Wednesday, January 30, 2008

Are we about to lose another Industry?

Given the current global financial crisis, which was created on Wall Street, is it possible that the mighty financial industry could go the way of the US manufacturing industries?

Take a trip back to the East coast and you will see the remnants of a huge industry that the US once dominated. Now only the buildings remain of the textile companies that once employed thousands. The mills were shuttered and the work sent abroad where cheaper labor and less restrictions on businesses allowed better profit margins.

Take another trip to the MidWest and you will see the people and cities that were devastated by the exodus of the auto industry. Competition has taken away an industry that was once dominated by the US and employed even more thousands.

It’s happened before to mighty industries. Who would have ever believed the auto industry would falter to this extent? Good paying jobs were lost forever.

Today, we are witnessing the struggles of yet another powerful industry. The financial services industry has managed to grow incredibly over the last 50 years. At one time, the US was the largest creditor nation in the world and it was only natural that the center of finance was located in New York where the largest suppliers of capital could be found.

That has all changed now. The US is a debtor nation and most of the new capital is coming from Asia and the Middle East. Read any paper and you will see that these new financiers are buying out America.

What has happened to cause this turn of events? Several things have contributed to the current situation.

For starters, government fiscal irresponsibility. Under Bush, the nation's debt has mushroomed. Secondly, the investment banks have gone from private ownership to public allowing risk to be transferred to shareholders.

As a result, the financial institutions were driven to find greater profits and take on riskier sources such as sub prime debt vehicles. In the frenzy, the US financial industry spread billions of dollars in losses around the world shattering it's standing with customers. You lose customers when you sell them junk, just like the auto industry lost its reputation for high quality cars.

Another factor is the devaluing dollar. In the past the dollar was the most stable currency around. It was the standard to measure everything against. Nearly everyone wanted to be paid in US dollars or have their money in US banks. That is no longer the case.

It is very possible that the financial industry, like manufacturing, will be yet another industry lost to foreign competition. In the end, the financial capital could move away, leaving New York a minor role to play and a shadow of it's former self!

Somehow, I don’t think interest rate cuts and tax refunds are the answer….

Tuesday, January 29, 2008

Three ways to Stimulate the Economy

What is the right strategy to stimulate the economy? Does it really need to be stimulated? Perhaps, letting it all play out is the best option.

Here are three traditional ways to jump start an economy:

#1 Create Jobs
It's classical economics, high unemployment results in low demand for goods. Unemployed people can’t buy a lot of stuff, so demand is low which forces companies to cut production and lay off more people. It’s a vicious cycle.

To combat this, governments create jobs, like public works projects. This puts money in peoples’ pockets and lifts demand. Once companies see this increase in demand, they will ramp up production, hire new workers, and eliminate the need for the government spending.

This is close, but not exactly the problem we have today. Unemployment is still relatively low. We have jobs, but a lot of them are low paying and people expect to have more stuff than ever before. Consequently, people borrow (use credit cards, home equity loans) to make purchases, increasing demand and so on. What happens if these folks can’t get credit? They stop buying, demand falls and companies cut back.

You could argue that people should spend less and live within their means. Living more frugally does help the individual, but it doesn’t help businesses grow.

#2 Cut Taxes
Another way to put more money in people’s pockets is to cut taxes. This is classical supply side economics. The tax refund proposals out there today are temporary, one time band-aids to the problem. Evidently, this is what POTUS thinks is all that this economy needs - a quick jump start and then once its running again it will become more efficient and spur more growth. Plus, it’s real popular with the people.

The big problem with this is that whenever governments cut taxes, they are also cutting revenue. To replace lost revenue, the government must issue new debt to borrow more money from foreign lenders. The credit worthiness of the US is at an all time low which translates into higher rates for loans. This ultimately contributes to the devaluation of the dollar, reducing buying power and lowering demand. Another vicious cycle.

#3 Do Nothing
There are three big time lags that typically thwart economic stimulation. First the government must recognize that there is a problem, then agree on a stimulus package and then it takes time for the “fix” to take effect. By the time all this happens, the economy may have already changed direction and played out on it's own anyway.

This approach may be just as effective as any other, but it is much more unpopular. It’s like going to the doctor and he says just wait awhile and you will start to feel better. To most people that’s not acceptable. They went to the doctor to get help and they want something, a medication, a “fix”, right then. Whether the “fix” helps or not it still makes us feel like we are doing something about the problem.

For more Personal Finance topics check out the festival of frugality carnival hosted by Mrs Micah: Finance and Life. My article: Opt-out of Mail-order Catalogs to Save $ and the Planet! was included in the carnival.

Monday, January 28, 2008

Behavioral Finance – Social Proof

Can you stick to your financial plan when everyone else claims the sky is falling? This is the seventh in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

7. Bias from over-influence by Social Proof
Social proof involves doing something or not doing something based on what everybody else is doing. It's also commonly known as going along with the crowd.

Charlie gives a couple of examples. One is the case of a young woman, Kitty Genovese, who was slowly murdered while more than 38 people did nothing to stop it. There were lots of excuses. Maybe the most apathetic was the one who told reporters, “I was tired.” But the fact remained that dozens of people stood by and watched a woman being brutally assaulted for an extended period of time, and did nothing. One of the explanations given is that everybody looked at everybody else and nobody else was doing anything. And so there was automatic social proof that the right thing to do was nothing.

Another example he cites is the run on fertilizer companies by Big Oil. Several years ago one of the large oil companies bought a fertilizer company and then practically every other major oil company ran out and bought a fertilizer company. There was no reason for all these oil companies to buy fertilizer, yet they did what their peers were doing. If Exxon was buying fertilizer then it was good enough for Mobil and so on. It turned out to be a financial disaster for the oil companies.

A more recent example would be the way US financial institutions followed each other into creating the current mortgage crisis. Only one of the major players, Goldman Sachs, managed to steer clear of the stupidity.

And of course, social proof, seems to be the mantra of Wall Street. The street reacts with a herd mentality concerning any and all financial related news. It’s an all out stampede with everyone trying to not be the last one to buy or sell. It takes a ton of courage and patience to hold your ground and stick with your financial plan when everyone else is screaming sell, sell, sell!

Especially in times like these when the talk of doom and gloom is ubiquitous. The pundits continue to argue that this time is different. This downturn is unlike all the other bear markets that we have been through. They say that back then whenever there was a stock market crash or a dip in housing prices, each of those markets were able to snap back rather quickly. But this time they say, it’s not just the market, it’s the whole economy.

The financial institutions are shaken and scared. Their only hope is to instill fear in the consumer in an effort to convince the government to come to their rescue. They have taken a huge gamble and lost and now the rest of the world is swooping in to buy up America at rock bottom prices.

In the end, these new owners will still be willing to give you a loan, but now instead of the US financial sector draining billions out of society (John Bogle refers to it as subtracting value from the economy), it will now go into the pockets of hedge fund managers, mutual fund managers, and bankers, etc. in another country.

For more on personal finance, check out the Carnival of Debt Reduction hosted by My Dollar Plan. My article: My beloved Supra has become a money pit was included in the carnival.

How I paid off my Home with a Home Equity Line of Credit!

I used a HELOC to pay off my home mortgage! How convoluted is that? I used the equity in my home to qualify for a loan. I then used that loan money to pay off the remaining mortgage amount.

