The Real Reasons Why You Buy

(from Carl Richard's New York Times' Bucks blog, 4/16/2012 - click here for the original post. Carl is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.) His new book The Behavior Gap is on shelves now.

Before we buy something we tell ourselves stories.

We are particularly fond of the story that goes like this: We have researched all the options, and the decision we have made represents that best one we could make given the facts. Just the cold, hard facts.

Of course, that story isn’t really true.

And we make up other stories as well, many of which have absolutely nothing to do with the actual facts. We create these stories to help ourselves feel good about a decision we have already made.

For instance, many times we actually reverse the process. We decide what we want, often for emotional reasons, and then we go looking for evidence to support the decision. As we are gather the evidence, we carefully omit anything that doesn’t fit into the story we’re writing.

This is so easy to do you could say that it’s natural to us. We don’t really have the time to consider every single option. If you did, you would never get past your closet in the morning. So we take shortcuts. We decide what we want and then gather a few facts to prove to ourselves, our spouse and our family or friends that we did the right thing.

When it comes to spending money, one of the stories we like to tell ourselves is that we aren’t just spending. This item is actually an investment. It’s an investment in ourselves and our quality of life, or an investment that will actually save us money over the long run.

So we run the numbers, or more likely we read about someone who ran the numbers. Then if the narrative matches, we use that as evidence that we’re doing the right thing.

It seems easy. A simple case of addition or subtraction.

Things get complicated pretty quickly, however, when we start using the argument of saving money as a Trojan horse to hide the real reasons we’re doing something. Let’s take the case of whether to buy a hybrid or electric car.

If you decided that you want a hybrid, it’s pretty easy to find evidence to support that decision, but be careful if you’re telling yourself that it will save you money.

Except for two hybrids, the Prius and Lincoln MKZ, and the diesel-powered Volkswagen Jetta TDI, the added cost of the fuel-efficient technologies is so high that it would take the average driver many years — in some cases more than a decade — to save money over comparable new models with conventional internal-combustion engines … Gas would have to approach $8 a gallon before many of the cars could be expected to pay off in the six years an average person owns a car.

To be clear, there are plenty of legitimate reasons to buy a more fuel-efficient car. Unfortunately for the buyers relying on the numbers argument, one of them isn’t saving money in the short term unless you buy specific models.

So why do we hide behind saving money?

It’s easy to point to the price of gas. It’s harder to explain why the environment benefits from one more person driving an electric car. And it’s harder still to explain why driving a hybrid just makes you feel good.

And few people want to admit to adult peer pressure. How could you live with the story that you actually bought that Prius because you wanted a cool spot to put your Apple sticker?

Obviously cars aren’t the only thing we try to make the saving-money logic stick to. How about the recent argument at Slate that you should run out and “buy, buy, buy” a house if you are currently renting? This is a classic case of using tons of “evidence” to tell a nice little story while ignoring the data that might not fit nicely in the narrative.

Based on the facts presented in this particular story, it looks like it might actually be cheaper to buy than rent, but it states that any consideration of where prices might be headed is “irrelevant.” It’s just one more example of how far we can go in our storytelling exercises.

And it’s not that simple, as you’ve probably guessed. What if prices fall 10 percent and you have to relocate for another job? What if you know you’re moving in three years and prices stay the same?

You may be very hard pressed to break even after you consider the costs associated with buying and selling the house (e.g., real estate commissions, closing costs, moving costs and taxes). With a little honesty, there goes that nice, clean “time to buy” story.

While cars and houses might require the most complex stories, we often tell ourselves little ones about things like vacation “deals,” using a rewards credit card and buying in bulk. Often they get brushed with the halo of saving money. In each instance, saving money may be one of the reasons you’re doing something, but you can rarely say that it’s the only reason.

And that’s the point.

We tell ourselves stories about why we’re buying something, and saving money is a good story.

But I think one of the best conversations you can have with yourself, your spouse or your family is about the real reasons behind why you spend money. Be honest, even if it means having to admit that you’re buying something only because you simply want it. Blurring our reasons for our decisions around spending money is a slippery slope that can lead to a lot of financial headaches.

