Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Archive for the 'Social Psychology' Category

Irrational Bins

Creative Commons License photo figure credit: “Irrational Bins” by MousyBoyWithGlasses

I finished up the preparation of our tax return today, and as you know, we are getting a sizable return.  In fact, I can’t ever remember having to write a check to cover any unpaid taxes for the year.  What bothers me, though, is that the government has been getting free use of my money all year.

I like to preach that people should strive to break even at the end of the year, or even owe a little bit rather than getting a refund.  In this way you’re not leaving your own money on the table in the form of bank interest or investment returns that you could be seeing — or better yet, having free use of some of the government’s money all year long.  This advice tends to fall on many deaf ears.  It seems, shockingly, that people like to get tax refunds and hate having to write a check to the government.

Many people have told me that a tax refund at the beginning of the year is a form of forced savings for them.  I tell them that they should adjust their withholding and then set up an automatic monthly or semi-monthly deposit to their high interest savings account of choice.  They tell me that they fear they just don’t have the discipline to keep up with something like this and will simply squander the money over the course of the year and have little or nothing to show for it.

Up until recently I thought this line of reasoning showed some kind of character weakness on the part of the tax-refund-as-forced-savings-plan (TRAFSP) crowd.  But as I get the same answer from so many people, I’m starting to re-think my judgement.  We’re all human, and we need all the help we can get when it comes to doing what’s best for ourselves the better part of the time.  I read the other day that when Warren Buffet wanted to lose weight, he bet his children that he could by giving them each an unsigned check for $10,000.  Buffett is “someone who understands his irrationality and builds systems to cope with it.”

So while TRAFSPs may be choosing the default option rather than building a system, they still understand this aspect of their irrationality and continue to choose a system that seems to work for them.  Personal finance is the confluence of a rational philosophy and irrational participants.  If it were all about math, most of us would be rich by now.  Instead, we all do irrational things when it comes to money at some point or another.  Those of us who understand our own irrationalities and build systems to overcome or circumvent them are the ones who will ultimately be successful at this game.  This might mean that we don’t always make decisions based on math, but rather on which option is more likely to be successful for us. TRAFSPs are one example.  Another recent example that comes to mind is J.D. Roth at Get Rich Slowly’s decision to go with a longer term mortgage than he could afford.  Lastly, a classic example of this is Dave Ramsey’s debt snowball.  These are all cases where the math says to do something different, but the math doesn’t mean a thing if the concept doesn’t ever succeed.

With all this being said, I’ve put off taking my own advice for many years.  The main reason for this is that we’ve had major lifestyle changes in each of the last 5+ years that have made our tax situation rather uncertain: we’ve changed jobs several times between us, sold a house, bought a house, started renting out a portion of our house, had kids, etc.  But 2008 and 2009 look like they will eventually shape up to be very similar from a tax perspective, so I have gone ahead and changed my withholding amounts with my payroll department.  I took home almost 10% more in my first paycheck because of this change.  I already have set up a monthly automatic transfer to sweep this extra 10% into a medium term savings account for one of our financial goals.

Killington

Creative Commons License photo figure credit: Derek Purdy

This past Friday I used some comp time at work to take advantage of some non-weekend skiing at Killington Mountain in Vermont.  My host for the day was an old friend who sold a company during the Dot-Com boom and has been, for the most part, living off of the interest and dividends provided by his investment of the proceeds of the sale.  We talked about a lot of things while riding the ski lift, from parenting philosophy to Wall Street bailouts to the whereabouts of our mutual friends.

My friend challenged me in many ways, not the least of which was in trying to keep up with him on the slopes.  But as the memories of freshly groomed courderoy fade away, I’ve been chewing on a number of the things I learned or relearned in our ski lift discussions.  Please excuse the fact that some of these are broad, and some are narrow, but that’s how the conversation went.

