Sketch Guy

Carl Richards
The New York Times

Your Investing Behavior Costs You Plenty

Today, we introduce the first of what will be regular dispatches (and back-of-the-
napkin drawings) from Carl Richards. Mr. Richards is a certified financial planner
and the founder of Clearwater Asset Management. He answered questions from
Bucks readers in November.

Investor behavior matters a lot. In fact, it probably matters more than skill. To
understand why this is true, first you need to understand one fundamental
concept: Investment returns and investor returns are almost always different.

An investment return is what you get if you invest your money at the start of a
period and then don’t touch it. You don’t buy or sell. You just buy and hold. But real
people in the real world don’t invest that way.

Real people are always chasing performance and investing by looking in the rear-
view mirror. The result of this never-ending hunt for the best investment causes
us real trouble.
The result is well documented: The average investor almost always does worse than
the average investment. The difference in returns comes from making classic
behavioral mistakes over and over again.

Here’s a recent example: According to Morningstar, the Dreyfus Greater China

Fund had an annualized return of 24.3 percent over five years through Dec. 31,
2009. But the average investor in that fund had a return of only 14.3 percent
during the same period. That’s a 10 percentage point difference.

Think about that for a minute: A 10 percentage point difference per year over five
years. How in the world can that be true? Well, it’s just one example of what I call
the Behavior Gap, and in future posts we will explore how and why this happens.

For now, the lesson is that investment success isn’t about skill. It’s about behavior.

Read No. 1
Beware Financial Comparisons With Others
When it comes to money, we like to think that we’d treat one dollar the same as
the next. After all, a dollar is a dollar, right? And if someone offers us two dollars
instead of one dollar, who wouldn’t jump at the chance? It will probably surprise
you to learn that how we make that decision depends on whether someone else is
involved.

Although we like to think we act independently (of course we’d always take the two
dollars!), an experiment conducted at Harvard University’s School of Public Health
in 1995 reveals we may not be as independent as we think. Researchers gave
participating faculty and students two options:

Option 1: Earn $50,000 per year while everyone else earns $25,000

Option 2: Earn $100,000 per year while everyone else earn $200,000

Participants were told to assume that everything else stayed equal, so more money
meant the option of buying nicer things. Doing the math, you’d assume that Option
2 was the overwhelming choice. Who wouldn’t want more money, regardless of what
everyone else earned?

Turns out, 50 percent of them didn’t want more money. For this group, the ideal
option was having more money than everyone else even though it meant having less
overall.

But this study was almost 20 years ago. Surely we’ve learned the lesson. We must
have gotten better at picking the best option for our individual situation, right?

Not really.

Comparable results were also seen in a recent study conducted by Jona Linde and
Joep Sonnemans at the University of Amsterdam. Study participants were
assigned a partner, someone who was identified as being similar to them, and they
played a game together. Following the game, participants were then presented with
options for potential lottery payouts.

Each lottery indicated the payout for both the individual and the assigned partner
and the potential risk of each option. However, instead of consistently picking the
option that meant more winnings to them, often at less risk, participants picked
options that meant doing better than their partner — even if it cost them potential
earnings.

Both outcomes seem crazy. Why on earth would we ever settle for less, as long as
someone else has even less than us? It turns out that we struggle with relative
comparisons and money. Instead of focusing on what’s in our best interest, we
compare ourselves with others and act accordingly.

It’s the equivalent of buying shoes one size bigger than your neighbor even though
your feet are the same size. You would never do that, but we see it all the time
when it involves money and investing.

For instance, I’m still baffled when people talk with complete confidence about
making a particular investment because Warren Buffett, a talking head on CNBC or
even their neighbors made that choice. Why make an investing decision that fits
someone else’s needs instead of making one that fits our own?

It seems to me that wanting to do better than someone else, even at a measurable

cost to ourselves, points to a big gap between what we say we value and what we
actually do. Instead of measuring our decisions against our goals, we measure them
against what we see around us. The problem with that strategy is that we’ll never
be satisfied.

These relative comparisons only represent a moving goal line. We may have made a
decision that puts us ahead of someone else, even though it cost us something. But
what happens when we compare ourselves with the next person?

That’s the part we invariably miss. There will always be someone else. How close
can we possibly get to our goals if we’re constantly chasing someone else’s?

Not very, because I doubt many of us have a line item on our plan that says, “In 10
years have more money saved than my neighbor.” And that’s the point. In the
pursuit of what we say we want, there are so many things outside our control, but
this isn’t one of them. We don’t have to do what we see others doing, but it will
take an active effort to control our urge to undermine others.

We can start by applying a filter to our decisions. The next time we’re faced with a
choice, we need to filter it through the possibility that we’re weighing our options
based on how it helps (or hurts) others.
When in doubt, look at the absolutes. Look at the numbers and do the math. Does it
move you closer to your goals or someone else’s? Ultimately if we end up moving
closer to what we say we value, it matters very little what we see going on next
door. And that’s a good thing.

Read No. 2

A Time to Splurge, and a Time to Pinch Pennies

A friend of mine never understood why his neighbors spent a lot of money on
things he didn’t care about, like houses and cars. To him, these things weren’t
worth the money. So one time when he was being particularly grumpy about it, I
asked him about his family’s spending habits.

I had noticed that compared with most families I knew, his family appeared to
spend a lot of money on vacations and even more on recreational gear. My friend,
being a smart guy, took only a moment to see the disconnect. Both my friend and
his neighbors had made a decision that it was worth it to them to spend more on
things and experiences that they really valued.
It’s not unusual to spend more money on the things that really matter to us. We
probably all have something we refuse to substitute for a cheaper option. However,
when we do spend more without building a framework for making these decisions,
it’s the kind of behavior that can blow up budgets and lead us to spend more on
things that aren’t worth the extra money.

Here are a few things to keep in mind.

1. It makes sense to spend more if we want something to last longer.

A few years ago, I had my eye on a new road bike. The bike I wanted wasn’t cheap,
and I debated buying a less expensive option. But when I started weighing the
purchase in terms of wanting to ride the bike for years, the more expensive,
better-built bike made more sense. I still have and love the bike.

Time matters when we’re debating spending more. When we anticipate using

something over a longer period of time, it’s important to compare the cost of
replacing a cheaper version two or three times. If the cost is comparable, the more
expensive option could be the better choice.

2. It makes sense to spend more if we want rare, specific experiences.

I imagine more than a few of you rolled your eyes when I shared my love of
expensive ice cream. Part of the reason I enjoy it so much is the anticipation. I
don’t eat it often, only once every few weeks. However, the pleasure I get from
anticipating that next pint is almost worth the price alone. I wouldn’t feel the same
way if it wasn’t a rare experience.

So when you want to spend more on something specific, remember to consider the
value of anticipation and how often you plan on doing it. The rarer the event, the
greater the anticipation, and research shows that anticipating a future event (like
a vacation) can match or even beat the happiness of the event itself. It’s the rare
two-for-one deal that makes it worth spending more if we’ve made the smart
decision to save and plan for it.

3. It doesn’t make sense to spend more if it’s not a priority.

Sometimes the generic is just as good as the brand. Unlike my ice cream, I rarely
opt for the most expensive laundry soap. Now, some of you may be really particular
about your laundry soap. The point is when we spend more, we need to consider
both reasons 1 and 2 and if it’s a purchase that actually matters to us.

If the options are interchangeable, then go for a less expensive choice. Don’t get in
the habit of spending more for the sake of spending more.

4. It doesn’t make sense to spend more if it’s about competing with people.

My friend didn’t care about his neighbors’ cars and houses. For him, spending more
on vacations and gear he really wanted was what mattered. So don’t forget the
phrase “keeping up with the Joneses” when deciding what something is really worth.

Commit to spending more only on the things and experiences that matter
personally. It doesn’t matter what our neighbors or friends want. Focus on what
matters to you and your family and ignore what everyone else is doing.

Spending a lot of money on something — even something we’d consider a luxury —

doesn’t mean we’re making a bad money decision. It may even be the best decision.
But to reach the point of knowing it’s a good decision, we need to be really aware of
why we want to spend more and do our best to align the decision with our values.

The more we can make money decisions that support our values, the less likely we
are to regret those decisions, even if they’re expensive choices. Keep that thought
in mind the next time you wonder if it’s really worth it to spend more. Brace
yourself: sometimes the answer will be yes.

Read No. 3

Trying to Outguess the Unpredictable

“All I want is for you to tell me when the market will go up and when the market
will go down.”

A client made this request early in my career. My first thought: “I totally

understand. Who doesn’t want to know that?” My second thought: “Too bad I have
no idea when either event will happen.”

It’s a very human thing to seek answers to unknowns, and we often start our search
by looking for experts and gurus. We try to find people we hope will reveal the
future and take away the gut-wrenching uncertainty of what comes next.

Few situations leave us feeling more uncertain than our investing decisions. If we
just knew what came next, we could sleep easier at night. But that’s not how the
markets work, and attempts to predict with certainty what the markets will do
next are best described as market timing.

When we’re honest about it, we’re looking for this kind of help from investing
newsletters. The problem is that we rarely get the results we’re hoping for. Mark
Hulbert of the Hulbert Financial Digest took a look at top-performing newsletters
from 1986 to 2010 and found they underperformed the S.& P. 500 by 2.6 percent.
Despite this and other research clearly showing how bad these newsletters are at
predicting the market, some investors still gravitate to them. They’re convinced
they’ve found a way to reduce the uncertainty and time the market.

Unfortunately, this so-called certainty can come with unexpected consequences. In

recent weeks, T. Rowe Price took the unusual step of banning 1,300 American
Airlines employees from trading among its funds in their 401(k) retirement plans.
Why? Because they were engaging in what T. Rowe Price described as “collective”
trading. As a group, these fund investors were making the same trades
simultaneously. Fund managers hate collective trading because it can leave them
scrambling to buy or sell, often at great expense, to cover the moves.

So what did T. Rowe Price see as collective trading? How about following
recommendations from an investment newsletter, EZTracker, to exit “T. Rowe
Price funds in American’s 401(k) plan six times since mid-2010 after a holding
period of less than a year.” These recommendations “triggered a rush of buys and
sells in the days following the end-of-month release of the newsletter,” the
company said.

Stop for a minute and think about that last part. Over the course of three years,
this particular newsletter recommended exiting funds six times after holding them
for less than a year. In terms of fees alone that’s a lot of activity. It’s also hard to
see these recommendations as anything other than market timing, and following
them as a group got people banned from trading. I doubt this was the outcome that
any of these investors had in mind when they subscribed to EZTracker.

Now, I know that it seems like an extreme example. After all, there must be
newsletters that don’t get their subscribers banned. However, this story highlights
what can happen if investors think they know what the markets will do next. And
that’s the underlying risk of relying on investment newsletters. They create a false
sense of certainty.

At its core, subscribing to an investment newsletter is an expression of hope that

someone somewhere knows more than we do. On some level, we’re hoping that, like
an expert or a guru, a newsletter will predict what the markets will do next. It’s no
different than tuning into financial broadcasts or studying the latest financial
publications. We’re looking for answers because we’re human.
Once we understand that it’s our first instinct to reduce uncertainty as much as
possible, it becomes a little easier to ask questions. It becomes easier to ask if it’s
really in our best interest to trust predictions regarding something that’s
inherently unpredictable. And it becomes easier to ask if this behavior really helps
us be better investors or just makes us think we’re better investors. So take a
deep breath, accept your human shortcomings, and realize that no one knows
exactly what the markets will do next. And that’s O.K.

Read No. 4

Be Wary of Even ‘Safe’ Investments

Carl Richards
What makes an investment “safe”?

I’ve always considered this a loaded question (what does “safe” actually mean,
anyway?). It’s rarely the right question to ask. But it comes up pretty often for an
average investor, and rarely for the right reasons.
Consider the recent allegations leveled by the Securities and Exchange Commission
at a financial adviser and wedding singer (apparently a successful one), Larry
Dearman Sr., and his friend Marya Gray. According to the commission, Mr.
Dearman and Ms. Gray convinced investors that "they were investing in an Internet
company, a real estate business and another firm that were controlled by Ms.
Gray.”

Instead, the S.E.C. said in its complaint that the pair defrauded investors of $4.7
million in investments, and stole about $700,000. And they persuaded people to
invest by assuring them that the investments “bore little to no risk.”

How did they persuade the 30 people to invest? According to the complaint, many
had known Mr. Dearman and his family since childhood, “thought of him as an active
member of their church and knew him as a popular local wedding singer.” In other
words, they thought it was safe to invest because they knew Mr. Dearman. After
all, why would a guy who sings at weddings steal your money?

But it’s not just people that you personally know who are promising safety and then
failing to deliver, as a recent example out of Spain made clear. A few weeks ago
The New York Times highlighted a “safe” investment that was promoted to Spanish
investors by Spanish bank officials. As a result, about 300,000 Spanish investors
over the last four years lost $10.3 billion collectively, and it was in investments
that they were told qualified as “safe.” I encourage you to read the original article,
but the basics are this:

During the economic crisis four years ago, Spanish bank officials started
recommending an investing “product” with a 7 percent return. That’s a great
return, right? Investors, on average, put in $40,000. It’s not a huge amount, but it
reflected the type of individuals who were pitched this “product” — lifelong savers
who wanted to protect their money. As with the S.E.C.'s complaint against Mr.
Dearman and Ms. Gray, it turns out that what the banks offered wasn’t much of an
investment:

“Bank officials hit on the idea of raising capital and cleaning debts off their books
by getting people with savings accounts to invest in their banks instead,” the Times
article recounted. “For many of these savers, the first hint of trouble — and
understanding that they had bought into risky investments — was when some of
these banks essentially failed about two years ago. Overnight, they were unable to
withdraw their money. Soon, they came to understand that they had purchased
complex financial products, originally designed for sophisticated investors. They
had become creditors, and not at the head of the line, either.”

Both of these episodes, and the many comparable stories we’ve heard over the
years, should make us think hard about pursuing the idea of “safe.” So next time
your friend or a big bank suggests a great deal for you that is just as safe as a CD,
but will deliver amazing returns, keep a few things in mind:

■ There are people out there trying to sell you junk. They know it’s bad, and they
don’t really care much about you and your needs. They will even lie to you.

■ When something is too complex to understand, either run as fast as you can or
hire an independent professional to help you navigate the complexity. Don’t just
guess and hope you understood correctly.

■ That said, getting professional advice at some level requires trust, but not blind
trust. You can’t trust anyone blindly. I’d suggest following the Russian proverb that
Ronald Reagan adopted during the cold war: trust, but verify.

■ When something appears too good to be true, it often turns out that it is. It may
not happen immediately, but at some point there will be a consequence.

■ Ultimately we have to take responsibility for our own decisions. This is painful.
After all, the system doesn’t always work the way we think it should. People lie.
People steal. And institutions we thought we could trust let us down. But it’s the
system we have right now, and even as we look for ways to improve it and get
justice for bad behavior, we can’t pretend that how we behave isn’t part of the
solution, too.

I feel horrible for the investors who lost money to the wedding singer and to
Spanish banks. Both stories, however, reinforce the reality that the question — is
it safe? — doesn’t tell us much. If we want to protect ourselves from individuals
and institutions alike, we need to ask questions that help us uncover the real
motives and whether it’s in our best interest to trust what we’re being sold.

Read No. 5
A Sweet Lesson in Price Perceptions

I have a confession to make: I love Talenti gelato. I often stop at Whole Foods to

get a pint of Sea Salt Caramel. I consider it a guilty pleasure for two reasons:

• I often eat the whole pint before I get home.

• It’s $4.99 for ONE pint.

That’s almost $40 a gallon, and just about every time I buy it, I think about how
crazy it feels to spend that much on a pint of gelato. Then a few weeks ago, things
changed.

As I opened the freezer section, there was something new sitting next to my
Talenti: Jeni’s Splendid Ice Creams. Jeni’s offers a Salty Caramel flavor!

Then my eyes landed on the price: $11.99 a pint!

At that precise moment, I noticed a shift in my thinking. Somehow the appearance

of an $11.99 pint of gelato made me feel much better about my purchase of the
$4.99 one. I smugly grabbed my regular Talenti and walked to the checkout
counter feeling as if I had saved $7.
At that moment, I anchored to a number. The price of the gelato I normally buy
didn’t change. It was still $4.99 a pint. What changed was how I thought about
that price compared with the new option at $11.99 a pint.

Now, I have to confess that I tried Jeni’s Salty Caramel, and I can make a strong
argument that it’s worth every penny. But as this experience shows, anchoring to a
number can change the way we think about our financial decisions. I went from
thinking it was crazy to spend $4.99 on a pint of gelato to convincing myself I was
“saving” $7.

Anchoring is a well-known financial problem, and my gelato buying captures a simple

version that doesn’t cost me much in the big scheme of things. But it can become a
problem when making big financial decisions, like buying a house or a car and selling
stocks.

1. Buying a House

In May, the Journal of Economic Behavior & Organization posed the question: What

happens when someone selling a house sets a high asking price? The researchers
determined that a higher asking price (10 to 20 percent over the actual value of
the house) led to a higher selling price.

Buyers weren’t stopping to ask the obvious question, “What’s the actual value of a
particular house?” Instead they were focused on the asking price, anchoring to the
higher number, and bidding more than they needed to. The ultimate price made
them feel as if they were getting a deal.

2. Buying a Car

Next to buying a house, a car is usually one of the biggest financial decisions we
make. It’s also heavily influenced by anchoring. For instance, when you go to the
dealership, it’s not unusual for the discussion about price to become a discussion
about the monthly payment you can afford. “Don’t worry about the sticker price,”
the salesman says. “I can get you that monthly payment.”

By anchoring the big price of the car against the smaller monthly payment, we miss
asking important questions like, “How much will I pay in interest?” If the monthly
payments seem reasonable when compared with the price of the car, it can seem
like we’ve made a good decision when in reality it may end up costing us more than
we ever planned to spend.

3. Selling Stocks

I discussed this issue a few years ago, but it’s worth pointing out again that
anchoring isn’t limited to buying stuff. We do it when we’re selling, too. The classic
example is the stock you bought last year for $50 a share. Today, it’s worth $30 a
share.

Instead of assessing whether it’s a stock you should own based on your goals,
you’re looking at the number. You tell yourself you’ll sell when it gets back to $50.
By anchoring to the bigger number, you’re ignoring the other reasons that it may
be time to sell, including opportunities to make investments that better fit your
goals. It’s a decision that may end up costing you more than $20 a share.

Knowing that we’re inclined to anchor, the smartest thing we can do is take the
time to figure out our real numbers. If you’re going to anchor, anchor on a number
that’s relevant to you and your decision. Don’t let someone else set the number
that determines if you buy or sell.

By taking the time to know which numbers really matter, like the actual value of a
house or how much interest you’re paying, you’ll avoid this classic behavioral
mistake. And if you’re really lucky, you’ll have saved enough so you can try Talenti’s
or Jeni’s for yourself. But be warned: It’s a hard habit to break.

Read No. 6

The Beauty of Limits

How often do we hear ourselves saying we want more? More freedom, more money,
more time. More seems as if it would always be great, until we get it. Then we’re
faced with a new set of problems that comes with having more.

My work is location-independent. My wife and I could live anywhere that our

budget will allow, and that ends up being a lot of places. Normally having more
options is what we want, but this has actually led to a consistent problem that we
spend a lot of time discussing.

When we decided we were ready to leave Las Vegas, the options were a bit
overwhelming. We started to envy friends who were transferred to a specific city
for work, even if the city wasn’t our idea of paradise.

It removed the pain of having all these options. It made things simple. They went
where they were told. Instead of considering multiple cities and states, our friends
just needed to find the best place to live within one geographic area.

Besides our budget, we didn’t have much else to help narrow our options. The
number of options wasn’t making the process easier, just more stressful. Luckily
our decision to land in Park City, Utah, has worked out incredibly well. But I’m not
looking forward to the day (if it comes) that we decide it’s time to move again.

I was reminded of this “more dilemma” a few weeks ago on my way to an interview.
The taxi driver asked me where I was headed. I explained that I was on my way to
talk about what advice I’d offer to the next Powerball winner. Barely able to
contain his excitement, my driver pulled out his lottery tickets, and while waving
them around, talked about how amazing it would be if he won.

Three tickets ended up winning the $448 million jackpot, two in New Jersey and
one in Minnesota. I’m pretty sure my taxi driver wasn’t one of them, but our
conversation got me thinking about this question: Why do we want to win? Yes, I do
know there’s an obvious answer, but the obvious answer hides a few problems.

We say we want more money (who doesn’t?), but it’s surprising to me how few
people can explain exactly what they’d do with that money. Oddly enough, not
knowing why we want more can create problems.

Think about our constant pursuit of happiness (it is affirmed in the Declaration of
Independence). We often define happiness as more money or time, but if we don’t
understand why we’re pursuing it, can we really understand the trade-offs
involved?

Do we understand that the pursuit may actually cost us the very thing we’re
pushing so hard to achieve?

Paul Graham, the co-founder of Y Combinator, has an interesting perspective on

this problem. As a successful programmer and venture capitalist, he’s had many
opportunities to see this pursuit of more up close and offered this thoughtful
insight:

“Most people would say, I’d take that problem. Give me a million dollars and I’ll
figure out what to do. But it’s harder than it looks. Constraints give your life shape.
Remove them and most people have no idea what to do: look at what happens to
those who win lotteries or inherit money. Much as everyone thinks they want
financial security, the happiest people are not those who have it, but those who like
what they do. So a plan that promises freedom at the expense of knowing what to
do with it may not be as good as it seems.”
It may seem counterintuitive, but constraints give us something to use as a
framework, a way to help us judge what we do next. Think about what constraints
do for investing. Imagine you had more time to focus on your portfolio. What would
you do with it?

I suspect you might do something kind of foolish, like trying your hand at being a
day trader. After all, you have the time, why not? But if your time is limited, how
much more likely are you to behave? How much easier would it be to buy good
things and then own them a long time because you don’t have the time to do
anything else?

It seems crazy to think about having too much time. Yet I see retirees or
entrepreneurs who sold their businesses bouncing off the walls in the first few
months of making the transition. They suddenly have all this time on their hands,
and freed from the constraints of a daily schedule, they don’t know what to do.
More time hasn’t made their lives happier, at least at the beginning, but I suspect
many of them thought it would.

Sometimes we become so focused on what we think we should want that we’re

blinded to what’s right in front of us. A great example is this classic joke:

A fisherman owns a boat and is running a nice fishing business with it. He meets a
venture capitalist who promptly offers to invest in the man’s business.

Fisherman: “Why would I want you to invest?”

V.C.: “Well, with my capital you can buy a second boat and double the size of your
business.”

Fisherman: “And why would I want to do that?”

V.C.: “Because eventually you’ll grow your business so large that you’ll end up selling
it and making a big wad of cash.”

Fisherman: “You mean, so that I’ll be able to retire down here and buy a boat?”

I’m the first to admit that more freedom, more money and more time can mean
good things for people. But the next time you hear yourself saying, “I want
more... ,” you’ll most likely be happier with the result if you remind yourself of
these three things:
1. More of anything doesn’t always make life easier, and it can make your choices
harder.

2. Constraints can give us structure and help us make the most of what we do have.

3. If you’re chasing after more, do yourself a favor and create a plan for what
you’ll do if you ever get it.

More without constraints or plans just becomes a burden, one more problem we
need to solve. And that seems like the last thing that will make you happy.

This article has been revised to reflect the following correction:

Correction: August 19, 2013

An earlier version of this article misidentified the American document that refers
to the pursuit of happiness. It is the Declaration of Independence, not the
Constitution.

Read No. 7

Diversification Isn’t Broken, It Just Takes a While

It’s a classic moment in sports history. With less than 20 seconds left in Game 6 of
the 1998 N.B.A. finals and the Chicago Bulls down by one, Michael Jordan goes one-
on-one with Bryon Russell of the Utah Jazz. He pushes off (clearly!), Russell
stumbles and the ball hits nothing but net. Game over. Bulls win.

Now let’s imagine that something different happened. Jordan misses the shot in
Game 6, and Game 7 comes down to the same spot: fewer than 20 seconds left with
the Bulls down by one. If you’re Phil Jackson, the head coach, do you set up the last
play for Jordan, or does the ball go to someone else? Remember, Jordan missed
the night before.

Of course the right strategy is to put the ball in Jordan’s hands. Just because he
missed the shot before doesn’t mean it was the wrong strategy to have Jordan
shooting the ball in the final seconds. The odds are incredibly high that he will
make the shot even though he missed it the night before.

I bring this up because it perfectly captures the investing adage that never seems
to die: diversification is “broken.” It seems as if this story pops up every year, but
it’s not really about anything new. Both Joshua M. Brown at The Reformed
Broker and Barry Ritholtz at The Big Picture have written blog posts about it
recently. Mr. Brown quoted an adviser who said:

“Why bother diversifying at all? It’s just a drag on performance. What’s the point
of owning any bonds or international stocks?”

So here’s the 2013 version of the diversification story.

Let’s say at the beginning of 2013 you finally decided you were going to stop
pretending to be a trader and instead be a long-term investor. You were going to do
what most of the academic research recommends and build a diversified portfolio
of low-cost investments. Then you planned to hold on to it for a long time.

As part of your new plan, you put something like 30 percent of your portfolio in
international mutual funds. Now seven months into the year, you’re disappointed
because international has done poorly relative to your Standard & Poor's 500-stock
index fund. In fact, year to date, your S.& P. 500 index fund is clearly the only
place you should have put all your money. Its gains have been twice those of almost
any other major asset class.

Obviously, it was a mistake to diversify, right? Wait. Before you answer, let me
share one of my favorite stories about diversification.

In 1998, the S.& P. 500 ended the year up 28.6 percent. But nothing else was really
performing. Small-capitalization stocks were down 2.2 percent, and small-cap value
stocks were in the tank. The temptation to go all in on large-cap technology stocks
proved to be too much for most of us. After all, nothing else was working.

Now fast forward to 2001. The tech bubble had burst. The S.& P. 500 was down a
bunch in 2000 and ended 2001 down 11.9 percent. Based on those numbers, it’s fair
to assume the stock market was terrible, right? Well, it depends on which market
you were talking about.

Remember those small-cap stocks that everyone was complaining about in 1998 and
’99? Sit down for this. In 2001, while the S.& P. 500 was getting crushed, small-cap
stocks returned 17.6 percent. And small-cap value stocks, down 10 percent in 1998,
ended 2001 up 40.6 percent.

Wild!
I suspect your first thought to this example is, “Why not just buy things right
before they go up and sell before they go down?” Let me save you a lot of money
and many headaches. It’s all but impossible for investors to catch all the up while
avoiding all the down. But it can be equally difficult for us mere mortals to stick
with diversification because it looks as if we should be able to time the market,
and, well, diversification isn’t sexy or exciting.

First, diversification works over time, and no, seven months doesn’t count. When
we talk about diversification working, we’re talking in terms of years, even decades.
Not just days, weeks or even months. In other words, we’re talking in investing
terms, not trading terms. We don’t like things that take a long time to work. We
want to know what’s working now.

Second, diversification is not exciting. It’s the investing equivalent of hitting

singles and doubles your whole life, and who grows up wanting to do that? We want
to hit home runs. Players who try to hit home runs every time (like timing the
market) are going down swinging in a blaze of glory or knocking it out of the park.
Either way, it’s cool, sexy and exciting — all the things diversification is not.

Finally, diversification can look like a mistake at any given moment. A well-designed
and diversified portfolio will always have something that’s not doing well, a few
things that are average, and, hopefully, one or two things that are exciting. The
problem, of course, is that the investments change places about the time you’ve
had enough and you decide it’s time to boot out the underperformers. It’s human
nature to run from things that cause us pain and get more of the things that bring
us pleasure. It’s why we look for ways to “fix” our portfolios.

It may seem counterintuitive, but if you have something in your portfolio that
you’re complaining about, it’s a good sign you’ve built a diversified portfolio. And if
that’s the case, you’re probably complaining right now about international mutual
funds and wondering why you aren’t invested 100 percent in the S.& P. 500. But as
Mr. Brown so wisely notes, “Five months still to go, anything can happen …”

Next year, there will be a different story about why diversification is “broken,”
but all it takes is looking at the year before that, then 5, 10, 15 and 20 years
before that to see why you want to hit singles and doubles for the rest of your
investing life. Personally, I’d rather save my energy for other things besides trying
to second-guess which market will take off next. I’ve got better things to do. Don’t
you?

Read No. 8

The Affordable, and Therefore Enjoyable, Vacation

Quality time with my family is on the top of the list of things that I value. In the
past, however, when we went on vacation specifically to spend time together, I was
often no fun to be around because I was so anxious about money.
Things always cost more than we had planned, mainly because we hadn’t really made
a plan. Sure, my wife and I would talk a bit about what we thought the trip would
cost. That process is no fun, though, so we would skip the details and just go with a
general idea. I would make some assumptions about the budget and then anchor a
number in my head. You can see the problem. The number was little more than a
guess, and it was always low.

So this summer, after close to 18 years of this pattern, we decided to try

something different: plan a trip that we knew would be in our budget. Then I tried
to stop worrying about it. We settled on how much we were comfortable spending
and planned the trip around that number. So what does this process look like?

First, pick your trip, then sit down and figure out how much things will cost.

We wanted the vacation to be both affordable and exactly the way we wanted it.
But if a particular trip wasn’t possible, we agreed to choose a different one that
fit both requirements. Trust me, it’s not worth going on a trip you can’t afford.
Just ask your spouse and children how much they enjoy being around you when
you’re telling them you can’t afford dessert.

Second, count on a vacation surprise factor.

Even if you’re the best planner in the world, the unexpected still happens, and
vacations aren’t immune to this reality. Food may cost more. Hotels may add on an
unanticipated charge. And some attraction you didn’t know existed will become the
activity your familymust  do.

For instance, on our recent trip, we stopped for lunch and the food turned out to
be more expensive than planned. I could feel the tension building in my shoulders.
My wife noticed and reminded me, “We planned on surprises for this trip.” That
quick reminder allowed me to let go of the stress and kept me from derailing our
trip.

In the end, this vacation and the experiences I shared with my family were worth
every second we spent planning, budgeting and assuming we would be surprised at
least once. You owe it to yourself and your family to follow these two simple steps.
It will probably change the way you think about vacations and let you enjoy what
you have worked so hard to accomplish.
Read No. 9

Some Investing Stories Sound Good Until You Analyze Them

Making smart money decisions is an incredibly difficult way to behave. So after my

post last week about buying a house based on your situation, my jaw dropped when
I saw an article in The Wall Street Journal about young home buyers.

“A new generation is skipping the ‘starter home’ and betting heavily on high-end
real estate.”

Seriously? We’re back to “betting” on real estate?

Now, the stories are incredibly persuasive, but hidden within them is something
else. When asked why they are buying an expensive home, or even buying multiple
expensive homes to rent, young buyers say they are doing it as an investment
strategy.
“Buying real estate has grown more attractive, these young buyers say, compared
with the stock market, which appears riskier to a generation that entered the work
force during a market correction,” the article in The Journal says.

This reminds me a lot of what I have referred to before as “that guy.” It’s the guy
at a neighborhood barbecue or in the office who always has a story to share about
how easy it is for him to make money. The problem is he only talks about the times
he made money, not the times he didn’t.

The stories of these young real estate buyers, like Matt Winter, follow a similar
theme.

“ 'I have always felt that having your money in property is the safest and best
thing to do if you want to grow your personal wealth,’ says Mr. Winter, who
founded his design company at 23. None of Mr. Winter’s assets are in the stock
market — he says the market ‘spooks him’ and that he prefers to invest in real
estate,” the Journal article reads.

Stop and think about this for a minute. Mr. Winter is now all of 28, and the story
he is telling is that property is the safest place to increase your wealth. But I
suspect that if you ask anyone dealing with real estate in the last 10 years (or who
is over 40), they would disagree with the idea of it being safe. So why is our
attention caught even though our experience tells us something different?

When we hear stories like this one, about young, beautiful people spending a lot of
money, it’s easy to go with the assumption that they must be making smart
decisions, too. After all, who doesn’t want to buy a house on the beach? And in our
desire to be like what we see in those glossy beauty shots, we ask the question,
“Shouldn’t I be doing that, too?”

We remind our children all the time, “If your friend jumped off a cliff, would you?”
And yet when we ask that question, we are engaging in similar herd behavior. We
need to recognize that we aren’t those people, and whether they are making a good
decision isn’t the point. All that matters is whether it is actually a good decision
for us, and these stories can make it difficult to reach this conclusion.

So lest you think I’m picking on these people only because they are young, beautiful
and wealthy, let’s take a look at what are some flat-out questionable arguments.
Buying real estate is a safe way to build wealth. Because most people don’t hand
over a sweaty wad of cash, real estate usually involves leverage in the way of a
mortgage. While leverage can be good, it’s a double-edged sword. There are
certainly home buyers in Phoenix and Las Vegas who would argue with the idea that
property is the safest investment.

You will get hurt in the stock market. I get why real estate looks so attractive,
especially to younger buyers. As the article noted, it is hard to trust the stock
market if what you have seen to date hasn’t been wonderful. But it takes a
willingness to ignore history to go with the story that real estate represents a sure
thing in comparison to the stock market.

It makes sense to buy a second property as an investment. If you’re thinking about

becoming a landlord, think again. Barry Ritholtz captured the problem with the
rental market perfectly: There are a lot of rental properties just sitting on the
market. And with a lot of people playing the rental and investment game at the
moment, can you afford to have your investment property sitting empty? Don’t
assume that a home you have bought to rent will actually generate rent every
month to justify the purchase.

Buying real estate may turn out to be a great decision for the people profiled in
The Wall Street Journal. But the notion of real estate as being somehow a better
or safer investment than the stock market doesn’t add up based on what we know.

We know that the weighty evidence of history tells us that having a low-cost, well-
diversified portfolio has been the better investment in the long run. We know that
we probably don’t want to become landlords, either. And most important of all, we
know what matters most when it comes to investing success: behavior.

So the next time you see stories like this one, keep in mind that you know better.
You know what questions you need to ask before buying a house. You know what
kind of investments you need to reach the goals that matter to you. And you know
that what might work well for someone else isn’t guaranteed to work for you.

Read No. 10

It’s Not Everyone’s Time to Buy a Home

My family and I are renters, and most of the time that feels fine. But last week I
found myself in a state of temporary panic when I read this Twitter post from the
financial journalist Felix Salmon: “John Paulson: if you rent, buy. If you own, buy a
second home.”

When I read it, I immediately felt anxious. I recognized the feeling. It’s the
feeling you get when you think you have to act on something right away or you’ll
miss out. After all, if John Paulson, the guy who made “The Greatest Trade Ever,”
was saying I should rush out and buy a house, I’d better get on it!

After allowing myself to get all worked up about this, I did what I’ve done several
times before. I pulled out a piece of paper and a pencil and worked through the
emotions and the numbers. In the end, I was reminded of something incredibly
important.

John Paulson doesn’t know me or my situation.

There is absolutely no reason I should be making decisions based on something he

said. The same is true for any other “expert” who decides to share his guess about
what he thinks will happen next in the housing market.
The same holds true for the other three people who just happened to express
similar concerns to me about buying right now. Two were convinced that if they
didn’t buy a house now, they’d be priced out of the market, and maybe they will be.
But I heard that argument a lot in 2005-6.

Then there was the third conversation I had.

It’s time for this person to downsize to a different home. The children have all
moved out and the house just takes too much work. But even though it’s the right
decision to sell now (given her individual situation) and buy a smaller home, a
decision has been made to wait because the news, the forecasts and even the
guesses are implying that the house could be worth substantially more sometime in
the next 12 months.