Can We Pass the Marshmallow Test?

In the late 1960’s, psychologist Walther Mischel conducted an ingenious experiment testing the ability of children to delay gratification.  A child was left alone in a room with a marshmallow on the table, and was told if he or she could wait 15 minutes to eat it, they would get a second one as a reward. 

About two-thirds of the kids failed the experiment – but the fascinating part of the study was the follow-up research on the children years later.  The kids who didn’t eat the marshmallow had stayed in college, made more money, and had fewer drug and alcohol problems.  The kids who had been able to delay gratification were more successful in life overall.  

As I read a Wall Street Journal article this morning about yet another government spending program that makes it impossible to balance the budget, I wondered why we’re surprised we have this problem.  It’s easy to be critical of Congress and its inability to make difficult decisions necessary to keep our county within its spending limits, but many people can’t balance their own family budget – so how do we expect states with competing interests to agree?  Congress is only a representation of the people it serves. 

Why has it been so tough for my baby-boomer generation to budget?  I have a theory.  We didn’t learn to delay gratification.  We grew up in a time of prosperity, and it felt like the party would never end.  Sure, we experienced the lousy stock market of the early 70’s, but most of us were just getting started, so we were unaffected.  We also experienced raises that were tied to inflation, and our salary increases in the 80’s bought us even better lifestyles when companies like Walmart and Costco drove down prices of the everyday things we purchased.  The easy credit of the 90’s caused our home values to race up and our cost of borrowing to drop - we were on a roll.  We didn’t have to budget like our parents and grandparents; until the Great Recession began in 2007. 

Although markets have recovered from their lows, it’s evident we may be in for an extended period of time when we won’t have the wind at our back.  And we need to adjust.  Like the kids in the lab, we must exercise some self-restraint; and like Congress, we have to make some tough decisions.  At the risk of sounding overly-dramatic, it’s much easier to make a change in our lifestyles today than it is to choose between buying food or paying the mortgage tomorrow.

I’ve had this discussion with clients and prospective clients over the past several years, and I’ve been told by some that they intend to enjoy life now, because it won’t matter when they’re old.  I think this is a battle we’re waging between our present and future selves.  It’s easy to delude ourselves today that it will be easier to get by with less in the future.  One of my favorite quotes on this subject was made in a presentation by Shlomo Benartzi, an economist who studies financial behavior:  “Self-control is not a problem in the future.  It’s only a problem now, when the chocolate is next to us.”

Marshmallow, anyone?

Jeannette A. Jones, CPA, CFP®

jjones@taaginc.com

www.taaginc.com

Playing to Fear, Not the Plan

After combing through what’s become a lengthy “future blog topics” list for this week, I was sidetracked by the recent onslaught of advertising by the world’s largest asset manager, BlackRock.

I don’t have anything against the firm, per se.  They aren’t managing more than $3 trillion just by accident.  It’s just the message behind their most recent ad campaign seems to be a perfect example of what we try to warn against on a regular basis; Wall Street playing to investors’ fears.  Even in a market that has been more positive than most might have expected since the fourth quarter of 2011, the message persists; what are you afraid of and how can I create a product to sell you that answers that fear? 

What’s wrong with that process?  In traditional business, absolutely nothing.  Our society has been built on the successes of those producing products to fit a need.  However, with investing, the process tends to completely disregard the question of whether or not the product is actually an appropriate investment for the investor’s situation. 

The product answers to fear, it should answer to a plan.

The ad states “2% ISN’T A RETURN; IT’S A RETREAT.”  Ok, I’ll agree.  The return on safe instruments such as cash and short term, high quality bonds are, as can be expected in this environment, paltry at best.  However, that doesn’t mean they don’t play a vital role in your portfolio.  “Mattress money” is meant to be just that, a place to safely store the returns earned on the risk you take in the stock market or other investments. 