The whole thing started when my mortgage lender, Washington Mutual, called me to re-finance. Their new rates were slightly lower than my loan. However, I already had plans to pay it off early and when I ran the numbers it just was not worth the drive to their office to do the paperwork. The loan officer on the other end of the phone was in disbelief. She said over and over that “It won’t cost you anything, it’s a free refinance!” I held my ground, I wanted a better rate or nothing at all.

The next day, the loan officer called back. She said she had just the deal for me. Now, I was really suspicious. She suggested that I pay off my mortgage with a HELOC that was 2.5 pts less than my mortgage rate. With this new low rate, it was definitely worth looking into. I made certain that I could pay off the HELOC early and that there were no fees. In addition, I ran the amortization numbers for several different increasing interest rates, because the HELOC rate is based on the prime rate which can change.

My intentions were to pay off my home loan within the next year, so I knew that it was very likely I would have it paid off before rates could climb back up to my original mortgage rate. That is exactly what happened. Rates did increase, but it never reached the level of my original rate before the loan was closed out.

That turned out to be a real benefit, because as the rate was increasing, I had the extra incentive to save and get the HELOC paid off within that year. The only downside of the HELOC is that I suspect it had a negative impact on my credit, at the time. Unlike a mortgage, a HELOC is a loan that can be used for anything and accordingly it presents more risk to the lender. I did some research on this and found some interesting facts.

  • HELOCs are structured as interest-only loans, so the minimum payments can be enticingly small. Case in point, I borrowed nearly $40,000 and the minimum monthly payment was less than $130 bucks.

  • HELOCs can affect your credit score. How much depends on the amount you borrow. A sizable HELOC of $100,000 is counted as an installment loan, while a small HELOC around $2,000 is considered revolving credit. For installment loans, like a large HELOC or an auto loan, FICO takes the ratio of the original loan amount to your outstanding balance on the loan to calculate a credit-utilization ratio. So a new loan can drag your score down for the first year or so. Whereas revolving credit, like credit cards, is treated a little more kindly - the ratio is the credit limit to your current monthly balance.

Saturday, January 26, 2008

My beloved Supra has become a money pit

I don’t have any traditional debt. I own my house, my two cars and I pay off my credit card every month. I must be carefree and debt free, right?

Well, not exactly, I own a 1989 Toyota Supra that has become a money pit. The car does start - occasionally. Unfortunately, I do not trust it anymore and I don’t want to get stranded somewhere away from home, so it just sits in my driveway - looking great, by the way. It doesn’t move or provide any service to me, but it costs me money all of the time. I keep auto insurance on the car (liability-only at $486/year), state registration tags ($45), and now it needs an emissions test ($50). It’s a little money pit. Oh, by the way this is the first car I ever purchased and because I have had it since it was brand new in 1989, I am emotionally involved.

Because it’s so old and of little monetary value, I don’t want to take it to a repair shop. If I did, the shop would probably come back with an extensive repair bill and then I would be forced to make a decision. I already know what that decision must be – it’s time to let go of the car, its time to donate it.

So, instead it sits in my driveway and I tinker with it. I have replaced spark plugs ($10), and checked the ignition coil, distributor wiring, ignition switch, ignition relay, replaced battery terminals ($5); all of this while chasing this electrical problem. I am just about stumped.

So far, I have been using the excuse that by doing all this tinkering, I may actually gain some knowledge about auto ignition systems. I even joined a Supramania website where I can ask "Supra experts" questions to help me with the diagnosis. Only problem with that is they get a little tired of dealing with rookies like me. LOL

My debt reduction plan begins with writing this post in hope that once I re-read the saga and take note of the money that the car is burning through, I will be spurred into action!

Live like it’s your second time around!

I just finished reading Viktor Frankl’s book Man's Search for Meaning
Frankl admits that he has mixed feelings about the success his book has achieved becoming a bestseller. He does not see it as an accomplishment, “rather an expression of the misery of our time, in that so many people are reaching out for a book to whose very title promises to deal with the question of a meaning to life”. Are we all so miserable in life that we are searching for some meaning?

The title did catch my attention, but I selected the book based on a recommendation from another author that I was reading concerning human behavior. Besides, if I can squeeze a little more meaning out of this life then I am all for it.

Frankl’s book starts with an autobiographical account of his survival of WWII concentration camps. He is a psychotherapist and provides a viewpoint on human suffering that I had never read or heard about before or even imagined. He closes the book with some very thought provoking maxims that I think can apply to many situations in life – even personal finance.

Here’s one of my favorites:
Live as if you were living already for the second time and
as if you had acted the first time as wrongly as you are about to act now.

Frankl says that this suggestion invites one to imagine that the present is past and the past may yet be changed. I had to read this idea a couple of times to really get it. Basically, it is premised on the fact that you must recognize that you are doing something wrong, for at least the second time and that you can change it this time.

One of the personal finance situations that comes to mind is overspending. We first have to be able to admit that we are overspending, then when the impulse to buy comes again and we are about to act wrongly, we can change our ways by reminding ourselves that we have been here before and we have the power to amend this act. This idea is essentially asking us to take responsibility. It’s okay to make a mistake, but the second time around it’s time to become responsible and make the right decision.

Friday, January 25, 2008

Opt-out of Junk Mail and feel good about being green

My mailbox has been overflowing for years with fliers, coupons, and advertisements that I don’t want or need. I was recycling all of it, but then I decided to do something to try to reduce the amount of waste. Earlier, I posted about opting out of mail order catalogs and I figured there must be a way to do the same with junk mail. After a little research, I found several ways to help free up my mailbox.

According to postal regulations, all fliers must be accompanied by an address card or an address label and will likely be addressed to the “current resident” or “occupant”. This card/label will have information that will help you identify the company that is mailing out the fliers.

Here is the contact information for three of the major flier/coupon mailing companies:

ADVO, Inc. You can remove your name and address from ADVO three ways:

  • Call ADVO's Consumer Assistance line: (888) 241-6760
  • Send a letter to: ADVO, Inc. Customer Assistance P.O. Box 249 Windsor, CT 06095
  • Fill out and submit the form at ADVO's website

Val-Pak Savings Coupons:

Abacus, Inc.:
  • By e-mail: with “remove” in the subject line and name and address in the mail.

If you are receiving junk mail from companies not listed here then look online for information to contact the company directly to have your address removed from their list.

Thursday, January 24, 2008

Rate cuts will widen the Gap

This recent NY Times article on the effects of the interest rate cut left me thinking that it will simply widen the divide between those with good credit/secure jobs and those that are struggling.

  • The rate cuts will indirectly result in lower mortgage rates and those with good credit can refinance, but those without credit can forget it.

  • Credit card rates should also drop, benefiting most everyone, but the savings on interest payments is expected to be insignificant for the average card holder at less than 15 bucks a month.

  • Rates on car loans will drop and once again borrowers with good credit will benefit.

Basically, those with good credit that can afford to spend money, will now get a better deal for their buck.

In addition to widening the gap between the haves and the have-nots another big downside to the rate cut is that savings account interest rates, money market and CD rates will all fall. This will negatively affect retirees and conservative, frugal-minded folks who like to save their money instead of invest in the market or spend every penny.

These lower rates coupled with the highest inflation rate in years is quickly eroding the value of a saved dollar. As is typically the case, this economic policy encourages spending and actually hurts those that are hunkering down and cutting back to hang on to the money that is in hand.

The rate cuts are not designed to help “savers” or the average American struggling to make ends meet, rather they seem to help the average financial institution, by inducing more spending. This quote by one of the financial luminaries really seemed odd to me the other day.

