Archive for the 'Social Psychology' Category
The central tenet of personal finance is to spend less than you earn. A close corollary to this is to learn to live with what you have. If you can learn to be happy as things are, then it makes it easier and easier to save more and more as time goes by. I wrote about these ideas in one of my first posts at this blog.
Last week, I found out that I am getting a raise to go along with a promotion that I got a couple of months ago. The challenge with getting a raise is to keep the central tenet and the corollary in mind: don’t increase your standard of living, and put most of the raise to work for your future. To do otherwise is what is commonly referred to as “lifestyle inflation.”
Lifestyle Inflation occurs when people continue to increase their standards of living as their means increase. There is generally nothing wrong with enjoying a higher standard of living — if you can afford to. Many people are already right on the edge, living paycheck to paycheck, and one unplanned expense away from financial disaster. However, when these same people get a raise, they raise their standard of living so that they are now spending all of their new income, but are still continually on the edge of ruin.
There are two ways out of this cycle: spend less or earn more. Most of us have a great deal of control over the former, and at least the perception of very little control over the latter. In order to break out of the paycheck to paycheck paradigm we have to trim our budgets so that we have some money to save each paycheck, not succumb to lifestyle inflation, or do at least some combination of both. (Of course, another easy way to avoid lifestyle inflation is to have your spouse get laid off in the same week that you receive your raise!)
Many people, especially in this economy, are lucky to be getting any raises at all, and those that are may still not be keeping up with inflation. However, it still makes sense to me to try to forget about the raise when you get it and focus instead of how that extra money can be used to advance your financial plan: paying down debt, additional retirement savings, down payment fund, new car fund, emergency fund, college savings for the kids, increased charitable contributions, etc.
Another great strategy, if you can’t stomach the idea of never getting a raise is to split raises with yourself. While it may sound crazy, splitting raises with yourself will still allow you to enjoy some of the benefits of your newfound wealth, but also advance your overall financial plan.
Realizing that “stuff” doesn’t make you happy can be very empowering. If you can forgo lifestyle inflation for an extended period of time, you can quickly get to a point where you are saving a substantial amount of your income. I recently read a story about a couple who saved raises for 10 years (looking for a link, anyone have one?) Imagine for a minute how early you could retire if you were saving 30% or more of your income. Avoiding lifestyle inflation also offers more security: if you only need a fraction of your income for your base needs, layoffs and other economic crises will be far easier to weather.
Ultimately though, none of this matters if you don’t have a spending plan, don’t pay yourself first, and don’t track your spending.
Are you guilty of lifestyle inflation? What do you do when you get a raise? Let’s hear what you have to say in the Comments Section below!
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With the recent market turmoil, there has been a lot of talk in the press and even around the water cooler about the nature of risk. Most people seem to understand that investing in the stock market is risky. They also understand that the more risk one takes, the greater the possible upside and downside of the investment. What many don’t seem to understand is what, exactly, is risky about investing in the stock market as well as how risks can be mitigated.
A great book on this subject is A Random Walk Down Wall Street by Burton G. Malkiel. This book details, for example, why a well diversified stock portfolio is less risky than a single stock. Malkiel shows that it takes a minimum of 20 to 30 stocks across a number of asset classes to provide sufficient diversification for a typical investor. For example, if one holds the 30 companies in the Dow Jones Industrial Average, a typical market cycle might have Coca-Cola announce a new product offering which boosts its stock price, while 3M announces layoffs. These types of stock movements are offsetting and are generally the reason why a diversified portfolio is less risky than individual stocks.
A diversified portfolio is still exposed to “systemic” effects on the market — effects that are spread across the whole market. This is most easily observed in the current market turmoil. Clearly it’s not possible for every company to be doing poorly right now — somebody must be making money in a Bear market. But the market average is down, and as a result, many good companies are getting hit hard on their stock prices simply because of the financial crisis.