What does BlackRock suggest you do?  Try some of their products, of course.  One they mention specifically, the BlackRock High Yield Bond Fund, might certainly boost your expected return, but at what cost?  Well, if you look back to Morningstar as to how the fund performed in 2008, it lost 27.8% of its value.  That doesn’t make it a bad investment, but it’s not something I’d want in my mattress.

Another suggestion is the dividend-focused BlackRock Global Dividend Income Fund.  Dividends are certainly a hot topic of late, and, for all I know, this particular fund, despite its 1% expense ratio (and up depending on share class), may be a perfectly reasonable way to access a global portfolio of dividend paying stocks.  But, just like the High Yield Bond Fund, that doesn’t mean it’s a reasonable replacement for cash or high quality fixed income instruments.

We’ve said it more than a few times in this space, there’s nothing in investing that can’t be boiled down to the relationship between risk and reward, fear and greed.  There are lots of ways to seek out returns that might outperform lower yielding instruments, but not without taking the appropriate amount of corresponding risk. 

What’s more important is to understand why you hold various asset classes, what amounts you hold and how that relates to your tolerance for risk and your long term goals and dreams.  It is our goal to assist our clients with this very important process.  If you ever have questions on how this relates to your plan or know someone who might, please let us know.

Have a great week!

Chip Workman, CFP®

cworkman@taaginc.com

www.taaginc.com  

The Ever-Shifting Balance Between Resources & Dreams

(from Carl Richard's New York Times' Bucks blog, 9/20/2011 - click here for the original post.  Carl  is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

Most of us have limited resources, like time, money, energy and skills. At the same time, we have needs, goals and dreams. All too often they exceed the limited resources we have, so balancing these two areas of our personal economy can be tricky. We also need to understand that over time both of these circles change.

Sometimes the resources we have will be greater and allow us to do more of the things we want. Other times our needs and wants will seem to dwarf the limited resources we have to throw at them.
But it’s not something that we decide once and then check off the list. It’s a challenge we have to revisit regularly. So here’s how to think about both of the circles.

First, we need to stop focusing on things outside our control. When we do that, we miss opportunities during both good times and bad (like now) to find our financial balance. Don’t put off making important and necessary adjustments, because no one else will do it for you.

Second, we need to be honest about whether our goals are realistic given our resources. You may want to retire at 50, but if you haven’t been saving money regularly, that’s not likely to happen. Aim for things that really matter to you, but don’t set yourself up to fail before you ever start. Remember: your goal is maintaining balance, not achieving perfection.

Finally, look for new ways to make the balancing act work for you. Only you know your goals and only you understand what resources you can dedicate to achieving your dreams. Get the help you need to figure out the details, but it’s up to you to keep these two areas in balance.

It’s amazing the changes that I see in people once they figure out how to match their dreams with their resources. They worry a lot less day to day about things they have no control over. They spend more time with the people they love and doing things that make them happy. Even if their balance between resources and goals doesn’t look like anyone else’s, it’s still getting them where they want to go.

And that is all that matters.

When Television Feeds the Urge to Trade

(from Carl Richard's New York Times' Bucks blog, 6/6/2011 - click here for the original post.  Carl  is a Certified Financial Planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)

Traveling last week, I shared some workspace where CNBC played all day on television. For most people, I realize that it’s often comforting background noise. However, since I almost never watch television, I found it amazing how bipolar I felt as they shifted from one commentator to another.

Given how wild the markets were last week, I imagine that there were many people tuning in trying to figure out what to do. And that’s the problem.

Watching CNBC might be entertaining, but unless you fancy yourself some sort of day trader, it will not help you figure out what to do with your life savings.

This won’t apply to all of you, but I’m going to make some assumptions here. I assume that for most of us the purpose of earning money, saving it and actually doing financial planning is to hit some sort of goal. I’ll also assume that those goals are typically things like getting out of debt, establishing a rainy-day fund and saving for retirement or college for kids.

If that’s true, what are you going to learn from watching hours of endless chatter about new-home sales or the jobs report that will be helpful in meeting those goals?