"Let’s face it, the U.S. consumer is dependent upon housing prices and stock prices and with both of them sinking rapidly the outlook for the economy is not good.’" WILLIAM H. GROSS, chief investment officer of the bond management firm Pimco.

I think he’s got it reversed. Stock prices and housing all depend on the consumer. If the consumer stops buying, those financial institutions that depend on stock prices and house prices are doomed for negative growth and lower valuations.

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Wednesday, January 23, 2008

Behavioral Finance - Bias from Reciprocation Tendency

Why is it so hard to not smile back at someone? This is the sixth in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

6. Bias from Reciprocation Tendency
Reciprocation is the tendency to want to pay back someone who has done something for you.
Any time someone receives a gift or even a kind gesture, it’s human nature to want to return the favor. It can be very simple. For instance, if an individual smiles at me in the hallway or at the coffee station, I am inclined to return the smile. In fact, it is very difficult to not smile back. It’s like they have extended themselves and no matter how lousy I might feel, I feel obligated to acknowledge their effort.

It’s a wonderful human trait to want to give back a favor, but it can also result in unfavorable business decisions. Charlie gives the example of Wal-Mart’s Sam Walton. Sam Walton would not let a purchasing agent take a handkerchief from a salesman, because he knew how powerful the subconscious reciprocation tendency can be. Taking anything from a salesman, could influence the buyer to direct a deal to the salesman as a kind of payback. And it’s possible the buyer would not even know that he/she is favoring the agent.

It may seem ridiculously militant to restrict small gifts, after all it’s just a handkerchief, right? But even when the gifts are restricted to a low monetary value, I have seen an incredible response from people. Once I gave free T-shirts to every member of a team that I was leading. I enjoyed working with the group, we had been through a lot and I wanted to show them I was grateful for their cooperation and hard work. I also thought it would boost morale for everyone to have team shirts.

Once they got the shirts, attitudes changed. What I didn’t expect is that most people felt obligated to do something in return. I got free cokes, free lunches, donuts, even compliments! I tried to gracefully decline, saying that it was a gift and that I did not expect anything back. I was even more surprised that they gave me favorable treatment at the test site by queuing my work first ahead of other jobs. I gracefully accepted this, as it meant I would be much more likely to meet my schedule!

Yes, these folks were being nice and wanting to show their appreciation, but I did not realize at the time what was also at work behind the scenes - a powerful human behavioral tendency was driving them to return the favor despite my objections. They felt like they had to do something.

As you can imagine, in business relationships as well as personal relationships, it’s very helpful to be aware of this type of tendency. It’s a wonderful human trait to want to give back a favor, but as Sam Walton knew, it can also undermine good, sound business decisions.

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Tuesday, January 22, 2008

Guess who is buying stocks?

While nearly everyone else is selling and running out the door, one of the greatest investors of all time is doing just the opposite. Hmmm

Warren Buffet’s Berkshire Hathaway continues to add to it’s positions through this market turmoil. He bought another 1.2 million shares of Burlington Northern Santa Fe, BNI, on Wednesday through Friday of last week paying an average of $77.10 a share. BNI is holding steady and closed at $76.51 on Tuesday.

I wonder if he is kicking himself for jumping in too early? If he had waited until this week, he could have bought the stock for $708,000 less. Probably not. Once he makes a decision about a stock, he buys in increments until he gets to his final desired holding amount. With all the cash that he has on hand right now, I imagine he will be adding even more BNI.

BNI is a good solid company, but I am not sure what is attracting Buffet. Growth is projected to be moderate, debt to equity is way too high for my comfort zone at 76%. I have read some speculation that he is interested in other assets that BNI holds, namely real estate. It’s that kind of insight into a business that is not readily available to the average investor that puts the individual at a distinct disadvantage. Not only is he able to undercover the gems, but he also has more access to information to detect the potential time bombs about to explode.

I fully intend to follow his lead and make some purchases in the near term, but instead of searching and screening for undervalued, strong balance sheets - maybe it's time to pick up a few more B shares, BRKB.

Since we’ve had a series of bad market days that can really test one’s confidence and resolve in sticking with an investment plan, I included this link to a short flick for a little inspiration.

Monday, January 21, 2008

Thank MLK, the markets are closed today!

Its going to be a rough opening to the market on Tuesday, based on the performance of the markets around the world Monday. Check out these one day declines for the leading national indexes:

Pan-European Dow Jones Stoxx 600 index SXXP down 4.3%
French CAC-40 index FR down 5%
German DAX 30 index DX down 6%
U.K. FTSE 100 index UKX down 3.6%

Losses have been attributed to the financial sector, continued recession fears and the disappointing proposed economic stimulus plan from POTUS.

We haven’t seen declines of this magnitude in a long time. Fortunately, for many reasons, I don’t think we will see anything like 1987 when there was a 20% drop in the US market in one day.

The new year continues to be a market freefall and that may be for the best. The market has got to shake out and I would rather see it wrung out quickly and sharply than to drag on for the whole year.

Saturday, January 19, 2008

It’s now a Felony to LIE on a Loan Application

Liar Loans are now a felony in Texas. Punishment is a $10,000 fine and prison for 2 to 99 years! This new law certainly penalizes the individual home buyer that fudged his financial numbers on an application to fool the lenders into giving him a loan. But, was that really the problem?

Where is the new law that addresses the predatory lenders that were in this mess as well? In fact, I would hazard to say that the majority of the fault lies in the lenders lap. You can’t tell me they were fooled into making bad loans.

The new state law took effect in September 2007 and makes borrowers swear in an application that all their financial and personal information is correct. If a lender suspects fraud or misleading statements, they are required to report the case to a mortgage task force made up of law enforcement agencies.

For some reason, I thought you were supposed to tell the truth on loan applications all along. The same with job applications, resumes, etc. Whatever happened to character? Integrity? honesty?

It seems the subprime housing debacle comes down to an issue of morality. A person of character would not lie on a loan application. A person of character would not give a loan to an individual that has no hope of repaying it. Does that seem rather harsh and judgmental to lump all of these loan defaulters and bad lenders into one pile and call them immoral? Does it help to sugar-coat it and say that their character is weak?

It’s interesting, I know of people who assess loan applications for a living and have approved a lot of bad loans. They believe that they were just doing their job. They have been given the authority to grant questionable loans. Because someone else authorized this action, they seem to feel absolved from the situation. “I was just following orders”. When everyday people start thinking in those terms, society starts breaking down. Your actions are always your responsibility.

Yes, its easy to criticize. What would I have done in that situation? I would like to think that I would have resigned.

For more on a study that measured the willingness of participants to obey an authority figure who instructed them to perform acts that conflicted with their personal conscience check out the Milgram experiment. It is amazing what people will do. Ordinary people, simply doing their jobs, and without any particular hostility on their part, can become involved in a terribly destructive process. And even more disconcerting, when they realize the destructive results of their work, very few people have the personal strength of character needed to resist authority.

Friday, January 18, 2008

Neat Gadget is a Great Motivator

After carrying this gadget everywhere for the last 13 days, I am pretty surprised by the results. I recently splurged an Amazon Christmas gift certificate to purchase an Omron HJ-720ITC Pocket Pedometer with Advanced Omron Health Management Software
I walk everyday with my dog and thought it might be interesting to log those miles as well as get an idea of how far I walk in a normal day.

I have an office job and am sitting at a desk for the majority of a nine hour work day. Occasionally, my work takes me to a laboratory where I get to move around some, but for the most part I have a sedentary job. Consequently, it seems that at least once a day I get that closed-in and/or itchy feet feeling and just have to get up and walk around.