This is madness!

Buying a home is one of the biggest financial decisions that most of us will make in
our lifetimes. And yet it’s often a decision in which the person with the most
knowledge about what makes the most sense gets overlooked: You.

There’s a simple way to fix this problem. As I was reminded last week, all it takes
is a piece of paper, a pencil and some time. So if you’re struggling with this decision
to buy (or sell), take a minute to think through these questions and write down the
answers, because I suspect you’ll need to refer back to them the next time
somebody decides to share what he thinks will happen with housing market. This
list is not meant to be prescriptive. It is meant to get you thinking about something
other than forecasts and guesses.

■ Can you afford it, and do you have enough saved for a down payment? Make sure
you include the cost for things like property taxes, homeowner association fees
and utilities.

■ Can you qualify for a loan? If the answer right now is no, then you can stop
torturing yourself, because it doesn’t matter if the market is about to take off.
You can’t buy a house.

■ How long do you plan to live in the home? There’s some debate about the minimum
time you should live in a home for it to be worthwhile, but if it’s less than five
years, forget about it.
■ What guess are you making about housing prices? It is a painful reality that the
one variable that makes a huge difference in this decision is unknowable. What is
going to happen to housing prices in the short term is anyone’s guess. But for your
own sanity, just assume that housing prices will continue to increase by about the
long-term average of inflation, or 3 percent. You really can’t afford to buy a house
if the decision depends solely on what the house might one day be worth.

The answers to all of these questions will depend on you and your individual
situation. And that’s the point. Hopefully it’s clear now how ridiculous it is to buy a
house based on some stranger’s advice.

Through this process, you may discover that buying and owning a house isn’t for
you, and that’s O.K., too. But these questions can also help end your anxiety around
what is probably the biggest financial decision you’ll make. Don’t you think that’s
worth a piece of paper, a pencil and a little time?

Read No. 11

Squeezing the Most Out of 401(k)’s, for Now

We hear a lot of discussion around the idea of reform. Reform the government.
Reform the banks. Reform education. Reform health care. In fact, it’s hard to
think of a system we’re 100 percent happy with.

So it’s no surprise to see many headlines and stories recently about the “failed”
401(k) experiment and how we need a different system to finance and manage
retirement. It’s also easy to see why John C. Bogle, founder and retired chief
executive of the Vanguard Group, described 401(k)’s as “a thrift plan that we’ve
tried to redesign into a retirement plan.” The average amount in 401(k)’s doesn’t
bode well for people looking to retire in their 60s and live 20-plus years. There are
clearly some issues with the current system.

Let’s say we accept the premise that the system needs to change, that we as a
society need to adopt a better way, a different way to help people finance their
retirement. Let’s say further that we agree that maybe saving for retirement is
better addressed as a collective, societal issue rather than an individual one. If we
believe that, then we should pursue reform and advocate change to our elected
officials.
But at the same time, we have to accept the reality we live in now. Even if we
believe that the retirement system is broken, it is the only system we have, and we
all know that it isn’t changing anytime soon.

It’s when we reach this point that I see a potential disconnect, maybe even a moral
hazard. If we focus exclusively on the problem, in this instance the 401(k) system,
it can be incredibly easy to abdicate personal responsibility. However, no matter
how bad the system, we’re only hurting ourselves if we separate personal
responsibility from reform.

We need to accept the fact that working for reform and taking personal
responsibility are not mutually exclusive.

Even though we may wish it were different, the 401(k) is the option most of us
have to plan for retirement. As part of the reform process, you owe it to yourself
to get the most you can from the current system. Simply saying the system is
broken doesn’t absolve you from making the best possible financial decisions you
can.

We have a personal responsibility to understand the current system and make the
best of it even as we’re trying to reform it. That means doing things like actually
participating in your 401(k), making sure you take advantage of any match your
employer might offer, selecting investments inside your plan that match your goals,
maxing out contributions and not borrowing money from your 401(k).

Obviously, these five things won’t fix the broader problem we have as a society of
being woefully unprepared for retirement. We have a system that needs fixing so
it can serve a wider group of people, and we should all be advocating for those
changes. But don’t let your frustration blind you to the things you can do right now
in the system we have.

It reminds me a bit of this idea that we’re all waiting around for the day when
scientists announce that they’ve found a pill that lets us eat anything, never
exercise and live forever. What if they made the announcement tomorrow but said
the pill wouldn’t be available for five years?

Would you stop eating healthy and exercising? Doubtful, because even though they
may not be your favorite things to do, they’re still the only things you have at the
moment to keep you healthy between now and five years from now.
That’s how it is with 401(k)’s. Hopefully something better will come along, but in
the meantime, work with the tools you have to get you from here to there.

Read No. 12

Lessons Learned From Well-Behaved Investors

During my time writing for Bucks, I’ve read several comments from different
people that share a common theme: “I don’t have any trouble behaving when it
comes to investing. So why can’t you?”

If you fall into this group, investing and behaving may appear so simple to you that
you can’t help but wonder if the rest of us are short a few brain cells. But your
ability to behave is really quite remarkable.

After all, as Daniel Kahneman noted in his brilliant book, “Thinking, Fast and Slow,”
we all suffer to some extent from cognitive biases that make it nearly impossible
to behave. These biases often cause us to take mental shortcuts that can thwart
our efforts to successfully balance logic and emotion.

In a recent interview with Morgan Housel of The Motley Fool, Dr. Kahneman
explains why some people (maybe you?) can better handle these biases. He also
discusses why these biases can be so hard to avoid (the portion of the interview
presented below was edited out of the video for space):

Morgan Housel: We often hear that Warren Buffett was born hard-wired for the
traits that he has as an investor, which sounds nice. But I wonder if there’s any
truth to that. Is there evidence that some people are more prone to cognitive
biases than others?

Dr. Kahneman: Yes. There certainly are differences among people. There are
differences in intelligence and there are differences in cognitive style and the
degree to which people check themselves. So some people definitely are more
prone to biases than others. That doesn’t mean that they are doomed to be biased.
But certainly being prone to self-control and to slow thinking in general, you’ll find
differences in children aged 3 or 4, and some of these differences persist into
adulthood.

Morgan Housel: So most of these biases are things that we are born with; they’re
not traits that we learn.

Dr. Kahneman: The biases that I’ve been concerned with are really characteristics,
I think, of the way we’re wired to interpret the world. So in that sense, yes, we’re
born with them. I mean we’re born to see patterns, and if seeing patterns leads you
into bias, then that bias is built in.

We’re born with our biases. So what’s an investor to do?

Since behavior plays such a huge role in investing — and as Dr. Kahneman notes,
these biases are hard to avoid — you need a strategy to keep you on track. The
best source for figuring all of this out is watching the people who do behave well.
What do they do differently than the average investor?

1) Separate decisions from emotion

I’ve often said that I’m great at making unemotional decisions when it’s another
person’s money. But when it comes to my own money, it can be a struggle. Warren
Buffett is a perfect example of this principle. Mr. Buffett has said over the years
that he tries to be fearful when others are greedy, and greedy when others are
fearful. That is essentially putting into practice the notion of “buying low and
selling high.” And it means sticking with a plan even when it’s painful (for instance,
when stocks suddenly jump or slump).
2) Doing nothing is the default choice

When I heard about the study that found soccer goalies could be more successful
by doing nothing, I immediately understood why there would be resistance to the
idea that not moving could block more goals. I suspect most of us have a bias
toward action, especially if we think we’ll look stupid if we stand still. The best
behaved investors understand that it’s in their best interest to do nothing most of
the time, even though everyone else around them may be saying otherwise.

3) Understand that investing and entertainment are two different things

I’m the first to admit that reading and watching the so-called financial news can be
interesting, even outright entertaining. But those who manage to behave seem to
have adopted two approaches: watch it, but don’t act on it or ignore it completely.
They’ve drawn a line between investing and entertainment. They may watch and
read, but what they see doesn’t sway them from their plan.

Obviously, none of these three things are particularly complicated. So is something

more going on? Is it a case of survivorship bias, where the people who appear to
behave just haven’t made a mistake yet?

I doubt it. I think well-behaved investors are just better equipped than the
average investor over the long haul. But  they’ve also done something that the rest
of us can do. They have acknowledged the connection between emotion and
behavior.

There are no guarantees that we’ll avoid our biases in the future, or that we’ll avoid
making mistakes. But simply recognizing that the land mine exists may get us out of
some difficult situations or avoid them entirely. So take a look around you.

Do you know anyone who seems particularly well-behaved? How about someone who
bought something like a low-cost index fund and then stayed put for 10, 15, even
20 years?

What have you noticed about them?

Maybe I’ve misjudged the situation, and perhaps it isn’t possible to behave over the
long haul. Still, I’d like to think that we have enough examples from well-behaved
investors to learn from. And that can help make the seemingly impossible become
more probable for the rest of us.
Read No. 13

Investment Plans and Forecasts Don’t Mix

“I know you can’t time the market. But in your view, where is the market going?”

I still get this question from people, at event after event, even after people have
heard me talk about the importance of behavior and how we can’t predict short-
term market performance.

During a recent trip to South Africa, I got even more specific questions:

 Where is the United States economy headed?

 Where are interest rates headed?

 Is now a good time to invest in Japan?

 Is the housing recovery for real?

Here’s the thing: I totally understand why people are asking questions about timing.
First, there’s an assumption that having an opinion — whether it’s about the
market, the economy, or Japan — makes someone look smart. Being able to talk
about these subjects must mean you have more money and your investments do
better, right?

Not true.

Second, if you don’t talk about sports or politics that only leaves economic issues
(Again, not true. It just feels that way). Now maybe you like to talk about all three,
but it’s reached the point where talking about the economy and markets is an
official spectator sport. We all feel capable of playing.

And while it may be fun to chat about what the market might do next at your
neighborhood barbeque, don’t kid yourself. What we know about the market comes
down to a bunch of guesses, also known as forecasts.

Forecasts about the future of the market are very likely to be wrong, and we don’t
know by how much and in which direction. So why would we use these guesses to
make incredibly important decisions about our money?

That’s right. You shouldn’t because you know better, and relying on what’s really
just a hunch is an all but guaranteed recipe for financial pain.

Instead of relying on guesses to dictate our financial decisions, we need to focus

on the investing basics:

o Figure out where you are today

o Make a guess about where you want to go

o Buy diversified, low-cost investments that have the best shot of

getting there

o Behave for a long time

Obviously, this list isn’t nearly as interesting as speculating about whether the Dow
will break 16,000 before the end of the year. But it is a list that will keep you from
doing something dumb, like thinking it’s a good idea to bet your portfolio on a guess.

So, just in case I’ve left you in doubt, please don’t forget: Plans and guesses don’t
mix!
Read No. 14

Talking Numbers With Your Children

Few things will humble parents faster than when they realize they’ve made some
dumb assumptions about their children. And twice in the last few weeks, my own
children have shown me where I’ve gone wrong when it comes to teaching them
about money.

I thought my wife and I were covering all the bases. We have talked about
budgeting. We have talked about saving. We’ve even talked about why we made
certain financial decisions. But guess what we never really talked about? Numbers.

You’ve probably done it, too. Let’s say your children know that you’re buying a new
car. You probably wouldn’t talk to them about how much it cost.  After all, they
could mention the number to your neighbors, and you wouldn’t want that to happen.
So, here’s what I learned from my children. Hopefully, my own experience will help
you have better conversations with your own children, as well as your spouse, or
anyone else that you share financial decisions with.

1) Don’t hide the numbers

One Saturday afternoon, I decided to stop at the boat shop. I have fond memories
of long summer days at the lake, and I wanted to see what it might cost to buy a
boat for our family. The fact that we don’t really need a boat probably explains
what happened next. But since I was feeling a little sheepish about the whole
“needs versus wants” subject, I hid the price tag when my son asked me how much
the boat cost.  And I compounded the mistake by making up some funny number,
like 54 quarters, to try to throw him off.

I should have shown my son the price and explained: 1) why a boat costs that much;
2) why I think it’s worth that much money; and 3) how we saved as a family over
the previous years to afford it (should we decide to buy it). In short, I would have
helped my son put the buying decision into context, which leads me to the next
lesson.

2) Don’t assume your children think the same as you

One of the best parts about being a parent is getting to watch my children make
decisions and try new things. Little did I know that my daughter’s decision to
explore soccer would be a lesson for my wife and me. After attending the
orientation meeting, my daughter came home and explained what she’d learned, and
my wife asked her about the costs to play.

My daughter replied “$20,000,” with just a slight hint of caution.

After seeing my wife’s shocked expression, she was quick to assure her mom that
it covered two uniforms and an assortment of other things for the entire season.
But, and I think you can see where I’m going, my daughter hadn’t made the
connection between the crazy number and what she thought she was getting in
return.

To be clear, the disconnect isn’t because we’re a family who uses money as paper
towels. And our children know what it means to earn a few dollars doing chores.
They have savings accounts. They have an allowance. But it appears that we haven’t
taken the time to give my daughter a point of reference for a number as large as
$20,000. Because a number this large was unfamiliar, and because she had never
played soccer before, she didn’t have any real context to help her understand why
it didn’t make any sense at all.

As it turns out, $20,000 was actually the budget for the entire team for the
entire season. The cost per player was closer to 1/10th of that number. But my
daughter’s experience made it perfectly clear that we had dropped the ball.

So, the next time you’re talking with your children, your spouse or anyone else
about money, please make sure that you’re talking about the same thing. Don’t avoid
talking about the numbers or the price. And please don’t make the same mistake I
did, and assume that it’s not worth having a conversation that gets specific. Based
on these experiences, I’m convinced that there would be fewer money issues in our
families if we worried less about what people thought and more about what our
families know.

I want each of my children to know what things cost so they can weigh the pros
and cons of buying this versus buying that. I want my kids to understand just how
much money $20,000 is so that they can make a fair judgment about the worth of
something compared to what they’re getting in return. And perhaps most important
of all, I don’t want my discomfort to stop me from providing my kids with the skills
and information they need to make smart money decisions.

I bet you want the same things for your children, too.

Read No. 15

Market Forecasting Isn’t Like the Weather

Because I live in the mountains where the weather changes often, I’ve never really
relied on forecasts. Instead, I prefer to look out the window to see what’s
happening outside. My low-tech approach made sense for years. But my strategy —
and the jokes about weather forecasters — may one day be a thing of the past.

Even as you yell at your TV during the weather segment of your local newscast,
forecasts are actually getting more accurate, as a story in The Seattle Times
points out:

Three-day forecasts today are as good as 36-hour forecasts were in the 1980s.
The average error in hurricane-track prediction has been slashed by two-thirds
since the early 1970s.

While it’s pretty impressive that we have gotten so much better at predicting
short-term weather patterns, seven-day temperature forecasts are still only
accurate 5 percent of the time. But we are getting better.

This improvement is a result of computer models that collect all the data —
temperatures, clouds and winds — and put it into mathematical equations. The
result was simulations that beat human forecasting during a 24-hour window.

These models were built by looking for and identifying variables that offered some
predictive value. Over time, as more of these factors were identified and fed into
the model, the accuracy of the forecast improved.
We have been attempting to do the same thing with the stock market. We have
spent endless amounts of time, money and human capital trying to identify
variables that help predict market behavior. We have looked at the ridiculous
(Super Bowl winners) and  the more serious (past performance). Still, none of them
have much predictive value, particularly over the short term.

But that doesn’t stop us from looking, which often leads to guessing. And guessing
is no way to make investment decisions. Once we think we have found something in
the data that appears to be a pattern, “we pretend to know things we don’t,” as one
weather researcher said in the article.

The pioneering investor Ben Graham is said to have described the market as being
hard to predict: “In the short run the stock market behaves like a voting machine,
but in the long term it acts like a weighing machine.”

And because humans are doing the voting, it’s very difficult to predict which way
the vote will go. Another reason is that investing is not a physical science.

It’s not like gravity, or even the weather. It doesn’t follow set laws. On any given
day, the stock market represents the collective feeling of all of us. More often
than not, those feelings are based on fear or greed. And it is only in hindsight that
we recognize that mistake. So while on one level human behavior seems predictable
(e.g., we get excited and buy stocks when they are flying high; we get scared and
sell when stocks decline), it’s awfully hard to know what we’re doing until it’s too
late.

I bring up the subject of forecasting because despite knowing better, I still see a
lot of people playing what I consider a fool’s game. There is no proven, market-
predicting model hidden in a computer that only a few people have access to.

The facts have remained the same. Over time (think 10, 15, or 20 years), stocks
typically do better than bonds, and bonds typically do better than cash. Low
expenses are typically a good sign of future relative performance. We also know
that a diversified portfolio will help protect you from the variability of the stock
market.

Beyond that, it’s just a guessing game. And we’re pretending to know something we
don’t.

I’m ready to stop pretending. Are you?

Read No. 16

What You Don’t Know About Your Portfolio May Help You

Back in 2008, a friend of mine left for a two-week trek in Nepal. While he was
gone, the entire financial world exploded.

Merrill Lynch was sold to Bank of America. Lehman Brothers filed for bankruptcy
protection. A.I.G. received an $85 billion loan from the Federal Reserve to avoid
bankruptcy.

But here’s the interesting part: he didn’t know anything happened because he didn’t
have any connection to the outside world. Although recently retired from the
investment industry, my friend would have been glued to his computer. But he had
no idea what was going on.

Think about that for a minute. I remember those days. I remember waiting up to
see how markets opened in Japan. I remember being so worried that I didn’t sleep
for days. And I remember another friend who called me from a cruise ship to ask
if things were O.K. He said that many other passengers got off at the first port
and flew home to deal with what was happening in the market.

My friend in Nepal missed it all, and it didn’t make one bit of difference. He was
actually better off.  All my worrying didn’t change one thing.
In fact, my friend said that when he got back and eventually heard the news,
something became crystal clear. He knew exactly what was going to happen for the
rest of his life: the markets were either going to move up and then down, and then
up and down again — and then he would die. Or, they would go down and up and
down and up — and then he would die.

In either scenario, he was still dead. And no amount of obsessing over the stock
market would change that.

This idea of being unconnected for a few weeks reminded me of Warren Buffett’s
statement: “Benign neglect, bordering on sloth, remains the hallmark of our
investment process.”

But it’s still so hard to ignore the market because we’re so connected. We seem to
be obsessed with economic news. I’m not sure when exactly it happened, but
sometime in the 1990s investing became America’s favorite spectator sport. I knew
there was a problem while sitting in my dentist’s office and seeing CNBC on the TV
in the lobby. It’s only become more difficult to avoid, now that everyone has a
smartphone.

But knowing doesn’t help. And much of the time, it actually hurts. Aside from the
tendency to trade too much when we’re following every market move, there’s also
the issue of our happiness. It doesn’t feel good when our investments go down,
even if it’s just for one day.

We have an aversion to loss. In other words, you’re likely to feel the pain of loss
far more acutely than the joy of an investment gain. We feel twice as bad losing
money as we do making money. And yet, knowing this, we continue to do things that
will cause us pain.

Since many of us use the Standard & Poor’s 500-stock index as a proxy for the
market, let’s take a look at the period from 1950 to 2012 to see how often we’re
likely to feel positive, based on how often we check our investments:

 If you checked daily, it would be positive 52.8 percent of the time.

 If you checked monthly, it would be positive 63.1 percent of the time.

 If you checked quarterly, it would be positive 68.7 percent of the time.

 If you checked annually, it would be positive 77.8 percent of the time.

So here’s the thing to ask yourself. Other than upsetting yourself half of the time,
what good is it doing you to look anyway? Maybe we should all invest as if we’re
going on a 12-month trek in Nepal!

So along with your do-nothing streak, let’s see how long you can go without looking
at your investments (assuming you’re in a low-cost, diversified portfolio, of course).
I think you’ll discover that it makes you happier, keeps you from doing something
stupid and helps you become a more successful investor.

Read No. 17

Avoiding the Easy Trap of Buying High

Just when I thought investors had figured out to behave, I took a look at some of
the recent barometers of investor sentiment. And it led me to ask, “Are we really
going to do this again?”

“This,” if you’re wondering, requires looking back to 2009. Remember how you felt?
Remember being so scared that you couldn’t get out of stocks fast enough? I
remember. In fact, I remember that many of us swore that we would never, ever
invest in stocks again. But some of the previously burned have apparently been
reconverted.
For instance, let’s take a look at the Consensus Index which, as of June 3, reported
that 73 percent of investors are feeling “bullish.” Other measures have similarly
shown positive feelings about the market (although the AAII Index reading isn’t
quite as upbeat).

Stop and think about this change in attitude for a minute. Both the Standard &
Poor’s 500 Index and the Dow have already gained more than 120 percent since
March 2009, and the vast majority of investors are feeling “bullish” about the
stock market.

Doesn’t this sound familiar?

Before you accuse me of being being all gloom and doom about the market,
remember that I haven’t said anything about what I think the market will do. In
fact, I have no idea what the market will do in the future. I am, however, nearly
positive that I know what these excited investors are going to do.

By and large, these investors are investing based on emotion — my neighbor is in

the market, I have to be in the market, too. But they’re only setting themselves up
to repeat the mistakes of the market meltdown in 2008-2009. That’s because at
some point (and this doesn’t require a crystal ball) the market is probably going to
drop again. So investors who jumps back into the market today are likely to find
themselves repeating that same pattern of buying high (now) and selling low (at
some point in the future).

To be clear, I am not saying we should get out of the market. I am not saying we
can time the market. I am saying that the idea of people feeling “bullish” worries
me, especially when I see headlines like this in “USA Today“: “Bull run gets solid
footing.”

So if you’ve decided that now is the time to increase your allocation to stocks,
please take the necessary steps to avoid eventually selling out of fear once again:

1. Remember how you felt in March 2009.

Perhaps you have a reminder somewhere of how you felt in March 2009. Maybe it’s
little note in a journal, or a blog post, that will help you recall that feeling of dread
that caused you to sell. If you can’t find a reminder, talk to your spouse, your
accountant, your financial adviser or anyone who could remind you of that moment.
Try to bring those feelings back for a minute so you can avoid making the same
mistake again.

2. Make sure you have a plan.

To be clear, my advice today isn’t about whether it’s a good or bad idea to invest in
stocks. But it is foolish to invest without a plan, regardless of where the markets
stand. So make sure you have a plan based on your goals. Pay attention to
investment fees. Make sure you’re diversified. Then do your best to ignore your
investments. For the average investor, that’s really the only way I know to keep
your sanity.

3. Figure out how you’re going to avoid quitting next time.

Yes, there will be a next time. At some point, just like the best roller coasters, the
market will take a drop, and they don’t ring a bell before it happens. So make sure
you’re prepared for that moment. Have you placed some emotional guardrails in
place to avoid going over the edge? You will want to sell, but unless it’s a part of a
planned rebalancing, you can’t afford to let emotion drive you from the market
again.

Ultimately, these investor sentiment surveys aren’t telling us anything we don’t

already know. Average investors tend to get really excited about the market when
things are going well. But the idea that we’re about to repeat the same cycle we
just survived is ridiculous. You owe it to yourself to figure out a plan that gets you
through both the ups and the downs of the market.

We know better. We should act like it.

Read No. 18

Avoiding the Easy Trap of Buying High

Just when I thought investors had figured out to behave, I took a look at some of
the recent barometers of investor sentiment. And it led me to ask, “Are we really
going to do this again?”

“This,” if you’re wondering, requires looking back to 2009. Remember how you felt?
Remember being so scared that you couldn’t get out of stocks fast enough? I
remember. In fact, I remember that many of us swore that we would never, ever
invest in stocks again. But some of the previously burned have apparently been
reconverted.

For instance, let’s take a look at the Consensus Index which, as of June 3, reported
that 73 percent of investors are feeling “bullish.” Other measures have similarly
shown positive feelings about the market (although the AAII Index reading isn’t
quite as upbeat).

Stop and think about this change in attitude for a minute. Both the Standard &
Poor’s 500 Index and the Dow have already gained more than 120 percent since
March 2009, and the vast majority of investors are feeling “bullish” about the
stock market.

Doesn’t this sound familiar?

Before you accuse me of being being all gloom and doom about the market,
remember that I haven’t said anything about what I think the market will do. In
fact, I have no idea what the market will do in the future. I am, however, nearly
positive that I know what these excited investors are going to do.

By and large, these investors are investing based on emotion — my neighbor is in

the market, I have to be in the market, too. But they’re only setting themselves up
to repeat the mistakes of the market meltdown in 2008-2009. That’s because at
some point (and this doesn’t require a crystal ball) the market is probably going to
drop again. So investors who jumps back into the market today are likely to find
themselves repeating that same pattern of buying high (now) and selling low (at
some point in the future).

To be clear, I am not saying we should get out of the market. I am not saying we
can time the market. I am saying that the idea of people feeling “bullish” worries
me, especially when I see headlines like this in “USA Today“: “Bull run gets solid
footing.”

So if you’ve decided that now is the time to increase your allocation to stocks,
please take the necessary steps to avoid eventually selling out of fear once again:

1. Remember how you felt in March 2009.

Perhaps you have a reminder somewhere of how you felt in March 2009. Maybe it’s
little note in a journal, or a blog post, that will help you recall that feeling of dread
that caused you to sell. If you can’t find a reminder, talk to your spouse, your
accountant, your financial adviser or anyone who could remind you of that moment.
Try to bring those feelings back for a minute so you can avoid making the same
mistake again.

2. Make sure you have a plan.

To be clear, my advice today isn’t about whether it’s a good or bad idea to invest in
stocks. But it is foolish to invest without a plan, regardless of where the markets
stand. So make sure you have a plan based on your goals. Pay attention to
investment fees. Make sure you’re diversified. Then do your best to ignore your
investments. For the average investor, that’s really the only way I know to keep
your sanity.

3. Figure out how you’re going to avoid quitting next time.

Yes, there will be a next time. At some point, just like the best roller coasters, the
market will take a drop, and they don’t ring a bell before it happens. So make sure
you’re prepared for that moment. Have you placed some emotional guardrails in
place to avoid going over the edge? You will want to sell, but unless it’s a part of a
planned rebalancing, you can’t afford to let emotion drive you from the market
again.

Ultimately, these investor sentiment surveys aren’t telling us anything we don’t

already know. Average investors tend to get really excited about the market when
things are going well. But the idea that we’re about to repeat the same cycle we
just survived is ridiculous. You owe it to yourself to figure out a plan that gets you
through both the ups and the downs of the market.

We know better. We should act like it.

Read No. 19

The Only Investing Pattern That Matters Is Behavioral

A few weeks ago, I stumbled on some research by David J. Leinweber at Caltech.

Apparently,  he’s figured out how to predict the stock market using just three
variables:
1) Butter production in the United States and Bangladesh
2) Sheep populations in the United States and Bangladesh
3) Cheese production in the United States

Statistically speaking, those three variables predicted 99 percent of the stock

market’s movement. Imagine what you’ll be able to do with that information.

There’s only one problem. The joke is on us.

In our very human pursuit of looking for patterns, we start seeing things that
aren’t really there. And as Dr. Leinweber highlighted in his study, we will mine the
data until we see what we think is a pattern. We think if something happened a
certain way in the past, then surely it will continue into the future. We start to
believe, we want to believe, that this pattern will have predictive value.

Consider what’s going on in the stock market. The bubble watchers are convinced
that they’ve identified a pattern from the past that tells us something about the
future. And they even have charts and numbers to back up their pattern.

One of my current favorites compares the Nasdaq in 1999 and 2000 to the
Standard & Poor’s 500 Index in 2013. When you overlay the charts, they match
perfectly. Imagine that. So, of course, we must be headed to an 80 percent
decline. If you look a little closer, however, you’ll see the scales aren’t quite right.
But it makes a fantastic visual if you’re looking for a pattern.

Then there’s the S.&P. 500 itself.  It is up 16.9 percent year-to-date. That’s the
fastest start for the S.&P. 500 since 1987, when it rose 18.7 percent during the
same time period. But later that year, we had Black Monday, when the Dow dropped
more than 22 percent in one day. So we should be looking for the same thing to
happen in 2013, right?

In fact the S.&P. 500 is full of patterns if you’re looking for them. Pick your
poison: sheep, the S.&P. 500, gross domestic product, or the latest unemployment
numbers. If you look for some sort of theme to emerge, it’s highly likely you will
see something. But the past is not prologue.

While some of these silly data mining tricks might be interesting to talk about,
they won’t help you. Every time someone approaches me with research — and it’s
always called research — that shows a pattern in the data, the pattern eventually
goes away. These things always work perfectly, until they don’t.
Oddly enough, the only pattern that will influence your investing success is your
behavior. Can you break the pattern of buying high and selling low? Can you break
the pattern of chasing after the next “big” investment? And perhaps most
importantly, can you buy low-cost investments in a diversified portfolio, and then
ignore it?

Now that’s a pattern I can endorse.

Read No. 20

In Soccer and Investing, Bias Is Toward Action

I recently attended a varsity soccer game at the local high school in Park City,
Utah. It was the quarterfinals of the state tournament. At the end of regulation
the game was tied, which meant overtime. After overtime, the game was still tied,
which meant a shootout.

A shootout is when each team gets five penalty kicks, and the team with the most
scored goals wins. For those of you not familiar with soccer, let me explain. A
penalty kick is when a stationary ball is placed 12 yards from the goal line, leaving
just the kicker and the goalkeeper.
It’s a tough and intense way to end a game. Because the ball is so close, and the
goalkeeper can’t move before the ball is hit, the goalkeeper has almost no time to
react. So the strategy has always been for the goalkeeper to pick a side and dive.
The choice of which side to dive to is made without having a chance to read the
ball — there just isn’t enough time.

Of course, there is a third option: stand in the middle. As I watched the

goalkeepers dive, I was reminded of when I played over 20 years ago. We did the
same thing then, too. In fact, I remember thinking, “If they’re going to dive, why
risk going wide by aiming for the corners? Just kick it hard right down the middle
because the goalkeeper won’t be there.”

A few of the players this weekend in Park City had the same idea. Kick the ball
straight down the middle while the goalkeeper dives heroically to the side.

In an odd coincidence, a few days later I learned of a study focused on decision

making and penalty kicks. The analysis covered close to 300 penalty kicks. It looked
at both the goalkeepers’ decision in terms of where they chose to dive, as well as
where the ball was actually kicked.

As it turns out,  the goalkeeper picks a side and dives 93.7 percent of the time and
just stands in the middle only 6.3 percent of the time. There was a clear bias
toward action. The kicks themselves are more evenly spread across the net, and
here’s the clincher: Almost 30 percent were kicked to the middle of the net.
Without boring you with the numbers, the result showed that goalkeepers could
almost double their save percentage by doing nothing. In other words, just
standing there was the optimal strategy.

What goalkeeper is going to do that? Can you imagine how silly that would look?
Everyone is expecting action. Every other goalkeeper in the world dives to a side of
the goal. Just standing there would be embarrassing.

We do the same thing with investing.

We all know that once you build a low-cost, diversified portfolio, you should avoid
making changes every other day. We’ve heard Warren Buffett say things like,
“Benign neglect, bordering on sloth, remains the hallmark of our investment
process.”

We know that time in the market is the key, not timing the market.
Despite all that, we often chose to do something instead of just standing there.
According to Dalbar’s 2013 Quantitative Analysis of Investor Behavior, the
average time we hold a stock mutual fund — by definition a long-term investment —
is just less than three and a half years. I know three plus years may feel like a long
time, but seriously? On top of that, we now have people talking about how great
exchange-traded funds are, often citing that they’re low cost (good) and that you
can trade then any second of any day (shouldn’t matter).

It’s all a bit crazy. But we feel that we must do something with our investments for
the same reason a goalkeeper dives.

Everyone else is moving, trading, talking. Why not us? It’s what investing is all
about, right?

Wrong.

That is called entertainment. If you want a term to justify it, you can call it
trading. But the evidence is clear that it doesn’t work. So this is one of those rare
opportunities to improve your results by being lazy. Build a portfolio that matches
your goals, and forget about it.

Maybe for years.

Try it. If you have a well-diversified portfolio, just try doing nothing for a month,
and then two, and then three. Start an “I’m doing nothing streak.” See how long you
can make it. In fact, go one step more and practice Mr. Buffett’s strategy. Learn
to feel good about benign neglect. Brag about the fact that you have no idea where
the market is, and you haven’t even looked at your investments for a long time.

And yeah, on top of giving you something to talk about, not to mention gaining a lot
of time and energy back, your results will probably be better, too.

Doing nothing may be one of the best decisions you ever make.

Read No. 21

Why We Fear Simple Money Solutions

I keep coming across an interesting problem. People say they want things to be
simpler — investing, life insurance, retirement planning, etc. But when a simpler
(and effective) option is proposed, they reject it as too simple.

In most of the money situations I’ve come across, the best solution is almost by
definition the simplest. (Note: I didn’t say the easiest.)

So why don’t we go for simple?

1) We don’t believe it will work.

We’re attracted to complexity because anything that requires a lot of something —

time, details, money — should work, right? By default, if it’s simple, say only two
steps instead of ten, we think we’re missing out.

2) We think simple should be easy.

It’s like the guy who goes to the doctor and says he doesn’t feel well. There must
be something wrong with him that a pill could fix. But all the doctor says is, “Get
more sleep, eat healthier food and exercise three times a week.”

It’s the simple solution, but it’s not easy.

3) We like tradition.
We get used to how things should look, work, act, etc. (Think of dishwashers; they
all basically do the same thing.) So any time we see something that’s too different
from what we’re familiar with, we treat it with suspicion. And if we’ve come to
expect that money options should be complex, we’re going to be wary of anything
simple..

The result? We paint ourselves into a corner.

This is one of the reasons that you have to go back to the A.T.M. to find the most
recent revolution in the personal finance industry. We need to see more
revolutions, not fewer. Simple and Ally are both examples of simpler banking, but I
don’t see Bank of America or Chase disappearing any time soon.

I had this exact discussion with a friend who complained about earning zero
interest on her money at the bank she always used. I showed her a few of the new,
simpler banks. But despite the fact that a two-year CD was paying a lot more than
the zero she was earning, she didn’t want something new. So she keep complaining.

We’ve got to come to grips with the reality that simple and incredibly effective
financial solutions are right in front of us. But they may look different. To get
there, we need to change our mindset, for example, from day trading to systematic
investing in low-cost mutual funds.

It’s time to stop assuming that complexity will solve your problem when a simpler
option may solve the problem and save you a headache.

Read No. 22

The Question You Should Be Asking About the Stock Market

With the stock market up more than 100 percent from those scary days in early
2009 and up 16 percent in 2012 alone, we’re now hearing plenty about how small
investors are getting back into the market. Andrew Wilkinson, the chief economic
strategist at Miller Tabak Associates, referred to it as a “a real sea change in
investor outlook.”

It seems we’re in danger of repeating the same old cycle of swearing off stocks
forever during scary markets, missing a huge rally and then deciding it’s time to
buy when stocks are high again. On the flip side, I’ve had a number of
conversations with Main Street investors who are asking if now is the time to sell
because the Dow Jones Industrial Average is hovering near 14,000 and the S&P
500 stock index is around 1,500 again.

So which one is it? Should everyday investors be buying or selling?

Do you see the problem here?

If we’re investing based on what the market has done, it’s a recipe for disaster.
Recent market performance tells us almost nothing useful about what the market
will do in the near future. Logically it seems like it should, but a quick review of the
market’s performance during the last six years should be evidence enough to
convince us that it doesn’t.
Remember how you felt in March, 2009? I bet you didn’t feel like investing, and
you weren’t alone. Almost no one did. It was a scary time. But it turns out that it
would have been a brilliant time to invest. Again, not because of what the market
had done, but what it was about to do.