Another aspect to risk, and the one about which I have been trying to remind my coworkers and friends, is the time factor. When purchasing an investment, one has to be aware of both the time one can afford to tie up money in the investment, as well as the typical time for the investment to achieve the kind of return being sought. This is fairly easy to see with a Certificate of Deposit: you buy a CD that pays a certain percentage yield and that has a limited lifetime of months or years. There are penalties for withdrawing money early. The equation is less well defined when it comes to investments such as houses, stocks, or tulips. The risk with investments such as these (well, not the tulips as much…) is not that the investment won’t hold value or yield a return, but rather over what time period the investment will pay off.
Conventional wisdom suggests investors be prepared for minimum investment times to substantially reduce the chance that the investment will depreciate while held. The purchaser of a house, for example, should be prepared to hold the house for 5 years or longer to have a high degree of certainty that the money invested can be recovered in full. Diversified stock portfolios are more like 10 years of holding time. In fact, (according to Malkiel) there has never been a 10 year period since 1926 in which the stock market has returned a negative yield, and there has never been a 25 year period in which the return was less than 8%.
The point in all of this is that you should not panic about the volatility of the current market. In fact, the less you pay attention to it the better off I expect that you’ll be. If you are investing for retirement and you have ten years or more left to invest, you shouldn’t even sweat during this crisis. If you have less than 20 years until retirement, or are retired already, you should have made and be making annual or semi-annual changes to your portfolio to reduce your risk exposure by locking up your stock gains in less risky vehicles like bonds. This is what’s known as rebalancing your portfolio. If your time horizon for a certain pile of money is shorter than 10 years, then your exposure to the stock market should be minimal.
The absolute worst thing that you can do right about now is to get scared and change the way you are investing because of the market fluctuations. Selling off stock now is the opposite of what everyone knows is the key to investment success: buy low, sell high. Selling now is “selling low” and locks in your losses. I have not lost any money in the current market, and I say this because all my losses are on paper so far. I still own the same number of shares this week as I did last week. Only by selling shares now can I be sure to lose money in this market. History tells us that some of the greatest days in the stock market follow some of the worst, and Monday’s stock market performance is certainly evidence of this. Selling when the market is low takes your money out of play and eliminates any chance of regaining the value lost in your portfolio as the market rebounds.
Are you concerned about the loss of value in your 401k plan? Have you made any changes to stem your losses, or are you just gritting your teeth and bearing it? Do you find yourself checking the value more frequently or less frequently because of the volatility? How much risk can you stomach? I’d like to read your perspective on the situation in the Comments Section below.
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While on vacation, ScrapperMom and I discovered a curious thing. We were watching a children’s TV show to keep daughter #1 busy and suddenly the show stopped and changed to voices and images that encouraged us to buy a bunch of stuff that we don’t need. Amazed by such a brazen attempt to sell me something, I asked our host about it who informed us that what we were watching were “commercials”.
Ah yes! Commercials! I had forgotten that such things still exist. You see, ScrapperMom and I purchased a Tivo back in 2003, and for the last 5 and a half years have been commercial free. And it has been wonderful. After watching way too many of these while on vacation, I had forgotten how insidious and manipulative they could be, and am glad that our daughter is still too young to be enticed by a toy dog that can roll over by itself, or a princess on a horse that can walk by itself.
I am often asked by friends, coworkers, and family if I have seen a certain commercial that may be funny or entertaining in some way. “No,” I usually say, “we don’t watch commercials.” Originally our disdain for commercials was simply practical: commercials account for 27% of total network TV time. We quickly found that with Tivo we could watch 30 minutes of TV in 22 minutes. We filled the saved 8 minutes with more interesting things, like reading, blogging, etc.
Having seen so many commercials during vacation, however, it has become abundantly clear to me that having Tivo saves us money. Exposure to advertisement makes you aware of things that you didn’t know you needed. It’s hard not to keep up with the Joneses when you are constantly bombarded with indications that you are too fat, too thin, too ugly, too short, too bald, don’t drive a good enough car, deserve a great vacation, etc. But life is not that bad when you don’t have all these unreal standards against which to measure yourself.