I used to always think and say that this place (work) was “extracting the life out of me”. And then I learned to use walking as a motivator. On those days when I found it difficult to get started on a work project, I would jump up, take a brisk walk around the building, get some fresh air and always come back ready to start the task. It sounds simplistic, but it does work.

Anyway, back to the pedometer. The gadget has some cool features like keeping track of aerobic steps as well as total steps. Aerobic steps require a minimum of 10 minutes walking without stopping for more than a minute. The device also has a USB port to download the data to a PC and some nice software that is very easy to use. The software has several different graphs to display the data and allows you to set up goals. It was surprising how quickly all those miles and steps added up. Wow! I walked almost 50 miles in thirteen days – that’s over 100,000 steps!

The pedometer has been a great motivator. Once I committed to a number of steps, I found myself wanting to meet the goal everyday. I would try to find ways to add short walks or to lengthen a walk. Which is pretty much the opposite thought process for most folks. Most people want to find the shortest route, the closest parking spot, etc. all to save time and steps, right? Well maybe its time to re-think that. I certainly have, especially after I realized it was possible for me to walk less than two miles on a given work day. That’s pathetic.

It’s also part of the culture in Texas – this state was built on cheap gas and abundant concrete. Texans do not walk. Almost everyone has a car, not necessarily a nice car, but they are on the road. When I first moved here, I was really surprised to see “no pedestrian signs”. It’s a sign with a person walking crossed out with a red X. I couldn’t believe it. People go to great lengths to avoid walking and Texans take it to another level. I even heard of a company in the Dallas area that issued pedometers to employees to keep track of their time away from their desks. If the pedometer reading was too high they were reprimanded!

It may take a lot more than a pedometer to get a Texan to take a walk, but if you already like to walk, it will make it that much more fun to log your miles and progress.

Will taxes on gas-powered cars become the cigarette “sin” tax of the future?

We now have tax incentives for alternate fuel vehicles, hybrids, etc as well as increasing gasoline taxes. And more are being proposed. Fuel efficiency standards are changing, gas prices are increasing, POTUS is asking/begging OPEC to open another valve….

Where is this trend going? It’s not hard to imagine that in large cities and environmentally conscious states people will be given even more incentives to drive alternative energy vehicles. The taxing will be levied for reasons that promote quality of life such as control of pollution, traffic and noise, as well as reducing the use of fossil fuels. Tax breaks will be given for alternative fuel vehicles, while those that insist on driving arcane gas guzzling cars will pay more tax. This is already happening in areas of London, where large vehicles like SUVs are taxed when driven in congested areas of the city.

The message appears to be that if you choose unhealthy, polluting ways, you will pay for the privilege.

Does this sound familiar? It reminds me of the cigarette taxes of today. Those who continue to pollute whether driving or smoking will continue to pay more in taxes. A lot of people are not going to like this, just like a lot of smokers do not think it is fair for cigarette taxes to shoulder the burden of so many government projects.

Have you noticed that when one tax is decreased, many times the lost revenue is then recovered by raising cigarette taxes? This is exactly what happened in Texas, recently. The Robinhood plan using property tax revenue to fund education was declared unconstitutional. Since this tax could no longer be collected based on property values, another source was needed. Voila. It was levied on to cigarettes. Evidently, the population of cigarette smokers is declining, and so is the magnitude of their dissent.

Many speculate that we are already at peak oil production. It seems obvious that dependency on any one type of fuel is a mistake. We need to fund more research to get alternatives to the main stream. Where will the tax dollars originate? Will this money be derived from an increase in taxes on gasoline powered cars? Or cigarettes? LOL

Wednesday, January 16, 2008

Hurry, Get your 401(k) Debit Card!!

Need some quick cash but no time to fill out a loan request? No problem. Just pull out your handy debit card and tap into your 401(k) retirement! Plastic makes everything easier, doesn’t it?

As unbelievable as this sounds, yes it is true. A company called The Reserve has a new service called ReservePlus that administers 401(k) loans through a debit card.

Evidently the IRS does have some limits on this deal. A participant is only allowed to borrow 50% of their account balance or a maximum of $50,000. That's Incredible. 401(k) loans of any type are a terrible deal because of the double taxation. The loan must be re-paid with after tax money that will then be taxed again at withdrawal.

Nonetheless, the new debit loan differs from a traditional 401(k) loan in a few ways.

1) No Payroll deduction. Participants can repay the loan when they are able to add funds at anytime. This sounds like a potential disaster – every loan should have a schedule of payments.

2) No amortization schedule, no annual fee. ReservePlus generates income by keeping a percentage of the interest on loan repayments from participants.

3) The loan amount is not withdrawn in one lump sum, rather it is moved to a money market account where it can be accessed with the debit card. At least the principal loan amount will be accumulating interest.

ReservePlus touts the program by saying that not only does it make it easier to access 401(k) money, but it is expected to increase 401(k) participation. With easier access, it is anticipated that the availability of a loan will result in more employees enrolling and contributing to a 401(k) plan.

I would agree with that, since I have known several co-workers who did not want to participate in a 401(k) because the money would be “too hard to access for emergencies.” It was a convenient excuse for them to not participate. So it’s possible that a plan like this would get them enrolled, but I think it would also be too tempting and way too easy to use the debit card to buy unnecessary junk on impulse and sabotage their retirement plan at the same time.

As a side note, the one event at my place of employment that did get more people to contribute to their 401(k) was the increasing of income tax rates. When Clinton raised the rates back in the 90’s, several of my co-workers decided to take action to shelter some of their income through pre-tax contributions to a 401(k). Of course, they were cussing him at the time –but now they are very glad that they invested in their retirement.

Tuesday, January 15, 2008

Behavioral Finance – Pavlovian Association

This is the fifth in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

5. Pavlovian Association
Most are familiar with the famous Pavlov experiments. By applying stimuli to animals in a variety of ways, using sound, visual, and tactile stimulation, Pavlov was able to make the animals salivate whether they were in the presence of food or not; a phenomenon he called the conditioned reflex. The stimulus or pattern of events was enough to trigger a response.

Searching for patterns
People have a tendency to misconstrue past correlations in decision making. It’s human nature to look for patterns, even when no pattern exists. We are always trying to draw a parallel between the unknown and the known.

This is a very worthwhile trait. People that could recognize patterns could use previous known solutions and apply that to the new problem to solve it. Recognizing patterns helped ensure survival years ago.

For instance, knowing what time the deer feed or go to water each day, allows one to get there ahead of the deer, setup and be ready to hunt. Consequently, seeing a pattern can improve your success rate at taking deer and feeding your family. Likewise, recognizing the changing seasons, the angle of the sun and when the best time to plant crops is also pattern recognition.

How can this be a problem?
Issues occur when people assign events to patterns that are not truly patterns. They are random events and having no correlation. You are essentially fooling yourself.

Some financial analysts use technical analysis to time their trades. The technical analyst is looking for patterns in stock charts and expecting them to repeat so as to predict the future of a stocks performance. Is this luck? Or serious analysis?

I personally believe that there are general patterns or trends to the market, but, I also recognize that selecting a stock because of the shape of it’s previous trading history is much less likely to be as sound an investment as selecting a stock because of it's intrinsic value.

The New tax brackets aren’t keeping with inflation

Income-tax rates are unchanged for 2007, but, as happens every year, the Internal Revenue Service has adjusted tax brackets to account for inflation. Or have they?