But there was no way to know that in March 2009.

Did anyone expect (or feel) like 2012 was going to turn into a 16 percent year? In
fact, almost all the unfortunate souls that make their living predicting the markets
got 2012 wrong.

Here’s the thing we need to remember: we have no idea if now is the time to be
buying or selling. But the good news is that it’s not even the question we should be
asking. Instead we should be asking, “How can we avoid making the big behavioral
mistake of selling low and buying high (again!) in the future?”

Instead of worrying about getting in or out of the market at the right time, take
that time to focus on crafting a portfolio based on your goals. Start by taking out a
piece of paper and writing a personal investment policy statement that addresses
the following:

1. Why are you investing this money in the first place? What are your goals?
2. How much do you need in cash, bonds and stocks to give you the best chance
of meeting those goals while taking the least amount of risk?

3. What actual investments will you buy to populate that plan and why? Make
sure you address issues like diversification and expenses.

4. How often will you revisit this plan to make sure you’re doing what you said
you would do and to make changes to your investments to get them back in
line with what you said in number 2?

A personal investment policy statement can be one of the most important

guardrails against the emotional investment decisions that we all regret in
hindsight. So, when you get worried about the markets and are tempted to sell
everything you own that has anything to do with stocks, go back to that piece of
paper. If your goals haven’t changed, forget about it.
And when you get excited about that initial public offering that your brother-in-
law says he can “get you in on,” pull out that piece of paper. If your goals haven’t
changed, forget about it.

When your neighbors are all wrapped up in how the latest apocalypse du jour is
going to ruin everyone’s retirement, pull out that piece of paper. If your goals
haven’t changed, forget about it.

I know this might not work all the time. In fact, it might not work at all when we’re
scared and dead set on getting out. But my hope is that having something we wrote
when we weren’t scared will give us a little time to pause and ask a few questions
before we do something that might end up being a mistake.

As a result, maybe, just maybe, we can shift the focus away from whether now is
the right time to buy or sell and place it squarely on whether that decision fits into
our own, personal investment plans.

Read No. 23 – Video

Read No. 24

Challenge What You Think You Know

I used to ride my road bike a lot.

While I didn’t race very often, I did ride with a group of really competitive riders.
And when you ride a bike competitively, especially when long climbs are involved,
weight is a factor. The less you weigh, the faster you go. Needing all the help I
could get, I got in the habit of stepping on the scale regularly, and that habit has
stuck with me even though I ride less now than I did a few years ago.

As I’ve observed my interaction with the scale, I’ve noticed a curious tendency. I’m
much more likely to weigh myself when I’ve been eating well, and I think I’m going
to like the number I see. I’ve also noticed that I pretend the scale doesn’t exist
after a late-night ice cream session. Sound familiar? Even the time of the weigh-in
mattered. Based on a quick poll of my athlete friends, their preferred time for the
daily weigh-in is after an early morning run and right before breakfast.
This tendency to look for information that supports the way we feel about
something isn’t isolated to the scale. We do this all the time. In fact, academics
even have a name for it: confirmation bias. It’s when we form an opinion, and then
we systematically look for evidence to support that opinion while discarding
anything that contradicts it.

The first place we go for feedback about what we believe is other people. And who
do we ask first? That’s right, people we know who are already inclined to think the
same way as we do. And friends don’t always tell one another the truth, even if
they disagree. The result is a dangerous feedback loop that actually confirms our
bias. It’s incredibly hard to avoid.

A great example of this bias is described in “Decisive: How to Make Better Choices
in Life and Work,” a new book by Chip and Dan Heath:

Smokers in the 1960s, back when the medical research on the harms of smoking
was less clear, were more likely to express interest in reading an article with the
headline “Smoking Does Not Lead to Lung Cancer” than one with the headline
“Smoking Leads to Lung Cancer.” (To see how this could lead to bad decisions,
imagine your boss staring at two research studies headlined “Data That Supports
What You Think” and “Data That Contradicts What You Think.” Guess which one
gets cited at the staff meeting.)

Confirmation bias is super tricky because it’s so easy to convince ourselves that
we’re right. We’ve found evidence to support our decision and people who agree
with us. The only solution that I see is to purposely expose yourself to views that
don’t match yours.

For a great example, let’s look at politics. Let’s say you consider yourself a liberal.
Chances are most of the people you hang out with are liberals, too. So the only way
to avoid this confirmation feedback loop is to expose yourself to views that don’t
match yours.

The hard part? You’ve got to do it with an open mind. As Stephen Covey, the self-
help and business author, has said, “Most people do not listen with the intent to
understand; they listen with the intent to reply.”

Your goal should be to understand. If you are just listening to judge, then you’re
only building more confirmation into the system.
So take a deep breath and turn on Fox News or listen to Rush Limbaugh. Try, just
try, to listen, to understand. See if you can get to the point where you can honestly
say, “I understand the argument and can see why they feel that way.”

Of course, this may not change your views. But then again, it might. In fact, the
possibility of changing your mind might be why this is almost impossible for most of
us to do. Beyond politics, we face just as much risk of confirmation bias in
investing.

Suppose you’ve watched the market race up during the last few months, and you
think the market is close to its peak. Maybe, you think, it’s time to get out. I can
guarantee you’ll be able to find evidence — probably enough to write a thesis —
that supports your decision. But I’m just as sure that there’s plenty of evidence
that says otherwise. And that’s the slippery slope of confirmation bias.

We’ll always be able to find something or someone that says, “Yes, you’re right.”
But our goal should be to understand the opposite of what we believe, put it into
context with what we think is true, and then see where we stand. Otherwise, what
we “think” we know will someday be trumped by what we don’t.

Read No. 25

Stock Investing Isn’t the Only Risk in Your Life

Often when we think of risk, we’re only focused on the risk of investing in the
stock market . We think, “Oh, the stock market is risky, and it’s a little scary to
buy risky things.”

I can’t tell you how many conversations I’ve had with friends — particularly when
they get a little older — that are only focused on this one risk. “I don’t want to own
stocks because, boy, that’s risky.”

I remember a conversation I had with a friend of mine who lives in a small town.
She was telling me how worried she was about the stock market going up and
down. Now, keep in mind, she had very little of her money in the stock market.
But she had some money in stocks , as is appropriate for somebody who could
expect to live for another 15 or more years.

Here’s the interesting part. When she finished telling me about her stock market
worries, she told me she was also very worried about how the price of everything
seemed to be getting more and more expensive each year.

This gets us to the big point. When you make a decision to avoid one type of risk,
you might be exposing yourself to another one.

In this case, my friend was very concerned about the risk of holding stocks. But
she overlooked the risk that comes with holding too little in stocks — which can
help her keep up with inflation.
It’s going to cost you more to buy the same loaf of bread in 20 years. Just look at
prices 30 years ago, when a loaf of bread cost $0.53, and a gallon of gas was $1.36.

I remember when I was a kid, 30 years or so ago, riding my bike down to the gas
station and putting a quarter in the soda machine to get a bottle of Fanta Red
Cream Soda. Today, if my kids wanted to ride down to the gas station to get a
soda, it would cost them at least a dollar. (Bikes are also a lot more expensive than
they used to be.)

The point is that we shouldn’t be thinking in terms of avoiding risk.  It can’t be
done. Instead, we should be considering which risks we’re willing to take on.

The reality of investing is about making these tradeoffs. It’s about raising your
hand and saying, “I’m O.K. with taking on this risk over here, in order to get rid of
that one over there.” That’s essentially what the market is —- a place to trade risk
and reward.

Back to my friend in the small town. (She isn’t unique. I seem to have this same
conversation about risk with lots of people.) When I heard her concerns, I told her
a story that always seems to help. If you have a well-designed investment portfolio
that’s tied to your goals, you’ve already made decisions and tradeoffs about the
risks you’re willing to take. We’re better off in the long run sticking with those
plans, because once you start looking for a no-risk investing solution, you’ll likely to
veer off into some shady, perhaps fraudulent, investment schemes.

So next time you’re nervous about the risk you’re taking with your investments,
remind yourself which risks you’ve actually gotten rid of because of those
decisions.

Read No. 26

Investing: Money Plus (Lots of) Time Equals Excitement

This post has been updated to switch the labels on the axes.

You’ve probably heard that starting early is one of the best investing decisions
you can make. That’s because investing done right is short-term boring but long-
term exciting.

The reason? The reality of compound interest. Let me explain.

Many people talk about the power of compound interest. Albert Einstein is rumored
to have called it the most powerful force in the universe.

Now, I suspect he probably didn’t really say that, but whether he did or not, it’s a
point that we often miss in the discussion about compound interest. Despite its
being one of the most powerful forces in the universe, it’s not one of the most
exciting – at least in the short term. Nothing really great happens until after years
and years of discipline and patience.

Take this silly (but true!) story that’s often told to demonstrate how powerful
compound interest is: If you start with one penny and double it every day for 30
days, you’ll end up with $5,368,709.12.

I should add a disclaimer here that if anyone offers you an investment that will
double in value every day, you should run as fast as you can in the other direction.
But let’s get back to the main point. Sure, compound interest — whether bank
interest or another form of investment — has a powerful outcome, but it takes an
awfully long time to become fun and exciting.

Now take a look at our penny example again. One penny doubled is 2 cents. Two
cents turns to $0.04, $0.04 to $0.08, $0.08 to $0.16, $0.16 to $0.32, $0.32 to
$0.64, and $0.64 to $1.28. Nothing very exciting there.

But when you stick with it, it’s that last few times when the figure doubles that it
gets very, very exciting. You’re looking at $1,342,177.28 becoming $2,684,354.56,
and $2,684,354.56 doubling to $5,368,709.12.

That’s the case with our investments, too. It’s not very exciting at the beginning,
but compounding becomes a powerful force after years of patience and discipline.

Let me give you a real example: Say you have Sarah, who decides at 25 to save
$1,000 a month. She does that for 10 years. And then she stops. Then you have
Roger, who waits until he’s 35, and he saves $1,000 a month for 30 years. They
both earn 7 percent a year on their savings.

Now, 30 years after she stops contributing Sarah would have $1,262,089.05. But
Roger, who would have put away three times as much as Sarah, would only have
$1,133,529.44.

The reason Sarah only saved a third as much as Roger but ended up with more
money is because she started earlier.

But here’s what you have to understand: Nothing too incredible happened during
that first 10 years that Sarah was saving and Roger wasn’t. The exciting part
happens years down the road. So we have to be patient and disciplined, counting on
the fact that compounding is going to do its work in its own time.

It’s kind of like planting an oak tree. As Warren Buffett said in an interview with
News Inc, “Someone’s sitting in the shade today because someone planted a tree
long ago.” The same thing applies to compound interest. We have to live through
the boring parts in order to reap the benefits down the road.

And here’s the key. Every day you wait you’re not cutting off the flat end of the
curve like I’ve drawn in the sketch. You’re cutting off the steep end. You can’t skip
the boring part and get right to the excitement.
That’s why we have to get started investing today.

I know that many of us didn’t start early. Maybe you haven’t even started yet. But
this is an incredibly important concept. If you’re 45 and haven’t started saving, you
don’t want to be 55 and in the same (actually a much worse) position. So start now.

Read No. 27

Let Diversification Do Its Job

Investors typically set up a diversified investment portfolio to reduce their risk.

Just hold a good mix of different kinds of stocks, along with some bonds and cash,
and your problems are over.

Right?

Not exactly. Diversification comes with its own risk. But before we get to the risk,
let’s talk about how we define this term in the first place.

When people say diversification, they’re often talking about two separate things.
First, there’s equity diversification where you split up the portion of your money
invested in stocks among big ones, small ones, undervalued ones, international ones
and so on.

The idea behind this strategy is that you can reduce your risk, since different
types of stocks often behave differently depending on market conditions.

Sometimes, it works. Dimensional Fund Advisors reported that in 1998, the large
company stocks that make up the S.&P. 500 gained 28.6 percent while small-cap
value stocks lost 10 percent. Then in 2001, the S.&P. 500 was down 11.9 percent,
while those same small-cap value stocks gained 40.6 percent.

Since it does help sometimes, equity diversification is a useful strategy. Do it. But
you have to understand that equity diversification sometimes fails to deliver
exactly what you expect it to and often fails when you need it most.

We saw this in 2008-2009, when almost every type of investment fell. Granted,
diversification would have saved you from making a mistake like putting everything
in Lehman Brothers stock, but you still saw equity holdings plummet.

If you think back to that time, you will most likely remember hearing people say
that diversification was broken, that it no longer worked. I remember thinking that
myself.

But remember, when that happens and people start running around again saying
diversification doesn’t work, they’re talking about equity diversification. There’s
another, more important type of diversification: the way you split your money
between stocks, bonds, cash and other investments.

This portfolio-level diversification is the primary lever to help you manage the risk
and return in your portfolio. Each type of investment plays a different role:

 Stocks provide the growth.

 Short and intermediate bonds provide more safety and a little income.

 Cash is there for liquidity and to protect your money.

The idea is to balance these investments in a way that gives up some higher returns
in exchange for lower overall risk. Essentially, you’ve given up the opportunity to hit
home runs for the benefit of never striking out.
With that out of the way, let’s talk about the risk of diversification.

Whenever you diversify, if you’ve done it correctly, there will always be something
in your portfolio that you’re in love with and something that you want to dump (or
will at least be the source of concern, as bonds are now in some circles). Some
investment or asset class will be doing fantastic compared to the rest of your
portfolio, and something will be doing much worse than everything else.

The trouble is, you never know when all of this will change. The thing you want to
buy more of now will someday become the thing you want to sell.

Think back to the example from 1998. Having lived through it, I can tell you it was
awfully tempting to move all your money out of small-cap value stocks and into
large-cap stocks. But that would have been a terrible decision given how well small-
cap value stocks did just two years later.

The same is true when you diversify among stocks, bonds and cash. When the stock
market is tumbling like it did in 2008, you want to move everything to cash, and it’s
really hard to keep money in bonds or cash when the stock market is having one of
those great years.

But here is the point. The risk of diversification is that you will bail on it as a
strategy at exactly the wrong time.

That feeling you get — the one that says, I wish I could dump this lame investment
so I could buy a whole bunch more of this incredibly hot one — can get you into
trouble fast. The temptation is greatest when it would be the most catastrophic
for you to succumb.

But that feeling is actually telling you that you’ve done the right thing: You’re
diversified. So remember that when the current fad ends and today’s rejects come
back into style, you’ll be okay. And you’ll be awfully glad you didn’t give in to the
temptation to give up on being diversified.

The next time diversification appears to not be working, remind yourself that it is
a long-term strategy that can’t be judged on your short-term experience. In other
words, just because something isn’t working right this minute — or even right this
year — doesn’t mean it’s broken. So instead of thinking, “I am a rocket scientist
and I can come up with something better,” just let diversification do its job.
Then go for a hike in the mountains instead of sitting hunched over the sell button
on your broker’s Web site.

Read No. 28

Don’t Mistake Investing Folklore for Personalized Advice

Most of what we hear about investing isn’t right or wrong. It’s a matter of applying
what we hear to our own situation.

When we make investment decisions, they should be tied to our goals. We get into
big trouble when we either:

a) Fail to get clear about our goals

b) Invest based on someone else’s goals

I’ve written before about the first situation. But as my friend Tim Maurer says,
personal finance is much more personal than it is finance. We need to take the time
to be really clear about our goals.
The second situation is a more nuanced situation. It can happen subtly, because a
lot of what we hear and do when it comes to investing is basically based on folklore.
We end up doing things because other people are doing them, and it leads to big
problems.

Here are a few examples:

 You hear that Harvard’s endowment is buying dairy farms in New Zealand.
 You hear your wealthy uncle talking about how important it is to own
municipal bonds. He has to be really smart because he’s so wealthy, right?
And what he’s saying sounds so sophisticated that you think there has to be
something there.

 You hear the cool kids who just got hired out of Stanford’s M.B.A. program
talking about investing 100 percent of their 401(k) in stocks. (They must be
smart too. They went to Stanford!)

In all three examples, you might be tempted to change your investments based on
something you’ve heard from someone else. But while dairy farms, municipal bonds
and stocks might be good investments, you aren’t just looking for good investments.
You’re looking for good investments that will help you reach your goals.

Your goals are not Harvard’s. Harvard’s goal is based on a different time frame, to
build an endowment that will be around forever. You, however, many have goals to
meet in 10, 20 or 30 years.

And your goals are not your wealthy uncle’s goals. He’s probably interested in
buying municipal bonds because of his ridiculously high tax bracket and the tax-
free status of the bonds.

Finally, your goals are probably different from the goals of people who just
finished business school. Clearly, these young hotshots feel like they can afford to
be extremely aggressive when setting up their retirement portfolios. Most of us
are in a different situation.

Your goals are just that: Yours.

It’s not that Harvard, your uncle and the business school graduates are wrong and
you’re right. The point is that when it comes to investing your money, the only goals
that matter are yours.
Read No. 29

The Over-the-Wall Portfolio for Excess Cash

If you’re an entrepreneur, you’ll spend years pouring everything — time, money,

passion — into your businesses with the hope that someday it will pay off. If things
go well, you’ll wake up one morning and find yourself with excess time, energy and,
of course, cash.

Great! But now you have to figure out what do with that cash, and this is when
things can get dangerous, fast.

Most entrepreneurs get twitchy at the thought of idle money. They’re used to
taking big chances and are comfortable with risk. So, there’s a temptation to
assume the same approach to controlled risk when investing outside their business.

One of the smartest guys I know runs an incredibly successful company but
provided a textbook example of this approach. As the business matured and
started throwing off excess cash, he began thinking about what to do with it. He
invested in some pretty strange ventures. He backed a doctor with a new
toothbrush design, a car wash and a company that made kayak paddles.
He knew nothing about any of these businesses. Not surprisingly, he lost that
money.

Instead of sticking to what he knew to make money and protecting the profits, he
made the classic mistake of thinking he could do more. He took risks with money
that he promised himself he would never lose.

It’s like what Warren E. Buffett said about the super-smart and incredibly wealthy
founders of Long-Term Capital Management, who ended up doing something really
dumb: “To make money they didn’t need, they risked what they did have and did
need, and that’s foolish.”

Don’t be foolish. If you’re fortunate to have enough money to last for a good long
while, the game can, and should, change. Of course you can still focus on growing
your business. Or, if you’re a serial entrepreneur, you can build the next one. But at
the same time, you can start building a portfolio to protect your future.

One thing I have heard over and over when interviewing successful entrepreneurs
is the idea of what I call the Over-the-Wall Portfolio. Of course, the
entrepreneurs didn’t call it that. They often referred to it as the safe money or
the money they promised their spouse they’d never lose.

Whatever you call it, the concept is pretty simple: You take the excess cash your
business generates, or the lump sum from the sale of a business, and throw it over
the wall into stable (and probably boring) investments.

Then you forget about it.

The allocation of an Over-the-Wall Portfolio will vary, but here are a few general
guidelines to consider:

 Boring. Remember: excitement comes from being an entrepreneur (or the

movies), not your over-the-wall money.
 Liquid. If something goes wrong, you want to be able to get to the money.

 Diversified. You can get rich by putting all your eggs in one basket, but you
stay wealthy by being diversified.
  Passive. The Over-the-Wall Portfolio can’t depend on you for day-to-day
management. You’re too busy with your business and having a life. The last
thing you should be doing at night is logging into your day-trading account.

The best part of this strategy? It lets you get back to doing what you do best —
running your business. But you get the added comfort of knowing that if your
business fails, you’ll be O.K.

Eventually, my entrepreneur friend recognized his problem. One day, he told me,
“Carl, I finally figured it out. My job is to stay focused on my business and make
money. And with the money I make, I have to be sure I never lose any of it.”

I couldn’t have said it better myself.

Read No. 30

A Warning About That Guy Who Is Beating the Market

I’m sure I’m not alone in running into “that guy.”

You know, the guy who always seems to make the best investment decisions. I seem
to run into him (and it’s almost always a “him”) everywhere: the neighborhood
barbecue, the company party or even a family event. Maybe it’s your co-worker or
your brother-in-law.

Based on the stories he tells you every time you run into him, making money in the
stock market is easy. Picking the best mutual funds, easy! Beating the S.&P. 500,
easy! Then, in his oh-so-casual way, he says, “If I can do it, anyone can do it. It’s
easy.”

These run-ins used to leave me with a sick feeling in my stomach. I wondered what
I was doing wrong. How come that guy makes it sound so easy? How come his
experience seems to be so different from mine? I must be missing something,
right?

Here’s a perfect example of “that guy” in action.

Dave Ramsey recently answered a question about investing with this:

I recommend mutual funds because they always beat the S.&P. … For example, take
a mutual fund with a 25-year track record.  Over the course of those 25 years if
you can see that the mutual fund almost always beats the S.&P., then that mutual
fund contains stocks that are winning more than the overall market is winning.

At the end of his answer (it’s on the audio, but not reflected in the transcript), Mr.
Ramsey concludes with, “But I’ve honestly done better” than 12 percent, “and I’m
no rocket scientist.”

I think most of us hear 12 percent (Mr. Ramsey has mentioned this number
before), and our jaws drop. Combined with his certainty (“always beat the S.&P.”),
it’s hard to square what he says with what the rest of us have experienced. We
must be doing something wrong, right? (Mr. Ramsey’s public relations
representative did not respond to messages seeking comment.)

When I asked the Reuters blogger Felix Salmon about all of this, he confirmed
something similar among the people he knows:

In New York, there’s a huge class of people earning in the $200,000 to $500,000
range who have money, don’t feel rich, and — most importantly — have very rich
friends. When I meet them, they invariably tell me about their very rich friends
and how those very rich friends are always making the most amazing investments,
selling all their stocks and going to gold right before the financial crisis, etc. etc.
It really is a Thing.

So the next time you’re talking to “that guy,” remember that you aren’t alone.
Other people feel the same way. In an effort to help you with that sick feeling in
your stomach, here are a few of the facts.

1) Beating an index isn’t a financial goal

Getting a better return than your neighbor isn’t a financial goal either. I realize
that this is not necessarily the goal of many financial gurus either. Still, it’s
important to understand that a real financial goal is, say, sending your children to
college or having enough money to retire.

Sure, getting the best return you can is a part (I’d argue a small part) of the
equation. But remember that it’s possible to beat an index and still retire broke if
you don’t focus on the things that really matter, such as how much you save, what
you spend, how much you earn and having realistic goals.

2) Skill versus luck

If your conversations with “that guy” veer toward past performance, remember
that you still need to determine if that mutual fund did well because of skill or
luck. In other words, is the performance repeatable? And will it happen again once
your money is in the fund?

Statistically, even if a fund beat the market average for 25 years we still can’t say
with any degree of confidence it was because the manager was skillful versus lucky.
Prof. Ken French at Dartmouth has already worked out these numbers. If you
assume the fund beats the market by five percentage points per year, which is a
huge number, and had volatility of 20 percent per year, you would still need 64
years of data before you could be confident the superior performance was because
of something other than luck.

64 years!

The point is that finding skill in the world of mutual funds is almost impossible, and
betting your retirement money on luck sounds like a bad idea to me.
3) Rear-view-mirror investing leads to accidents

Even though it seems logical, making investment decisions based on past

performance doesn’t add up. In almost every other area — business, construction,
medicine — past performance matters. But with investing, past performance tells
us virtually nothing about future performance. At this point, it’s settled doctrine.
The academics, regulatory agencies and most professionals agree: when it comes to
investing, past performance has zero predictive value.

But for the sake of argument, let’s say there is some value in past performance.
Most thoughtful people will not argue that it’s impossible for a mutual fund
manager to outperform the market. The bigger question is this: How will you
identify that manager in advance?

When you’re talking to “that guy,” be prepared to hear how much he thinks the
past influences the future. Now you know better.

4) Reversion to the mean

I know this probably never happens to you, but I’ve found that just about the time
I think I’ve identified the best investment, and I decide to buy it, it turns into the
not-so-great investment.

It turns out there’s data to support this pattern. If we look at all mutual funds
that have been around for 25 years (and they are rarer than you might think), 62
percent outperformed the S&P 500 over the last 15 years. This (and the figures
below) is according to Morningstar’s Principia database.

Keep in mind that, presumably, the only funds still around after 25 years are ones
that have done well. So the 62 percent figure overstates the performance of all
funds over time. We call this surviviorship bias.

Meanwhile, when we look at the last 10 years, that number plummets to 37 percent.
And keep in mind that we’re including precious metal funds, bond funds, everything
— not just stock funds.

Then consider what happens if we look only at funds in Morningstar’s large-blend

category of stock mutual funds instead of all funds, as we did previously. Among
those funds, only 47 percent beat the S.&P. 500 over 15 years. And here’s the
reality check: only 32 percent have done it over the last 10 years
The law of averages tells us there’s an increasing likelihood that if a fund has done
well in the past, it’s less likely to do well in the future. At some point it’s going to
revert back to the mean. So about the time you think you’ve identified the next
hot manager, it’s about time for that manager to be the not-so-hot manager.

5) If it’s too good to be true, it often is

Beating 12 percent per year is incredible. People who can achieve those returns
year in and year out should be running their own hedge fund. For perspective,
consider that among large-cap blend stock mutual funds (funds that should use the
S.&P. 500 as a benchmark) with a 25-year record, not one had an annualized return
of greater than 12 percent over the past 10 or 15 years.

When looking at all mutual funds with a 25-year history, there are only a few that
have beaten 12 percent annualized over the last 10 years, and most of those are
funds that invest primarily in precious metals. I suspect that 10 years ago most of
us weren’t willing to bet our retirement money on mutual funds invested in precious
metals, and I sure hope no one is doing that now.

The issue isn’t whether you’re hearing something like this from some self-styled
investment guru or your brother-in-law. What does matter is that we need to have
realistic investing expectations, and “that guy” rarely provides them. So while some
people may claim to have no problem hitting 12 percent, I have yet to see an
academic study or hear any planning professional suggest that 12 percent is a
realistic number for building a plan.

To see what I’m talking about, let’s walk through two hypothetical examples and
use the simple calculator found at Bloomberg.com. For this little experiment, we’ll
focus only on the portion of your portfolio invested in stocks.

In one plan, let’s use 12 percent, and in the other let’s use 7 percent. Say you’re 25
years old, and you’re starting a savings plan with no money. Your goal is to have $2
million by the time you retire at 65.

So how much do you need to save? You could:

 Base your plan on 12 percent, which means you need to save $217 a month.
 Base your plan on 7 percent, which means you need to save $834 a month.
Do you understand the implications of these assumptions now? In this hypothetical
world, you can assume 12 percent, and if you’re wrong, you’re in big trouble. On the
other hand, if you take the more conservative approach and assume 7 percent on
the portion you have in stocks, and you wake up 40 years from now having earned
more than that, it’s fantastic.

That’s why this issue is so important. If you’re serious about your financial goals,
you can’t afford to take “that guy” seriously. I wish there was a shortcut or some
magic way to find the best investments, but the fact of the matter is that meeting
your goals is about boring things like saving as much as you can, knowing not to
chase after past performance and avoiding the pain of buying high and selling low.
Counting on a high number like 12 percent takes your eye off those things that
matter and over which you have some control.

Now, back to “that guy.” Over time, I’ve learned just to ignore those guys. I used
to try to reason with them, but that is a waste of time. It’s a little bit like trying
to have a logical conversation with a teenager.

So if you find yourself at a barbecue and “that guy” tries to start up a

conversation about his investment prowess, maybe it’s time to excuse yourself and
go see if the hamburgers are ready.

Read No. 31

A Financial Plan for Misbehaving Lottery Winners

First, congratulations! You’ve just won more money than most of us could ever
imagine.

And you’re probably thinking that your financial problems are over. That’s true – as
long as you avoid costly mistakes.

Let’s be clear: Your financial life is no longer about spreadsheets and managing
money. Now it’s about managing behavior.

You see, I have a pretty good idea of what will happen to you. It’s not a secret. On
average, 90 percent of lottery winners go through their winnings in five years or
less.

And I know there’s a temptation to think you’re different from everyone else. All
those other lottery winners? They were foolish.

Which brings us to the first mistake you need to avoid: Overconfidence.

Think about what happens when you ask a room full of men how many of them
believe they are above-average drivers. You’ll probably see over 60 percent of the
hands go up. It’s just not possible for 60 percent of the men in a room to be above-
average drivers, unless you’re at a Nascar convention.
Recognize that there’s a high probability that your life after winning the lottery
will turn out like other average lottery winners. You will indeed be broke and back
at work within five years, unless you do something different.

So what can you do differently?

After splitting this particular jackpot between two winners and accounting for a
generous estimate of federal and state taxes, let’s say you end up with around $55
million each.

Go ahead and do anything you want with $5 million of that. Want to pay off debts
or take trips? Fine. Want to invest in your brother-in-law’s “sure thing?” Go for it.
Or, maybe you want to start your own business. It requires some capital and might
also be a little risky. Don’t worry about it.

But take that other $50 million and put it in good, safe investments and spend only
the interest. Let’s say, hypothetically, you earn only 1 percent a year on those
investments — you’ll still have $500,000 a year before taxes to spend for the rest
of your life. And the money will still be there for your children and their children
(if you’ve also taught them how to behave).

You’re going to be tempted to do crazy or even stupid things with that money.
That’s why you have to put something in place to make sure you stick to that
commitment. Maybe you can have a lawyer or a financial adviser put that money
into something like a blind trust. The goal is to put one or two steps between you
and your ability to spend the principal.

Another idea is to find someone you trust, like that lawyer, financial adviser or
even just a committee of three of your best friends. Then make a commitment
that you’ll talk to them before ever touching the money.

One idea I like a lot: Write a letter to yourself or record a video that describes
how much you love your life now and how you never want to go back to work again.
Tell yourself that you’re going to be different than all those other lottery winners.
Then, put that video or letter some place safe and pull it out at least once a year,
or anytime you think about spending the money.

With these guardrails in place, you’re increasing your odds that you don’t become
like the other lottery winners who blew through their money. It’s pretty simple,
really. You’ve got to put something between you and stupid.
And this advice doesn’t just apply to lottery winners. The rules apply to anyone
with sudden money, like people who receive an inheritance, sell a business or even
get a tax refund they didn’t expect. Think about your latest windfall. Can you even
remember where it went?

Probably not. In fact, there’s actually research that says we tend to spend a
windfall more than once. Need a new television? Hey, we’ll spend the tax refund.
Need a vacation? That tax refund will help cover it!

It’s easy to make too big a deal of windfalls, regardless of their size. But when we
receive any sort of unexpected money, we’ve got to put something in place to
control our behavior and make sure we don’t lose that money.

So again, congratulations on your new wealth. If you can manage your behavior, you
won’t have to worry about managing money ever again.

A version of this article appears in print on 12/08/2012, on page B4 of the

NewYork edition with the headline: Letter to a Lottery Winner.

Read No. 32

You Probably Don’t Care Enough About Your Goals

How badly do you want it?

I’ll ask this question when someone tells me about a goal they have in mind and
their struggles to reach it. It’s usually an important goal, connected to their
career, their families or some sort of personal achievement.

And when I ask this question, the responses tend to fall into two categories:

1) I want it badly, and I’ll do whatever it takes to get there.

2) I want it badly, but I don’t think it’s possible.

Think about those two answers for minute.

If you answered the first way, that you’ll do whatever it takes, you’ve made a
choice. You’ve decided that this goal means enough to you that you’ll pursue it until
you achieve. I don’t worry too much about these people.
But if you answered the second way, that you don’t think it’s possible, then I have
to wonder if you really want it. I most often get the second response when people
are talking about money goals. And when I ask a few more questions, like what they
have tried already, the answers astonish me. A majority of the time, people have
put these goals aside aside because they seem impossible, not because they
actually tried to reach the goal and failed.

Here’s a classic example. A few months ago, I had a conversation with an

acquaintance who earns a super-high income. He tells me that he wants to make big
changes in his life, like cutting back on work, maybe even changing jobs completely.
He really wants these changes, he tells me.

So when I ask him why it hasn’t happened, he explains that he doesn’t have enough
savings to make the change. But you have excellent cash flow, I reply. Well yes, he
says, but I don’t really want to change my lifestyle.

And right there we see the problem. How badly does he want it? Apparently not
badly enough to change his spending and increase his savings.

We can all be guilty of similar thinking. We walk around with big goals and talk
about how important those goals are to us, but what are we really doing about
those goals? How badly do we want them?

It’s a rare goal that doesn’t require sacrifice of some sort. So what are you
prepared to sacrifice to achieve your big goal? Do you want to pay off your debt?
Buy a home? Travel more?

You owe it to yourself to explore all the possibilities before you concede defeat
and say that it’s impossible. Don’t be like all of the people who walk away from what
they want because they aren’t willing to answer the question and say out loud just
how badly they actually want it.

Read No. 33

You’re Probably One of Two Kinds of Shoppers

It’s official: I’m not a shopper! It has been a long and lonely road to this point, but
it feels good to finally discover the truth about myself.

Last summer I needed a new sport coat. My current one was 10 years old and
looked it. I kept putting off buying a new one, because every time I go shopping it’s
no fun. No fun for me and no fun for anyone who goes with me. My wife vows never
to go with me again after just about every shopping trip. Luckily, she forgets the
pain just enough since I need her help if I have any hope of looking presentable.

Based on anecdotal evidence, I’m guessing that some people find shopping fun, even
(or especially) on Black Friday. I have even heard that people actually like to go out
with friends for the specific purpose of shopping. Some people even plan vacations
around the activity.

This has long been a puzzle for me. It’s not that I want to become a recreational
shopper. I just want to make it a bit less painful for people to be around me when a
situation requires a trip to the store.

After years of working on my problem, I think I have it figured out.

In an effort to simplify the issue, I’ve divided the world into two kinds of people:
those who think shopping is fun and those that don’t. There’s only a problem when
you don’t know which camp you belong to.
Shoppers enjoy options. I guess it’s fun for them to think about which shirt goes
well with the sport coat they’re there to get. To nonshoppers, options just get in
the way of getting stuff done. For them, shopping is not about entertainment,
mixing and matching or assembling an evening ensemble (whatever that is).

It’s about the fastest way in and out of the store with the exact item you already
know you need or want. This activity isn’t even the same thing as shopping. It
deserves its own name, maybe purpose-driven-shopping, or even better “getting
stuff.”

When you’re getting stuff, you know what you want. It was determined before you
walked in the door. No need to even think about accessories. Now here’s what my
clothes shopping looks like! Need a tie with that? Hmm, let me look at that list.
Nope, it’s not there. A belt? No, it’s not on the list. Extended warranty? Not on the
list.

Getting stuff requires research. You need to know what you want. If you’re a
nonshopper, don’t go to the store to do that research, or if you do, don’t take a
shopper with you. They will think they’re going on a fun activity, like a fourth-grade
field trip. Since you’re at cross purposes, it can lead to conflict when you put on
your game face in the parking lot. For you, this is not fun and games; it’s getting
stuff done.

The Internet is a great place for research, and I suggest you call it that. When
you’re approached by a shopper and they ask what you’re doing on the Gap Web
site, tell them, “Research.” This will make it clear that this is not fun, and if they
decide to help, there should be no expectation of fun.

Looking back on the arguments I’ve had over money with my wife, many of them
involve silent drives home after shopping. So if my theory holds true,
acknowledging that I’m a getting stuff person and my wife is a shopping person can
end these arguments. The same could hold true for you.

How does this compare to your shopping experience? Do you fall into the category
of “getting stuff” or “shopping?”

Read No. 34
An Election Probably Shouldn’t Change Your Financial Plan

New information is scary. When things change, we often don’t know what to do. We
may have had a plan before things changed, but things are different. So now what?

