They’re absolutely correct, but that’s the whole point. The dollar has the fiat, both from the government and (implicitly) from investors who flock to it in the face of danger. Gold has an implicit fiat from a limited number of investors and practically no governments. And…oh forget it. If you’re going to buy gold, at least don’t listen to Glenn Beck and buy coins through Goldline.

TIPS: An imperfect option, but the closest to perfect you’ll get.

Treasury Inflation-Protected Securities are Treasury bonds created by the U.S. government whose principal also adjusts with the Consumer Price Index. As many people point out, CPI is an imperfect measure of inflation. Even putting aside the specious, government-lies-about-everything arguments for a moment, there is no possible way that what you spend money on will track CPI exactly. If you, for example, have to spend a lot of money on healthcare, whose cost is rising several times faster than CPI, your personal inflation rate will be higher.

However, TIPS, and their less-mentioned cousins, I Savings Bonds, will at least track inflation loosely, without the wild, speculative swings that stocks, commodities, and gold fall subject to.

Right now, a 10-year TIPS bond yields 1.09% after that periodic inflation adjustment. Given that regular Treasury bonds of that length yield less than 3% right now, that implies investors think inflation over the next decade will actually be extremely low.

And best of all, TIPS can easily be bought straight from the U.S. government. One word of warning though, if you buy them this way, make sure you hold them until they mature. Selling individual bonds is expensive, and bond prices will move around as interest rates move. If you think you’ll sell before the maturity date, try a TIPS mutual fund or ETF instead, though they won’t track inflation as exactly.

Anyway, I’m sure there are good arguments in favor of some of the traditional inflation “hedges” investors have used over the years, and throwing a few charts out there does not a Ph.D. dissertation make. How would you challenge some of the arguments I’ve laid out here?