The IRS is required by law to adjust the dollar amounts for a variety of tax provisions each year to keep pace with inflation. The adjustments of tax brackets, standard deductions, personal exemptions, earned-income credits and other things affect about three dozen areas of tax rules.

Let’s take a look at the new brackets. In the table, I have listed the tax rate, break point and calculated the percentage change from last year. Several things really jumped out at me from this chart.

#1 The tax brackets increase by different amounts for each tax bracket. The lowest bracket for those reporting income of less than $7825 has been adjusted for inflation by 2.56%. While the highest tax bracket received an increase of only 2.28%.

#2 The tax brackets increase by different amounts for single and married filers. It’s not a big difference, but it is there.

#3 Most of the brackets have been increased by less than the estimated CPI, which is 2.4% for 2007. Note, the official CPI data is to be released on January 16.

#4 And finally, did you notice that the gap between single and married taxpayers shrinks significantly with increasing salary? And eventually disappears in the 33% tax bracket. It’s like that second person just completely disappears after a couple earns more than $357,700 a year.

Monday, January 14, 2008

Opt-out of Mail-order Catalogs to Save $ and the Planet!

Tired of receiving hundreds of catalogs that you don’t want? I feel terrible throwing away so much. Fortunately my city recycles, but still it is a waste. Some companies are relentless –sending one or more a week even though I never purchase anything from their mail-order catalog. I have wanted to opt-out for a long time, but it might take all day to call each catalog company to get my name removed from their mailing lists.

Now there is a website called Catalog Choice that can make it easier. On their website, you find and decline your unwanted catalogs using their search facilities. Then Catalog Choice contacts the catalog providers on your behalf, requesting that your name be removed from their mailing lists.

This service is free and is designed to benefit everyone – even the catalog companies!

  • You benefit by reducing mailbox clutter, and the amount of time you spend sifting through unwanted mail.
  • You also benefit by not being tempted to buy more stuff. You may actually save money by not having these catalogs around to tempt you with their products.
  • Your participation benefits merchants, lowering their cost of distribution and helping them better target their market.
  • Your participation promotes the use of best practices in the direct mailing industry
  • Your participation will collectively make a huge positive impact on our environment

Here are some facts from the website concerning the environmental impact of catalogs.
  • 19 billion catalogs are mailed to American consumers annually

  • Number of trees used – 53 million trees

  • Pounds of paper used – 3.6 million tons of paper

  • Energy used to produce this volume of paper – 38 trillion BTUs, enough to power 1.2 million homes per year

Also, if for some reason you change your mind, you can revoke your request (on-line) and start receiving the catalog again.

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Saturday, January 12, 2008

Another excellent PF book – Into The Wild

A Young man leaves everything behind and walks out into the wild Alaskan frontier. What? it doesn’t sound like a finance book? It certainly wasn’t written with the intention to help you with your finances, but it will encourage you to rethink your values, goals, everyday activities and your very existence. The young man, Chris McCandless, graduates from college, heads West, gives away his most valuable possessions, burns the cash from his wallet and heads off on a directionless journey. He lives day to day, not knowing what the next will bring.

Chris McCandless left several letters to friends and acquaintances encouraging them to redirect their energy and find their adventurous spirit. While I don’t advocate his approach of completely ignoring a need for security, I find it very interesting to examine his point of view, since I don’t think anyone knows with any certainty what is the “right way” to live. Below is an excerpt from one of his letters.

I really think you should make a radical change in your lifestyle and begin to boldly do things which you may previously never have thought of doing, or been too hesitant to attempt. So many people live within unhappy circumstances and yet will not take the initiative to change their situation because they are conditioned to a life of security, conformity, and conservatism, all of which may appear to give one peace of mind, but in reality nothing is more damaging to the adventurous spirit within a man than a secure future. The very basic core of a man’s living spirit is his passion for adventure. The joy of life comes from our encounters with new experiences, and hence there is no greater joy than to have an endlessly changing horizon, for each day to have a new and different sun. If you want to get more out of life, you must lose your inclination for monotonous security……

Have you ever had a chance while on the road or at the invitation of a friend to go see a new sight? But for some reason you wanted nothing more than to bolt right back home as quickly as possible? For some unexplainable reason, you wanted to get right back to the same situation which you see day after day.

He further states that - you are wrong if you think joy emanates only or principally from human relationships. Joy is all around us. It is in everything and anything we might experience. We just have to have the courage to turn against our habitual lifestyle and engage in unconventional living. You do not need me or anyone else to bring this new kind of light into your life. It is simply waiting there for you to grasp it, and all you have to do is reach for it.

I have to agree that most people do look to relationships for meaning. And when they don’t find it or are sadly disappointed, they typically turn to things, which leads to an insatiable desire for money.

He also understood the pleasure that comes from living frugally. McCandless suggests that - you get out and start seeing the great things on this earth. And you must do it economy style, no motels, do your own cooking, as a general rule spend as little as possible and you will enjoy it much more immensely.

I highly recommend the book, Into the Wild, it's a quick read and an interesting look into the heart of an adventurer.

The Flight to Safety – Money Markets at record levels

I always keep a stash of cash in a Money Market fund. It’s usually a hefty amount – at least 3X my annual expenses. It serves multiple purposes:

1) It’s my emergency fund. Notice that I said 3X my expenses and not 3X my salary. If necessary, I could live for 3 years on this money.

2) It provides some asset diversification with a solid rate of return at almost no risk. My portfolio is heavily weighted in stocks. I have very little in bonds, so I consider this as my only fixed income asset.

3) and it's my holding area. All new money coming in to my portfolio first goes through this money market account. I invest from this account using dollar cost averaging as well as one time stock or mutual fund buys to keep my asset allocation balanced.

In volatile markets, like the last couple of months, I have continued to make the automatic DCA purchases, but have held off on any other buys. I don’t expect to find the market bottom, but I would like to wait until I think the market is sufficiently wrung out, before investing large sums. Consequently, my Money Market account is starting to balloon.

This does not go unnoticed by the financial community. In fact, they are watching and waiting for all of us to flee to the safety of MMs. Since, people tend to put their money into MMs in times of uncertainty, they reason that once MMs reach record levels and the market is wrung out, stocks will then rally.

Money Markets are now at record levels
MMs are 30% above the previous peak in 2003. Wow! This must be the sign. But, hold on. Would you believe that the amount invested in stocks is also at record levels? The equity in stocks is 43% above the previous peak set in 2000.

We have had a very successful bull run for the last several years building a lot of equity into the market. Of course, that 43% number is based on current stock prices and as the market continues to decline that number will also decrease.

Show me the Money
To get a better idea of where the money is going, we need to look at the two assets relative to each other. I have included the chart below (from Minyanville) which combines the data to come up with a ratio of total Money Market assets to total stock fund assets. The chart gives a very good indication of investor sentiment.

Money Market assets are currently 40% of equity fund assets, well below the bear market peak of 77% following the dot com bust. I consider the dot com bear market to be akin to the 40 or 50 year flood – its going to flood again and again, but it is unlikely that it will be as bad as the 2000 disaster. So, I don’t expect that we will hit the 77% number, but we do have a ways to go before this market turns around.

Behavioral Finance - Consistency and Commitment Tendency

This is the fourth in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

4. Consistency and Commitment Tendency
People will hang on to past beliefs and reinforce those beliefs by repeating them even in the presence of contradictory evidence.