With the election last week, we suddenly have lots of new information, or at least
it feels like we do. A little less than half the country is surprised and even
disappointed. And unless you’re living in a cave, you’re now hearing about the
uncertainty surrounding the looming budget showdown.

At times like these, there is a tendency to act now and ask questions later. Before
you do, take just a moment, a small pause, and walk through a few steps to avoid
making a big mistake.

1. Do you have a plan?

I’m assuming you do. You have a clear idea of where you are today, where you want
to go and you have spelled out the investment process that you think will get you
there.

2. Does this new information change that plan?

Any investment or financial plan most likely has risk built into it. Uncertainty is not
new. Of course, this time might indeed be different, but don’t bet on it. Instead,
make sure that the level of risk you’re taking matches your goals.

3. Should you change course?

After reviewing your plan in light of this new information, the key question to ask
is whether a change is warranted. The primary reason for making changes to a
sound plan depends on changes in your life and goals, not changes in the markets or
politics. So if your goals haven’t changed, and you have a rational plan to get there,
stick with it.

If, on the other hand, this new information has you reassessing your goals and the
level of risk required to get there, it might be time to revisit your plan. Do it
deliberately and with care, because history has shown that selling when worried
can be a bad idea.

And all this process requires is that you pause and ask a few questions before
acting. It seems like a small thing to do to avoid making the same painful mistakes
over and over again.

Read No. 35

You Should Try a Multi-Day Spending Cleanse

Bad habits are tricky. They sneak up on you. Before you know it, you’re doing
something that you didn’t really think about because you do it out of habit.

We do this all the time with money. We spend for all sorts of reasons. It can be as
simple as to make us feel better, to fit in with a group or just because we’ve always
gone shopping the day after Thanksgiving.

Sometimes breaking these bad habits takes radical action. It’s not enough to have
a few conversations with a spouse, a personal coach or a shrink. Some habits
require a complete intervention.

I learned about one tactic during a conversation I had with Steve Fellows, a friend
of mine in Las Vegas. When I asked him how he keeps his spending habits in check,
he walked me through something he and his wife refer to as a spending cleanse.

Every once in a while for several days, sometimes as long as two or three weeks,
they try to avoid spending money. He rides his bike to work, they avoid eating out
(including lunches) and pass on any travel or movies.

It’s hard, but he says that it has the powerful effect of helping you get clear
about how you want to spend your money and time compared to what you might be
doing just out of habit.
This approach is a bit on the extreme side, but sometimes an extreme exercises
can be a powerful way to provide perspective. It can be a way to shock you out of a
rut you may have been in without even knowing it.

Try it! Try going for a few days, maybe longer, without spending any money at all.

What about food? Go out Saturday and shop for a week in advance.

What about bills? Plan to pay them a day or two before you start and the day after
you end.

What about trips? Don’t go on any.

What about entertainment? This one can be interesting. Instead of going to the
movies, go for a walk. Read a book. Go fishing. Ride a bike. Have a conversation.
Draw a picture. There are plenty of things to do that won’t require money. Those
of you who lost power in the last week have probably learned a bit about this
already.

Your goal is to prepare yourself to go for several days, even longer if you can
manage it, without spending a dime. I have managed to do it for a few days
previously, but I’m planning to try it again myself when I wrap up some travel in
November.

Is it hard? Yes. But it will be worth it.

It will be worth it to see where we’re spending money out of habit.

It will be worth it to see if this changes how we think about money.

It will be worth it to see if it can stop some of our worst money habits, perhaps
ones we haven’t even recognized yet.

Most of all, it’s a personal financial challenge that ultimately doesn’t cost us
anything but can pay huge dividends. Once we’re really clear about why we spend, it
can be the difference that determines whether we’ll reach our financial goals.

Isn’t that worth a few days of zero spending?

Read No. 36

Six Tips for Setting Your Financial Goals

If you managed to get unstuck and created your personal balance sheet recently,
then you should have a really clear idea of where you are today. The next questions
you need to address are these: Where do you want to go? What are your financial
goals?

This can be a frustrating process, since it involves making some really important
decisions under extreme uncertainty. None of us know what next week will look
like, let alone where we will be in 30 years. On top of that, making financial goals
involves a whole bunch of assumptions — guesses, really.

We have to guess what our 60- or 80-year-old self will want to do. We have to
guess what the markets will do, where interest rates will be and how much we can
save. Those reasons and many more often lead us to forget that this is a process.
We get stuck, unsure what to do next.

Well, despite all the uncertainty and assumptions, we need to have goals. It
reminds me of the conversation between Alice and the Cheshire Cat:

“Would you tell me, please, which way I ought to go from here?”
“That depends a good deal on where you want to get to,” said the Cat.

“I don’t much care where,” said Alice.

“Then it doesn’t matter which way you go,” said the Cat.

“— so long as I get somewhere,” Alice added as an explanation.

“Oh, you’re sure to do that,” said the Cat, “if you only walk long enough.”

But the problem is that we do care where we end up, and part of deciding where to
go depends on setting goals.

So there are a few really important things to keep in mind here. Before you get too
excited or frustrated, here are a few things to consider.

1. These are guesses. 

While it is important to admit these are guesses, you should still make them the
best guesses you can. Be specific. Just saying, “I want to save for college for my
kids,” isn’t enough. How about, “I’ll find $100 to add to a specific 529 account on
the 15th of each month”?

Even though you need to be specific, give yourself permission to be flexible. An

attitude of flexibility goes a long way toward dealing with uncertainty. There is
something very powerful about having specific goals but not obsessing about them.

2. These goals will change.

It’s a continuing process, and it will change because life changes. But don’t let this
knowledge stop you from doing it. You need to start somewhere.

3. Think of these goals as the destination on a trip.

You would never spend a bunch of time and energy worrying about whether you
should take a car, train or plane without first deciding where you are going. Yet we
spend countless hours researching the merits of one investment over another
before we even decide on our goals. Why are you stressing about what stocks to
pick if you don’t have goals in mind?
4. Prioritize these goals.

Once you have them all written down, rank each goal in terms of importance and
urgency. Sometimes you will have to deal with something that is urgent, like paying
off a credit card bill, so you can move on to something really important, like saving
for retirement.

5. This is a process.

If you set goals and then forget about them forever, that is a worthless event.
This is a process. Since we’ve given ourselves permission to change our assumptions
about the future as more information becomes available, we need to do it. Part of
the process of planning involves revisiting your goals periodically to see how you are
doing and making course corrections when needed.

6. Let go!

As important as it is to regularly review your progress, it’s also very important to

let go of the need to obsess over your goals. Define where you want to go, review
your goals at set times, and in between, let go of them! Goals for the future are
important, but so is living today. Find that balance.

This list may not seem like a big deal, but you would be surprised at the number of
people who cannot tell you their goals, let alone break them down into categories or
rank their priority. Once you have your goals, you will be able to move on to the
next step: making a plan.

Read No. 37

Call It an Uncertainty Fund, Not an Emergency Fund

A few weeks ago I wrote about the challenges of managing a lumpy income—one
that varies a lot from month to month or year to year.

With this shift to lumpy incomes comes the increasing need to pay attention to
what my friend Manisha Thakor, a financial adviser and author, calls an
“uncertainty fund.”

We used to call this thing an emergency fund or a rainy day fund, but the basic
idea is this: You set aside a bunch of cash to see you through emergencies like a
job loss or huge medical bills.

There are a lot of old rules floating around about emergency funds. The most
common one says you need to save between three and six months of your income to
really be safe. But there are few problems with that rule.

 It’s arbitrary. Why is three months or six months right for everyone?
 Who has that kind of money anyway?

 Where should collecting that pile of money land on the priority list?

Do you stop building your retirement account for a year or two or three to build up
your uncertainty fund? Should you pay off your credit card debt first? What
about saving for your kids’ college tuition?
So the old rules of thumb are inadequate for most of us, yet the need for an
uncertainty fund is rising. Now what should you do?

In this case, I’m not going to try to replace an old, arbitrary rule with a new one. I
suggest you ask yourself two crucial questions to decide how to solve your own
uncertainty fund problem.

1. What is the level of uncertainty in my life?

To decide how much risk you can afford to take with your finances, consider the
risk you’re taking with your human capital. If you’re on a risky career path, you
might need your uncertainty fund to be a lot bigger.

We used to think of risky careers as those that crazy entrepreneurs pursue. But
now, for the first time, you’re at risk even if you have the kind of steady job we
used to think was secure for life.

I have a lot of friends in Las Vegas who are dentists. I don’t know of any of them
who went into dentistry out of a spirit of entrepreneurial risk-taking. They went
into it because it was stable.

But then they woke up one day and found that the economy had crashed. The real
estate market imploded, people were moving away and my friends worried about
losing their practices. These guys are dentists — they didn’t sign up for all of this.
They signed up for doing the same thing for 30 years. They didn’t really do
anything wrong. It’s just that the landscape shifted. So examine whether that
same shifting landscape has put your own career in greater uncertainty, or whether
it might before too long.

Consider other potential financial uncertainties too. What do you worry about?
Maybe you fear that your elderly parents might become dependent on you or your
children might have to move back in with you after college.

2. How can I deal with it?

Now think about the resources available to you if you lost your job, had to support
an aging parent or needed to pay off a huge hospital bill.
Some of us may decide the best approach is to save as much as we can in an old-
fashioned rainy day fund. But if money is so tight that saving isn’t a realistic
option, you have to get creative.

 Do you have home equity you can tap? Consider getting a line of credit now
to serve as your safety net in case of emergencies.
 Can you borrow against the money in your 401(k) plan? Would you want to do
that?

 If your spouse doesn’t work, could he or she get a job?

 Do you have decent disability insurance?

 Do you have a fallback plan if you lost your job? Maybe you used to wait
tables or paint houses and might be able to pick up some work on the side
while you look for something better.

The point is that an uncertainty fund doesn’t have to be $100,000 parked in a

money market fund. But it’s important to have some kind of plan in place that will
offer at least some cushion against financial blows.

What creative ways have you discovered to add to your uncertainty fund?

Read No 38

Try to Focus on Your Personal Economy

As many of the social structures we have relied on in the past for retirement seem
to disappear or appear vulnerable (company pensions and Social Security to name
two), we’re becoming increasingly more responsible for our own financial futures.
But at the same time we’re overwhelmed with information about how to handle our
money.

Never before have we had so much information at our fingertips about how to
handle money, and never before have so many of us felt out of control. Sorting
though this noise is more important than ever before, not only for our financial
futures but for our mental health.

Think I’m overstating the problem?

In 2011, IDC Digital Universe published a study, “Extracting Value from Chaos.” It
found we have 1.8 zettabytes (1.8 billion terabytes) of data floating around. What
does that look like?

 Every person in the United States tweeting 3 tweets per minute for 26,976
years nonstop
 Every person in the world having over 215 million high-resolution MRI scans
per day
  Over 200 billion high definition movies (each 2 hours in length), which would
take one person 47 million years to watch if that person watched for 24
hours a day

 The amount of information needed to fill 57.5 billion 32 gigabyte Apple

iPads.

In 2012, that number is expected to grow to 2.7 zettabytes.

Obviously, it’s easy to get distracted. And based on the questions I get, people are
really distracted when it comes to money.

 Should I buy this stock?

 What do you think the market will do?

 Will Europe go down in flames?

 Will the economy ever recover?

But what if instead of asking those questions, we asked just these questions:

 How much can I save?

 How is my portfolio allocated?

 Can I pick up some extra work this month?

 Can I start a little business on the side?

By asking these questions we switch our focus to things we have at least some
control over. We start to focus on our personal economy, instead of the global
economy. Our personal economy becomes the filter for all the noise. Things like
Europe, the market, and individual stocks drop off our radar. Instead, we focus on
information that helps us with the one thing we can control: ourselves.

Obviously with so much noise, it can be incredibly hard to get this focused. But the
sooner you figure out the value of this filter, the faster you’ll be able to make
sense of the noise.

So besides burying your head in the sand, what have you done to filter the noise?

 
Read No. 39

When the Tax Tail Wags Your Investment Dog

With less than a month to go until Election Day, it’s hard to miss all of the
speeches about taxes. Tax rates, tax codes, tax deductions. So it’s easy to see why
we’re so tempted to get really focused on our own personal tax situation and how to
eke out a better result for ourselves.

But you know the old saying that we shouldn’t miss the forest because we’re so
focused on the trees? Well, it happens with our investment decisions and taxes on
a regular basis.

I had a recent conversation with some friends about a rental home they owned.
They were evaluating their options for the property. Should they keep it? Remodel
it? Sell it and look for an alternative investment?

As we walked through the details, it became clear to all of us that they have a
great little investment in the context of their overall financial plan. Based on the
price they paid years ago, the money they put into the house, the rental history
and the income they collect, it appeared to be a much better investment than the
alternatives they were considering, even when we accounted for the risk
associated with rental properties.
But as soon as we came to that conclusion, they asked me this: “Why did our
accountant tell us the opposite?”

Now, their accountant prefaced his advice with the disclosure that his job was to
focus on taxes. Based on that perspective, his advice was to sell it because they
currently qualified for a substantial tax savings on the capital gain that would not
be available to them in the near future.

To be clear, the accountant didn’t give my friends bad advice. Instead he gave
them advice based on one perspective, taxes. The reality is that smart, long-term
financial decisions need to take more than one thing into consideration. But
because taxes are associated with so much emotion (given how much people truly
hate paying them), it’s incredibly easy to let taxes become our sole focus. And that
can lead to bad decisions.

In this particular example, even when you included the tax savings, it still made
sense to keep the property once we zoomed out and considered the decision in the
context of their overall plan. In this instance, we were trying to avoid the trap of
the tax tail wagging the investment dog.

Another situation where taxes can cloud our judgment comes in the form of
spending more to deduct more. I’ve heard one of my doctor friends say that she’d
been told to buy a larger home with a bigger mortgage so she could receive the
greater interest deduction.

Now there may be other reasons to buy a bigger home, but spending another dollar
in interest just so you can get something far less than that back in taxes just
doesn’t make sense unless it’s part of some bigger plan.

Taxes and the way we feel about them can pull us into emotional quicksand. And
when we make taxes our primary focus for financial decisions, it’s no wonder we get
trapped into making decisions we may regret later. In the case of my friends, if
they’d skipped over their initial assessment and made the decision to keep or sell
the rental property based solely on the tax advice, they most likely would have
regretted it.

Yes, we need to know the tax implications of our decisions, and getting good advice
on the issue is helpful. But we need to be really careful to not let one perspective
keep us from seeing the forest and making the wiser decision for our overall plan.
Read No. 40

A Simple Place to Start: Your Net Worth

The world is a crazy place. We hear reports that say the economy is getting
better. Next month, we hear that things don’t look so good. It feels like a tug-of-
war, and we’re caught in the middle. Looking around, you may feel like the only thing
you have any hope of controlling is your financial situation. So you want to make
some changes and put a framework around your financial future.

But there’s so much information! Credit card statements, mortgage payments,

insurance renewals, student loan bills and every other piece of financial data about
your life can be overwhelming. It’s incredibly easy to throw up your hands and say,
“I don’t know where to start.”
The best place to start is with your current reality. Seems obvious, right? But if
it’s so obvious, then why haven’t we done it?

1. It can be painful. The reason you’re looking to change things is because

something isn’t working. That something may be incredibly personal, like how
you talk about money with your spouse. So we avoid our current reality and
tell ourselves things will get better tomorrow.
2. There are a million other things to do. We’re all busy. Thinking about what’s
right and wrong with your current reality probably doesn’t make anyone’s Top
Ten list.

But if you find yourself in a situation where you’re ready to make a change, the
best place to start is at the beginning by creating a personal balance sheet. Your
goal is to discover where you stand financially right now.

You don’t need a fancy spreadsheet or even a computer for this exercise. Just
grab a blank piece of paper and a pen. Then draw a line down the middle.

On the left side, list all your assets in detail. Bank accounts, the fair market value
of your home, investment portfolio. For every asset, list it and its value.

On the right side, list all your liabilities. Credit card debt, mortgage, school loans.
Again, get specific and list the actual amounts of each liability.

If you don’t know, call your bank, credit card company or your adviser. In this
exercise, guessing isn’t allowed, so ask the questions and get the real numbers on
paper.

Then, add up all your assets and subtract all your liabilities. You now have your net
worth.

What does it look like? If you’re not happy with the number you see, you have two
choices that will probably involve some hard work:

1. Increase your assets

2. Decrease your liabilities

If you’re wondering why I suggest starting with something so simple, it’s because I
keep crossing paths with people who don’t know how their assets compare to their
liabilities. And the reality is that if you don’t know where you stand today, then
how will you ever figure out where you want to be tomorrow?

So the next time you think you don’t know where to start, ask the question, “What
does my current reality look like?” Once you know where you stand, then you can
make an honest assessment of your options and what comes next.

Correction: October 1, 2012

It is the fair market value of your home that should be listed on the asset side of
the ledger. This post originally suggested putting "home equity" there, but with
"mortgage" already listed on the liability side, that would lead to an incorrect
result.

Read No. 41

Your Hazy Future Is No Excuse for a Lack of Planning

Who do you think you’ll be in a year? Five years? Twenty years?

One of the big problems with setting goals, especially financial ones, is that we’re
really bad at imaging our future selves. Just remember what you imagined you’d be
as an adult when you were a kid. I’m guessing there are some gaps between the
dream and the reality.

Earlier this year, Alina Tugend outlined some of the science behind this problem in
The Times:

…many of us don’t have the incentive to eat healthy or save money or add to our
retirement accounts because we think of ourselves in the future as someone
different altogether. In fact, a future self can seem to be this annoying other
person who wants to prevent you from having fun in the present.

The reality is that when we talk about financial goals we’re often talking about long
time frames. When we talk about retirement, it could be upward of 20 or 30 years.
You can’t even imagine yourself at that age, let alone plan for it. That’s your
parents, not you!

We do the same thing with our children. When my first daughter was born, college
was the last thing on my mind. But by the time we had our fourth child, I had a
good idea how fast 18 years would go by. When we start talking about our distant
future selves, it’s easy to rationalize the decision to not do anything.

But there’s a problem, as Ms. Tugend explained. When the future arrives:

…we’re still the same selves we were last week or last month. We don’t want to
drink the icky liquid, and we don’t necessarily feel we can afford the time to do
worthwhile, but time-consuming, deeds.

So what’s the solution?

Start by getting really clear on your goals. Yes, nailing down the details may not
happen right away, but don’t pretend that 18 is a long way off for your first-
grader. It’s not.

You may feel like you’re still 30, but if you just celebrated (or mourned) turning 40,
it’s time to get real. Our future selves will be here faster than we think. Remember
all the stupid stuff you did as a teenager? Don’t be the 60-year-old that wants to
hit your 30-something self over the head for doing stupid adult stuff, like not
getting clear on your financial goals.
I promise you that your future self will be happier the sooner you reconcile today
with tomorrow.

Read No. 42

Tips For Managing Your Increasingly Lumpy Income

Graduate from college, get a job with a stable paycheck that grows each year by a
little, work for 30 or 40 years and retire with a pension.

While it may have been common among Tom Brokaw’s book “The Greatest
Generation” and even with many baby boomers, the idea of working at the same
place your whole life, having a stable paycheck and getting a pension check
afterwards seems like a fairytale now. It’s hard to pin down the numbers, but
increasingly it seems like we’re facing the new reality of living in Daniel H. Pink’s
book, “Free Agent Nation”.

It is a place where many of the structures we used to rely on have either gone
away or are predicted to go away. Retirement accounts we manage ourselves have
replaced company pensions, and in many cases our income has become more
variable.
The issues that come with variable or lumpy incomes are not new. Think of farmers,
small business owners and artists. Add to that list all the real estate agents, trial
attorneys and other jobs that rely heavily on commissions or bonuses. These jobs
come with fat years followed by lean ones.

But most of the personal financial literature focuses mainly on the nonlumpy, on
people with steady incomes and a paycheck every two weeks.

For this group, it’s logical to think of saving a percentage of your income each year
and allocating that savings to different buckets, like college and retirement. It’s a
strategy that works fine if your income is steady and steadily growing over time.

This approach gets confusing when you fall into the lumpy category though. In one
year you may have X amount, then the next year you may may earn 10 times X or
one-tenth of X. The variation can be incredibly difficult to predict, making it a
challenge to plan for your financial future.

For example, think of artists who have a big art show and make two to three times
their annual income from that one show. They may not make any income during the
next two years while preparing for a new show.

You may not be an artist, but it’s hard to miss the drastic changes in the job
market. How many people still work for the same employer for 30 years? I predict
that over time more of us will face the challenge of lumpy incomes even if we don’t
right now.

People with lumpy incomes need to think about financial planning a bit differently.
Many of the standards will hold true, but if you find yourself looking at a lot of ups
and downs in your income, you want to be aware of a few things.

1) SPENDING When you have that first big year, where your income is two, three,
or even 10 times as big as your previous high mark, there’s a tendency to think of it
as the new normal. It’s easy to assume that you’ll always earn that new income. It’s
also very easy to start and continue spending at that level.

A friend told me the story of a trial attorney she knew who won a big trial many
years ago. He made upgrades to his lifestyle that he still follows today, even
though he hasn’t had another big win since the original one. It’s starting to catch
up with him, but he appears unwilling to modify his lifestyle. So with your first big
year, be careful that you don’t reset your expectations to a markedly higher level
and then years later realize you’re in trouble.

2) SAVINGS Depending on your situation, saving a percentage of your income may

still make sense, but it can also help to think in terms of setting a spending
threshold. With a spending threshold, you spend a certain amount and then
everything over that amount gets saved. From that savings, you’ll allocate some to
retirement, education or other goals you’re working towards.

3) TAXES Often people with lumpy incomes are in for a big surprise every April.
You’ll want to work with a certified public accountant to set aside enough to cover
you, particularly if you’ve done really well that year. There are few things worse
than having a big year, something that’s cause for celebration, and then being
shocked by the tax bill.

When I think of the lumpiest incomes, it’s hard not to think of farmers and their
time-tested rules. For instance, when you have a fat year, set some aside for lean
years, or live on far less than you make. The problems come when you try to manage
a  lumpy income using a set salary mindset. If you have lumpy income, you should
act like a farmer, not a salaried employee.

We need to start rethinking some of the rules of traditional financial advice and
adapting them to better fit incomes that go up and down, often without warning.
It’s easy to forget that most people lived this way for years before we got used to
the idea of company pensions and working at the same place for 30 years.

If you earn a lumpy income, what have you done to better align your spending and
saving with your income?

Read No. 43

Spending Your Money to Make Someone Else Happy

In the early 1990s, I went to Philadelphia on a Mormon mission and lived in a tough
section of the city. One day I received a letter from a friend. In it was $100 and
instructions to spend it doing something nice for someone else. No spending the
money on myself.

It was the holiday season, and I figured it would be fun to provide a great dinner
for a family we had recently met who was clearly going to go without. We bought a
turkey, stuffing, all the fixings, a pie and small gifts. I still remember leaving the
box of food on the doorstep, knocking a few times and running.

We watched from a hiding place as someone came to the door, looked at the food,
looked around, gathered it all up and went inside. I have no idea what the reaction
was after that. We never saw that family again, but I do know that the experience
ranks among the best I had during that time in my life.

I find it interesting that spending that money on someone else made me far
happier than it would have if I had spent it on myself. Part of that feeling might
come from the fact that the money was a gift and came with specific instructions
on how to spend it.

But there’s another part to consider. In a fascinating paradox, the more we try to
find happiness and the more we devote our resources, time, talents, energy and
money to making ourselves happy, the less it seems to work. Something weird
happens when we use our money to make someone else happy though: we get
happier. This seems to be true of charitable giving in general, as well as for gifts
to family and friends.

Turns out that there is research to support this idea. In a paper by Elizabeth
Dunn, Daniel Gilbert and Timothy Wilson that was originally published in the
Journal of Consumer Psychology, they shared the results of a 2008 experiment:

Researchers approached individuals on the University of British Columbia (UBC)

campus, handed them a $5 or $20 bill, and then randomly assigned them to spend
the money on themselves or on others by the end of the day.  When participants
were contacted that evening, individuals who had been assigned to spend their
windfall on others were happier than those who had been assigned to spend the
money on themselves.

So if happiness is the goal, we get a two-for-one deal when we spend our money on
other people. We’re happier, and the people we spend it on are happier too. And
then there’s the story Gretchen Rubin shared in The Huffington Post as part of
her encouragement to pursue nonrandom acts of kindness:

… a friend told me a wonderful story about a nonrandom act of kindness she’d

performed. On April 15 a few years ago, she was standing in a post office crowded
with people who needed to mail their tax returns. There was a huge line in front of
the one machine that dispensed stamps.

When my friend’s turn finally came, instead of buying the minimum number of
stamps, she bought $20 worth. Then she went along the line of people behind her,
handing each person as many stamps as needed, until she ran out.

The people who got the free stamps were ecstatic – and even the people who didn’t
get the free stamps were ecstatic, because the long, slow line got so much shorter
so quickly. Everyone was surprised, excited and laughing.

Imagine if someone walked up to you today and handed you $100. How would you
use that money to make someone else happy? For close to 20 years my experience
has stuck with me. I have a strong suspicion that if you try it, it will stick with you
too.

Read No. 44
Striving to Lead More of an Heirloom Life

The inventor Saul Griffith gave his new baby son a Rolex and a Montblanc pen. Odd
gifts, right? But for Mr. Griffith, it was about buying the only watch and pen his
son would ever need.

Over the last few years, Mr. Griffith has argued that we need to design more
things to last, what he calls heirloom design in an interview with Good:

An object with ‘heirloom design’ is something that will not only last through your
lifetime and into the next generation, but that you also desire to keep that long
because it’s beautiful, functional, and timeless.

It reminded me of the case I made this summer that we might actually save money
by spending more on a high-quality item when we plan to keep it. I know this isn’t a
new or revolutionary concept, but when I read the comments, I was surprised to
learn how many cool sayings there are from around the world that capture this
advice.

“We’re too poor to buy cheap things.”

“Owning just a bit less and buying good quality stuff that lasts longer ends up
making a huge difference over a lifetime.”
“I don’t buy much, but I make sure it is something I really want.”

“Buy cheap, buy twice!”

“There is an Italian peasant saying that sums it up nicely: We’re too poor to pay
less. (Siamo troppo poveri per pagare meno).”

“Or, as the Scottish say: Buy less, pay more.”

“Buy the best and buy it once.”

These comments and the idea of heirloom design got me thinking about passing
things on, of living an heirloom life.

What if instead of buying things to replace, we bought things that last? What if
we bought with intention, choosing items with timeless design? And in line with the
idea of spending a little more, what if we embraced buying fewer items of a higher
quality?

Obviously, not every buying decision falls into this category. But asking two
questions can help separate what makes sense and what doesn’t:

1. Do I hope to pass this on to my kids or grandkids?

2. If I break down my purchase as cost per use, does it benefit me over the
long term to spend a little more for something to last longer?

Much of what we buy won’t be something we pass on to our kids. But that doesn’t
mean we shouldn’t buy to last.

For instance, the idea of heirloom shoes sounds a bit silly. But then I think about
the shoes I wear the most during summer. My favorite pair is my Chaco Flips. If
they ever wore out, I wouldn’t hesitate to get a new pair. However, they do cost
$60 a pair.

I know that price seems like a lot for flip-flops. However, I’ve had my current pair
for five years. Realistically, given how much I wear these shoes, I could easily go
through 10 pairs of $12 drugstore flip-flops in the same time. So if I look at it
from a price per use basis, spending more money for the higher quality shoes has
saved me money, time and aggravation.
Depending on where you’re at in life, you may feel like an heirloom life isn’t an
option. And I know we’re bombarded with the message that everything is
replaceable. Between these two competing forces, it can be tempting to buy cheap
and cross our fingers. But it’s hard to ignore that there’s something special about
receiving a treasured family item from your parents or grandparents.

In many ways, spending more is only part of an heirloom life. The other part
requires spending wisely. Your goal with an heirloom life isn’t to buy for the sake of
buying, but to buy because you want something to last.

Read No. 45

Don’t Let the Original Price Haunt Your Decision to Sell

Over the last few weeks, there has been a lot of chatter about Facebook stock.
The headlines all seem to echo each other by focusing on the opening price:

 “Facebook gains after dropping under $19, half of initial public offering
price” [Washington Post]
 “Facebook hits record low for third straight session, falls to less than half
of IPO price” [Mercury News]
  “Facebook stock falls below half its IPO price” [Los Angeles Times]

These headlines are a prime example of our very human tendency to anchor to a
number, and it’s usually the first number we see. In this instance, they’re referring
to the number $38, Facebook’s initial public offering price.

But here’s the deal: the decision to buy, sell or skip Facebook stock shouldn’t have
much to do with its opening price of $38.

Because we’re human and we like anchors, that $38 price is hard to ignore.
Anchoring can lead us to make mistakes with other money decisions, too. For
instance, Derek Thompson, writing for The Atlantic, highlighted how that first
number can impact your buying decisions:

You walk into a high-end store, let’s say it’s Hermès, and you see a $7,000 bag.
“Haha, that’s so stupid!” you tell your friend. “Seven grand for a bag!” Then you
spot an awesome watch for $367. Compared to a Timex, that’s wildly
overexpensive. But compared to the $7,000 price tag you just put to memory, it’s a
steal. In this way, stores can massage or “anchor” your expectations for spending.

It’s common to see a version of anchoring when people are selling their homes. Not
surprisingly, most sellers mentally start with the price they paid. Depending on the
market and other factors, they may play around with that number a bit, but it’s
hard not to anchor to that original price.

Let’s say a family bought a home for $300,000 back before the housing market
crashed. Over time, the house climbed in value, but then the market came to a
screeching halt, and the home’s value dropped. Then the homeowners got a job
offer in another city, so it’s time to sell. Even though they know the market has
gone down, it’s hard to forget that they originally paid $300,000.

So they list the house for $300,000. A few weeks and then months go by, and
finally there’s an offer for $275,000. Because of anchoring, it can be incredibly
hard for the homeowners to weigh the offer on its merits. After all, they already
had a number in their heads.

We carry sets of numbers in our heads in so many ways, and without realizing it,
those numbers can weigh down our decisions. Instead of acting in a way that best
suits our needs, we get stuck because the numbers don’t match. Maybe we bought a
stock for $100, determined after a time that it didn’t fit our goals anymore and
decided to sell it. But the stock now sits at $75. Do you still sell or do you wait?
You’ll find it’s incredibly tempting to wait in the hope the stock will get back to
$100.

Numbers matter, but you need to avoid the trap of anchoring to a single number
and making it the primary guidepost for your decision. The first number will rarely
be the number that should matter the most to you. As I’ve discussed before, the
only number that matters when you need to sell is the price today.

Read No. 46

Three Ways to Figure Out What Stuff You Should Keep

We really like being able to store stuff. So much so that there’s now 2.3 billion
square feet of self-storage space in the United States. To give you a better idea
of how big that is, think of it, as the Self Storage Association does, as “an area
well more than three times the size of Manhattan.” And about 10 percent of us are
using that space to store our stuff.

Now maybe you’ve managed to keep all your stuff in closets, basements or garages.
But many of the more than 300 comments on my post from last week indicated that
we have mixed feelings about getting rid of our possessions. Those feelings become
even harder to sort through when we’re dealing with stuff that we have an
emotional attachment to.

This takes me back to the main point I had hoped to make: Does what you own add
to your life or take away from it?

To be clear, I’m not saying we shouldn’t buy and own things. For instance, my family
owns some outdoor equipment that we probably use only  three or four times each
year. But we take good care of it, and it adds something positive to our family
activities. For us, it’s worth storing because we know why we own it.

On the other hand, we still own a lot of stuff that seems to take way more time
and effort to deal with, and we’re constantly trying to cut back. Like a garden, our
house seems to take constant work to avoid being overrun.

A few additional thoughts came out of the conversations around last week’s post:

1) Move out I have some friends who just moved for the first time in over a
decade. They were shocked at how much stuff they had just taking up space. They
commented that it was scary to think about how long all that stuff would have
continued to take up space and mental energy if they hadn’t been forced to deal
with it in the move. Since they had to move, they had to deal with it. I’ve heard
people say they like to move every five years or so because it forces them to
become cold-blooded stuff killers.

So while you might not be moving, go ahead and pretend that you are.

“Move” everything out of the house or apartment and be ruthless about what you
allow to stay. You can do this room by room if you need to. Move everything from
your bedroom into another room. Live with it bare for a day or two, then slowly
start inviting the stuff you love/want/need back. Repeat with every room of the
house.

2) Go on a trip Put together a pile of everything you’ll need over two weeks. I’ve
discovered that most people are surprised by what they actually use compared to
everything they have around them.

3) Figure stuff per square foot If you have so much stuff that you’re renting
extra space to accommodate it, how much does that cost you? The cost per square
foot will vary depending on where you live, but it can be incredibly helpful to do the
math and understand how much your stuff costs you after you’ve bought it.

Again, I’m not advocating that the only way to live a happy life is  owning a small
pile of stuff. But I do support the many comments that caution against letting your
stuff own you and the value in gaining some perspective about what you own.

I don’t think there’s a magic number of items to own that guarantees a happy life. I
also don’t think it’s automatically a bad thing to rent storage space. But I do think
there’s something incredibly valuable about taking the time to understand why you
own what you own and making thoughtful decisions about buying new stuff.

Read No. 47

You Probably Have Too Much Stuff

When a man named Andrew Hyde began an adventure in minimalism, he only owned
15 things. It eventually moved to 39 and now it sits around 60. It all started when
he decided to take a trip around the world and sell everything he didn’t need. As
Mr. Hyde noted on his blog, it changed his life after a brief period of
befuddlement:

I’m so confused by this. When we were growing up, didn’t we all have the goal of a
huge house full of things? I found a far more quality life by rejecting things as a
gauge of success.

When I came across his original story of only owning 15 items, I was so inspired I
immediately went home and found 15 things to give away. Most of these things
were clothes that I had long since stopped wearing, but I held on them because . . .
well, just because. In fact I have no idea why I still had a tie I hadn’t worn in four
years or a shirt that no longer fit.
I still own way more than 39 things, but getting rid of some of them felt amazingly
good. In the process, I realized how much holding on to those things was actually
costing me. That is the paradox.

When we hold on to stuff we no longer want or use, it does indeed cost us

something more, if only in the time spent organizing and contemplating them. I
can’t tell you how many times I have thought about getting rid of that tie (for
instance), and every time I went to choose a shirt for the day, I would think about
the few that no longer fit.

Even though Hyde’s example is an extreme one, I love thinking about extreme
examples because they have the power to compel us to act. In this case I found
myself thinking:

 Why exactly do you own what you own?

 What could you get rid of and not miss?

 Do I really still need that?

 What is it costing me to own that?

Maybe the attachment to stuff comes in part from a notion that we should be
prepared for anything. When David Friedlander interviewed Mr. Hyde about his
project, he highlighted this issue:

Americans in particular like to be prepared for the worst-case-scenario, having

separate cookie cutters for Christmas and Halloween. We seldom consider how
negligible the consequences are when we running out of something or are
unprepared. Nor do we consider how high the consequences are for being over-
prepared…

Think about that for a second: there’s a consequence for being over-prepared.
Often that consequence goes beyond the financial cost. It can easily have a
physical cost that we didn’t expect, say in the need for more space to put all of our
stuff.