  1. Citigroup is not going back to $45 - Throughout most of the 2000s, Citigroup’s stock price was in the $40 to $50 range.  It closed at $1.03 on Friday.  There are two important lessons here: A. You should not own individual stocks unless you own enough and varied stock to be able to weather problems in one particular market segment, like banking or energy — in other words you should be diversified enough to mitigate non-systemic losses.  B. Even if you believe that the market will bounce back, it will have to do so without Citigroup, GM, and any number of other well established, large companies whose stock is now all but worthless.  Money invested in Citi at $45 is gone.
  2. Koreans make bad pilots – There’s a book out now by Malcolm Gladwell called Outliers.  In it, there is a story about the problems that Korea Air had keeping their planes in the sky in the 80s and 90s.  Apparently the problem stemmed from a cultural requirement for co-pilots and other crew members to respect their elders by not questioning their authority and decisions in the cockpit.  It seems to me that a lot of the financial mess we’re in today stems from people not asking enough questions when they didn’t understand the terms of a deal, be it a mortgage or a credit default swap.
  3. This is not the first time the government has bailed out a “too big to fail” company – Do you remember a company called Long-Term Capital Management?  I didn’t either.  But I learned that this was a hedge fund that failed “spectacularly” in 1998 and was bailed out by a consortium of banks.  This fund was “too big to fail” in that its quick liquidation would have led to a collapse of financial markets.  You can’t sell large stock positions all at once since it causes the price to fall sharply, and you certainly can’t do so for many stocks all at once since it causes entire markets to fall sharply.  My ski buddy wonders why we put ourselves into a position again in which unregulated entities were allowed to become too big to fail.
  4. When you can’t find value in something that you need, you can always go for cheap – I was eyeing the sushi bar at lunch time, but a $15+ dollar lunch was not worth it to me.  Instead I went with a $4 hot dog.  This is similar to why I choose index funds instead of managed mutual funds.
  5. Giving up a little can be worth a lot – A season pass at Killington cost $999.  A season pass with 14 blackout days costs $650.  By giving up less than 10% of the available days during the ski season — which also happen to be the days with the longest lift lines — you save 35% on the pass.  This works the opposite way as well.  I’m reminded of the fact that most of the gains in the stock market happen on VERY few days.  If you had invested $10,000 in 1996 in an S&P 500 Index Fund, you’d have $17,280 in 2008.  If you had missed the 10 best days during that period, you would have just $10,748.  If you had missed the 20 best days, you’d have lost money and be left with just $7,360.  (Source)
  6. The government should not have let Lehman Brothers fail – It was distasteful to the American people that the government bailed out Bear Sterns, so it let Lehman Brothers fail to appease the taxpayer rather than do what was right with respect to fiscal policy.  In all likelyhood this has cost the taxpayers far more than it would have otherwise in the form of bailout after bailout.  The failure of Lehman Brothers began a downward spiral which seemingly has not yet found it’s floor.
  7. Don’t take the experts at their word without doing your due diligence – The weather.com “ski index” for Killington on Friday was a 1 out of 10, with 1 being the worst.  I decided to make the 3+ hour drive and see for myself.  At the very worst case it would be a long way to go for a couple of beers.  My friend says that he would have given the day a 4.5 overall (5 in the morning, 4 in the afternoon).  I would give it a 7, since my bias is towards smaller, less challenging mountains with generally worse conditions.  Check out this clip from The Daily Show which features a great quote from Jon Stewart: “If I’d only followed CNBC’s advice I’d have a million dollars today…provided I’d started with $100 million.” (Thanks to David at My Two Dollars for posting the link earlier this week.)

I had a great time skiing, and a great time chatting on Friday.  I like to think they were both somehow good for my soul.  I like to hear your opinion on any of these points.  Leave a Comment below.

Spinning Top

Creative Commons License photo figure credit: chefranden

We are all probably familiar, to one degree or another, with the concept of inertia:

“an object will always continue moving at its current speed and in its current direction until some force causes its speed or direction to change. This would include an object that is not in motion (speed = zero), which will remain at rest until some force causes it to move.”

A similar concept is frequently observed in human behavior: It is often difficult to start doing something that you should or want to do, and it is often difficult to stop doing things that you shouldn’t or don’t want to do.  Many people, for example, are not enrolled in their company retirement plans, or are under invested in them, simply because they never filled out the paperwork to do anything different.