Once an idea gets in to the human mind and gets reinforced by making public statements, the brain has a tendency to shut off and allow no other disconfirming information in. It seems that when a public disclosure is made, you are committing to it and essentially pounding it into your own head. It takes a lot to break through and sever that commitment.

For instance, many of the protestors that we see on TV or at city hall that are out there screaming at us, aren't convincing us or changing our minds, but they are forming mental change for themselves.

An interesting take away from this is:
what you think
may change what you do,
but perhaps even more important,
what you do
will change what you think

You have probably heard that thinking negatively or always being gloomy seems to keep one in a downward cycle. The negativity feeds more negativity. To bring about change, it can be as easy as changing your thoughts. You can control your own mind. Practice taking control. With practice, it will get easier. Thinking good thoughts can change your attitude and lead to good actions.

Whenever you catch yourself making negative statements or thinking negative thoughts - push out the negativity, squash it and redirect your mind to more creative and constructive thoughts.

Friday, January 11, 2008

14 Rules for keeping your Head in a Troubled Market

It's days like these, when the market is showing so much weakness, that I like to revisit some sage investing advice. The following rules are based on the writings of Robert Menschel, a 50+ year veteran of Wall Street and author of Markets, Mobs & Mayhem: How to Profit From the Madness of Crowds These rules can help you keep your head when everyone else is losing theirs.

I especially like to re-read #2 – the stock market always comes back. I have seen it rebound several times in the last 20 years and am expecting it to do that again.
I also have been taking note of some very interesting potential buys. It's for times like these that I have stashed cash on the side to take advantge of the sale price of stocks like BRKB and AAPL.

  1. Remember that at the time of extreme fear in the marketplace, when all the excess has been wrung out, great buys are all over the place.

  2. Remember, too, that the stock market always comes back, no matter how shocking the events that drive it down. Within three years of the December 7, 1941, attack on Pearl Harbor, of John Kennedy's assassination, and of the 1993 World Trade Center bombing, the market was up anywhere from 21 percent to 81 percent.

  3. Define the sandbox you want to play in. Invest in growth-value companies that have records of consistent sales and earnings performance, management committed to a defined strategy, and with strong franchises that are highly focused. Only buy these stocks at sensible multiples and don’t add new companies unless you are willing to sell the weakest.

  4. Have a buy strategy and stick with that. Buy in to a stock in steps, instead of at one price. Once the stock price is within range, begin with an initial buy in of 25% of the total desired holding. Then add increments of 25% to reach 100% of your total buy.

  5. Stick with what you know. Invest in companies that create products and services that you can personally field-test day in and day out.

  6. Stick with who you are. Be aware of your own risk tolerance. Understand that what is considered too risky by one might be too cautious for another. When your risk tolerance and portfolio are not aligned, bad decisions can follow.

  7. And stick with companies that know what they are, too. Invest only in companies that stay focused on their core competency and have a strong franchise. Menschel also recommends avoiding technology companies because industry changes are so rapid that most of them turn into commodity businesses with no lasting franchise.

  8. Always do due diligence. Invest your money only after thorough study. It's the mistakes that kill your investment performance. Evaluate the downside risk as much as the reward side, and you'll never have to be brilliant.

  9. Never make a buy or a sell decision in your broker's office. Brokers are too close to the roar and the feeding frenzy of the crowd. Take time to make your decisions.

  10. Buy for the long term. If you were to die tomorrow, would this be a stock you would want your heirs to hold? It sounds morbid, but it is not a bad test to apply. Stocks should be for the ages, even if we won't survive them.

  11. Accept a little boredom in your life. Greedy management bent on making overpriced acquisitions gets the headlines, but good companies with superior management teams and a culture of teamwork, turning out good, usable, affordable products, make money. Look for companies selling at a reasonable multiple, generally no more than 50 or 60 percent greater than the rate of growth in earnings.

  12. The faster a stock has a run up in value, the faster it is likely to run down. Almost no company can safely grow earnings faster than 15 to 20 percent a year without attracting fierce competition.

  13. It's the small things, not the big ones, that count. In baseball, homerun hitters get all the attention. Investing is simpler: Hit for average, swing for singles, not the fences. This race is ultimately to the sure, not the swift; the tortoises, not the hares.

  14. And finally, Never forget the miracle of compounding. A modest 8% rate of return will double your initial investment in 9 years and nearly triple in 14 years.

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Thursday, January 10, 2008

What is the Fair Tax? And how will it help me build wealth?

Its difficult to not be cynical, since there has been discussion about scrapping the IRS for as long as I can remember. Yet, the IRS continues to grow into a gigantic government bureaucracy. It's ridiculous. What’s even more distressing is that there is very little talk amongst presidential candidates to overhaul the system.

One idea that does catch my eye is the national retail sales tax or fair tax that Mike Huckabee is advocating.

I found a quick guide at CNN and have included the meat of the article in this post. It asks some common questions about how the "Fair Tax" is supposed to work and some of the problems it might run into.

As for Personal Finance, the best part of the Fair Tax is that it will not penalize us for investing. No more taxes on dividend income, capital gains, or interest from savings. Everything that you save will have tax free growth and remain tax free right up to the day you spend it. This would make a huge difference for someone in my situation where my federal taxes exceed my living expenses!

How would the "Fair Tax" change the tax code?
It would scrap it almost entirely. You wouldn't pay income tax, Social Security and Medicare payroll taxes, the alternative minimum tax, a capital gains tax or estate tax. No more complex tax returns to fill out, either.

Instead, everyone would pay a flat sales tax on almost everything they buy: Food, clothes, new cars, diapers, even health care and financial services.

How high would the sales tax be?
Under the proposal, you'd pay a 30% mark-up over the pre-tax price.

A 30% tax on food and medicine would be hard on the poor, wouldn't it?
Not exactly, the sales tax plan would partly offset this effect by sending every household in America, a check to cover the taxes on their spending up to the poverty level.

Factor in that cash from the government, and each family's net tax burden goes down, so that the Fair Tax looks more progressive.

For example, a family of three earning $30,000 a year and spending all their income would give 7% of their pay to the government; one earning and spending $125,000 would pay a net rate of about 19%.

What's the point of doing this, anyway?
Shifting to a sales tax gives people more incentive to save and invest, which supporters believe would be a big spur to economic growth.

But the cover of The FairTax Book sums up the real grassroots appeal: It shows the letters "IRS" inside a red circle, with a big red line slashed across.

Could this happen?
The Fair Tax may have fans among talk radio listeners, but it hasn't been taken very seriously in Washington so far. That may be because the sales tax would take away many special tax breaks and loopholes beloved by lobbyists.

And with all taxes rolled into one high rate, the temptation to cheat could be very high as well. Too much evasion would require the government to raise the tax.

So while there might not technically be an IRS anymore, you can bet there'd still be plenty of government employees out there enforcing the tax laws.

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Wednesday, January 9, 2008

Are we Sabotaging our own Wealth?

I have seen more than one study where a remarkable number of people say that they would rather not be wealthy. One of the primary reasons is that they believe the money would turn them into greedy people who consider themselves superior. Evidently, a lot of people have very negative views of the wealthy.

Money doesn’t turn you into anything. In my opinion, it just makes you a bigger whatever you already are. If you are jerk you will become a bigger jerk. If you are charitable then you will give even more. One might argue that sometimes it does appear that money has changed someone, but I counter that they were probably that way all along and the money has now only amplified the situation. Personal values and ethics do not change overnight.