In a way, this all circles back to the notion of buying good things and holding on to
them for a long time. It can help to think in terms of, “Do I have room—physical,
emotional, mental—to bring one more thing into my life?”
If the idea of cutting down on your possessions is equally appealing, but still
daunting, start simple:

1. At the end of every season, go through your clothes. If you didn’t wear it
one time, get rid of it.
2. This process will generate a stack of stuff. For what it’s worth, don’t try to
sell it on eBay. It’s another cost (in time). So save yourself a headache,
donate it to a charity and take the tax credit.

You don’t need to get down to 39 possessions to feel the impact. Instead, this
exercise is about getting clear on why you own what you own and what it might be
costing you to own it.

Read No. 48

Why Your Family Should Talk About Money More Often

It’s no secret we’re uncomfortable talking about money. Talking about money often
ends in arguments about money. So we avoid it, and that leads to all sorts of
problems.
The discomfort is often at its worst with those we love the most: family. When was
the last time you discussed money in any meaningful way with your kids (or your
parents)?

For most of us, we probably haven’t sat down and had even the most basic of
conversations about what money may mean to our family. If you own a business or
have significant investments or other assets, at some point these money issues will
have an impact on your family, even if it’s only a question of inheritance.

Learning to talk about money in a way that’s productive is important, and you may
not even need to divulge your income or net worth to succeed. For wealthier
families, however, it may be part of the discussion. Last week, Paul Sullivan outlined
several examples of how unprepared some heirs felt when they received an
inheritance. No one had talked to them or explained what was coming.

Jason Franklin, now 32, said he received a call from his grandfather’s secretary
asking if he wanted to serve on the board of the family foundation. He was 21 at
the time, and up until that point, he said he thought his parents were just affluent
professionals like his friends’ parents. The invitation prompted questions.

“If your family has enough money to create a family foundation, that means you
have to ask about issues of wealth,” said Mr. Franklin, who works for a
philanthropic consultancy.

This may seem like a great problem to have, but it’s a problem just the same. I’ve
written before about a friend who was determined that his kids wouldn’t felt
entitled. From an early age, he met every request his kids made to buy something
with, “We can’t afford that.” One evening when his oldest was a teenager, my
friend’s son came to him concerned and said, “Dad, between homeless and Bill
Gates…where are we?”

My friend realized that he had not communicated his intention clearly. He had
avoided having discussions about money because, like most of us, he didn’t know
how.

If you don’t take the time to talk about money, how will your family understand
money’s real value? Have you talked to your kids about the relationship between
hard work and money? Have you talked about the financial sacrifices, delayed
gratification and the need for financial discipline? Have you talked to your kids
about the only way to buy happiness?

You owe it to yourself and your family to get past the uncomfortable part and talk
about the role of money in your family. Getting it out in the open can go a long way
towards avoiding problems later.

Read No. 49

One Key to Happiness: Let Go of Some Long-Term Goals

We’ve all heard how important it is to set and track goals.

We’re encouraged to write them down, tape them to the mirror and review them
daily. It’s now common to hear people refer to their “bucket lists.” But after
setting all those goals, we’re often faced with a hard truth: we will not have enough
money to reach all our goals.

Not now. Not ever.

It can feel incredibly painful to discover that you spent years expecting to do
certain things but ended up being limited by a lack of money. I often refer to this
feeling of disappointment as the gap between our expectations and our reality.

For some, this disappointment comes when we realize that the retirement we
planned is no longer an option. Years of working and saving just didn’t turn out the
way we’d hoped. So it’s no surprise that if we spent a decade or two attached to a
certain outcome, even delaying life because we’re so focused on that outcome,
we’re really disappointed when it doesn’t happen.

A few weeks ago, I spoke with someone about her bucket list. With tears in her
eyes, she told me she finally realized that she might not ever have the money to do
some of the things on her list.

Yet this same person appeared to live a life that many would consider a dream. She
participated in her community and enjoyed meaningful work. Life wasn’t bad in any
measurable way. But while that’s easy to say, it was clear from our conversation
that the pain of her unmet expectations was very real.

The question is what do we do about it? Can we avoid it?

I suggest something radical. I believe it’s time we let go of outcome-based goal

setting and instead focus on the process of living the lives we want right now.
Letting go of outcome-based goals can bring us freedom. We can start by:

1. Letting go of expectations.

Just in case life hasn’t already shown you otherwise, the world doesn’t necessarily
owe you anything. Goals are great, and they can help us focus our efforts toward
doing and being better. But you need to focus on having them remain goals and not
turning them into expectations.

2. Letting go of outcomes.

Focusing on the process is a far better way to set goals. When I wrote my book, I
hoped that in some small way it would help people make decisions about money that
were more aligned with what is really important to them. My goal wasn’t to write a
New York Times best-seller but instead to help people. Even starting out with the
right intent, I sometimes forgot that goal and instead focused on a specific
outcome out of my control. And no surprise, it led to anxiety and often
disappointment.

3. Letting go of worry.

I know how hard it is to stop worrying about money. After all, there are so many
money things to worry about. What if it all goes away? What if I can’t afford to
send my kids to college? It’s a hard habit to break, but it doesn’t do us any good.
Can you think of one single thing that got better because you worried about it?
Obviously it’s different from sitting down and crafting an action plan to solve a
problem. All worrying does is create an uncomfortable rut.

4. Letting go of measuring.

We’re competitive. We like to compare ourselves to other people. We love to race

to see if we’re good enough to win. As I wrote earlier this year, we’re all striving
for happiness. But we don’t have units of happy we can measure. I think in some
instances we’ve substituted measuring money for happiness even though few people
have set the explicit goal of having more money than the next person.

5. Letting go of mindless tracking.

A bit different from measuring or comparing yourself against others is letting go

of tracking every penny in and out. For some people, there’s a belief that spending
should be painful. And I’m all for tracking your spending habits to learn about
yourself and your relationship with money. After doing it for eight years, however,
my wife asked me what good it does to know down to the penny how much we spend
on gas in a month. In this case you don’t want to confuse the process with the goal.
The goal isn’t to track every penny but to know where your money goes.

Goals can be a great things. We just need to do a better job making sure they don’t
turn into expectations that leave us disappointed and unhappy.

Read No. 50

Questions to Ask When Picking a Financial Adviser

I’m the first to admit that finding a financial adviser/planner/manager/consultant
that fits your needs can be a challenge. All the different titles and abbreviations
alone can be confusing. But knowing what questions to ask is crucial to beginning
the process of finding someone who will fit your needs.

For today, I want to focus on one of the most important: how advisers are
compensated. Often people ask the questions, “How do I pay you?” or “What am I
charged as a client?” It’s important to understand that asking advisers how they’re
compensated is a different question than those two.

That’s because many financial advisers’ compensation can include bonuses for
meeting sales goals, spots on “educational” trips or direct compensation for selling
you certain products. So asking how they’re compensated will help you identify
potential conflicts of interest.

An even more specific question you shouldn’t be afraid to ask is, “Do you get paid
(or win) anything based on the products you recommend to me?” And try this one
too: “Do you receive compensation for our relationship from anybody other than
me?”

A recent New York Times article by Susanne Craig and Jessica Silver-Greenberg
about former brokers at JPMorgan highlights why it’s so important to ask the
question:
These financial advisers say they were encouraged, at times, to favor JPMorgan’s
own products even when competitors had better-performing or cheaper options.
With one crucial offering, the bank exaggerated the returns of what it was selling
in marketing materials, according to JPMorgan documents reviewed by The New
York Times.

To be clear, uncovering a potential conflict doesn’t automatically mean it’s

something bad; it’s just very important to know about it.

There are some financial professionals who are only compensated through what you
pay them. It’s not a catchy name by any means, but they’re referred to as a fee-
only adviser. (Full disclosure: I work for one.) What that means to you is that this
person doesn’t receive bonuses, “educational” trips or compensation for selling
certain products.

As Josh Brown noted in The Wall Street Journal, this model isn’t perfect, but it
does reflect an improvement in the financial industry:

There will always be conflicts, the world is not a perfect place, but we can say
emphatically that the industry has come a long way. The major potential conflicts
are washing away as the tide turns from brokerage to advisory but some small
flaws still persist. And that’s okay, so long as we’re moving forward for everyone’s
benefit.

Obviously the compensation question isn’t the only one to ask, and I’ll cover others
in future posts, but it’s certainly one of the most important.

Read No. 51

Five (Bad) Reasons You’re Worrying About the Markets

One of the most important things to consider when you’re investing is the question
of when you’ll need the money. If you need it next year, you should invest far
differently than if you need it 20 years from now.

If you’re invested in hundreds or thousands of stocks all over the world, and the
money is for an event 20 years from now (say, retirement), you can worry less
about losing it all. With that kind of diversification, risk becomes in part a function
of time. The odds of all the companies in your portfolio going to zero is pretty low.
It could happen, but if it did, we’re all moving to the hills to grow our own
vegetables anyway.

We know the market will go up and down in the short term, yet people sometimes
worry anyway about that fluctuation even if they don’t need the money for 20
years. Here are a few reasons why.

1. You’re not confident in your investment process.

If your portfolio is based on a thoughtful approach that relies on the best

academic evidence we have, then it can be easier to stick with the long-term plan
when things get scary in the short term. On the other hand, if what you own is a
collection of random mutual funds instead of a well-designed, broadly diversified
portfolio, it’s easy to get spooked. You start to wonder if the reason you’re losing
money has something to do with the investment instead of just the normal ups and
downs of the market.
2. You’re watching too much news.

Counteracting this one is simple, but not easy. Turn it off! Go on a media fast. If
you’re confident in your investment process, what does the daily news about the
markets do for you? Either ignore it, or get really clear about why you’re tuning in.
Is it to be informed so you can have an intelligent conversation at dinner parties?
Is it because you find it funny? I have a friend who refers to the Money section of
USA Today as the “Funny” section. Whatever your reason for watching or following
the news, just make sure you’re clear about it. If you’re watching out of habit, and
it makes you anxious, just stop it!

3. You’re listening to people with different time frames than yours.

Josh Brown recently posted this helpful reminder on his site, The Reformed
Broker:

“Everyone has an opinion and there is a lot of smart stuff being said for long-term
investors, short-term swing traders and day traders out in the Wide World of
Market Punditry — but the trick is not just figuring out who’s right, it’s
determining whether or not something is relevant to your time frame.”

If you’re an actual investor, and not a short-term trader, make sure the
information you’re worrying about matches your time horizon. If you’re investing to
pay for your kids’ educations 12 years from now, why do you care (at all!) about the
latest apocalypse du jour?

4. You’re projecting the recent past into the future…forever.

This is a classic mistake, and one that is really easy to make. We are pattern-
seeking animals and are notorious for looking at the recent past and thinking that
it will last forever. We did it with tech stocks in the late 1990s, real estate in
2005 and now we’re just positive the European debt crisis will never, ever end. But
it will. Remember, things change.

5. You think we’re all moving to the hills to grow our own vegetables no matter
what we do.

I can’t help with this one. Until I learn differently, I still believe it’s in our best
interest to be invested in a broadly diversified portfolio since capitalism as we
know it will not fall apart anytime soon.
Your timeline is your own. Not your neighbors’, your co-workers’ or your brother-in-
law’s. So do yourself a favor and make investing decisions based on what your time
frame requires and not what the talking heads on TV are saying to fill a 24-hour
news cycle. You’ll sleep better and will hopefully feel a bit less like running to the
hills.

Read No. 52

Build Systems to Cope With Your Bad Investing Behavior

At some point in our lives, most of us have done something that we knew ahead of
time made no sense but went ahead and did anyway. (Just think back to your
teenage years.)

After the fact, we’d shake our heads and wonder what we were thinking. Maybe it
wasn’t our fault. Maybe the science shows that there are times when biology works
against us and makes it difficult to act rationally.

In the case of investing, both the science and the anecdotes seem to back up the
idea that sometimes our biology gets in the way of our ability to assess risk. That
matters a lot when you’re investing, according to John Coates, who wrote about it
on Time.com recently:
…when we take risk, including financial risk, we do a lot more than think about it —
we prepare for it physically. Body and brain fuse as a single functioning unit…
[However] (e)ffective risk-taking morphs into over-confidence and dangerous
behavior and traders on a winning streak may take on positions of ever-increasing
size, with ever worsening risk-reward trade-offs.

Even Warren Buffett, known to encourage investors to be fearful when others are
greedy, and to be greedy when others are fearful, isn’t immune to biology
according to Dan Ariely, a behavioral science expert:

He is what behavioral economists call a sophisticate: someone who understands his

irrationality and builds systems to cope with it.

Since irrational behavior appears to come naturally to us, we need to be like

Buffett and build our own coping systems:

1. Acknowledge our problem. Most of the time the market is not the problem;
we are. We buy high because it feels good or our gut tells us we’re right. We
sell low because we feel like we have to to avoid extinction.
2. Write the money story. Look back at your track record in terms of bad
behavior and see what story it tells. The great thing about financial
decisions is that we have evidence. We have tax returns, brokerage
statements and online transaction details. Take the time to see what your
story says about your experience and write it down. Did you buy tech stocks
in late 1999? Real estate in 2007. Bail out of stocks in 2008 or 2009? Or did
you have a disciplined process that helped you cope with biology?

3. Establish guardrails. Think of it as building a preflight checklist. Those

checklists aren’t there because pilots aren’t smart and experienced. They
are there to prevent pilots from making a dumb mistake despite that they
know what they’re doing. In other words, recognize that no matter how
smart you are, you can still make mistakes if you don’t install guardrails for
investing. This could be as simple as a written statement (financial advisers
call it an investment policy statement) that outlines what you will and will not
do when it comes to investing. How much risk are you willing to take? When
will you rebalance? How often will you reevaluate your plan? And who else is
part of it? Knowing the answers to these questions can keep you from going
off the road when trouble hits.
 4. Automate good behavior. Because bad investing behavior tends to be our
natural default, we have to automate the opposite. Check the box to
rebalance your 401(k) automatically if you can and ask for that option if it’s
not available. Arrange to have the money you want saved for education
automatically pulled from your checking account monthly. Have a set day to
review your spending and savings goals every month or quarter. Schedule a
quarterly review of your investments. The things that get automated will
vary from person to person, but they make fighting biology a little bit easier.

Remember: there is rarely a time when investing skill matters more than investor
behavior. So make your behavior count.

Read No. 53

Don’t Punish Yourself Every Time You Spend

My daughter made the cross-country team, and she needed new running shoes.
Have you shopped for new trail-running shoes recently? They’re so expensive that
it hurt! I was telling someone I know about the experience and said I hoped buying
something like shoes never stopped being painful, because I never want to get
casual about spending that kind of money.
She surprised me by asking this: What good does it do for it to be painful? How
did that help?

That’s a really good question. I was going to buy the shoes for my daughter anyway.
I’m excited she is running cross country. In fact, that is exactly the sort of thing
our family wants to spend money on, and it fits in our budget. So why make it
painful?

Turns out there is some research on this connection between spending and pain.
Scott Rick, a University of Michigan marketing professor, and other researchers
did a study to measure how people felt about their buying decisions. Along the way,
they discovered something interesting, as a Kiplinger writer noted:

Spendthrifts don’t feel enough pain for their own good, so they overspend, carry
more debt and feel guilty later. Tightwads, however, experience too much pain,
which leads to feelings of regret for not having spent enough. Rick says it’s worse
to be a spendthrift because of the financial costs, but neither extreme is as good
as the middle group, labeled unconflicted. “Spendthrifts are bad off financially and
psychologically,” he says. “Tightwads have big bank accounts, but we find that
they’re less happy than the unconflicted group.”

George Lowenstein, a professor of economics and psychology at Carnegie Mellon

University, has also looked closely at the psychological connection of pain and
money:

People experience what my research collaborators and I call a ‘pain of paying’ when
they pay for purchases, and this pain is more intense with cash than with cards.
Paying with cards is more carefree.

So as Lowestein notes, paying cash is a physical thing that results in having less
cash in your wallet. You can see it happen, and you know that you immediately have
less money. Knowing you’ll have less money then makes you less likely to spend
because you want to avoid the pain.

When you pay with a credit card, however, your action is disconnected from
spending the money. You end up with the gratification of getting what you want
immediately, but the pain of paying for it is delayed several weeks until the bill
arrives.
It’s hard not to wonder if this focus on pain has contributed to our less-than-
healthy relationship with money. How can it be good for my children to hear me
talk about both the car repair bill and their summer camp bill being painful?

What if we focus instead on making sure the way we use our money is aligned with
what we say is important to us? In other words, shouldn’t we be happy about
spending money on things we value and are within our budget?

In fact, I believe it’s this kind of aligned spending that makes it possible to spend
our way to happiness. So instead of looking for pain, let’s look for alignment. Next
time you reach for the debit card, or cash (if you like pain), ask yourself this:

1. Does this fit in my budget? In other words, can I afford this?

2. Is this something I value?

If the answer to both is yes, then you should be able to put a stop to most of the
pain and actually enjoy the purchase. This is one way we really can spend our way to
happiness.

Read No. 54

The Case for Spending a Little More Sometimes

A number of years ago, it was time to buy a new road bike. There was one that I
always wanted, but it was more expensive than I could afford. I remember thinking
that I should just settle for a cheaper bike, one that I didn’t really want but told
myself would be fine.

But I decided that instead of settling for something I didn’t really want, I would
wait until I could afford it. Later, I bought the bike I really wanted.

And guess what?

I still have that bike, and I still love it! I’ve watched other people go through three
or four bikes in the time I have had this one. In the end, I suspect I spent less
money by buying the one that cost more.

We’re faced with these decisions all the time. It may not be a bike, but maybe a
watch, clothes, a new car or even a house.
It’s tempting to tell ourselves this little story about being frugal as we buy
garbage from WalMart instead of the quality stuff that we want. Stuff that lasts.
Stuff that we can own for a long time.

Here is the issue: when we settle for stuff that we don’t really want, and instead
buy stuff that will be fine for a while, it often costs more in the long run.

How many shirts do you have in the closet that you never wear because you bought
them on sale, despite feeling that they weren’t quite right? Those shirts you saved
so much money on are now costing you in more ways than just money.

We have to deal with storing them. We have to deal with the uncomfortable feeling
we get each time we see them, knowing that we shouldn’t have bought them in the
first place. Then, we have to figure out how to get rid of them. Next thing you
know, you’re trying to sell that shirt you bought on sale for $10 for only a quarter
at a yard sale.

Why not just wait and buy the $20 shirt you will actually wear and then keep it?

Too often I think we convince ourselves that buying for the long term doesn’t
matter. We can always replace it, right? But how much simpler would life and our
money decisions be if we bought with the goal of owning that item for a long time?

Taking this approach puts a new spin on how we spend our money. Maybe it makes
us think a little harder about what we’re buying. Maybe it makes us wait a little
longer so we can afford exactly what we want. Maybe it makes us a little happier
about what we have because we’re buying things we want around for a long time.

When we start treating everything around us as disposable, it’s hard to not think
of money as disposable, too. And it’s this line of thinking that gets us into trouble.

Don’t be the person who ends up with a storage unit full of stuff you didn’t really
want in the first place and an empty bank account. Do be the person who buys good
things and then hangs on to them. Both you and your bank account will be happier.

Read No. 55

3 Basics of a College Financial Plan

When I suggested a couple weeks ago that we need to talk about and plan for
college sooner, one question kept coming up: how?

While the specifics of your plan will depend on you and your children, there are
some basics that make sense for most everyone.

1. Where are you today?

Perhaps this one is obvious, but you need to be super clear about your current
financials. It’s really hard to plan a trip if you have no idea where you’re starting. A
good place to begin is to create a family balance sheet. It may seem a simple thing,
but you’d be surprised how few people have one.

2. Where do you want to go?

Normally, when you decide to go on a trip, it helps to know where you want to go.
But with financial goals, like saving for college, it’s rarely a straight line. Since the
future is uncertain when we try to plan, and especially when we pretend we can be
precise with planning, it can end in frustration.

Think of all the guesses that go into a plan for reaching financial goals.

 What will it actually cost?

 What about inflation?
  What rate of return will we earn?

 How much can we save?

Then, there’s maybe the biggest unknown: where will your children want to go AND
will they get accepted?

But if that seems too complicated, there’s always the approach taken by my friend
Brad.

One time I asked him if he knew if he was saving enough for his daughter’s
education. Did he have a plan? He said: “Hey Carl, how about this plan? I’m saving
as much as I reasonably can.”

With that in mind, let’s walk through the two options.

If you need motivation to save, then it may be helpful for you to take the time to
forecast (really, guess) what it will cost you to pay for college. I’ve seen motivated
people suddenly find ways to save more, either by spending a bit less or earning a
bit more. If you need help, there are plenty of tools. Try this total cost calculator,
or if you want to get more specific in your guess, you can compare public and
private colleges by state.

But maybe you’re more like my friend Brad: just save as much as you reasonably
can. Since saving is one of the few things that may be in our control, I like this
plan. Saving as much as you reasonably can may be all we can do anyway. Ultimately,
it really doesn’t matter how much it will cost to send my daughter to Stanford. I
can only save as much as I can, and I may not enjoy the idea of constantly
reminding myself that I’m not doing enough.

What if I focused instead on the other things that matter? Things like having real
conversations with my daughter about her goals and what it will take to get there.
And there’s definitely value in helping her explore all the available scholarships and
financial aid and what she can do to improve her chances with grades, sports and
other activities.

After all, as Felix Salmon pointed out, we often don’t even know the cost until the
acceptance letter arrives. In some cases, the colleges we assumed would be beyond
our financial reach could end up costing slightly more than other colleges because
of financial aid.
3. Where do I save the money?

It’s hard to argue against using a 529 account for at least some portion of the
money you’re saving for college. There are two options available: prepaid tuition and
college saving plans. Such plans can offer tax benefits. But remember that if you
withdraw money from these accounts for something other than education, there
may be penalties and fees. To get a sense of what’s available, here’s a tool for
helping you evaluate the different 529 plans.

No matter what path you select, one of the most important and valuable parts of
the process might be the conversations you have with your children. Besides
helping prepare them for college, you’re helping them learn how to set and achieve
their financial goals. And that’s an education they can always use.

Read No. 56

The Two Keys to Investing: Pickiness and Persistence

Based on the e-mails I’m getting, I guess that the stock market is getting scary
(again). Will someone please remind me why we’re surprised when the market has
periods — sometimes long periods — of turbulence and even decline?

We have a word for this: risk. Sometimes, we swap it out with the word volatility.
You hear people complain that the market sure seems volatile lately, or they use
the market’s ups and downs as a reason (or excuse) for putting all of their money in
cash until things “clear up.”

But here’s the deal: the reason that stocks are likely to return more over time
than bonds, and bonds more than cash, is precisely because they are more volatile
(risky).

When it comes to investing, risk and reward are related. It’s as close as we get to
a fundamental law in finance. If you want or need a greater expected return, you’ll
have to accept more risk. The times I’ve tried to skirt this law, it’s been painful.
So if we believe that risk and reward are related, then investing becomes a pretty
simple exercise. You buy good things and hold on to them for a long time.

Buying good things is easier than it’s ever been. Diversified, low-cost investments,
like index funds, are good things and seem to be available on every online street
corner. Also, figuring out how much to put into stocks versus bonds or international
versus United States investments has been made easier by the introduction of
target retirement date funds that use low-cost index funds like the ones at
Vanguard.

A great place to start would be using the Vanguard fund that matches your
retirement goal, like the 2045 fund. Then there’s the option of taking your age and
putting that percentage of your portfolio in a bond index fund or taking 100 minus
your age and putting that percentage in a global stock index fund.

Like Vanguard’s founder, John Bogle, said, you could find advice that was better
than this, but the amount of advice that was worse was infinite. If you need more
specific help, find an adviser you trust who uses index or other passive investment
funds to make more customized portfolios.

Now, just because buying good things has become simple and easy doesn’t mean
long-term success is guaranteed. You can design the best portfolio in the world,
make one behaviorial mistake and blow the whole thing up. This natural tendency to
react to the endless stream of useless news we get from the financial pornography
networks is hard to overcome.

Of course, we want to do something (anything!) when the world is coming to an end.

The problem is that it seems like the world is coming to an end — a different end
— every week. If it wasn’t, what would they talk about on CNBC?

So that is where this second part of my little plan comes in: after you have bought
good things, hold on to them for a long time.

If you’re invested in the stock market, I’m assuming you believe that risk and
reward are related. If you don’t believe that, or if you think that it used to be true
but now the game is rigged, get out and stay out. You can’t have it both ways. If
risk and reward are no longer related then there is no reason to invest in stocks.

So much of what we think of as investing would be recognized as little more than a

fantasy of market timing when viewed in this light:
  The idea that you can be in the market when it goes up and out when it goes
down: Fantasy.
 The idea that you can pick stocks that will go up when the market goes down:
Fantasy.

 The idea that your buddy from college who worked on a trading desk for
years and has now started a hedge fund that uses a proprietary trading
algorithm that can get the same return as the market with less risk:
Fantasy.

The tricky thing about all these fantasies is that someone is always successful just
often enough, for just long enough, to get a spot on television or to make the cover
of a magazine. At that point, we’re enticed into believing we can get in on the
action. Then, just about the time you think you have found investing Shangri-La, it
disappears, right after you commit your capital to it.

Because we can’t have it both ways, if someone promises you higher returns, you
need to ask the question: What’s the corresponding risk? If you can’t identify it,
don’t be fooled into thinking it isn’t there. It is, and it’s likely to show up when you
least expect it.

If you still believe that risk and reward are related, buy good things and hold on to
them for a long time. If you no longer believe, then get out and stay out. The thing
to remember is that either choice is O.K., but trying to do both is a very bad idea.

Read No. 57

Start Your College Value Conversation Now

My daughters are 15 and 13, and my wife and I have been planning for their college
expenses for a while. With just a few years to go, however, it’s starting to feel
really serious. And that has led us to frequent conversations about our feelings on
the value of a college education.

With every conversation, I’m finding it fascinating to work through my assumptions

and preconceptions on this crucial issue. We all dream of our children having a
better future, so it’s no surprise that our conversations about education can get
emotional. Money and dreams mixed together will do that to you.

Part of these conversations includes the very interesting experience of working

through the basic assumptions I’ve made about the value of a great college
education compared with the reality of paying for it. My wife and I set the goal of
sending our children to the best schools they can get into. But with the costs of
such an education spiraling out of control, I find myself questioning that goal.

One of our daughters decided a long time ago that she was going to Stanford. I’ve
been careful not to crush her dream, but there’s a reason why they say reality
bites.

Let’s say she manages to get accepted. (Stanford’s acceptance rate is 7 percent, so
I know it’s a long shot for anyone.) According to Stanford, the costs for a typical
undergraduate student adds up to $58,846 per year. That’s over $200,000 for an
undergraduate degree, and that doesn’t even account for the next several years
worth of inflation.

Sure, Stanford is a striking example, and the college is generous with financial aid.
But in 2011 the average outstanding student loan balance was over $23,000, with
10 percent of those loans being above $54,000, and the data shows people are
having a harder time keeping up with the payments. If we don’t take the time to
think through our assumptions about college, it becomes much easier to end up in
that 10 percent group before earning a single paycheck.

The conversation gets even more complicated when we balance it against the fact
that college students now say that being financially secure is their most important
life goal.

See the issue here? On one side of the argument we’ve been taught that getting
the best education money can buy is the best investment you can make. On the
other side sits the fact that the skyrocketing cost of education can be a major
hurdle to the thing that we say we value the most, financial security.

The tricky part is that we don’t have a single right answer for everyone. As my
friend, the financial planner Tim Maurer, would explain, this is the kind of personal
finance issue that is more personal than it is financial.

What if my daughter does end up going to Stanford and decides in her junior year
that she wants to teach elementary school? I’ve seen the amazing work of my
children’s teachers, and it’s clearly a worthwhile goal. But what about the debt she
might incur getting that fantastic education? Can she realistically earn enough as a
teacher to repay that kind of debt?

Also, how much does the debt matter if having a degree from a top-flight school
can help open doors that might not otherwise open? Do those doors lead to an
increased shot at financial security and happiness once all the debt is paid? Again,
I’m not sure what the right answers are, but it helps if we start by asking the right
questions.

One question that comes up more often now that would have seemed like heresy in
the past focuses on whether college is even worth it. Another version of this
question is what I call the Dropout Myth. When it’s brought up, we’re presented
with the names of some famous people who dropped out of school and went on to
become wildly successful. We love to hold people like Steve Jobs, Bill Gates and
Mark Zuckerberg up as examples of why going to college might be a waste of time.

But that can be a dangerous road to go down. I think it’s hard for someone to claim
with any seriousness that Steve Jobs’s success happened because he dropped out
of school. This doesn’t mean we shouldn’t ask hard questions about the value of
college, particularly with the example of the interesting work of people like Josh
Kaufman and his Personal MBA.

The reality of the hard choices around education were brought home to me on my
recent trip to Canada. I had a conversation with several recent grads who hadn’t
thought through how expensive college would prove to be and the impact of the
debt on their lives. So when they asked me what advice I’d offer to someone
preparing to go to college, I suggested that the answer was in line with how we plan
for the other parts of our financial futures: we need to start talking and asking
questions about these things sooner rather than later.

Talking should lead to planning, and hopefully the process of planning will lead to
making decisions that are aligned with what we say is important to us.

Read No. 58

The Most Important Question to Ask About Specific Investments

On a regular basis, I get asked whether someone should buy a specific investment.
I also get asked about the market, the economy and specific things like gold, the
Facebook initial public offering or the European debt crisis.

All of those things are very interesting and they seem to be something we spend a
lot of time talking about and debating. But I wonder if our obsession with current
events and specific investments focuses on the wrong questions.

What if the better question to ask is, “Does this investment fit in my plan?” If
your answer is, “Plan? What plan?” that gets to a broader issue I’m seeing more
often.

While it may be interesting to talk about specific investments, it’s far more
important to get a plan in place first. Only then should you go looking for specific
investments to populate that plan. It’s kind of like figuring out where you’re going
on a trip before you decide the mode of transportation to get there.

When we focus on the wrong question (“should I have gotten in on the Facebook
I.P.O.?”), we’re more likely to make poor decisions based on short-term thinking
and emotion. Instead, we ought to realize that we may not even know the correct
answer to the bigger questions about our long-term plans.

We don’t know how the most recent I.P.O.’s will perform. We don’t know how things
will work out with the European debt crisis. We don’t know what will happen to the
price of gold. But if we have a plan, we can know whether those things have a place
in our long-term strategy.

Let’s take the I.P.O. example. I would argue that in most sound investments plans,
I.P.O.’s rarely fit. Investing in one of them puts you in the position of owning a
specific, individual stock as opposed to being diversified. So if you’re debating the
question of whether to buy, you should do so on the basis of answering the
question, “Does it fit?” If the answer is no, move on. Go back to what you were
doing before, which was, hopefully, enjoying your life.

Depending on your plan and your situation, it may make sense to commit capital to
an individual stock or an I.P.O. Perhaps it’s important for you to own a small
allocation of an individual stock for work reasons, or maybe you just enjoy the idea
of having a little “play money” to invest. Whatever your reasoning, it needs to be a
part of your plan.

It may look like this: I will allow myself to use up to 5 percent (this as an example;
your number could be different) of my investments as play money, but I will not
allow it to go higher. It is super important to understand the value of having that
cap specifically spelled out in your plan.

When we start to make investment decisions in isolation, without understanding

the why of those decisions in the context of our lives, we tend to do things
emotionally. And emotion makes it that much easier to commit the classic
behavioral mistakes, like buying high and then later selling low.

As simple as it sounds, it all really goes back to the idea of asking the right
question.

Read No. 59

The Right Way to Try to Buy Happiness

Money can’t buy happiness.

You hear this all the time, but is it true? I know we can point to rich people who
appear miserable and poor people who appear happy. Of course there is that study
from Princeton University that I wrote about in 2010:

…Daniel Kahneman, a winner of the Nobel in economic science, and co-author Angus
Deaton found that people reported an increase in happiness as their incomes rose
to $75,000 a year. Then, the impact of rising income on happiness levels off.

I understand the idea: if you’re a miserable person, then having more money
beyond what you need for basic necessities will not make you any happier. I’m also
sure that having more money is not a requirement for being happy. But think about
this: if your income doubled tomorrow, do you think you would be happier?

I asked my wife that question a while back. She paused before answering, then
said, “I feel like I’m being set up. Is this a trick question?”

Based on that conversation, I have started asking this question every chance I get,
and many people seem conflicted. If we are honest, we feel like we would be
happier, but acknowledging it feels wrong.

So why the conflict?

Part of it might be that being content with what we have is a good idea. Spending
all your time wanting more, or thinking about how happy you would be if you just
had “X” more, is a surefire way to be unhappy.

But there is another issue that I think we need to spend more time exploring.
Maybe we are looking at the relationship between money and happiness the wrong
way. Often when we think of money, we think of things like bigger houses, flashy
cars and more stuff. That does not lead to happiness.

But according to another article about money and happiness that ran in The New
York Times in 2010, there is plenty of research suggesting that experiences, time
spent with people we love, and memories of special events contribute significantly
to happiness. In it, Elizabeth W. Dunn, an associate professor in the psychology
department at the University of British Columbia, had this to say:

“’It’s better to go on a vacation than buy a new couch’ is basically the idea,” says
Professor Dunn, summing up research by two fellow psychologists, Leaf Van Boven
and Thomas Gilovich.

Professor Dunn and her colleagues also wrote a paper about it that can be summed
up by the title: “If Money Doesn’t Make You Happy Then You Probably Aren’t
Spending It Right.”

Money is just a tool and having more of it does not make us happier by itself. But
just like any tool, the impact is in how it is used.

Here are something things I can do with money that will make me happier:

1. Spend more time with my family. This doesn’t have to be a big deal.
Establishing a routine of being at games or performances, walking the kids to the
bus stop or being at home one day a week when they get there would make me
happier for sure. That means working more efficiently at other times to make this
possible. It can also mean choosing work that I enjoy and that gives me a bit of
flexibility.

2. Spend more time outside exercising. Exercise makes us happy. Time outside
makes us happy. Having the right gear makes that possible.

3. Pay off debt so I feel free and secure. When I ask people what is important
about money, almost universally the first answer is security and freedom.
4. Establish an emergency fund. Even a little bit adds to a feeling of security.

5. Travel with my kids. I love helping them see the world or even just the next
city over.

6. Build or make things by hand. Sure, time is money, but there is satisfaction in
the act of construction that does not come from a stop at the store.

7. Sleep more. This is not because I’m lazy, but because it’s a fact: Many of us
sleep too little. Why? We are so busy working we don’t have time. Money can help
me have more time, since it may enable me to work less.

Maybe in the end this is not about having more money. Maybe this is about choosing
to spend what we do have in a way that is more aligned with what we say is
important to us and understanding that happiness is not about getting more money.
It is about spending it right. In fact, it is clear to me that we can spend our way to
happiness if we understand how and why we are spending. 

Read No. 60

How to Talk About Money With Your Spouse

Years ago, my wife and I had dinner with another couple, whom I’ll call Bob and
Sue. During the meal, we discussed money, the market and our goals and dreams
for our families. Then we started talking about retirement, and that’s when Bob
got a big surprise.

Sue mentioned that traveling more was her primary goal for retirement. As Sue
talked about her travel plans, I looked at Bob and could see he was shocked. Bob
then admitted that he’d never heard Sue say anything about travel. “I didn’t know
it was a goal,” said Bob.