Things change so fast, and on television the reactions in the markets are amplified by the need to have something to talk about to keep everyone watching so they don’t miss the latest breaking news. This constant stream of information makes us feel like we should be doing something.

But the question is, what?

What should we be doing? What changes should we make based on the latest breaking news? Do you see the potential problem? If we’re tuning in to figure out what the latest news means for our investment plans, and we make changes based on what we hear … well, that’s an awful lot of changing.

Doesn’t it make much better sense to design our investment plans based on our goals, and then make changes when those goals change, instead of trying to react to the minute-by-minute updates? The only thing we know for sure is that things will change. Does your financial plan help you weather these changes or are you tempted to jump every time a new headline pops up on television?

The Best Investment Advice: Stop Losing Money

(from Carl Richard's New York Times' Bucks blog, 5/9/2011 - click here for the original post.  Carl  is a certified financial planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, www.BehaviorGap.com.)




I’m more convinced than ever that Mark Twain was correct when he decided that he was more interested in the return of his money than the return on his money.

A couple of weeks ago, we discussed how often people in their 60s and 70s say that their primary residence of over 30 years was their best investment. This belief exists despite the fact that home values barely kept pace with inflation. How can this be, given that during the same time period average annual returns in various stock market indexes ranged from 8 to 13 percent?

Because for most people, it was the only investment that didn’t lose money!

While the same outcome may not apply to housing in recent years, the principle still applies to investing in general. Most of us are chasing the highest return, because that’s what investing is all about, right?

But the experience of many people has been that the well-intentioned search for the best investment actually cost them money. They bought at the peak and sold at the bottom, and their overall returns ended up being meager. I suspect lots of these people would gladly trade their actual experience over the last decade or more with simply having their money returned to them.

So, what if the key to investment success is to start by making sure that you don’t lose money? Could it be that accepting a lower rate of return might result in having more money than continuing the wild goose chase of this magical 10 percent we hear that the stock market delivers over time?

Part of the problem is that we focus on the wrong thing, like finding the very best investment or beating a particular stock market benchmark. Both are a wild goose chase. Having the money for a dignified retirement, however, is not. By setting real financial goals, we can quit chasing investment performance and focus instead on creating a plan for the future that makes sense.

Once a plan is in place, it may very well be that the best thing we can do with our investments is to simply not lose money and take the time and energy we were spending in the chase and focus on those things that we have more control over. Things like finding creative ways to earn or save more, or just enjoying the one life we have to live.

Don't Confuse the Urgent with the Important

Carl does a great job in the blog below of reminding us of why those things with low urgency, but a high degree of importance on our to-do list deserve our time and attention before it's too late.  

(from Carl Richard's New York Times' Bucks blog, 3/21/2011 - click here for the original post.  Carl  is a certified financial planner in Park City, Utah. His sketches are archived on the Bucks blog and on his personal Web site, BehaviorGap.com.)
  

Last weekend marked the beginning of spring, and even though there’s still snow on the ground here in Park City, it reminded me that nearly a quarter of the year has come and gone.

Like many of you, I made resolutions in January. There were a lot of important things I wanted to accomplish. And for a few weeks, I did really well. But now it’s March, and part of me is panicked. There’s still so much to be done. But another part of me latched on to the second half of the equation: I still have three quarters of the year to go. What’s the big deal?

The problem results from the distractions that come from things that seem urgent. They cause us to lose our focus on the important issues.

On a day-to-day basis it’s easier to focus on those urgent things that capture your attention. After all, who wouldn’t focus on getting the car fixed over making sure the will is up to date? That seems like a logical decision that trumps the merely important goals you set in January.

Bob Goldman, a financial planner, said that he sees a surge in business around January and February. So at least they’re trying.

But Mr. Goldman added that he often doesn’t see those people again for years. Following through on the big decisions tends to  drop down the list quickly when you’re confronted by life’s urgent demands. After all, many of these important goals appear complex, like buying life insurance or setting up college savings accounts. So we often push them aside in favor of the urgent and immediate.