Evidence of this sabotage includes the countless stories of people acquiring new wealth only to lose it by making questionable financial moves. It’s almost as if they could not accept being wealthy.

“When the disparity between one's life in childhood and one's adulthood is too great, human psychology seeks to reduce or resolve that disparity”. Years ago, I heard this referred to as the “Clinton Syndrome”. Bill Clinton rose to the presidency from rather humble beginnings and proceeded to “shoot himself in the foot” on a regular basis.

Certainly this isn’t something we would do consciously? Is the subconscious really that powerful that we would sabotage our future by making the present more consistent with our past?

Let’s look at the opposite end of the spectrum. What about the individual who inherits a large sum of money and then becomes paranoid that they will lose, squander and/or have the money swindled away from them?

They know that they could not replace the money and they are fearful of making a mistake. These folks sabotage their wealth in another way. They are too anxious to use it and too guilt-ridden to enjoy it. This type of anxiety/stress can destroy a person’s health and wreck relationships by making them suspicious of others. They are a noble bunch that wants to earn their money and are uncomfortable winning anything.

So maybe we all sabotage ourselves in one way or another.

I still prefer to think that all is not lost for the long term investor. Perhaps this sabotage effect is muted in the case where one slowly accumulates money and gradually builds wealth. The mind has more time to adjust to the situation. Instead of feelings of guilt, a long term investor will believe he/she has earned the money and deserves the wealth. Whereas, speculators, lottery players, and get-rich-quick schemers may have a very different attitude that sets them up for sabotage.

Which type are you? It is your choice.

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Tuesday, January 8, 2008

State of Denial – Gas Prices rise 4% or 34%?

The Department of Energy provides a weekly summary of US retail gas prices. For the US, they report that the gas price for Jan 7, 2007 is $3.109/gal. That is up $0.803 from one year ago. Okay, you do the math that’s a 34.8% increase in gas prices in one year. That sounds about right to me based on local gas prices.

What doesn’t sound right is that today my employer sent out a notice:

The government standard mileage reimbursement rate for business travel has increased to 50.5 cents effective January 1, 2008. The new rate for business miles compares to a rate of 48.5 cents per mile for 2007. That’s an increase of 4.12%. What! How do they figure that?

I did some exploring to find that all IRS mileage reimbursement rates are based on a national study of the costs of operating vehicles, including gas, oil, tires and general maintenance. If we assume that you drive a moderately fuel efficient vehicle getting 20 mpg, your cost per mile just for gas is now 15.5 cents up from 11.5 cents last year. That equates to an extra 4 cents a mile this year while the government is claiming the costs only increased by half of that (2 cents). And that does not include oil, tires and maintenance!

Is the State in Denial of inflation? The data does not appear to support the policy, likewise for the last several years, the CPI inflation numbers have not seemed to be realistic, either. While housing, gas, food, cars and insurance, etc. have been increasing by nearly double digit rates the CPI is continually reported in the range of 3%.

Coupled with the sharp drop in the dollar over the past few months it's obvious that our buying power is much less. Whether the dollar drops or prices increase - it all equals rising inflation.

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Cutting the Cable – now that’s an Economic Indicator

Bloomberg is reporting that - AT&T Inc., the biggest U.S. phone company, faces "softness'' in its consumer business because of slowing economic growth, Chief Executive Officer Randall Stephenson said.

The shares dropped the most in more than five years after Stephenson said AT&T is disconnecting more home-phone and high- speed Internet customers for failing to pay their bills. The pressure hasn't affected the mobile-phone unit or corporate sales, he said at a conference in Phoenix today.

These folks are not switching....they are failing to pay their bills. As a result, they are being cut off from what has become an integral part of society. The internet is a social center; it entertains, informs and alleviates our boredom. Nearly every one expects to have internet access. It has become an entitlement. This can not be an easy choice. It's one thing to reduce spending by cutting out lattes, but internet access? Ouch!

To me this report is a telltale sign that it’s starting to trickle up – if you know what I mean. The average guy has been feeling the economic pinch for some time and now it’s affecting the bottom line of one of the largest companies in the US.

Monday, January 7, 2008

Getting a handle on Stock Market Volatility

Ever gone golfing with a friend and then after a few bad shots watch them explode? I have seen people throw golf clubs, knock over golf bags, throw down hats, and kick the cart after an undesirable shot. I have wanted to do the same thing at times! But, then I remind myself that I am out there to have a good time. I am not a professional golfer and I don’t play the game well enough to get that upset about a poor shot.

To earn the right to get that mad, you have got to become disciplined enough to become a good golfer. If you are not that good at a game, then there is no reason to get irate. Instead, relax and have a good time. That is the message from motivational speaker, Bryan Dodge. He asks the question why get so upset, when you are not that good?

That’s easier said than done. We all want to improve our skills and when we fail or make a bad shot, its upsetting. Its upsetting because we are impatient. We want to get better now, not next week or next month. Nobody wants to be just average, especially when we have tried to improve our game. Similarly, its frustrating in times like now, when the stock market declines are erasing large chunks of our hard earned money. You and I have been trying to improve our financial situation, gaining investment knowledge, reading PF books and blogs, building an allocation plan and then the
DJIA drops 4% right out of the 2008 gate.

Got Discipline?
Just like the golfer, you have got to be disciplined to become a better investor and build a retirement portfolio. It's easy to become impatient. But its very important to keep working towards your goals, even in stock market turmoil like we are seeing in the beginning of this year. If you have an asset allocation plan - stick with it. Keep investing using dollar cost averaging or value averaging at these lower prices and eventually things will turn around. We all know the key to successful investing is to “buy low, sell high”. Well, this is the time to “buy low”. Do you have the courage and the patience to be a successful investor? We are fixin’ to find out, aren’t we?

Sunday, January 6, 2008

Behavioral Finance – Incentive-cause Bias

This is the third in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

These behaviors are not all bad, many are good in some way - that is why they survived. In fact, these behaviors served some purpose that helped extend life at some time in the evolutionary process.

3. Incentive-cause Bias
Munger also refers to this as the tendency of the salt salesman to tell you how much salt you need, or hammer-owners to see every problem in nail-like terms.

For an example, look no farther than the recent home mortgage crisis. The goal was to get more liquidity in the housing markets by bundling mortgages and selling them to the financial markets. This created a demand for more loans, so lending agents were given incentives to sell mortgages to anyone and everyone. Because the lender immediately sold the mortgage, the agent was off the hook if the loan defaulted. Consequently, the agent did not try to make a good quality loan.

In other words, there was no incentive for the lending agents to scrutinize the credit risks of the borrowers, but plenty of incentive to turn those mortgages around and get them out the door. The incentive-cause bias is alive and well and has come close to toppling the banking system

Saturday, January 5, 2008

Can you get Creativity and Motivation out of a Bottle?

No, but you can get a heavy dose of inspiration out of a bicycle. Today was an unusually warm (76F), sunny but windy day in Texas. I pumped up the tires on my Trek and hit the road. After spending the last few weeks riding an indoor trainer, this was exhilarating. To my surprise, with every mile, ideas were bubbling up to the surface of my mind. I had brainstorms for three new blog posts by the time I hit mile seven. The words and concepts came very easily while I was riding. I then spent the next twelve miles wondering if I would remember it long enough to get it transferred to bits and bytes on my computer!

And that gave me another idea - I think I need to get a voice recorder. So when I come up with these epiphanies while riding, rollerblading or walking I can capture them at the moment.