What made this so surprising is that Bob and Sue had been together for over a
decade in a solid relationship. Clearly, even the most engaged couples or partners
don’t automatically cover all the bases when it comes to the big stuff, which means
we need to make a concerted effort to do better.
More than once, I’ve been in client meetings where it’s clear that couples are
having their first discussion on big decisions — kids’ education, saving, even
retirement. Without fail, either one or both individuals is surprised, if not
shocked, by their partner’s opinion on a topic. So from what I’ve seen, it seems
obvious that the more conversations you have about money before you have to
make major financial decisions, the happier you’ll be in your relationship.

I think it’s safe to say the rules apply to whatever relationship you’re in, whether it
be personal or professional. Having the conversation before the decision gets made
can make a huge difference in not only your happiness, but also the long-term
success of your relationship.

Here are a few things I’ve found that can make a difference:

1. Set a spending threshold. Often our biggest arguments come from surprises.
For instance, one of the easiest ways to start an argument is for one spouse to
make a big purchase without telling the other. I’ve found it helpful to set a
predetermined limit. You choose what it is. Depending on your budget it may be as
little as $50 or as much as $500. The point is that you discuss it with your partner.

2. Talk about education. It may seem odd, but one of the most common
disagreements I see between couples revolves around their children’s education.
One parent may say, “I supported myself and paid for my school. It’s better for
our kids if they do that, too.” The other wants to pay for the best school the kids
can attend, no matter the price. The point isn’t that one is right and the other is
wrong. Since it’s a topic that can raise strong feelings, it needs to be discussed,
preferably before the first child is a senior in high school and sending out
applications.

3. Decide where to live. Some people really want to own a house, others don’t
mind renting. Couples need to have this discussion because it can be an emotional
decision. There needs to be an honest conversation about expectations on both
sides and what’s right for you as a couple and family. I also can’t emphasize it
enough: Don’t view your home as an investment. Buy a house for reasons that aren’t
connected to selling it again in a year. Otherwise you may head down a road that
causes frustration in the future.

4. Talk about vacations. Because big dollars can be involved, you need to talk
through your vacation expectations. You need to be honest with each other about a
budget that makes sense for travel and put it in the context of your other
financial obligations. The last thing you want to do is go on vacation and then come
home only to be shocked by the credit card statement.

5. Review your retirement expectations. The way we think of retirement is

changing, and you need to discuss it with your spouse. You may be in the camp that
says, “I’m working for 40 years and then I’m done.” However, I’m seeing more
people say they want to work long enough to then be able to do something that’s
less stressful but more fulfilling. Talk it through and be clear about what’s
important to you.

At this point, you may be wondering how to get started. Here’s a few ideas:

Each month set aside a specific time and place to talk. Doing so can help you avoid
tricky conversations when they’re least expected or when you may already be
irritated by something else. By setting aside time, you can prepare and know what
to expect. There may still be disagreements, but because you’re talking about
money regularly, it’s less likely to get blown out of proportion.

Also, have a “no shame, no blame” rule. Many discussions around money can end in
heated arguments. Take the heat out by giving both individuals permission to have
these discussions without shame or blame. The point is that you’re talking through
the problems. Then, take responsibility for your actions. While there shouldn’t be
any shame, with every discussion you should commit to learn from your mistakes
and move forward.

Write the decisions down so you can track your progress. A benefit of monthly
meetings is that you can assess how you’re doing, but it requires keeping track of
what you’ve agreed to do. Write things down and revisit them during your meeting.
Have you made progress? If not, what needs to happen? The list can be a great
way to manage your monthly conversations. Don’t be afraid to use it and hold each
other accountable.

Finally, automate your decisions. If you decide it’s important to save $200 for
education every month, give this decision a head start. Work with the institution
that’s holding your savings to make the payment automatic. It will give you one
more thing to check off the list and save you from having to remake the decision
monthly.
Talking about money with our spouse or business partner doesn’t have to be a scary
or stressful affair. In fact, I think we can dial down the stress significantly when
we have a better understanding of what matters to the other person in our
relationships. It also doesn’t hurt that we get the added benefit of greater
financial success in our lives by talking through these big financial decisions before
they become critical.

Read No. 61

Hope, Stupidity and Other Causes of Your Own Financial Crises

A few weeks ago, Timothy F. Geithner, the Treasury secretary, stated what many
of us know but few want to admit:

“Most financial crises are caused by a mix of stupidity and greed and recklessness
and risk-taking and hope.”

For the purposes of this discussion, put aside your sense of outrage that Mr.
Geithner, as the head of the New York Fed, was one of the people driving the bus
that ended up in the ditch, both leading up to and during the credit crisis.
Yes, many people bear responsibility for letting this particular crisis happen on
their watch, but we can’t ignore the key roles of stupidity, greed, recklessness and
hope. Many of our personal financial crises are also caused by that same potent
mixture of greed, hope, ignorance and the overriding mistake of overconfidence.

It is easy to see the stupidity in others.

A bit too easy I’m afraid. I have found that if we focus on the actions of others
and continually look for some third party to blame, we have a tendency to repeat
the same mistakes over and over. But if we instead examine our own decisions so
we can learn from them, we have a shot at changing that behavior.

Mr. Geithner also highlighted another reality that we can’t ignore: “You can’t
legislate away stupidity and risk-taking and greed and recklessness.”

We can’t assume that some third party will be available to prevent every bad
financial decision. But on a personal level, we can move a bit more slowly. We can
recognize that we don’t know everything. We can diversify away the risk of being
ignorant. We can decide that slow and steady does win the race. We can
understand that when something seems too be good to be true, it most likely is too
good to be true.

Now’s the time to focus on our own situation, our personal economy, and realize
that the things over which we have control are often also the things that matter
the most. It helps if we take the long view and ignore the noise of the latest crisis.

Don’t miss your opportunity to stop the Four Horsemen of your personal financial
apocalypse.

Read No. 62

The Danger of Too Much Comfort in Your Financial Life

Change can be a scary thing. So it’s no wonder that we’re drawn to things we
recognize — to things that are familiar — and stick with them. It’s why we go to a
chain restaurant, buy clothes from the Gap and drive the same kind of car for big
chunks of our lives.

It’s human to look for the familiar and to keep coming back. But when it comes to
investing and money, this pattern creates some problematic biases. Let’s take a
look at how they might be impacting your life.

1. Paying Every Month

Each month there are certain bills that we get in the habit of paying without really
thinking about them. Some, like our utilities and mortgage, are a given. But what
about that gym membership? We’re even more oblivious to the bills that get paid
automatically.
Over time, we can end up spending more money than we’d like on things we don’t
really want and maybe aren’t even using. But we do it because we always have, and
we haven’t stopped to ask why.

A new month starts on Tuesday. I suggest you sit down and make a list of all your
monthly bills. Then go through each one and ask the question: Do I really need
this?

2. Believing in the Company

Secretaries becoming millionaires because they own a bunch of company stock are
the exception, not the norm. So don’t kid yourself that working for a company,
having a 401(k) with that company AND investing the rest of your money in that
company’s stock makes a lot of sense.

For every Google, there’s plenty of Enrons. Don’t let familiarity with your company
get in the way of you planning for the future. If you’ve made one company your sole
source of income, what happens if it ceases to exist? You may know your company
incredibly well, but that’s no guarantee of future success.

3. Inheriting an Opinion

Every so often, I’ll hear from someone who inherited some stock. Oddly enough it
usually ends up being a utility. People rarely want to part with the stock. Whether
from emotion (My grandma gave it to me!) or fear (What would I buy instead?),
people will cling to the stock instead of honestly assessing if it makes more sense
to sell it.

This becomes even more complicated when there are emotions connected to the
decision.

A classic example involves the breakup of AT&T in 1984. When Ma Bell was split
into the Baby Bells, shareholders received equal amounts of stock in each new
company. However, by the time Gur Huberman studied the proportions of holdings
for his 2001 paper “Familiarity Breeds Investment,” he found that investors
tended to disproportionately hold shares in their local Bell.

Your goal is to invest in what makes sense for you, not what your grandparents
thought was best.
4. Being Sold Life Insurance

Life insurance is almost always sold and rarely bought. What do I mean by that?

Few people wake up in the morning and say, “I’m going to buy life insurance today.”
They’re usually approached by someone they know — a neighbor, an uncle, even the
infamous “evil” brother-in-law — and sold on the idea.

The insurance that requires the most selling is variable or whole life, which comes
with an investment component in addition to the death payout, because it’s
generally not a good idea for most people. Because it’s not a good idea, it has to be
pitched, and the people most likely to give in are those who know the person doing
the selling. We do this even though our intuition tells us that it probably doesn’t
make sense.

Then, even though we suspect we’re throwing good money after bad, we keep paying
those annual premiums because we’re used to it (see above). Stop it! Don’t be afraid
to admit that it might not be the best option for you. Continuing to pay the
premiums doesn’t correct the mistake, it just compounds it.

5. Buying U.S.A.

We like what we know. So it makes a ton of sense that we have a bias towards
owning United States stocks. And the research shows that investors tend to hold
far more domestic stocks than the market would dictate.

In the book Behavioral Finance: Investors, Corporations and Markets, Hisham Foad
noted that United States investors had 87.2 percent of their stock holdings in
domestic stock in 2005, even though the country makes up only 43.1 percent of the
global market. Investors in the United States aren’t the only ones with a bias.

Polish investors had 99.4 percent of their stock allocation in domestic stocks even
though Poland’s stock market is only 0.2 percent of the world market. See the
problem this can create? Your goal is to find the best mix of stocks, so don’t limit
yourself to national borders.

Between looking for the familiar and finding comfort in the status quo, we can
make financial mistakes that add up over time. I totally understand why it’s hard to
ask the questions and to break the patterns. But don’t cheat yourself out of a more
secure future because you’re comfortable today.
Read No. 63

How to Protect Yourself From Your Own Investing Ignorance

Part of my goal in writing “The Behavior Gap” was to encourage people to do two
things:

1) Have more meaningful conversations about money.

2) Get really clear about their relationship with money by using simple, hand-drawn
sketches

Much to my surprise, both have happened.

During my recent exhibition at the Kimball Art Center, I asked people to draw
financial concepts and display them on a wall we set aside for that purpose. When
we started, I worried that we wouldn’t even fill up the wall. In the end, we had to
take stuff down and rotate the art because we filled the wall multiple times.

There were so many great examples that I contacted a few of these artists to ask
them to share their drawings with all of you and explain the thinking behind the
sketch. Over the next few months, I plan to share some of the different
submissions.

Today’s sketch comes from Ann Ford of Salt Lake City, which is posted here with
her permission. Here’s how she described the feelings behind her sketch:

I’ll say it: I’m ignorant about financial matters. I’m talking really ignorant. I try to
educate myself, and it’s like trying to teach French to a French poodle. I know I
need to save and invest, but in what?

The answer is this: Invest in more than one thing. Diversify. By spreading funds
across a variety of investments, no single ignorant decision I make can sink my
savings. True, not everything I invest in will perform equally well, but I can sleep at
night. Sleep is worth more to me than money any day.

Ignorance can also mean the things we can’t know, like the future or nuances about
our investments that we miss, even if we’re well versed in investing. We can’t know
everything; by diversifying, we don’t have to.

I love Ann’s sketch!

I love it because we often think of diversification as a technical term, something

we just have to do. So we forget why we do it.

We diversify because we simply do not (and cannot) know everything. In other

words, we’re ignorant about issues that might represent a huge risk to our financial
futures.

Risk is what is left over after you think you’ve thought of everything. It is that
“stuff” that is left over that we need to protect ourselves from. But because these
risks, the real risks, are often surprises or things we didn’t think would happen, the
only real way to protect ourselves is to avoid having all our eggs in one basket. So
we diversify.
The smartest people I know are the the ones who understand that they don’t know
everything and put policies in place to protect themselves from their own
ignorance. And Ann’s sketch is a much better way to say all of that.

Read No. 64

How to Protect Yourself From Your Own Investing Ignorance

Part of my goal in writing “The Behavior Gap” was to encourage people to do two
things:

1) Have more meaningful conversations about money.

2) Get really clear about their relationship with money by using simple, hand-drawn
sketches

Much to my surprise, both have happened.

During my recent exhibition at the Kimball Art Center, I asked people to draw
financial concepts and display them on a wall we set aside for that purpose. When
we started, I worried that we wouldn’t even fill up the wall. In the end, we had to
take stuff down and rotate the art because we filled the wall multiple times.

There were so many great examples that I contacted a few of these artists to ask
them to share their drawings with all of you and explain the thinking behind the
sketch. Over the next few months, I plan to share some of the different
submissions.

Today’s sketch comes from Ann Ford of Salt Lake City, which is posted here with
her permission. Here’s how she described the feelings behind her sketch:

I’ll say it: I’m ignorant about financial matters. I’m talking really ignorant. I try to
educate myself, and it’s like trying to teach French to a French poodle. I know I
need to save and invest, but in what?

The answer is this: Invest in more than one thing. Diversify. By spreading funds
across a variety of investments, no single ignorant decision I make can sink my
savings. True, not everything I invest in will perform equally well, but I can sleep at
night. Sleep is worth more to me than money any day.

Ignorance can also mean the things we can’t know, like the future or nuances about
our investments that we miss, even if we’re well versed in investing. We can’t know
everything; by diversifying, we don’t have to.

I love Ann’s sketch!

I love it because we often think of diversification as a technical term, something

we just have to do. So we forget why we do it.

We diversify because we simply do not (and cannot) know everything. In other

words, we’re ignorant about issues that might represent a huge risk to our financial
futures.
Risk is what is left over after you think you’ve thought of everything. It is that
“stuff” that is left over that we need to protect ourselves from. But because these
risks, the real risks, are often surprises or things we didn’t think would happen, the
only real way to protect ourselves is to avoid having all our eggs in one basket. So
we diversify.

The smartest people I know are the the ones who understand that they don’t know
everything and put policies in place to protect themselves from their own
ignorance. And Ann’s sketch is a much better way to say all of that.

Read No. 65

It’s Probably Not Going to Be You Who Beats the Market

Growing up, we learned that two plus two equals four. We take comfort in numbers
having a set value. So it’s totally logical that when we look at the ticker tape of
numbers scrolling across the television screen, we think that there must be some
perfect formula for revealing the secret of investing.

Numbers don’t lie, right?

But as this article about pension funds trying to improve their performance using
alternative investments reminded me, we need to understand what we’re up against
when we start searching for an amazing, index-beating manager, fund or
investment.

Turns out that finding the next Warren Buffett is not impossible. But it is highly
improbable. Think I’m too pessimistic? Consider these three points carefully:

1. The data (not just me) shows the odds aren’t in your favor.

As I discussed back in February, Standard & Poor’s most recent Persistence

Scorecard highlights just how difficult it is to identify consistent market outliers.
For instance, ending in September, 2011, only 9.72 percent of all the large-cap
mutual funds managed to be above average, every year, for five consecutive years.

2. If superior managers exist, how do you plan to find them beforehand?

So there are a few managers that have the ability to outperform the average, at
least over five years. But how do you plan to identify them beforehand? And how
confident are you that the formula you’ve set up will identify the superior manager
for the next five years? What about the next couple of decades?

Any bragging from your friends (or their fund managers) about how well they did
the last 10 years doesn’t matter at all. What we need to know is who will do well for
the next 10. The fact that some managers do indeed deliver  leads us to the false
and very dangerous assumption that we can identify them beforehand.

But there is a large body of academic work looking at every variable in the hopes
that we can find something that will have predictive value. Past performance,
education, experience, or hair color — none of them help.

Turns out that the one variable that seems to have predictive value is cost. The
more it costs you to own the fund, the lower your return will likely be. Makes sense.
After that it seems to be a crap shoot. Again, not impossible, just improbable.

3. Streaks come to an end.

Managers are hot, until they’re not (like Bill Miller). Some managers are great, but
then they retire (like Peter Lynch). At some point, the streak will end. Do you know
with certainty that your formula will predict that end date accurately?
Do you think anyone saw the downfall of Tiger Management? Introduced in 1980
with $8 million, the fund peaked in 1998 at $22 billion. Could your formula predict
a few bad bets and the subsequent investor withdrawals? Two years later, Tiger
was liquidated with only $6 billion in assets.

You do have an alternative. And in this instance, the math is in your favor.

I think of it like a game of golf. What if you could make par (a great golf score)
every time you played? Many golfers I know would jump at the chance. In investing
terms, making par is comparable to buying a low-cost index fund. You give up the
chance of hitting a hole-in-one but avoid the very high likelihood of landing in the
pond.

Maybe it feels un-American to do this and that if we work really hard, the numbers
will swing in our favor. But do your research. Look at the evidence.

The reality is that for many of us, playing for par is going to be awesome. But if
you insist on swinging for the hole, go into it with your eyes wide open, having
evaluated every last bit of data.

Read No. 66

A Few Things to Ask Your Financial Adviser

For years, I’ve encouraged people looking for help managing their money to ask
questions, lots of questions. One of the best questions you can ask is, “Do you act
as a fiduciary?”

A fiduci-what?

Even though it’s a topic that’s gotten more coverage in recent years, you’re not
alone if you haven’t heard the term as it relates to financial advisers.

So what does it mean to act as a fiduciary?

In simple terms, it means that your customers’ interests come first. The client and
advice to the client are at the center of a fiduciary relationship. Not the advisers.
Not the firms. The clients.

More specifically, an adviser, financial planner or broker who claims to act as a

fiduciary is held to standards outlined in the 1940 Investment Advisors Act.
Besides acting in your best interest they must:

 Owe you undivided loyalty and act in good faith

 Avoid engaging in activity that’s a conflict of interest, and, at the very least,
disclose any potential conflict

 Provide a full disclosure of any advice they offer

If you’re still wondering what that means to you, HighTower Advisors, an adviser-
owned company, came up with an easy way to think of what acting as a fiduciary
means:

… you wouldn’t expect your butcher to give objective dietary advice … If you want
advice about what to eat, you go to a dietician, and by analogy when you want
financial advice, you go to a fiduciary.

We all understand the difference between an adviser and a salesperson. We would

never expect a Toyota salesperson to send us to the Honda dealership if a Honda
were better for our family. We know when we walk into the dealership that they
are going to try to sell us a Toyota, and we’re prepared to protect our own
interests.

But things get confusing when we have salespeople calling themselves advisers. I
know of no other industry where it’s harder to figure out who does what. Everyone
in the traditional financial services industry calls themselves an adviser, so you
would think that means they are giving you advice that will be in your best interest.
And sometimes they are.

Other times, things aren’t so clear. We have all heard plenty about advisers who
clearly put themselves and the firm they work for ahead of the clients. To make
matters more confusing, there are some advisers who aren’t legally able to call
themselves a fiduciary but still act like one. Despite working in an environment that
might reward someone for selling garbage to unsuspecting clients, they manage to
fight the good fight and put their clients first.

On the flipside, there are some advisers who are regulated as fiduciaries that may
put their interests ahead of the clients.

There is a debate in the industry about how to solve this problem, but don’t hold
your breath. Instead, start by asking yourself if the adviser you’re considering or
work with acts like a fiduciary.

 Do they put your interests ahead of their own and the firm they work for?
 Does the firm they work for have a culture of putting the client’s interests
first?

 Do they work hard to make sure you know how they are paid and to disclose
any conflicts of interest?
If you have any doubts, have a very candid conversation. Ask them. Remember, this
is not a foolproof way to find someone you can trust, but it is these kind of
conversations that will put you in a better place to carefully evaluate the nature of
your relationship and act accordingly.

Read No. 67

Beware of ‘Market Predictors’

We live relatively short lives. Most of us last less than 100 years, so it’s no
surprise that we often get caught in the trap of small sample sizes. Imagine, for
instance, if you go to Seattle for two days, and it’s sunny both days. You may start
to think all these stories of rain are just a trick by the locals to keep you from
moving there. But it’s only two days. What about the other 363 (or 364) days?

We have a habit of looking to the past in the hope of seeing a pattern and then
projecting that pattern into the future. In theory, this makes sense, considering
that whole “learn from history” thing. But when we’re pulling from a small sample
size of days, months or even years, we can end up guessing wrong. And this can
cause big problems when it comes to investing.
Consider the story last week about a team of computer engineers and scientists at
the University of California, Riverside, led by a professor, Vagelis Hristidis, who
looked at whether Twitter can predict the stock market:

For his part, even Hristidis is puzzled by his findings, saying, “To be honest, I’m
not sure why we found the correlation.” It has been hypothesized, however, that
the kind of bad news that drives down stock prices tends to focus people’s
attention, while good news is typically less interesting and prone to creating
tangents.

The sample size was four months. Personally, I’m not ready to trade in my financial
plan just yet.

As the Twitter story noted, we know that people have been trying to crack the
code as long as markets have existed. The amount of computer power we use trying
to predict what’s going to happen next on the stock market is mind boggling. But
that doesn’t seem to stop us from trying, particularly when it comes to picking the
“best” people.

In the 1970s, David Baker ran 44 Wall Street Fund and even managed to beat the
returns of Peter Lynch’s legendary Fidelity Magellan fund. Based on Mr. Baker’s
performance in the 70s, investors might think he was a sure bet in the 1980s. But
by the end of that decade, Mr. Baker hit the bottom hard, with his fund losing 73
percent of its value even as the Standard &Poor’s 500 returned 17.6 percent a
year.

But maybe if we go five years longer, that will make a difference. Bill Miller of the
Legg Mason Value Trust beat the S.&P. 500 for 15 years through 2005. Investors
jumped in. But the fund has lagged in five of the last six years. Assets have
dropped to $2.5 billion today from $21 billion in 2007. The man previously named
“Fund Manager of the Decade” and “The Greatest Money Manager of the 1990s”
will step down from the fund in April.

To demonstrate how ridiculous market predictors can be, a gentleman named David
Leinweber decided he could prove a point with butter production in Bangladesh:

After casting about to find a statistic so absurd that no sensible person could
possibly believe it could forecast U.S. stock prices, Mr. Leinweber settled on
annual butter production in Bangladesh. Over an 13-year period, he found, this
statistic “explained” 75 percent of the variation in the annual returns of the
Standard & Poor’s 500-stock index.

By tossing in U.S. cheese production and the total population of sheep in both
Bangladesh and the U.S., Mr. Leinweber was able to “predict” past U.S. stock
returns with 99 percent accuracy.

When we go looking for a pattern, odds are high that we’ll find one. And small
sample sizes only make it that much easier. These examples will hopefully make you
leery of looking for market patterns. Over all, you’ll probably have fewer regrets if
you stay broadly diversified in something like an index fund instead of betting on
patterns that you think you see in the data.

Read No. 68

Falling for the Lottery Trick

When 24-hour news channels debuted, we wondered how they’d fill up the time.
Now we have an answer. Just consider the life-changing stories that appeared
during the last week:
  Boost Your Odds of Winning the Lottery (CNNMoney, which has now taken
down the video because it didn’t meet the network’s “consistently high
standards.” Or might it have been because of Felix Salmon’s withering
commentary?)
 Keeping Wine in the Family (Fox Business)

 Buy Foreclosures with Your I.R.A. (CNBC)

Clearly I’ve been doing it wrong for years. Instead of focusing on boring things like
saving enough, being broadly diversified and keeping fees low, I should have been
touting the virtues of buying foreclosures with the money in my I.R.A., or even
better, buying lottery tickets, right?

Just consider the expert on display in CNN’s lottery story, Richard Lustig, per Mr.
Salmon:

Richard Lustig is a get-rich-quick hack with no idea at all of how to beat any
lottery. Yes, he’s won an impressive number of jackpots. But he also advises that
one third of all your winnings should be “reinvested” into lottery tickets — which
means that he’s betting an enormous amount of money every week. He never gives
any indication of what his ROI is; indeed, he never actually comes out and says that
he’s a net winner. Neither can I see any indication that all the money he’s gambling
is his own.

Spending money on lottery tickets is a stupid idea, but pretending that it’s actually
a reasonable way to invest money is ludicrous. Yet here we have CNN presenting
this story as legitimate financial advice. It was on the CNN Help Desk, for heaven’s
sakes!

This would be really funny if it weren’t for all those people who do buy many
lottery tickets, convinced as they are that there is some hope that they will pay
off. Maybe because it’s so outrageous we’ll learn the lesson: Even if you find this
entertaining in some sick way, it is certainly not financial advice.

Read No. 69

Five Ways to Think About Diversification of Your Investments

Many of us learned the lesson years ago: don’t put all your eggs in one basket. But
when we start to call it diversification, we forget the simple things that make this
concept so powerful. What follows are a few thoughts on diversification that might
spark a conversation about money in your home or office.

Before we begin, let’s start with a couple of assumptions:

 You’re using broadly diversified mutual funds in your portfolio.

 When we mention bonds, we’re talking about bonds that are high quality and
not junk bonds.

I know there’s a ton we could talk about just in terms of what those two
assumptions mean, but for this post, let’s just leave them be. Now, on to the
interesting stuff.

1) Asset Allocation: How you divide your investments between bonds and stocks
will be one of the most important decisions you make, and it is far more important
than the question of which bonds or stocks you actually choose. Sure, those things
matter. But you should only address them after you decide on an allocation gives
you the best shot at reaching your long-term goals.

2) Correlation: The reason we diversify is because we want to own investments

that move in different directions at different times. We want one to zig when
others are zagging. The reason you include bonds in your allocation is to counter
the times when the stock market is down (remember, I said high-quality bonds).
This is true when we talk about including international stocks in a portfolio.

The main reason to include international stocks is because they often act slightly
different than domestic stocks. You can make the same argument for stocks of
small companies versus large companies, value companies versus growth companies,
real estate stocks and even commodities. Your goal is to consider portfolio options
that act slightly differently than everything else in your portfolio. If it acts the
same and has the same expected future return, why add it?

3) Temptation: When you diversify correctly, you will usually have something in
your portfolio that you don’t like. Just remember that it will probably change next
year. This year, maybe your international fund will do well. But that creates a
temptation to get rid of everything else and move all your money to the
international fund.

Resist that temptation! Things change. Next year the investment you wanted to
fire might turn into your new favorite. This process is likely to repeat. So instead
of making the classic mistake of moving all your money to an investment that just
did well, remember that the winners in a properly diversified portfolio will probably
rotate.

4) Concentration: You can make a lot of money by being concentrated instead of

diversified, but you can also lose it all. Often you hear people say that
diversification is overrated. It’s easy to find examples of people who have gotten
insanely wealthy by laying it all on the line with their business or investments, but
what we often forget is how many people lose it all doing the same thing. Betting it
all might be exciting and celebrated in our society, but slow and steady still seems
to be the best way for the most people to have the best chance of winning the
race.

5) A Real Financial Plan: Design your portfolio based on your life and not the
markets. Your asset allocation should reflect your goals. If you do it that way, you
should only make changes when your goals change, not when the market does.

Despite knowing better, I continue to see people ignoring the lessons of

diversification. Are you one of them?
Read No. 70

Your Misguided Search for a Money Guru

Lately, a lot of people have been asking me where I think the stock market is
headed. It’s a common question, but it does get more frequent when the Dow is in
the news for crossing some barrier, like reaching 13,000.

Why do we look for someone to divine the future for us?

I think we all know that predicting where the market will head is next to
impossible. And it’s even more unlikely that we’ll find a guru who will predict it
correctly again and again. Yet we still look.

Maybe we’ve always been this way. We look for someone, anyone, who can take the
complex and seemingly random landscape we’re trying to navigate and make sense
of it.

We do this in many areas of life, seeking shortcuts or mental tricks we can use to
find an answer. Think about the weather. The forces that control it can be
complex, and despite rather predictable seasonal changes, it can feel random on
any given day. So even though the weather forecast is often wrong, we keep
checking.

When it comes to money, we look for a guru to answer questions like:

 With the Dow back at 13,000, is now a good time to invest?

 With the Dow back at 13,000, is now a good time to sell?

 What will happen in Europe?

 Should I invest in real estate?

 When are certificate of deposit rates going to improve?

I’m reminded of a meeting I had with an investment committee of a sizable

endowment fund. The members bemoaned the fact that all they really wanted was
for someone to tell them when the market was going down or up so they could know
when to get out and when to get in. They said it was fine if it wasn’t a perfect
system, but surely the “pros” could get close.

Unfortunately, they can’t. No one rings a bell when things are about to turn around.
Think back to March 2009. Who was predicting a market run like we’ve seen since
then?

I’ve also had multiple people tell me that while you can’t time the market (how
silly!), you can “just tell” when it’s getting close to the top. You can just “feel it.”
But I don’t recall that working out very well either.

It’s easy to find people willing to tell you where they think things are going. Jim
Cramer will tell you where he thinks 40 stocks a day are headed. Alan Greenspan
was more than willing to tell us that a “national severe price distortion seems most
unlikely in the United States.”

I don’t fault people for being wrong, but I do think we should stop listening unless
we’re doing it for fun. You know, like going to the circus.

Another challenge when searching for gurus is that they often seem to be saying
different things. What are we supposed to do when we read these two quotes
within days of the other?
  “We’ve been counseling investors that it’s time to get back in the market.” —
Douglas Cote, chief market strategist at ING Investment Management.
 “We think the next pullback could be particularly sharp.” And, “There is very
little chart support beneath the market, in our view, so when a drop comes,
get your fingers out of the way.” — S&P Capital IQ.

So what if we finally stopped looking? Imagine what life would be like if we built a
plan that didn’t depend on a guru and instead spent time focused on what we do
have some control over, like how much we save, our asset allocation and how much
we pay in fees.

What if instead of searching for the guru, we read a book or went to a movie?
Looking for something that you will never find is no way to spend our most valuable
resource: time.

Read No. 71

Really Big Claims Based on Too Little Data

Few things frustrate me more than people making claims based on really small
amounts of data or no data at all. Last week a friend sent me a segment from CNBC
that highlights this issue in real time. It all started with a conversation between
Brian Sullivan, co-anchor of “Street Signs,” and Michael Shinnick, the manager of
the Wasatch Long/Short Fund. The segment begins with this exchange:

Brian Sullivan: Mike, I guess I’ve sort of made the case for your industry, and
active management.

Michael Shinnick: … The basic thought that we have is that this religion, if you will,
of efficient markets and modern portfolio theory doesn’t actually hold up in
practice.

If Mr. Shinnick is right that modern portfolio theory and efficient markets don’t
hold up in practice, then it would show up in the data we have on active managers.
We should see the most skillful managers staying at the top of their class year
after year. If it’s as easy as being “long the stuff that is undervalued and short
the stuff that’s overvalued,” as Mr. Shinnick says, then we should see it showing up
in past performance data.

For a look at the evidence, let’s use Standard & Poor’s most recent Persistence
Scorecard. One of the goals of the scorecard is to answer that question of
whether the past performance of active managers really matters. In this instance,
the numbers do not support the case for active management.

Very few funds manage to repeat top-half or top-quartile performance

consistently. For the five years ending September 2011, only 9.72 percent of large-
cap funds, 6.08 percent of mid-cap funds and 3.27 percent of small-cap funds
maintained a top-half ranking over five consecutive 12-month periods.

That means that only 9.72 percent of all the large-cap funds managed to be above
average, every year, for five consecutive years. Think about that for a minute. Less
than 10 percent of funds managed to be better than just average every year for
five straight years.

It’s worth noting that you can avoid all the bother and just “buy” the average using
a low-cost index fund. But let’s pretend you don’t know that. If you only heard this
particular conversation on CNBC, your natural conclusion might be that you should
sit down and try to figure out how to find a great manager.

If that is the case, let’s look at your options if you had done so in 2006. First,
you’d start by looking at managers with great, five-year track records and limit it
to managers in the top 25 percent. However, even though you are picking from the
top of the list, consider what happens in the following five years. Only 12.23
percent of the large-cap funds in the top 25 percent in the five years ending in
2006 stayed in the top 25 percent over the next five years.

In fact, only 25.9 percent of large-cap funds with a top-quartile ranking over the
five years that ended in September 2006 finished the next five years above
average. To be clear, this post isn’t about Mr. Shinnick personally but about the
claims that are made and the data (or lack thereof) that is used to support them.

In this instance, I would argue that far from making the case for active
management, the data actually shows how difficult it is to find a mutual fund that
will do well over the five years going forward based on the previous five years. And
while I know it is tempting to think you can find those mythical managers that do
well over time, please accept the data that says the odds are stacked against you,
and it will lead you to do dumb things with your money.

Read No. 72

Dollar-Cost Averaging: An Emotional Insurance Policy

It’s hard to imagine just sitting on a pile of cash that ought to be invested, but the
situation comes up more often than you might think. And such a situation can be
intimidating, as there are natural fears that arise from deciding to invest a large
sum. To cope, individuals may turn to a strategy called dollar-cost averaging, which
can make sense in specific situations but cause problems in others.
Before we jump into the discussion, let’s clarify the difference between dollar-
cost averaging and systematic investing. Dollar-cost averaging is when you have a
lump sum to start and you decide that instead of investing it all at one time, you’ll
invest in equal amounts over a given period (e.g., many weeks or months).

In contrast, systematic investing is when you make regular contributions to a

retirement or other investment account, like contributing a set amount of every
paycheck. Making regular, automatic contributions is simple investing, and it’s a
great way to automate good behavior.

Now as an investment strategy, dollar-cost averaging doesn’t make much sense.

George Constantinides published a paper in 1979 (“A Note on the Suboptimality of

Dollar Cost Averaging as an Investment Policy”) that demonstrated why dollar-cost
averaging isn’t optimal and there hasn’t been much debate about it as an investing
strategy since, even though there’s still some confusion about it.

Even if it doesn’t make sense from a spreadsheet perspective, however, there is a

way it can serve a valuable purpose. Let’s say you end up with a lump sum to invest.
It might be from the sale of business, a recent retirement or even a change in your
investment strategy. You have designed a portfolio that you feel matches what
you’re trying to accomplish.

But when it comes time to carry out the strategy, you start to worry about the
timing. Your mind races and you wonder, “What happens if I invest all this money,
and the stock market drops?” You freeze, waiting to see what the market does
before you invest.

Then the question becomes how you get over the emotional hurdle of plunging into
the market. If it will kill you to see the market drop after you get back in, then
dollar-cost averaging might be your ticket. Think of it like an emotional insurance
policy that makes you “feel” protected against a large, sudden drop right after you
invest your money.

In practice, dollar-cost averaging involves investing a specific percentage of your

lump sum at regular intervals over a given period. For example, you might invest
one-sixth of your original sum on the first day of every month for six months.

So if you think that dollar-cost averaging will help you deal with the emotional risk
of investing, go ahead and do it. Just keep a couple things in mind:
1) Invest the money over six months or less. Don’t drag this thing on forever.
There is some evidence that six months or less accomplishes the benefit you’re
looking for and avoids keeping you out of the market for too long.

2 Have a written plan and stick with it, no matter what the market might do. The
moment you start reacting to the market you’ll get into trouble real fast.

Read No. 73

Tomorrow’s Market Probably Won’t Look Anything Like Today

Every day we rely on habit to get a lot of things done. We commute the same way
to work every day, we eat at the same restaurants and we shop at the same stores.

We rely on habit to help us make things easier because few people want to reinvent
their lives every day. But this habit of forming habits also does something else. In
academic circles, it’s called the recency bias, and it can trick us into making
decisions we might not make otherwise.

The recency bias is pretty simple. Because it’s easier, we’re inclined to use our
recent experience as the baseline for what will happen in the future. In many
situations, this bias works just fine, but when it comes to investing and money it
can cause problems.

When we’re watching a bull market run along, it’s understandable that people
forget about the cycles where it didn’t. As far as recent memory tells us, the
market should keep going up, so we keep buying, and then it doesn’t. And unless
we’ve prepared for that moment, we’re shocked and wondered how we missed the
bubble.

When the market is down, we become convinced that it will never climb out so we
cash out our portfolios and stick the money in a mattress. We know the market
isn’t going back up because the recency bias tells us so. But then one day it does,
and we’re left sitting on a really expensive mattress that’s earning nothing.