Many businesses try to take advantage of this “behavioral inertia”.  Most people have been asked to sign up for a free 30 day trial of something — which still requires a credit card — and after 30 days have forgotten to cancel, as well as 60, 90 and 180 days later.  Many of us have also fallen victim to the gym membership where the cost is automatically deducted from your checking account even though you never go.

It is with this concept in mind that I recently had the opportunity to break my behavioral inertia, if warranted, by reassessing how much I pay for various services.

Two weeks ago I received my auto insurance renewal and was surprised to see that the cost for another year was similar to that of the previous year.  Last year my state changed the way that it oversees the setting of auto insurance rates.  This was supposed to make insurance cheaper for the lowest risk drivers and more expensive for the highest risk drivers.  Since ScrapperMom and I both have the best driver ratings, I expected to see a big drop in our premiums, but this was not the case.

I immediately went to a few websites of competing insurance companies and filled in the information needed to obtain a quote for insurance.  The first site quoted me a price than was 65% that of the quote I got from my current insurer.  The other sites indicated that someone would get back to me, but no one ever did.  I also called my current insurer to find out if the quote was correct and if there weren’t any other discounts that might apply.  The customer service representative said that the quote was correct, and that it was $200 less than the year before.  She was right, I had incorrectly remembered the cost of insurance from the year before.  She also cautioned me about the other quote that I had received.

The new quote that I had received was just for 6 months, and had simply doubled it to get the annual price.  It turns out, however, that a lot of “budget” insurers will quote a low price for the first 6 months and then raise the price in the next 6 months — banking on your behavioral inertia — so that it ends up being equal to or more than an annual quote from another insurer.  I could not get a full year quote from the new insurance company, which made me suspect something was not as it should be.

In the end, I decided to stay with our current insurer, who I have been with for many years.  But I feel good that I at least shopped around to make sure that I was getting the best price, and I also put them on notice, to a certain degree anyway, that I’m not just going to take whatever price they give me without doing my due diligence on the matter.

I performed this same exercise to determine if I’m paying as little as necessary for our TV and internet service.  After looking around, all of the other options were within a few percent, plus or minus, of what we pay now for the same service.  It doesn’t make sense in this case to change providers, but at least I know that I’m not overpaying for the equivalent service.

There are a number of other services that I use that I can reassess as well. I plan to reassess the cost of my cell phone and rental movie service, among others. I’m also going to look to be sure that I’m getting the best deal I can on the interest that gets paid to me on cash investments such as our money market account and CDs — one of which matures in the next month.

Have you been the victim of behavioral inertia or do you have an example of overcoming it?  Share your story in the comments section below.

Nail Biting

Nail Biting: A Bad Habit Creative Commons License photo figure credit: coxy

We’ve had a busy few months:

During this time, we have not paid very much attention to our finances.  Most of our finances are automated, so our bills still got paid on time, and I know that we’re generally doing okay.  However, I really can’t say whether we’re still saving enough, or even whether we have anything to save.  

Our busyness is really no excuse for taking our proverbial eyes off the ball here.  The truth of the matter is that I’ve had my head in the sand since shortly after ScrapperMom lost her job.  I really did not want to have to acknowledge the drop in income and figure out how to live without it.  As a result, I haven’t looked out our Spending Plan in months, I have no idea whether we’re spending more than we earn.  I do know that we have not yet made any retirement contributions for 2009 even though we are already 13% of the way through the year, and that’s starting to bug me.

Good personal finance is a habit like any other.  Breaking bad personal finance habits takes time, dedication, and work.  We’re all susceptible to falling back into our old habits, especially during times of stress, inattention, etc.  I gained a few pounds over the holidays (no excuse again…), and I’ve been working to take the excess off again.  Similarly, it’s time to get serious with our finances again.

Tomorrow I will draw up a new Spending Plan.  I will find money to contribute to our Roth IRAs, even if I have to take it out of our savings.  I will forget about our spending over the last month or two and focus on the future.  I will get back into the habit of good personal finance.