Plus, we enjoy the sense of checking urgent things off a list. The more urgent the task the greater the sense of satisfaction. By comparison, sitting down and working through the details of your personal and financial lives doesn’t offer the same sense of excitement and immediate gratification.

Here’s the danger in all of this though. Once time passes, the important eventually becomes urgent. But by then it may be too late to do much about it.

Think about the stories of friends and colleagues who are dealing with complicated estates because family members let the urgent trump the important. Then there are the parents who didn’t think 18 years would pass so quickly; now they’re unsure whether they can help pay for college.

A friend who is an estate planning attorney noted that people will often come to him in a panic right before taking a trip without their kids. With worst-case scenarios floating through their minds, these couples want their wills done in case the plane goes down or the ship sinks. Since these things take time, it’s often impossible to finish before they leave town. Then, my friend doesn’t hear back from them again until a few days before the next trip.

See a pattern here?!

If there’s one resolution that I hope each of you keeps it’s this: please set aside time each month to tackle these important questions. Yes, you will be tempted to brush them aside until next month because there will be something urgent going on. But you can’t keep making the same resolution every January to deal with your important decisions this year. The tasks will never get smaller if you don’t start dealing with them one by one.
After every financial crisis we often ask, “How did we miss the signs?” Unlike a large-scale crisis that only seems obvious in hindsight, you know that you can prevent a personal financial crisis by tackling the important tasks in your life right now.

Time for a Reality Check

(from Dan Solin's Huffington Post blog, 10/28/2010 - click here for the original post)

As year-end approaches, this seems like a good time for a reality check.

On October 9, 2007, the Dow Jones Industrial Average closed at its all time high of 14,164. At that level, it had gained 94% over the preceding five years. The euphoria of the bulls was palpable.

On March 9, 2009, the index reached a new twelve-year low, closing at 6,547. The bears became the talk of Wall Street. Doom was in the air.

How you dealt with your investments during this period is indicative of everything that is wrong with the securities industry and why you need to fundamentally change the way you invest.

Few brokers predicted the greatest financial crisis since the Great Depression. Almost no one predicted both the meltdown and rapid recovery of the markets. Yet more than 90% of individual investors maintain brokerage accounts and rely on the flawed advice of their "investment professionals."

What if you didn't panic and did nothing from October 9, 2007 to date? I call it the Seinfeld approach to investing. You were in a globally diversified portfolio of low cost index or passively managed funds in an asset allocation (the division of your portfolio between stocks and bonds) appropriate for your tolerance for risk and investment objectives.

As of September 30, 2010, if your allocation to stocks was 50%, your portfolio has fully recovered. Investors with with an allocation of less than 50% to stocks have positive returns. If you were among the small percent of investors for whom an allocation of 100% stocks was appropriate, your total return is down almost 20%.

Check your portfolio returns. How do those results compare? Most likely, not well if you were listening to the financial pundits and "fled to safety" when the market crashed.

Almost all clients of brokers invest in actively managed funds, where the fund manager attempts to "beat the market." The use of these funds is another reason why investors typically underperform the market. If there is one compelling reason for terminating your relationship with your broker, it's the fact that recommendations of actively managed mutual funds are the way brokers make a living.

In a recent blog, Eugene Fama and Kenneth French, two of the most distinguished Professors of Finance in the country, explained the folly of investing in actively managed funds. They concluded that, when you factor luck into the equation, they expect 97% of actively managed funds to underperform a passive alternative.

Their conclusion is consistent with other studies that have shown over 99% of active fund managers have no genuine stock picking ability.

If your personal reality check persuades you to enter the New Year with a new investing approach, don't necessarily assume you can do it yourself. Studies over a 30 year period show that even those who pursue an indexing strategy on their own fail to capture 100% of market returns. They still do far better than investors in actively managed funds, but their failure to rebalance their portfolios and the lack of discipline to stay the course when times get rough, take a heavy toll.

A competent passive advisor, who focuses on your asset allocation and recommends investments only in index funds, passively managed funds or Exchange Traded Funds, can be a wise investment.