The point isn’t that you should have predicted the timing of the bubble or the
upswing but that you should have considered both possibilities as potential
outcomes and planned accordingly. Instead of taking the long view and considering
as many factors as possible (the market goes up AND down), we settle into a rut
and keep behaving as though nothing will ever get us out of it.

Being prepared and recognizing that the bias exists costs very little. I think of it
like the winter weather kit anyone who lives in the mountains should keep in their
car. Even though I’ve never been stranded traveling in the winter, I know I should
have a kit in the car with water, food and other stuff to help me survive if I do.
We’ve got to get over this idea that because something has never happened (not in
the last six months anyway) that it won’t happen in the future.

All things considered, it’s pretty easy to put some plans in place to help see us
through the ups and downs. So quit letting yesterday be the only thing to
determine what you do tomorrow with your money.

Read No. 74

Your Mistaken Belief in Financial Willpower

Each year, many of us set resolutions to do (and be) better. We like the idea of
improving ourselves, so we tell ourselves that because we want it badly, willpower
alone is enough to see us through.

We do this despite knowing that sticking to something takes discipline and

patience. Frankly, it can be hard, and we often underestimate just how hard it will
be. Think of all the information out there on diet and exercise. Eating well and
exercising are not complex. We have all the information we need, but we still have
a tough time doing it.

The tendency to rely on willpower, the sheer grit-your-teeth-and-do-it sort of

stuff, only works for a very small number of people, particularly when it comes to
money.

So what if we stopped relying on willpower and discipline alone to avoid bad money
behavior? What if we simply automated good behavior?
If you’re trying to eat well, you don’t bring a box of donuts home. So if you’re
trying to save $100 a month for your child’s education, don’t force yourself to
remake that decision ever month. Automate it. We have access to a lot of tools
that make good money behavior automatic, so it’s ridiculous to not use them where
possible.

If we continue to rely solely on willpower, we will continue to get the same result:
failed budgets and emotional decisions with our investments. Not every financial
decision can be put on cruise control, but why are you fighting the same battle
every single month if you don’t have to?

Here are three things you can do to take some of the headache out of good money
behavior:

1) Portfolio Rebalancing One of the easiest and most overlooked automation

options is portfolio rebalancing. I’ve written about this in the past, but I’m still
amazed at how many people overlook this really powerful tool. By choosing to have
your portfolio rebalanced automatically you reduce significantly the odds that you’ll
buy high and sell low.

2) Automatic Savings Most accounts now allow for automatic savings each month.
It may be a service offered by your employer that splits a check between two
accounts or your bank may offer the option to transfer automatically a set amount
from checking to savings each month. Whatever the option, sign up for it.

3) Automatic Payments For set payments, things like your mortgage or car loan,
consider setting up automatic payments. Since most systems allow you to set the
date of payment, you can time the withdrawal from your account to make sure that
you never get hit with late fees or feel the bite of extra interest.

By automating specific financial decisions, you’ll lessen the temptation to cheat.

For instance, if you have to remake the decision to rebalance every time the
market fluctuates, it will be incredibly hard to sell when stocks reach all-time
highs or not liquidate your portfolio if the market takes a nose dive. If you have to
physically transfer money to savings each month, there will be months that you tell
yourself it’s O.K. to skip.

The emotions around money are so enormous and often so complicated that the
more we can do to automate good behavior, the better off we’ll be in the long run.
Read No. 75

Filling in the Worry Groove in Your Brain

I’ve noticed that I sometimes fall into the trap of worrying obsessively about an
event that may or may not happen in the future. If you’re like me, there is a fine
line between being informed and being anxious about the future.

Recent conversations I’ve had both here and in Europe lead me to think that many
of us have crossed that fine line. We seem preoccupied with the pastime of looking
for problems, and the funny thing about looking for something is that you often
find it.
But instead of actual problems, what we do have are events that may or may not
happen in the future that we’ve defined as problems today.

I‘m no psychiatrist, but as I continue to hear these same stories over and over, it
sounds as if we’ve let these worries create a virtual “groove” in our brains. As we
let these worries loop around over time, it becomes easier and easier to see them
as problems because they end up fitting whatever pattern we’ve created in our
heads.

Getting out of this groove and breaking the pattern takes practice and
determination, but I’ve found that there are a few questions to ask yourself that
can help:

1.) What is the worst thing that can happen? Sometimes carrying something to its
illogical worst case is helpful because the process helps us realize the holes in our
logic and that whatever it is will almost never end in death at least.

2.) When I worried about this in the past, did it ever actually help? Worrying about
things in excess almost never helps. We shouldn’t bury our heads in the sand when
there are legitimate challenges that require our attention, but being aware and
getting stuck in the loop are two different things. Schedule time to address the
challenge, write down your conclusion, and set it aside until it’s time to revisit the
discussion.

3.) Does this situation mean I have a problem right now? Again, most of the things
that we label as problems are actually just us worrying incessantly about something
that may or may not happen in the future. Often we discover that we created a
problem of mythical proportions when really there’s nothing to be worried about.

Think of all the mental energy we can free up for family, creative pursuits, or even
earning a little money on the side if we stop worrying unnecessarily about would-be
problems. In the same way that the worry loop is a habit, we can create a new habit
by asking a few questions to help us assess whether our worries amount to actual
problems.

Read No. 76

There Is No Perfect (or Permanent) Financial Plan

Given the amount of time in each day and the number of resources we have at our
disposal, it’s only natural that we have an expectation that we’re going to get the
decisions we make about money “perfect.”

Over time, we figure out how much money we should spend and define our financial
priorities. But then things change and we have to make another decision, leaving us
frustrated.

If we have to keep making the decisions over and over, then what’s the point?

Whether we like it or not, life is not static. We don’t live in bubbles. And even
though one day may look very much like another, life is rarely the exact same every
week let alone from year to year. Perhaps the basics stay the same — work, school,
relationships — but little things change, and we learn to adapt to those changes.
We need to think the same way about money. Even after we make smart decisions
life will continue to happen.

The decision to save money each month may need to change if someone loses a job.
The decision to have another child may mean that you need to buy a new car sooner
than planned. The decision to retire early may be put on hold after a health
emergency. In each example, no one did anything wrong; life happened.

The unavoidable reality we face is that few financial decisions are set in stone. At
some point, we’ll need to recalibrate, to take into account new circumstances that
change our decisions. Too often people get caught up in thinking that this
recalibration is a sign they made a mistake. Hardly. They just have a life.

In fact, in many ways, if you aren’t recalibrating your decisions as you go, then
you’re likely ignoring decisions that will turn into mistakes and compound over time.

But, even as you look to recalibrate, you can’t ignore that some of these inputs will
be outside your control, which takes us back to the idea of making perfect
decisions. At any given point, we may make what appears to be a “perfect” decision,
but there’s only so much that’s in our control.

It all brings the Serenity Prayer to mind:

God grant me the serenity to accept the things I cannot change; courage to change
the things I can; and wisdom to know the difference.

Our goal shouldn’t be to pursue perfection in our decision making, but to get really
good at knowing when we need to make a change. It will take practice and likely be
something you need to do for the rest of your life.

Read No. 77

Why You’re Waiting Too Long to Fix Money Mistakes

Recently I’ve had a lot of conversations with people about why we avoid facing
painful financial decisions. These conversations have got me thinking about the
time between the first sign of trouble and the moment when we finally decide to
face reality.

Sometimes that space needs to be long — we need time to sort out all the options
or maybe we just need to be patient and wait for a new path to open. But most of
the time we’re just delaying the inevitable.

So why do we take so long to act?

Being wrong isn’t fun. When there’s a problem, it’s often because we’ve made a
mistake. We’ve been conditioned to believe that making a mistake is something
shameful. Embarrassed, we tell ourselves stories to avoid recognizing that we’re in
trouble. We tell ourselves that things aren’t actually that bad. We tell ourselves
that things will get better. We even look for others to blame.

No one likes losing. For most of us, the pleasure we get from gain, like our
investments doing well, is dwarfed by the pain we feel from loss. While this pain
can be chronic from a continuing issue, it becomes acute when we decide to face
the facts and do something about it.

Think about the last individual stock you bought that went down after you bought
it. You didn’t do much research, and on an intellectual level, you knew that buying
individual stocks without any more research than your brother-in-law’s suggestion
was a bad idea. You knew that you should sell it and move on.

The pain is there, like a low-grade headache. Then one day, you decide to do
something about it. And the process of actually facing the fact that you just
realized a loss by selling represents finally admitting that you were wrong. Now you
might even have to explain it to your spouse or, even worse, your accountant. That
is painful!

We’re busy. Often we know we need to make a change, but we just put it off
because we tell ourselves we’re too busy to “research” it right now. We’re all busy,
and I don’t know very many people that put facing their current financial reality
very high on their list of things to do next weekend. And of course, we tell
ourselves that we need a lot of time to research all our options, which might be
true.

But big mistakes almost always start as small mistakes. Then we delay doing
something about them, and they grow until we find ourselves in a hole that we
thought unimaginable just a short time before.

You’ve probably heard the old saying that your first loss is the best loss. I’m not
sure who said it first, but I did see that Jim Cramer has it as commandment
number two, which means something. Based on my experience this is true. When
things go wrong, it is often best to act quickly and move on.

So when you realize that you’ve made a mistake, think about the space between the
mistake and the solution. Decide if this is one of the rare mistakes that take time,
or the more common that ought to inspire immediate action. If it is the latter, it’s
time to stop making excuses and to start seeking solutions.

The tough decisions won’t go away on their own, and like compound interest, the
size of our problems will only grow over time. Ultimately, we’re only doing ourselves
a favor by shortening the space between when we know we made a mistake and
when we finally decide to do something about it.

Read No. 78

You’re Responsible for Your Own Behavior

Bernie Madoff spent most of the last two decades running the largest Ponzi
scheme in history, defrauding thousands of investors of billions of dollars. Many of
those investors were intelligent, sophisticated people. Some were top managers at
major Wall Street firms.

So what happened? Same old, same old. He promised the moon, and we wanted to
believe he could deliver it.

There were warning signs. Many people on Wall Street had their suspicions of
Madoff. A few were flat-out convinced that he was a fraud (and tried to tell the
Securities and Exchange Commission and other regulators). Some Wall Street
firms avoided doing business with the guy.

Others kept sending clients to him.

It would be nice to blame the whole thing on a few dirty rotten scoundrels. But
that’s too easy. Part of the problem lies with our almost universal tendency to
believe what we want to believe. It’s really, really hard to resist a deal that looks
too good to be true — especially when other people are buying into it.

I understand why people invested with Madoff. The guy had great credentials, and
his record was very strong. Most folks didn’t ask questions. They wanted those
returns, and they trusted their advisers to protect them. Their advisers, in turn,
trusted regulators. And regulators didn’t get the job done.
Whatever. The fact remains that some pretty sophisticated people didn’t nail down
the facts before they put money (their own and/or their clients’) at risk.

It happens all the time. Few people asked many questions when supposedly
conservative bankers started offering high-yielding but risky new products to
mainstream investors, like derivatives and securities backed by subprime loans.
Meanwhile, we kept borrowing more money even as we sensed that no-money-down
mortgages made little financial sense. The banks offered us cheap access to
money, so we didn’t ask questions. We took it, and hoped for the best.

You, me, and most everyone else struggle to work up the nerve to question things
that appear too good to be true. But as usual, it turns out that our financial
security is our own responsibility. And sometimes, that means we have to be
skeptics.

Read No. 79

Everyone Should Use the Overnight Test

A friend of mine recommends what he calls the Overnight Test. Ask yourself what
you would do if someone came in and sold all of your investments overnight. The
next morning you wake up and you’re left with 100 percent cash in your account.
Here’s the test: you can repurchase the same investments at no cost. Would you
build the same portfolio? If not, what changes would you make? Why aren’t you
making them now?
 

People have a tough time with this one. Maybe they’ve long since forgotten why
they bought those investments in the first place (there must have been some
reason, right?). It’s kind of like certain relationships: you grow apart, your lives
take different directions and there’s nothing much left to talk about … but you
keep hanging around with each other because change would require work.

In the case of investments, you can’t afford that kind of stagnation. You need
investments that make sense given your current goals, which means you need to
take a look at those goals, which means … work. This is why some people who take
the Overnight Test just want to ask (Please!) for their old investments back. They
may not admit it, but they just don’t want to do the work of coming up with new
ones.

I understand. We’re busy. We have a lot on our minds. Who wants to add another
item (in this case, “review investment portfolio”) to their to-do list? Unfortunately,
this is one to-do that really needs to get done. I’m not talking about change for the
sake of change. Buying and selling investments costs money. I’m saying you need to
know what you own, and why you own it.

Read No. 80

Why Awareness Beats Anxiety

Gathering information — being in the know — is not the same thing as being
mindful, being aware, being present for what’s actually going on behind the news
and the chatter and the stuff that just doesn’t matter.

Often when we think about money, it’s in terms of either past mistakes or worries
about the future. Both of those types of thoughts take us away from focusing on
the present.

Many people have a tendency to beat themselves up when they make a financial
mistake. But most of us should spend less time worrying about things we could or
should have done differently.

Instead, we can use our experiences to help ourselves and others avoid similar
mistakes without getting involved in feelings of blame or feelings of shame. We can
look at our mistakes, make note of the lesson and move on.

Spending too much time worrying about the future can also undermine our
enjoyment of the present. This is a tricky issue for me because my work often
involves encouraging people to have more meaningful conversations about the role
that money plays in their lives — and normally such talks revolve around plans for
the future.

One solution is to draw a line separating the time that you spend focused on
planning for the future and the time you spend living for today.
Planning for the future is very important, but it needs to be done in isolation to
avoid overshadowing the joy of today.

Think about setting aside time each month to evaluate your recent financial
behavior. Try to identify any mistakes you may have made, and note the lessons
that you need to learn. Think about your goals and what you should do now to move
closer to reaching them.

Once you’ve done that, get on with living your life.

Money decisions are emotional decisions — and making good money decisions
requires emotional clarity. So try to pay attention to your emotions around money.
This can be as simple as considering how you feel when you get your monthly
investment statement or when a medical bill arrives in the mail. Acknowledging
those feelings and being aware of their potential impact on your decisions can be
important, often in ways that aren’t clear right away.

I’ve found myself asking some really fundamental questions during the last several
years. Whom I can trust? What’s really important to me? What do I really value?
How much is enough? How should I really be spending my time?

I’ve watched as close friends have lost their businesses, their homes and even
friendships over money. I’ve seen friends struggle to find jobs at a time when they
had planned on being well into retirement. Other friends have had to move parents
into care facilities that fall short of their family’s hopes but are all that they can
afford. I’ve seen my own children’s disappointment when I had to tell them that we
couldn’t afford something they really wanted.

When we go through these experiences we can feel sorry for ourselves and get
angry. Or we can try to understand past mistakes, practice self-awareness and act
from our deepest instincts.

Which approach will bring us closer to reaching our most important goals?

Read No. 81

Stranger Danger: Personal Finance Really Is Personal

Take it from me (a stranger): following the advice of strangers is a tricky business.

Let’s say you’re planning a vacation. You read a magazine article about someone who
had a great time at a dude ranch in Montana. The pictures look fantastic. You go —
and the bugs drive you crazy and you hate the heat and the food and the horses.
Maybe the travel writer actually had a great time. But you’re not him.

The financial press, personal finance bloggers and best-selling authors are all
sources of information. They may have good ideas, which you may find useful. But
they can’t tell you how the information and the ideas apply to your situation. They
don’t know you. More to the point, they aren’t you.

My friend Tim Maurer is a financial planner, educator and author. His favorite line
goes like this: “Personal finance…is more personal than it is finance.”

It’s true. Planning for your financial future is personal. It has to be. A good plan
will be unique to your situation, and what is right for your situation may be a
disaster for your neighbor. So ponder how the advice you encounter applies to you
before you make important decisions about your money.

Read No. 82
The Financial Lesson in Too Many Skis

I live in Park City, Utah, where some of us take skiing pretty seriously. One
morning some years back, a friend swung by my house to pick me up to go
backcountry skiing.

I ran into the garage to grab my skis. I stood there for a second looking at my four
different pairs of skis, each designed for particular conditions, and suddenly, I was
paralyzed. I just couldn’t choose.

My friend sat in the car honking the horn — Let’s go, Carl! Move it! The sun’s
coming up! The snow’s getting soft! — while I stared at those skis. It was
ridiculous. I’d spent all that money and time and energy collecting these skis so I
would be ready to deal with any situation — and now I just felt powerless.
That day was a turning point for me. I got rid of three pairs of skis, and kept my
favorite pair: the ones that would let me do what I really care about doing, which is
to move light and fast through the backcountry.

The skis I kept aren’t perfect in every condition. They’re actually a pretty bad
solution in heavy snow or in really steep terrain. So what? They’re a decent
compromise in most situations, and they work beautifully in the conditions I like
best.

Now I don’t have to think about which skis to bring on a trip. I just grab the ones I
have and go. I trust my experience and my instincts and my luck to make it through
situations when my equipment isn’t perfect.

Lots of people think that to make good money decisions you need to have a plan for
every situation. You need insurance for every possible setback and investments for
every market condition. All of your assumptions about the future need to be
refined to perfection, so that you will never be surprised. You need to know and
understand everything about the financial markets, and you need to budget your
spending to the last dime.

But that kind of thinking is based on fear.

We fear (naturally enough) life’s uncertainty, its ups and downs. And so we make
plans that we hope will give us the power to control our future. If I do this, that
will not happen; if I sell now, I will avoid the coming downturn; if I pick the right
investments, I will be financially safe; if I worry enough, I will be ready when bad
news comes.

Trouble is, the real world is complicated. We don’t know what’s going to happen.

That means that most of our plans are useless. When I had four pairs of skis, I
was always choosing the wrong ones anyway!

The point is, no plan will cover every situation — and that’s O.K. You don’t have to
choose the perfect investment or save exactly the right amount or predict your
rate of return or spend hours watching television shows about the stock market or
surfing the Internet for stock picks.

You don’t need a plan for every contingency.

Read No. 83

A Plan for 2012 That You’ll Actually Follow

For 2012, I have a challenge for you: make financial decisions on purpose. Too much
of what we do is based on habits and assumptions instead of a thoughtful plan.
During the next year, see what happens when you do these three things:

1) Define your current reality. I used to think this was the easy part. Turns out I
was wrong. Most people don’t know where they actually stand financially.

After the last few years, it’s tough to face the reality of our situations. Even if
you have a sense that things have gone well for you financially, building a personal
balance sheet doesn’t rank very high on the fun meter, but it has to be done. It
makes it hard to reach any goal if you have no idea where you are starting from.

2) Set some goals. This step hangs people up because often we have no idea what
we will be doing in five days, let alone five years. Still, it’s really hard to get
somewhere if you don’t know where you’re going.

Let go of the need for precision. These are guesses, so make the best guess you
can and move on. How important is paying for college for your child or children (or
grandchildren)? Define it a bit. How much will it cost, what can you save, when will
it happen?

Be honest. Be realistic. Of course part of this process will involve making some
assumption about rates of return you will earn. Be conservative and focus instead
on having realistic goals and saving more. If you can’t save more, maybe spend some
time trying to earn a bit on the side.

3) Commit to course corrections. Plan on then, in fact. Break down what you have to
do into quarterly action steps, and then revisit the plan every three months.

If you are off course, make changes while you’re only a little bit off. If you leave
Los Angeles on a flight to New York City and you’re a half inch off course, it’s much
easier to adjust when you are over Nevada than it will be a few miles outside of
Miami.

Planning for a better financial future is an continuing process, not a single event. It
is also short-term boring but long-term exciting.

In 2012, commit to doing small, simple things consistently and over time. It will be
the opposite of what we’ll hear in the news every day about making enormous
changes, so part of the challenge will be to ignore the constant call for rash
actions and sweeping reform.

Let’s make 2012 about subtle, small actions so we can make progress towards our
goals over a long period of time.

Read No. 84
Why ‘I Don’t Know’ Is Often Your Best Money Answer

Of all the phrases in the financial planning world, “I don’t know” may well be the
most powerful.

There are other phrases like “it depends” that are similar, but underlying them all
is the fact that we are trying to make money decisions without a great deal of
certainty. The reality is that we just don’t know what the next five, 10 or 20 years
are going to look like.

Sure we can model it based on history, but that would just be a model. One of the
most dangerous things I see in the investment and financial planning world is a
false sense of precision.

In fact, I think there is a tremendous sense of freedom that comes with

recognizing that we just don’t know what the future will look like. At that point,
the process of financial planning becomes about making the best guess we can
about that future. Then we consistently course correct as we go, before we get
too far off track.

You may have heard me use this example before, but I often put it in terms of a
pilot’s flight plan. Pilots take the process of preparing a flight plan very seriously,
but they also know that the moment they take off, their plan will probably need to
be changed. The weather may change, birds may start migrating or the airport
they’re headed to may close halfway there. All they know for sure is that they’ll
need to make ongoing course corrections throughout the flight.

Accepting the fact that we just don’t know allows us to let go of any anxiety
around the idea that we should be able to find someone who does know. And let me
share a secret with you about that: There isn’t anyone who knows what the next
week, month, year or even decade will look like in the stock market. Anyone who
says they do is someone you should run from.

What are some other things we just don’t know?

1) When our certificate of deposit rates are going to move up.

This comes with all sorts of implications. If you are waiting to refinance your house
because gurus are telling you that interest rates will go down, please realize that
they just doesn’t know what they’re talking about.

How many people have been sitting in money market accounts earning virtually zero
because C.D. rates were “only” 1.5 percent and surely they would be going up soon?
The reality is no one knows when interest rates will go up.

In fact, the academic evidence is pretty clear. The best estimate for future
interest rates is today’s interest rates, meaning we just don’t know.

2) The direction of housing prices.

3) When the economy is going to turn around.

4) What’s going to happen to Apple (or Google or G.E. or Pepsi) stock.

The reality is no one knows. Jim Cramer doesn’t know. The teams of experts from
the large banks and brokerage firms don’t know. And we all know what happens
when you rely on a Federal Reserve chairman knowing. It turns out he doesn’t know
either.

It’s so tempting to believe that there’s someone out there, someone with a big
enough computer or access to a huge research staff. But there isn’t. And even if
there is, it’s highly improbable that you or anyone will identify them beforehand,
when their predictions will be of any value.
Sure, there are plenty of people who can claim that they got a certain prediction
correct after the fact. But remember, if you’re in the prediction or forecasting
business, you’re bound to get a few right, just like a broken clock is right at least
twice a day.

If you choose to get help making financial decisions, look for someone with the
experience to help you navigate the uncertainty. Someone who understands that
the really important part is the ongoing course corrections based on what you learn
in the future.

Sorting out our financial lives involves process, not products, and it means making
the best decisions we can, learning new information as we go, making subtle tweaks
based on that information and continuing to do so over and over and over again.

Read No. 85

How to Get Real About Risk

One of the most common mistakes, and certainly the most dangerous, that we make
as investors is taking on more risk than we originally intended to.
The tragic story unfolding at MF Global is just the most recent very public example
of a situation where things turned out to be far riskier than the people who took
them initially thought. But this isn’t just a problem among aggressive traders. Each
time there’s a market decline, it seems like we have to re-learn this lesson.

How often have you heard someone say they were surprised, shocked, disappointed
or depressed about the fact that their investment portfolio was down during a
bear market? And why are we surprised, anyway?

Bear markets are part of the normal market cycle and have been around since we
started providing operating capital in exchange for fractional ownership of
companies (i.e., the stock market). We shouldn’t be surprised when portfolios go
down, but we still are. For some, the surprise isn’t the decline itself, but the
magnitude or severity of the decline.

So why do we keep making the mistake of designing investment portfolios that are
more risky than we want or need them to be?

The solution to this problem is taking the time to understand the risk associated
with diversified exposure to the stock market. Then you can build a portfolio based
on your unique need, willingness and ability to take on that risk.

Because this is such an individual pursuit, and every portfolio should be crafted to
match your situation, following rules of thumb can be dangerous. But everyone
needs a starting point, so here are a few things to get you thinking:

1. Accept that there is no reward without risk.

Risk and return are related. I’m talking about responsible, diversified risk, not
stupid, thoughtless risk. Owning one individual stock is a stupid risk. Taking huge
bets on distressed European sovereign debt is another stupid risk. But owning a
diversified basket of index funds? That’s responsible, diversified risk. See the
difference?

After building a plan to meet your goals, you may determine that you need, and are
willing, to have a portion of your money invested in the stock market. Because of
the historical returns, you’re willing to live with the risk. And that risk is the high
probability that the market will go down temporarily as part of a long, upward
march.
I’ve often heard it said that the primary risk to owning stocks is that you’ll get
scared out of them at the wrong time. One of the key implications of this idea is
that there is no way to own equities without taking on the risk. So give up on the
idea that you can time the market. There is no one that stands ready to ring a bell
before the market goes down.

If you understand this and believe it, it’s actually a very freeing concept. Design a
portfolio to match your goals and your ability to take the risk. Rebalance it
periodically to match your original plan design, and live your life.

2. Practice a lifeboat drill.

The great thing with investing, and our investing behavior, is that the numbers
don’t lie. After all we have records of this stuff.

So here’s an exercise that can help. Pull out your tax returns and investing
statements. Review your investment behavior over the last 12 or so years. Did you
buy technology stocks in 1999? Did you get out of the market in 2002? Did you
become a “real estate investor” in 2006 or 2007? Did you go to cash in early 2009?

Reviewing behavior can tell us a lot about how we feel about risk. If we made the
classic mistakes of buying high and selling low over and over again, clearly it’s time
to consider a portfolio that won’t be vulnerable to our own mood swings.

3. Review economic and stock market history.

This suggestion needn’t be painful or boring, particularly if you recognize the

benefits of understanding the history of investing and cycles. There’s been serious
debate recently about the value of history to investing. But we have a choice: we
can either choose to make important decisions with our life savings while ignoring
history, or we can make those important decisions with the benefit of the weighty
evidence of history.

Even if you tell yourself that “this time is different,” there are still lessons to be
learned from history that can help avoid poor decisions. Go back and look at the
major declines in the stock market. Look at the early 1970s. Read the history of
Black Friday. Review what happened in 1999 and then the decline that followed.

The major lesson from these events is that while periods of incredible pessimism
and panic get most of the headlines, things have a way of working out. It turns out
that rational optimism has been the correct view of the world for the last hundred
years. It would seem to be a reasonable assumption that it will continue.

This short-term panic and pessimism hasn’t turned out to be the right outlook for
the long term, so why let it keep you awake at night? We usually find ways to work
through the underlying problems, and chances are high we will again. Yes, we face
serious problems, but we have faced serious problems in the past.

So now, let’s apply this thinking to our investment portfolios. Building a broadly
diversified portfolio that matches your need, ability, and desire to take risk, then
holding onto it, has been the correct way to build wealth in the past. It seems
reasonable to assume that the same will hold true in the future.

Certainly we will be surprised again in the future, as we have in the past, about the
timing, nature, and cause of major market turmoil. But we shouldn’t be surprised
that it happens. And that fact should play a major role in how we design our
investment portfolios.

Read No. 86

The Risky Sport of Bubble Spotting

During a recent conversation, someone asked me if I thought the last few years
made me better equipped to spot the next bubble. Since we had recently been
through a real estate and credit bubble could anyone credibly claim that they
would be prepared to spot the next one?

My response was simple: no.

While the last few years hasn’t made me any better at bubble spotting, it has made
me realize that when it comes to investing it’s truly better to be safe than sorry.
For anyone who thinks that living through a market that clearly got ahead of itself
somehow makes you better able to forecast the next bubble completely misses the
point.

The supposed ability to spot bubbles is just another way of talking about market
timing. Market timing, while not impossible, has certainly proven to be highly
improbable.

It’s certainly tempting to believe that somehow we could identify a variable or

series of variables that would tell us when the market was officially in a bubble. It
reminds me of a conversation I had a few years ago where somebody who was
clearly exasperated said, “All I want is for someone to tell me to sell before the
market goes down and to buy before it goes up. Seems quite simple to me!”

Looking for a bubble spotter is just the latest way we’ve come up with to trick
ourselves into thinking that there is a way to time the markets. We can get very
sophisticated in the stories we tell ourselves. We look for things like quantitative
models, advanced forecasting software, years of academic research and studies.
But in the end, it’s all just market timing. And for the most part, it simply doesn’t
work.

One of the big problems with some of the recent bubble spotting methods is that
they work perfectly, just so long as you’re looking backwards. Many of these
techniques are based on extensive research that relies heavily on back-tested
models.

We are very good at analyzing the past and coming up with surefire ways of
avoiding the exact same mistake again in the future. But what we are particularly
bad at is thinking about things that we have never thought of before. Most bubbles
are blazingly obvious with the benefit of hindsight, but when we’re honest with
ourselves, we have to admit that often they were caused by things that we hadn’t
even considered possible. And the exact cause of the next bubble will surely be
different than the cause of the last bubble.

This current obsession we have with bubble spotting isn’t new. It’s just the latest
reincarnation of the age-old desire we have to make sense of the world around us
and have some sense of control about the future. But if we do want to use history
as a guide, we need to realize that even those that were best positioned to spot
bubbles have been wrong.

In July 2009, The Wall Street Journal surveyed 50 economists about where
interest rates on the 10-year Treasury bills would be one year later. Rates were
sitting at 3.3 percent when the article came out. Forty-eight respondents said they
would be higher one year later, while only two suggested rates would fall below 3
percent. The rate was 2.95 percent on June 30, 2010.

And it’s not just in recent times that the bubble predictors didn’t get it right. As
Jason Zweig recently noted in The Wall Street Journal, even the guy who wrote
the most famous book about bubbles missed a big one:

On Oct. 2, 1845, [Charles] Mackay wrote that “those who sound the alarm of an
approaching railway crisis have somewhat exaggerated the danger.” He went on to
ridicule anyone who argued that “the Railway mania of the present day” was similar
to the devastating bubbles he had described in his own book. “There is no reason
whatever to fear” a crash, he concluded. He couldn’t have been more wrong. From
1845 to 1850, railway stocks fell by two-thirds — the equivalent of roughly $1
trillion of losses in today’s money. Mackay never fessed up to his own extraordinary
delusion.

So back to the original question. If we’re not any more prepared to spot the next
bubble than we were just a few years ago, then what?

The point is we should stop trying to trick ourselves into believing that if we just
buy a bigger computer, hire the right analyst, find the secret newsletter and read
enough magazines or books then we’ll somehow be able to buy before the market
goes up and sell before the market goes down.

We need to give up on the idea of timing the market and finally pay attention to
the academic research that shows it’s a fool’s errand. Instead we should devote at
least some of that time to developing a financial plan that starts with where we are
today and plots a course to where we want to go. Once we have built a plan, no
matter how basic, then we can figure out how we need to invest our money to meet
those goals.

Read No. 87

The ‘Just This Once’ Money Trap

When we make financial plans or build a family budget, there’s no way to predict
one-time financial events, like the car’s breaking down, the furnace’s going on the
fritz or a hospital stay.
So we save as much as we can in the hope that it will be enough to cushion
ourselves against these financial shocks. But given all of the uncertainty that
already exists, why is it that we let ourselves get sucked into other, supposed one-
time events that are totally within our control?

Friday was one of the biggest shopping days of the year, and today, Cyber Monday,
is another big one. And what is pulling us in? The idea that we’re somehow getting a
deal.

Think about how crazy this is. We try to spend “11 months living frugally,” focused
on our goals, as Adam Davidson put it in The New York Times Magazine. And then
we blow the whole thing in “four crazy weeks buying tons of stuff we don’t need.”
Often the discipline that is required to stay on track results in frugality fatigue,
and we crack.

The crackup isn’t always at this time of year. But as Mr. Davidson noted: “Holiday
binge-buying has deep roots in American culture: department stores have been
associating turkey gluttony with its spending equivalent since they began
sponsoring Thanksgiving Day parades in the early 20th century. And to goose the
numbers, they’ve always offered huge promotions too.”

Now we may very well have holiday budgets that we’ve planned and saved for, and
that’s great. But there’s a trap around these big shopping days that pops up at
other times during the year too. It’s the idea that it’s just this one time. Like the
excuse we might have heard from a friend in high school as justification to do
something stupid, “just this once” is almost always a sign of trouble.

It often starts with a promotion of some sort. Two-for-one. Free prize with
purchase. No money down. You’ve seen the ads and heard the pitch. Whatever the
angle, the perceived consequence is the same: If we fail to act now, we’ll regret it
for the rest of our lives. I’m exaggerating a bit, but there’s no getting away from
the fact that marketers know how to get us to act on impulse.

Then there are the days when we tell ourselves we need a special treat, a pick-me-
up to make a bad day better. It’s not a big deal; it’s just this once, and we’ve been
so good the rest of the time that an extra latte won’t make a big difference to our
budgets. But what about the next time, and the time after that one?
We’re tempted all the time to use this “logic” to rationalize bad money behavior.
Gifts, vacations, clothes and anything else that’s extra on top of our budgets often
gets justified with that notion that we’ll do it one time and then never again, or at
least not that often. Yet it keeps happening.

I’m not saying that we should never do something special that requires some
financial maneuvering. But we need to be honest about why we’re doing it and the
consequences that may follow.

And if the spending happens often enough, we have to stop referring to the these
things as one-time events. Instead, account for that extra something in a budget
when it starts happening on a regular basis.

By continuing to allow these optional, one-time events to in fact be regular, they

can be the very thing that stops us from achieving our dreams and goals. And the
last thing we want to do is look back and wonder if that trinket was really such a
good deal after all.

Read No. 88

More From the Financial Pro Who Lost His Home

One of the most powerful outcomes of writing about your experience is that you
learn things you didn’t know before you started.

The process of sharing one of the more intense experiences of my life, the short-
sale of my home, was terrifying. In hindsight, I’m glad I did it because of what I
learned. Here are a few of those lessons and answers to some of the questions
that readers raised:

I told myself stories: As David Brooks recently pointed out, “people are really
good at self-deception,” and I’m no exception. Real people are notoriously good at
gathering information, data and “facts” to support the conclusion we want to hear.
Often we even call that research.

We are even better at ignoring information that we don’t want to hear. Have you
ever noticed how you avoid the scale when you’ve been eating garbage and seek it
out when you are eating well? I have wondered if I rationalized my behavior, and
the answer is, of course I did. I made mistakes and then looked for a way to make
sense of them.

Short sales: A short sale is a negotiated settlement between a borrower and a

lender. I worked closely with the bank to explain my situation. The bank reviewed it
very carefully, and in the end, we worked something out that both parties felt was
better than the other available options.

My wife and I found a buyer for the house at a price the bank agreed to accept. It
accepted a loss on the risk it took, and we accepted the consequences on our side
of the deal. We lost our home and trashed our credit. Both parties agreed to the
deal, but neither party escaped without consequence.

Obligation to society: While I don’t have a debt to the bank, I do feel like I have
an obligation to society. This is one part of the experience that I still really
struggle with. I know that my decisions had an impact on society as a whole. My
individual impact was small, but just like everyone tossing a small piece of trash, it
adds up. I’m not sure how I will fulfill that obligation, but I’m pretty sure that it’s
part of my life’s work.

That obligation is also a large part of why I do what I do for a living. We have to
change the way we deal with money if we’re going to avoid repeating the same
mistakes over and over. I have recently found myself really interested in learning
from others who have both succeeded and failed because it’s incredible what you
can learn from people who have already been there. Maybe, just maybe, sharing my
story can help someone avoid the same mistakes.