Tivo is near the top of our top 10 list of must have gadgets, and it’s nice to see that after having it for so many years, we are still realizing new value in it.
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$1,000,000,000,000
The term $1 Trillion has been in the news a lot lately, but rarely have I actually seen it written out. That’s a lot of zeros! To look at it another way, it is :
$1,000,000 X $1,000,000
One Million Dollars times One Million Dollars equals One Trillion Dollars.
If you had a trillion dollars and wanted to count it, and could count at a rate of one dollar per second, it would take over 31,000 YEARS to finish! (Apparently, aside from the lifespan issue, you couldn’t actually count this high this fast anyway, because some numbers would take longer than 1 second to say, like nine hundred and ninety-nine billion, nine hundred and ninety-nine thousand, nine hundred and ninety-nine.)
A stack of $1 Trillion dollar bills would wrap around the earth at the equator two and half times.
Those same dollar bills laid end to end will reach further than the sun — at it’s farthest approach.
Do you think $1 Trillion is a lot of money? I do.
Hope your great-grandkids don’t mind paying taxes…
What do you think about the proposed bailout out of the financial industry? Let’s hear your thoughts in the comments section below!
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It’s been a few weeks since I’ve had a chance to highlight some of my favorite articles in the rest of the blogosphere, so here’s what’s been going on:
Gather Little by Little tells us what the dumbest thing on which he ever spent money is. He asks what others’ dumbest purchases are. The first thing that comes to mind for me is a Bowflex machine. It really did seem like a good “investment” in our health at the time, but like many things, it was too good to be true, and in retrospect way overpriced for what you get (a lot like a certain speaker company’s products that rhyme with “nose”). A close second is a pair of those Ionic Breeze air cleaners. At least we bought them on Ebay and saved a lot of money off of the MSRP.
GLBL also has a great guest write up on how to start an envelope budget system. This is not the system that we use, but the best system for you is the one that works, so if you’re still looking, give this a read.
FrugalBabe writes about missing a home owners’ association payment and getting hit with a late payment as a consequence. Her excuse is that they don’t actually bill her. I’m a big fan of making things automatic, and I suggested setting up an automatic bill payment with her bank. Few people realize that they can set up a billpay payment for things other than utility, credit card, mortgage, and other “typical bills”. Heck, you can often send your friend a payment for the dinner you split last week.
J.D. at Get Rich Slowly puts it to his readers for suggestions on how to cope with a spending addition. I don’t think the young woman in this case has an addiction as much as a bad habit. My advice here again would be: Make it automatic. Set up a Debt Snowball and then set up automatic payments that take effect the day after she can be sure that her paycheck gets deposited. Of course she has to cut up her credit cards as well for now, but once she does this, if she doesn’t have the money in her bank account, she won’t be able to spend it.
J.D. also wrote another great post on “The Idea of Having.” I hear him on this one. Having “stuff” is a constant struggle for us. We’re always going through closets and bookshelves and can usually bring ourselves to part with some stuff, but not other stuff that we don’t ever use but that we can’t bring ourselves to throw or give away either. Sometimes I wish we had to live in just one room so that it would force us to pair things down to that which is truly important.
Pinyo wrote an analysis of when to start taking social security benefits. He argues that while the starting benefit goes up as you age, you might not live long enough to recoup the difference. However he missed the fact that a given person’s lifespan also increases with age. A person born today in the US can be expected to live to 75 on average. But a person who is already 62 can be expected to live into her 80s. A person who is already 70 is likely to live into his late 80s. This has to be factored into a full analysis on when to begin social security benefits.
Lastly, filed under the “just for fun” category, Freakonomics published an article detailing the correlation between states that have high occurrences of Bigfoot sightings and those with high occurrences of UFO sightings. The best explanation given for this was in the comments section:
It strongly suggests to me that the aliens are Wookies.
— Posted by Doug
PS: I have a deeply discounted Bowflex machine for sale. Seriously.
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photo figure credit: jonworth