Do you fall back into old habits?  How do you get yourself back on track when you do?  Share your story in the Comments section below.

Receiver

Creative Commons License photo figure credit: cinz

We have a 10+ year old stereo receiver that I paid $1500 when I was a senior in college (and in all likelyhood paid several hundred more in interest in the years that followed).  The motor that controls the volume knob on the stereo when you use the remote control has been on the fritz for over 4 years.  Now, whenever the remote doesn’t work, I walk over and rap hard on the volume knob until the motor starts working again.

We have a universal remote control that has truly lived up to its name: Harmony.  Logitech makes a line of these remotes that allow not only my wife, but also anyone who visits our house the ability to turn the TV, stereo, DVD, VCR, Tivo, etc. on, off, change the channels, fast forward, etc., with little to no coaching in a very intuitive way.  It even has a help button on it that gets things back on track if necessary.  Over the last year or so some of the buttons have stopped working.  As a stopgap measure I was able to reprogram some of the lesser used buttons to take over for some of the failing ones.

As I look around our house, I see many items that we purchased when we made more money and had less expenses, items that put us in debt, or items whose purchase kept us from getting out of debt: laptops, a big screen TV, stereo, fancy universal remote control, espresso machine, air purifiers, exercise equipment, etc., etc.

Some of these purchases are doing nothing but collecting dust, and that’s okay.  We’re older, we’re wiser.

Others, however, are essential, daily use items.  The stereo and the remote are two examples, as is the TV.  Someday these things are going to wear out, die, or otherwise stop working and require replacement.  What I struggle with now is the question of what to replace these luxuries with.  We have gotten used to having some expensive things, many of which we could not afford when we bought them — but now having done so, paid off the debt, and gotten on with life, find many of these items to be indispensable.  When these items do inevitably die, do we “deserve” to replace them with like items?  Do we need another 43″ TV?  $1500 stereo? $600 coffee maker?

Luckily for us, the nature of technology has made it such that we can buy replacements for many of these items that are many times better than what we’ve got now, and are also several times cheaper.  An eight year old 43″ rear projection TV can be put to shame by a 40″ flat panel display for less than half the price paid for the original TV.  A similar cost reduction and improvement can be found in the stereo market.

Yet despite the ability to replace many of these items with lower cost, higher quality products today, there is still the nag that I feel every time I start to spec out something like this.  I always start to need this feature or that feature that I don’t have today, but can’t possibly imagine living without for the next 10 years.  The truth is that many of the features that I overpaid for on these current items I don’t even use: 800 lines of resolution on my standard definition TV (nobody can even tell me how to take advantage of this…), 7 channel, multi-room capability on the “flagship” receiver, etc.

Additionally, the cost bar has already been set high by these initial purchases, and since we’re in a better financial situation now than we were 5 or 10 years ago, the rationalization starts to creep in: Go ahead, by another $1500 receiver — you’re going to use it every day, you’re going to keep it for 10 years, it’s going to sound so much better than the $750 one — in fact, spend a little more this time since you’re so much better off.

And herein lies the difficulty with keeping our financial house in order: we’re human and we have wants, dreams, desires, etc.  It’s not easy to deny oneself the things one “deserves”.  Many people have estimated what percentage of personal finance is math and what percent is psychology.  All seem to agree that the former is low and the latter is high.

All of this is not to say that if we have the money to do so (which we don’t at the moment), and that we’re meeting or exceeding all of our other personal finance goals, that we should not buy whatever we want.  We most definitely should.  But that still doesn’t mean that we should not approach the replacement of items like this with frugality in mind.  We’re still going to end up with products that are better by our standards than the items that need replacing, but avoiding lifestyle inflation will keep more of our hard earned money in our pockets and working even harder for us on our other financial goals. I hope that when the time comes we’ll have the discipline we need to remember this.

Have you ever been faced with replacing an item that you couldn’t afford the first time? How do you avoid the urge to buy more features than you really need?