This phenomenon that I call “exercise induced motivation” is nothing new for me, but every time it happens it feels astounding. I recognized the power of exercise many years ago while a freshmen in college. After classes, I would attend practice for the volleyball team. Lots of running, jumping and hitting the ball really got the endorphins and blood pumping. Following practice, I would return to my dorm room and immediately sit down to crank out my homework – engineers are assigned several problems or exercises for most classes. The engineering problems seemed to be a breeze and go much faster after a good workout.

In addition to cycling, I like to walk every day with my dog, but for me it doesn’t heighten my creativity the way cycling does. I think to get maximum inspiration you must work up a good a sweat. Walking is a good way to clear the mind and cycling is the best way for me to jumpstart my motivational motor.

Overturning Maslow’s Hierarchy of Needs?

I have seen a few comments lately that chastise PF bloggers for obsessing about retirement and not living for today. It’s true that sometimes when you have a goal you tend to focus too closely on that goal at the expense of everything else in life. Its important to keep things in perspective and helpful to remember Maslow’s hierarchy of needs.

Maslow’s Hierarchy of Needs

A strong foundation is needed to reach the higher levels. But that foundation must also be maintained, if it is allowed to erode or break down, everything could topple.
Maslow recognized this inherent human flaw.

According to Maslow from his book entitled "On Dominance, Self-Esteem, and Self-Actualization, by A.H Maslow":

"If they are dominated by a higher need, this higher need will seem to be the most important of all. It then becomes possible, and indeed does actually happen, that they may, for the sake of this higher need, put themselves into the position of being deprived in a more basic need."

He recognized that we often obsess about our goals and leave behind other matters which are vitally important. It’s possible to see this flaw, where we have effectively turned the hierarchy upside down, in many different areas of our lives.

For instance, some of us have become too focused on our careers. We work so much that we don’t have time or energy to create a healthy meal at home. Consequently, we grab something fast and eat junk food. This upsets part of the good foundation that healthy food provides. Others spend so much time surfing/blogging and playing video games that they neglect their families, parenting duties, home maintenance, etc. While others enjoy the moment by making excessive purchases and neglecting to plan and fund their retirements. These actions erode the foundation, impact relationships and jeopardize our futures.

Its great to have goals and the drive to achieve them, but it’s also essential to apply moderation to achieve a happy and fulfilled life.

Friday, January 4, 2008

Blogging can be a path to achieving your Goals

Everyday I look forward to reading my favorite Personal Finance blogs. What is so neat about blogs is that once you find a writer that you like, you can read his/her articles nearly everyday. You don’t have to wait for their next book or weekly newspaper column to come out. And Bloggers are a conduit for information. It’s like having dozens of eyes scanning the internet, financial magazines and TV shows for interesting PF information.

It wasn’t long before I started thinking about blogging. I had already written down a few goals that I wanted to reach, but I wasn’t sure what the next step would be to get there. I needed an action to get me on the road and I thought that starting a blog might help me work towards those goals. The first thing I did was to list the reasons that I wanted to Blog.

Why Blog?

  • Evaluate financial choices – researching the info and then writing a coherent analysis is a great way to evaluate something.
  • Improve writing skills. I have a goal to write a post every day. Practicing any skill with that kind of commitment will generally lead to improved performance.
  • Extra shot of Motivation. Making public statements about goals, plans, metrics adds a little more motivation and commitment to actually see it through.
  • Improve creativity. Finding something interesting to write about with enthusiasm everyday requires imagination and creativity.
  • Get Feedback. Most blogs have a comment section and those comments can be very helpful for making adjustments and fine tuning your style.
  • Share ideas and give something back to the community
  • Meet people with similar goals and interests

These reasons convinced me to give it a try. Now, after a month, I have listed some thoughts about my blogging experience.

Blog Reflections

Getting started
I did not expect some things to be so difficult. I went round and round over picking the blog name. And I never imagined that pressing the publish button would be so cool. The first time was a rush - I had my own space on-line and I could write just about anything that came into my head

Second thoughts
At first, I had a lot of reservations. Will I run out of things to write about? Am I wasting my time? Then I would think who cares if no one reads it, I am writing about stuff that I want to learn more about. That was my primary driver, so I told myself to keep researching topics and cranking it out. I did not tell anyone about the site, not even family or friends. That wasn’t easy. Anytime you are working on a new project, its just natural to want to talk about it.

Setting a writing goal
I set a goal to write each day for a couple of months to build up content. I would do this before even trying to lure readers or place ads on my site. I wanted to keep it simple, neat and clean as long as possible and focus on writing good content with consistency. I noticed that it got easier and easier to write and I got faster at writing – precisely my goal. Not only did my writing improve, but I noticed that it became easier to think of just the right word when speaking. Words and thoughts just seem to flow more easily, now.

Don’t Break the chain
I followed the mantra of Jerry Seinfeld, the comedian. As a comedian, he needs to write new material quite often. He would pull long, stressful hours to meet a deadline. To alleviate this pressure he decided to dedicate himself to writing everyday. He motivated himself by keeping track of how many days in a row he had written. He wanted to keep the chain going. His mantra was – don’t break the chain.

Site meter
My curiosity got the best of me, I added a site meter. I will admit that it was a thrill to see that people were coming to the site and reading more than one page! Because I had not received many comments, the traffic count was a lot more than I had suspected. Maybe they were lost???

No Ad Blogging
After a month, I wondered if I would ever open my site up to ads. Money has never been a driver and the ads are a nuisance. Then one of the blogs that I read regularly, came out and cancelled most of his ads! What a surprise. I decided to hold off even longer – no ads.

What does WORK mean to you?

I just finished reading Your Money or Your Life. The book has several thought provoking exercises that made me examine my values and goals. I especially enjoyed the section on the exploration of work and what is considered to be the main purpose of work. Below is a list of some common reasons to work. Its interesting to read through and identify those that apply to yourself.

Earning money
For food, clothing, shelter
For comforts
For Luxuries
For giving to Charity
For an estate to give to heirs

A sense of security
To meet your needs
To have your value as a human being recognized

To carry on a family tradition in a profession
To maintain a sense of continuity and connection with the past

To hang out with interesting people
For entertainment and fun

To do your fair share for society

To make a contribution to others and the world

To acquire new skills

Prestige and status
To receive praise and respect

To feel the power you have over people who report to you and follow your lead
to influence decisions and have power over the course of events

interacting with coworkers
meet the public and feel part of the community

Personal growth
to be challenged in new ways
to expand your emotional and intellectual life

to get feedback for success
to compare yourself with others in your field

Creativity and fulfillment
to achieve fulfillment and the feeling of being utilized
to stay challenged, sharp
to create something new

Time structuring
to schedule your time and give an orderly rhythm to life

Don’t know
because work is what people do

While getting paid is a critical part of work, it seems there are a lot more reasons to work than just making money. I was a little surprised at how few of these applied to my current job. I agree that earning money, security and enjoyment are on my list, but I do not look to work to fill all of these other needs. It may happen, but I don’t expect that from my job. Maybe I should expect more from my career??

It’s even more interesting that as I have been contemplating retirement, I have been thinking about part time work. I do not have to work in my retirement, I could just be a couch potato. But, I am pretty sure that I would enjoy some type of part time job and for very different reasons than why I currently work.

My reasons to work part time include: enjoyment, duty (giving back), service (helping others), learning, socializing, personal growth, and time structuring. These are very different from the reasons that I go to work everyday at my current job and have nothing to do with making money. I know that as soon as I free myself from the shackles of money, I will look for another type of “work”.