Security versus securities: One of the things in my story that got the strongest
response was how I got into the financial world by applying for what I thought was
a security job.

I recently had a meeting with a senior executive at a large research company who
told me that he remembered applying for a job after college. It was a window sales
job. He thought he would be selling Microsoft Windows software. It turns out it
was actually the kind of windows you look through.

I guess I should have included the fact that it started as a part-time job when I
was still a full-time college student. I also delivered flowers and worked at Subway.
But what followed were years of some of the best training in the industry, a
degree in finance and one of the more rigorous industry designations there is.

The point I was trying to make was that life is a journey, and most of the time the
path we thought we were on will take a twist, often for the better.

Why I told the story: There’s no good way to address the claim that I wrote the
story to sell books. It reminded me of the press conference after Lance
Armstrong won his first Tour de France. He was asked how he would respond to
people who claimed that his chemotherapy was performance enhancing. As I recall,
he said something like, “Let them try it!”

There would be far better ways to sell books than to take your family through
three years of hell and then, just as things were starting to feel normal, share it
with the whole world.

I decided to tell the story after people I knew asked me for over a year to tell it.
These were people who genuinely felt that it needed to be told because it might
help others make sense of their situation. Based on the overwhelming number of
gracious e-mails I’ve received from people sharing their stories, I think telling my
own was the right thing to do.

Getting a second opinion: As my friend Tim Maurer, also a financial planner, says,
“Personal finance is more personal than it is finance.”
Because it’s so personal, it’s very hard to stay objective. We are just too close to it
to think clearly. Doctors routinely avoid operating on or treating family members
and really close friends. After all, that emotional connection could very easily cloud
their judgment should something go wrong and require a critical decision during a
stressful situation.

When you think about what money represents, it’s easy to see that it’s emotionally
charged. Money is about more than spreadsheets. It’s about our most cherished
dreams and often our greatest fears. With those stakes on the line, why is it so
hard for us to recognize that we shouldn’t be “operating” on ourselves?

Unless you wake up in the morning and see Warren Buffett in the mirror, chances
are you need help. Finding someone to act as a sounding board, an objective third
party, is worth the effort.

Now I realize that as soon as I say that we have another issue – who? The
traditional financial services industry has a well-earned reputation of being
untrustworthy. It’s still really hard to determine who is a real financial adviser or
even what they do that makes them worth the cost.

But it’s crucial to try. We can seek out a trusted friend, parent, C.P.A. or our
lawyer. Our family hired a real financial planner and after working with him for just
a few months, I’m convinced we would have avoided many of our mistakes had we
hired him five years ago. Just having a rule that before making major decisions you
will walk some objective third party through your thinking would be a step in the
right direction.

Co-pilot: Getting advice is different from abdicating responsibility. In the end,

after all the advice in the world, there is only one person that can make the best
financial decision for you. It’s you.

I like to think of this objective third party as playing the role of an experienced
co-pilot. This person is there to point things out and to make sure you have thought
of alternatives, but ultimately the decision and responsibility is yours. So while I
take full responsibility for my decisions, it does help to know that my family now
has a trusted third party to help us, hopefully, avoid bad decisions in the future.

Moving forward: No matter what we do, the reality is we all make mistakes. When
we make these mistakes, it seems like we should face the consequences, glean the
lesson and then move on. We all have a choice. We can wallow in self-pity, blame
others and complain, or we can move forward. I’m not sure what role talking about
it plays in moving on, but I do know that hiding from the past never seems to help.

One of the things I did learn from my experience is that until you walk in someone
else’s shoes it’s impossible to understand what they’re going through and the
motives for their actions. I have found myself a bit kinder, a little slower to judge
and maybe even looking for ways to give others the benefit of the doubt.

I had zero expectations that sharing my story would change anyone’s mind about
what I did. I did hope that it would help people struggling under the crushing
weight of financial mistakes. I also had a teeny, tiny hope that those people who
vehemently disagree with me would maybe see the other side of the story and
understand.

Not agree, just understand.

Read No. 89

Think Twice About That ‘Hot’ New I.P.O.

Initial public offerings get a lot of coverage, and why not? Everyone loves the idea
of taking hard-earned money and using it to gamble in the hope that they’ll end up
owning the next Amazon or Google and not Pets.com or Demand Media. What often
gets lost when we get all excited about a hot new I.P.O. is the pesky fact that most
of the time buying an I.P.O. is a great way to lose money.

Wall Street Roulette

BusinessWeek did a little math on the 25 hottest offerings of 2010 and 2011. The
results don’t look so good.

There’s a lot of red: after the initial “pop” — the jump from the offering price to
the open — 20 of those 25 tanked. Many have fallen 50 percent from their first
day opening price in the stock market (one high-profile example: Demand Media,
down 68 percent since its January debut), a few more than 80 percent.

But those were just the “hot” offerings of the last two years. What about the rest
of the I.P.O.’s? What happened to their prices after that first day of trading?

The total for all 333 I.P.O.’s from 2010/11 for which Bloomberg has data is minus
11.1 percent.

The Odds Aren’t in Your Favor

And in case there is any doubt, almost every study I can find on the performance
of I.P.O.’s shows the same thing:

 Looking at 1,006 I.P.O.’s that raised at least $20 million from 1988 to 1993,
Jay Ritter, a University of Florida finance professor, showed that the
median I.P.O. underperformed the Russell 3000 by 30 percent in the three
years after going public. The same analysis showed that 46 percent of
I.P.O.’s produced negative returns.
 Another study focused on I.P.O.’s issued in 1993 and their performance
through mid-October 1998. The average I.P.O. returned just one third as
much as the S&P 500 Index. Over half traded below their offering price and
one third went down more than 50 percent.

 A study by what was then U.S. Bancorp Piper Jaffray looked at 4,900
I.P.O.’s from May 1988 to July 1998. By July 1998, less than one third of the
new issues were above their initial offering. Even more startling, almost a
 third were no longer traded (that is, they went bankrupt, got acquired or
were no longer traded on an active market).

 Of 1,232 I.P.O.’s issued from 1988 to 1995, 25 percent closed on the first
day of trading below the initial offer price. Adding insult to injury, “extra
hot” I.P.O.’s, the ones that rose 60 percent or more on their opening day,
performed the worst over the long term and underperformed the market by
2 to 3 percent a month during the next year.

So the math says it’s a bad idea — but we keep doing it. Maybe it is the word “hot”
that gets us excited. Groupon sure is “hot”:

“That was some concerns before the road show,” said David Schwartz, a fund
manager for DAZ Capital. “But I’ve been in this business since 1986, and I can tell
you when a deal is really hot and this is a hot deal.”

Winning the Lottery

I remember standing in a long line in 2006 for an open house for a new Toll
Brothers community being built in Las Vegas. The person in front of me and the one
behind me were both real estate agents on the phone with what I assume were
clients, imploring them to get down there right now because this “deal was HOT!”
Hot is not a word that you should use when you’re considering investing your hard-
earned money. Can you imagine Warren Buffett and Charlie Munger getting all “hot”
about their next deal? In fact, I can think of nothing “hot” about investing
correctly.

Of course, there are I.P.O.’s that do well. Think of all the money you would have
made if you had just invested in Amazon or Google at the I.P.O. price. Those
instances seem to happen frequently enough for us to ignore the fact that the
odds are against us. Sounds a bit like the lottery.

Normally when you invest money, you actually need it for rather important things
like sending your children to college. So you do at least a little research. I.P.O.’s in
general are hard to research, and Groupon has been no exception. You have the
chief executive, Andrew Mason, saying things like, “With a market measured not in
billions but in trillions of dollars, we’re just getting started.” And on the other
hand, you have a new company in an industry it almost invented, with no profits.

Sounds like a tossup to me.

There is nothing wrong with using money to gamble on a tossup. Who knows, you
may be right. Just do everyone a favor and stop pretending that it’s an investment.
It’s a lottery.

Read No. 90

It’s Time to Occupy Your Checkbook

The last few weeks, there’s been plenty written about the Occupy Wall Street
protests. As they’ve spread from New York to other cities, it’s been interesting to
see people take to the streets to protest everything from bank bailouts to tax
policy.

But it’s also made me curious. Does our willingness to protest the bad behavior of
the government and corporations distract us from protesting (or even recognizing)
our own personal financial behavior?

This question applies to everyone. Regardless of whether you’re marching, or even

if you disagree with these groups, I think there’s a lesson to be learned. By
focusing on the financial decisions of others — banks, business, government — we
risk putting aside our own questionable behavior in the name of trying to make
global change.
In some respects, I think it’s easier to focus on what we believe others should do
than face our own situations. As W.R. Alger, a Unitarian minister, put it, “We give
advice by the bucket, but take it by the grain.”

To be clear, I think there is plenty to be angry about. I think there are things that
must change on a national and even international scale. All I am suggesting is that it
might help that effort if we ourselves, as the saying goes, try to become the
change we want to see in the world. So in addition to marching through cities
around the country, I wonder if we can stage a personal version, an “Occupy Your
Checkbook” movement.

Last week, I wrote about how difficult it can be for people to figure out where
they stand financially. Part of the difficulty comes from an unwillingness to sit
down and do the math. Maybe you can outline in detail everything the banks did
wrong, but how familiar are you with your own financial situation? Isn’t it time we
devoted some attention and passion to our personal finances?

Perhaps it’s time to talk openly about past mistakes we’ve made. Time to take
responsibility for our own financial situations and make a plan to improve it. Time to
stop buying crap and hoping it makes us happy. Time to stop pretending to be
something we aren’t financially. Time to stop trying to keep up with the Joneses,
since we all know they’re buried in credit-card debt anyway.

Occupy Wall Street may or may not lead to change. But I know for a fact that if
you Occupy Your Checkbook there will be.

Too often I hear people blaming a third party for their financial problems. In some
instances (like fraud, theft or medical emergency), we don’t have control. But in
many cases, the only person at fault is the one we see in the mirror.

The credit card companies didn’t make you buy that big-screen television. The
banks didn’t make you take out a $500,000 mortgage. When it comes to our
discretionary financial decisions, we hold full responsibility. How long can we keep
pretending that these choices fall on someone else?

So tackle the things that you can control. Figure out exactly how much debt you
owe. Work through your budget and understand where your money goes. Ask hard
questions about your needs and your wants.
Again, I know these seem like small things in comparison to the other stuff. But be
honest with yourself. What’s more likely to have an immediate and direct impact on
your life, Occupying Wall Street or Occupying Your Checkbook?

Read No. 91

Kidding Ourselves About Our Financial Reality

In its most simplistic form, financial planning is the process of charting a course
from where you are today to where you want to go. The first step is to become
crystal clear about what I call your current reality, or where you stand now.

I used to think that being very clear about your current reality was the easy part
of financial planning. Once you did that, the hard part started: Making guesses
about other things, like where you want to be in 20 years, the rate of return you
will earn and inflation.

Compared to those variables, defining your current reality should indeed be the
easiest part of the process. It’s certainly a matter of fact. But apparently getting
this clear is harder than I thought.
Based on a new study from the Federal Reserve Bank of New York, it appears that
we have a problem: Many of us are actually far from clear about our current
financial reality. According to the study, only 50 percent of households reported
having credit-card debt, while credit-card companies indicated that the number is
actually 76 percent of households.

In addition, even after adjustments were made for people paying their full
balances every month, the average household reported credit-card debt of $4,700.
Lenders, meanwhile, report an average balance per household of over $7,100.

While I haven’t read the entire study, my sense from the conversations I’ve had in
the last couple of years is that these misunderstandings are indeed a problem. A
number of reasons could explain the difference, but among them is the reality that
many of us may not know where we stand with respect to our finances. In fact we
may not want to know.

As the study’s authors point out, this result “could come from willful ignorance, as
credit-card balances are not welcome information.” When you are overweight the
last thing you want to see is a scale!

But how can you expect to make progress if you have no idea where you’re starting
from? Over the years, I’ve noticed that the biggest differences between people
who reach their financial goals and those who don’t is knowledge of where they
stand in the first place. When I ask financially successful people for a balance
sheet showing their assets and debts, not only do they know what a personal
balance sheet is, they often have one that is relatively current.

The point here isn’t that a balance sheet leads to guaranteed financial success. But
if we’re to have any hope of getting to a destination, it helps to start by being very
clear about where you’re leaving from. In this instance, a balance sheet can help
with that clarity.

If you’re unhappy with your financial situation and want to make a plan to change it,
start today by defining where you stand. Take all the credit cards out of your
wallet, flip them over to the back, find the phone number and call the credit card
company to ask for your balance. Write the balances down on a piece of paper. Add
up the total.
Now make a plan to deal with what you’ve just learned. There’s been plenty written
about how to do that, but it all starts by getting very clear about where you stand.

Read No. 92

The Struggle to Define What We Truly Need

There seems to be a constant battle between what we have, what we need and
what we think we want.

About a year after my wife and I had our first child, we moved into a neighborhood
with homes built decades earlier. Each had two or three bedrooms. We soon
noticed that when people had a third or fourth child they moved from the
neighborhood in search of more space. One day I mentioned this to my next-door
neighbor, who was 70 at the time, and he expressed surprise.

He and his wife had raised their five kids in one of the smallest homes on the
block.

One of the most challenging personal finance issues we all face is the ever-
expanding definition of “need.” Things we once considered clear luxuries have
somehow becomes necessities, often without any consideration of how the change
in status happened.

Cars that seemed just fine now seem old fashioned. Then there are children and
their cellphones. Only a few years ago it would’ve seemed outlandish for 14-year-
olds to need one at all, let alone the latest iPhone.

Achieving clarity about the difference between our needs and wants remains one
of the biggest challenges in personal finance and a tremendous source of potential
conflict within families. While simple in theory, the calculation is much more
complex in practice.

One of the most discouraging parts of modern life seems to be this never-ending
sense that we should want more. While this may not be true for everyone, it does
seem like it’s become more difficult to be content with what we have. Whether it’s
the media, our friends or even our family, it can be a challenge to separate real
needs from wants. So here are a few of things to think about:

 What if financial happiness is not about getting more but about wanting
less?
 What if things start out as wants and become needs not because the thing
itself has changed but because our feelings about it have changed?

 What if you can never really get enough of something that you don’t need?

From personal experience, I know that the shiny new toy I just had to have often
ends up in a pile of things that I eventually need to sell on eBay. I’m not the only
one that’s fighting this battle. It’s yet another example of why personal finance
can be so complex. Because there’s no definitive list of the 100 things that every
family must have, these end up being very personal decisions
I’ve talked about some of the ways I’ve seen people look for balance between wants
and needs. They include things like sleeping on a decision overnight. My personal
rule is that before I buy a book, it has to sit in my Amazon shopping cart for five
days.

What have you done to help better define the difference between a want and
need? And how have you focused more on being content with what you have instead
of always striving for what you think you want?

Read No. 93

The Surprising Money Habits of Successful Entrepreneurs

After many years of talking with entrepreneurs, a calling that seems to appeal to
the creative side of people, I’ve come up with what I define as the Unified Theory
of Capital Management.

It goes something like this: We all have at least two types of capital that we
should be managing: our personal human capital and our financial capital.In simple
terms, human capital is the ability we have to earn money. Financial capital is our
savings or investments.
So why should this matter to you?

Based on my experience and talks with entrepreneurs, I believe everyone, not just
entrepreneurs, needs to manage these two types of capital differently than they
do now. So I came up with some strategies to help you manage these two distinct,
but connected, resources.

For personal human capital, you want to do three things:

1. Concentrate
2. Educate

3. Compound

For financial capital, you want to do two things:

1. Diversify

2. Protect

The majority of entrepreneurs express a strong desire to focus on things they can
control, or have at least some control of. For example, I’ve noticed that it’s hard
for entrepreneurs to invest in the stock market because they have no control over
the outcome.

I remember meeting with a friend of mine whose family had owned a fairly
prominent real estate development company that was successful over multiple
generations. Behind my friend’s desk, the same desk that his grandfather and
father sat at, there was a framed stock certificate.

When I asked him about the stock certificate and why it had such a prominent
place, he replied that it was the first and last publicly traded stock that the family
ever bought. When the stock started to go down, it proved too frustrating for the
family because they couldn’t do anything to fix it. They couldn’t paint the fence,
change the zoning, remodel or come up with a new marketing plan. Things seemed
completely out of control. So they made a decision to focus on those things that
they were good at, in this case real estate development, and then protect the
money they made.
Again and again, I’ve heard successful entrepreneurs say that their success came
from similar focus on personal human capital and those opportunities where their
creative skills, relationships and experiences can mitigate  potential risk. But once
they make their money, they protect their financial assets by investing far more
conservatively than you might think given their propensity for making risky
business decisions.

One thing that I’ve heard over and over is that the way to become wealthy is
through focus and concentration, while the way to stay wealthy is through
diversification and protection. To that end, you do not have to be a creative
entrepreneur to benefit from the Unified Theory of Capital Management.

Everyone can focus on improving personal human capital — compounding it — by

looking for ways to take on a side job, increasing salary and improving skills and
education. Then, look for ways to protect the money through diversification using
conservative investments.

Read No. 94

Your Financial Honeymoon Will Eventually End

I’m not a marriage counselor, but sometimes I feel like one.

In my role as a financial planner I’ve heard countless discussions between couples

about money. Even after 16 years of marriage myself, I’m still learning when it
comes to money and marriage.

With that in mind, I thought it might be helpful to review a few things about
money and its impact on relationships.

1. It’s almost impossible to overestimate money’s role. Arguments about money,

whatever they may be, often lead to divorce. There’s no question that a
relationship is better when the financial side of life is stable, both people know
what’s going on and work together to make decisions. So we shouldn’t ignore money
in our relationship discussions.
2. We all come with baggage. One big challenge is that each spouse brings a set
of deeply ingrained beliefs, habits and feelings about money. Most of us were
raised in families where money (and religion and politics) were subjects not to be
discussed in polite company. As a result, we have very little training on how to talk
about and deal with the emotional issues that are inherent to our financial lives.

The challenge here is that money is not simply a means of exchange; it represents
our goals, dreams and fears. In fact, money has (unfortunately) almost become the
air we breathe. For most of us this represents a challenge, because we have to
figure out someone else’s (sometimes unspoken) views to build and maintain a
successful relationship.

3. Money seems to be the last thing we talk about (at least at first).
During a courtship or engagement, money is often not a topic of conversation.
There’s this sense that if you need to talk about money in your relationship, you
may not be in love. Prenuptial agreements are passé, and no one wants to be
accused of marrying just for the money.

But no matter how much we avoid this discussion before marriage, the time will
obviously come when reality will hit, and we will have to deal with the role that
money plays in our lives and our relationships.

Not every couple has a problem talking about money. But it is clear based on the
conversations I’ve heard, and even within my own marriage, that we need to do a
better job of it. And it seems like a good idea to start those conversations before
anyone says “I do.” Learning to have meaningful and honest conversations about
money is something that should be part of every relationship both new and old.

From the sketch above, you might think that I believe there’s some specific point
when money becomes a problem. Not quite. I could have written, “One Month,” “10
Years,” even “20 Years.”

But financial honeymoons always end, so there is no time like right now to do the
hard work of having honest and meaningful conversations about money.

Read No. 95

The Hard Work of Recalibrating Financial Expectations

During a meeting I had last week with the incredibly creative design minds at
Fahrenheit 212, someone reminded me of the old saying that disappointment is just
the difference between our expectations and reality.Given how many people are
disappointed with their financial lives at the moment, I got to wondering about how
we might adjust our thinking.

Often when I have conversations with people about the “expected” rate of growth
in their net worth over time, I get wildly divergent answers.

In 1999, an 8 percent expected investment return was wildly pessimistic. Fast

forward just a few years, and it was blindly optimistic.

All this goes to show how hard the expectations game is to play. After all, there is
no way to know what the future rate of return will be for any investment plan that
includes stocks. What we do know is that it’s better to be safe than sorry. If
you’re building your financial plans based on a 10 percent rate of return, what
would happen if you “only” get 8 percent or 6 percent, and reality turns out to be
dramatically different than your expectations? Surely you will be disappointed.

There’s an entire industry built around the idea that it’s our job as investors to
search for and ultimately find the best investment. If we just look hard enough or
pay for the latest research, we’ll be able to identify the next hot stock, sector or
mutual fund.
In fact, I think it’s fair to say we’ve come to expect that we can find that mythical
great investment. But this almost always leads to its own disappointment. The
research is pretty clear that it’s far better to simply accept the fact that finding
a great investment is improbable. Instead, this may be one place where we should
expect to be average.

As for our work, where presumably none of us want to be average, I’ve thought a
lot lately about the notion that we should follow our passion and money will follow.
Should we really spend years and years trying to find an occupation that we
absolutely love? What’s wrong with being content with what we’re doing right now?

My grandfather was a patent attorney. I can’t remember him saying that he was
passionate about the work per se, but I do remember him giving me some great
advice. If you can find work that you enjoy even 50 percent of the time and that
allows you to spend time with your family and serve the community, you’re better
off than 90 percent of the population. So I wonder where the line is between
finding work that you are passionate about and being content with the current
situation.

Ultimately,  securing your financial future will probably require some tradeoffs.
And it starts with setting realistic goals.

Sure, I want to believe in the version of the American dream that says we should
think big, and we can do anything if we just put our minds to it. I’ve always believed
in setting big ambitious goals for myself. But I also feel the need to draw a line
somewhere between thinking big and being content.

So how have you balanced having big goals and expectations for the future while
being content, even happy, with the present?

Read No. 96

The Ever-Shifting Balance Between Resources and Dreams

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.

Read No. 97

How Rebalancing Takes Emotion Out of Investing

The idea behind rebalancing is that you periodically reset your portfolio back to
the original split between stocks, bonds and other investments.
Most people seem to follow two rebalancing philosophies: do it according to the
calendar, say once a year, or do it when you reach a certain trigger point, when one
portion of your portfolio grows or shrinks outside of a predetermined range.

Here’s an example of how rebalancing might work:

Let’s say you sat down in 2006 and decided that based on your goals, the right
portfolio for you was 50 percent in stocks and 50 percent in bonds (high quality,
short-term bonds). As part of that process, let’s also assume that you committed
to rebalancing your portfolio back to that original 50/50 allocation whenever your
portfolio balance strayed too far from it.

At 50/50, your portfolio allocation represented the amount of risk that you felt
you needed in order to achieve the return necessary to achieve your long-term
goals. Thirty percent in stocks would be too little to meet your goals, but 70
percent in stocks represented more risk than you felt you could take.

Fast forward a few years to the meltdown of 2008-9. If you went into 2008 with
50 percent of your money in stocks and 50 percent in bonds, then as the market
dropped, the composition of your portfolio would have changed from the original
50/50 allocation to something different. We’ll also assume that nothing else in your
life changed and your goals remained the same. The only thing that changed was
the market.

For our example, let’s assume that you’re using a trigger point to rebalance. Since
it’s pretty common to rebalance when your portfolio allocation strays more than
five percentage points off of your target, when the market fell in 2008 you would
have rebalanced when your portfolio hit 55 percent bonds an 45 percent stocks.
That would have meant selling bonds to buy more stocks.

Rebalancing is not a scientific way to time the market, nor is it a magic bullet to
increase your returns. It is true that disciplined rebalancing could result in slightly
higher returns, but it could also lead to slightly lower returns depending on what
the market does. Rebalancing also does not automatically decrease your investment
risk, but again, depending on market conditions, it may slightly increase or slightly
decrease your risk over shorter periods of time.

While there is plenty of debate about how to rebalance and the pros and cons of
rebalancing, there is one clear benefit to employing a disciplined rebalancing
strategy: it prevents you from making the classic behavioral mistake of buying high
and selling low. Warren Buffett has said that the key to investment success is to
be greedy when everyone else is fearful and fearful when everyone else is greedy.
As we all know that is super hard to do.

It was really hard to buy in March 2009. It was also hard to get yourself to sell in
December 1999 or October 2007. But if you had committed to rebalance that is
exactly what you would have done. Not because you were a market whiz, and not
because you knew what the market was going to do. Instead you rebalanced
because it made sense to stick with your plan. Rebalancing is the only way I know of
to give yourself the highest likelihood of buying low and selling high in a disciplined,
unemotional way.

Rebalancing reminds me a bit of the simple checklists used by doctors. I remember

going in for a routine surgery that was going to be done on the left side of my
body. When I went in for surgery, I met with the doctor who knew exactly what
side of my body she was operating on, but as part of her checklist, she asked me
again during pre-op. After she left, no fewer than four different people came in
with my chart and asked me which side they were operating on.

Each time I answered the left side, but I became increasingly curious about why
they were asking me so many times. Then, as I was on the operating table and
before I was put under, the doctor who I had just seen the day before asked me
which side she was operating on and then handed me a Sharpie and asked me to
mark the side.

When I saw her a few days later as part of my post-op visit, I asked her why they
had followed such a procedure. She told me that it was a simple checklist to keep
them from doing something really stupid, like operating on the wrong side. It took
them an extra minute or two and a Sharpie to avoid what would obviously be a huge
mistake.

And that’s the real magic of of rebalancing; it becomes our investment Sharpie.

Read No. 98

How Rebalancing Takes Emotion Out of Investing

The idea behind rebalancing is that you periodically reset your portfolio back to
the original split between stocks, bonds and other investments.

Most people seem to follow two rebalancing philosophies: do it according to the

calendar, say once a year, or do it when you reach a certain trigger point, when one
portion of your portfolio grows or shrinks outside of a predetermined range.

Here’s an example of how rebalancing might work:

Let’s say you sat down in 2006 and decided that based on your goals, the right
portfolio for you was 50 percent in stocks and 50 percent in bonds (high quality,
short-term bonds). As part of that process, let’s also assume that you committed
to rebalancing your portfolio back to that original 50/50 allocation whenever your
portfolio balance strayed too far from it.

At 50/50, your portfolio allocation represented the amount of risk that you felt
you needed in order to achieve the return necessary to achieve your long-term
goals. Thirty percent in stocks would be too little to meet your goals, but 70
percent in stocks represented more risk than you felt you could take.

Fast forward a few years to the meltdown of 2008-9. If you went into 2008 with
50 percent of your money in stocks and 50 percent in bonds, then as the market
dropped, the composition of your portfolio would have changed from the original
50/50 allocation to something different. We’ll also assume that nothing else in your
life changed and your goals remained the same. The only thing that changed was
the market.

For our example, let’s assume that you’re using a trigger point to rebalance. Since
it’s pretty common to rebalance when your portfolio allocation strays more than
five percentage points off of your target, when the market fell in 2008 you would
have rebalanced when your portfolio hit 55 percent bonds an 45 percent stocks.
That would have meant selling bonds to buy more stocks.

Rebalancing is not a scientific way to time the market, nor is it a magic bullet to
increase your returns. It is true that disciplined rebalancing could result in slightly
higher returns, but it could also lead to slightly lower returns depending on what
the market does. Rebalancing also does not automatically decrease your investment
risk, but again, depending on market conditions, it may slightly increase or slightly
decrease your risk over shorter periods of time.

While there is plenty of debate about how to rebalance and the pros and cons of
rebalancing, there is one clear benefit to employing a disciplined rebalancing
strategy: it prevents you from making the classic behavioral mistake of buying high
and selling low. Warren Buffett has said that the key to investment success is to
be greedy when everyone else is fearful and fearful when everyone else is greedy.
As we all know that is super hard to do.

It was really hard to buy in March 2009. It was also hard to get yourself to sell in
December 1999 or October 2007. But if you had committed to rebalance that is
exactly what you would have done. Not because you were a market whiz, and not
because you knew what the market was going to do. Instead you rebalanced
because it made sense to stick with your plan. Rebalancing is the only way I know of
to give yourself the highest likelihood of buying low and selling high in a disciplined,
unemotional way.

Rebalancing reminds me a bit of the simple checklists used by doctors. I remember

going in for a routine surgery that was going to be done on the left side of my
body. When I went in for surgery, I met with the doctor who knew exactly what
side of my body she was operating on, but as part of her checklist, she asked me
again during pre-op. After she left, no fewer than four different people came in
with my chart and asked me which side they were operating on.
Each time I answered the left side, but I became increasingly curious about why
they were asking me so many times. Then, as I was on the operating table and
before I was put under, the doctor who I had just seen the day before asked me
which side she was operating on and then handed me a Sharpie and asked me to
mark the side.

When I saw her a few days later as part of my post-op visit, I asked her why they
had followed such a procedure. She told me that it was a simple checklist to keep
them from doing something really stupid, like operating on the wrong side. It took
them an extra minute or two and a Sharpie to avoid what would obviously be a huge
mistake.

And that’s the real magic of of rebalancing; it becomes our investment Sharpie.

Read No. 99

Why It Shouldn’t Have Been a Lost Decade for Investors

When people talk about being a buy-and-hold investor these days, they are often
confronted by others who declare that the last 10 years were a “lost decade.”

When I wrote about the power of compound interest a few weeks ago, many of the
comments focused on this idea that the decade ending on Dec. 31, 2010 was the
decade of lost money for most investors. Not surprisingly, people then take the
next step and say that it could continue, and the United States could end up
looking like Japan — 25 years of negative or flat stock market performance.

I know this isn’t the first time this issue has been addressed. Allan Roth wrote
about it on the CBS MoneyWatch Web site in December 2009, and Ron Lieber
wrote a Your Money column about it in January 2010. But it seems like we need yet
another reminder that the lost decade is a myth.

The lost decade claim starts with the assumption that whenever we talk about
investing, we’re talking about owning just American stocks, often using the S.&P.
500-stock index as the proxy for our investment experience.

And if that’s your frame of reference, then the lost decade feels very real. If you
had invested in just the S.&P. 500 over that 10-year period (2000-2010) your
annualized return, including dividends, was 1.4 percent per year.

But much of the widely accepted research about portfolio design does not involve
putting all your money in an S.&P. index fund then letting it sit.

The point of being diversified is that you have a mix of different asset classes
included in your portfolio. A properly designed portfolio is not a random collection
of individual investments but rather a mix of investments you choose carefully
based on the way they interact with the others. If you do it properly, the goal is to
have some investments that zig when others zag.

When you view this 10-year period from the perspective of a diversified and
balanced portfolio, 2000-2010 was anything but a lost decade. Consider the
following (all numbers reflect annualized returns over 10 years and include
reinvested dividends):

 U.S. large stocks (the S.&P. 500) = 1.4 percent

 U.S. small stocks (the Russell 2000 Index) = 6.3 percent

 U.S. real estate stocks (the Dow Jones US REIT index) = 10.4 percent

 International stocks (MSCI EAFE Index) = 3.9 percent

 Emerging markets stocks (MSCI Emerging Markets Index) = 16.2 percent

I’m not recommending that anyone should have all their money invested in a single
index. And we also know that no one could have predicted back in 2000 which class
would be the best performer.

But let’s assume that we decided to be broadly diversified at the beginning of the
10 years. We didn’t get terribly scientific about it, and since there are five broad
asset classes, we simply put 20 percent into each of the five indexes I listed
above. This sort of split is standard practice among professionals and amateur
investors who know just a bit about how markets tend to work.

Then we just sat there. We did nothing! No rebalancing, no rethinking. Nothing.

The return for this diversified stock portfolio for the same 10-year period was an
annualized 8.35 percent. That is a far cry from a lost decade.

It’s also worth noting that earning the 8.35 percent annualized return would have
required behaving and not reacting badly during a painful 2008 and early 2009.
Resisting the temptation to get out during that period was the cost of earning the
8.35 percent.

That said, most real people wouldn’t (or shouldn’t) have all of their long-term money
invested in stocks even if they’re broadly diversified among many different
indexes. So what happens if we add bonds to our long-term portfolio to act as
ballast to the equity exposure?

Including bonds (sometimes referred to as fixed income) in the portfolio means

you’ll have something that’s stable or even gains value slightly when your stocks
fluctuate wildly. For our purposes, when I talk about fixed income exposure, I’m
referring to intermediate-term bonds with an average maturity of around five
years. And for this next example, I use the most widely accepted bond index, the
Barclays U.S. government intermediate-term index.

So we build a portfolio that looks like this:

 60 percent equities (evenly split among our five categories)

 40 percent fixed income (Barclays U.S. government intermediate-term

index)
The 10-year annualized return for this portfolio was 7.83 percent. Again, that’s a
far cry from a lost decade. And of course the purpose of including these bonds
would be to make 2008, for example, a little less painful. While it was still painful,
this 60-40 portfolio was down 24.06 percent in 2008 versus the S.&P. 500, which
was down 37 percent. That was still painful, but at least it would have been a little
more emotionally manageable.

Too often when we hear the market report for the Dow, the S.&P. 500 and even
the tech-heavy Nasdaq, we let those numbers become our investing reference
point. We often fail to look past those daily reports to what’s happening in markets
and investing as a whole.

Clearly things were bad for the S.&P. 500 during the past decade, but singling out
one market to declare a decade of investing as “lost” ignores the reality: a broadly
diversified portfolio can deliver respectable returns even if individual classes
perform poorly.

Read No. 100

Gyrating Markets Are What You Signed Up For

During the last few weeks, I’ve heard a lot of chatter about volatility. I knew
something was going on when I overheard people at the grocery store talking about
their investments, saying things like,”This volatility is killing me.”

I used to joke that volatility was a word that people in the investment industry
used and the rest of us nodded our heads at in agreement, pretending to know
what it meant. Volatility has long been used as a proxy for risk, but in all the
conversations I’ve had over the years, no one has admitted to laying awake at night
over concern about their volatility.

Volatility is a measure of the variation of the price of an investment over time, but
over the years I’ve referred to volatility as the amount something wiggles. Stocks
wiggle more than bonds. Bonds (intermediate term bonds) wiggle more than cash.
And, of course, cash wiggles the least of all.
So if you believe that risk and return are related, then volatility represents the
risk of investing in a diversified basket of stock-based mutual funds and in turn it
is the reason we get paid more to own stocks over the long haul than we do sitting
in bonds or cash.

In the last few weeks, we’ve lived through a historic seesaw, including a period
when the S.&P. 500 either rose or fell over 4 percent for each of four consecutive
days. While these dramatic days have us all talking, it’s important to realize that
volatility and investing go hand in hand. They always have, and chances are they
always will.

So if you’ve discovered that you can’t stomach the wild swings, now might be a good
time take note of how much you didn’t like it so that when the time is right you can
reduce your exposure to the stock market and add more bonds. The entire idea
behind including bonds and cash in a longer-term investment portfolio is to smooth
out the ride a little. Bonds act as ballast to the portfolio so that the swings aren’t
as dramatic.

Please note that I’m not saying you should sell or buy stocks now. That is a entirely
different discussion. I am just trying to point out the role volatility plays in an
investment plan and one of the ways of dealing with it.

No one really knows if this type of volatility is here to say, but in the end it really
doesn’t matter much. After all, volatility has always been part of the deal when you
invest in the stock market. If you still believe that stocks will be a better
investment over time than bonds, then you will simply have to deal with the
volatility.

Read No. 101

To Those Who Have Lost Faith in Investing

Part of the investor’s dilemma is that no matter how much data we have about the
past, we have no data for the future. No matter what history says about the long-
term, upward trend of the stock market, we still don’t know for sure what the
future will bring.

So after all the spreadsheets are put away, investing becomes a matter of faith.

This act of faith is most evident when it comes to the stock market. Assuming
you’re invested in something like a basket of diversified index funds, the core
question becomes this: do you still believe that stocks will continue to do better
than bonds, and bonds will continue to do better than cash, just like they always
have?

If you approach investing from the perspective of the historical evidence, then
temporary declines, no matter how terrifying, are just part of the deal. While this
doesn’t make investing easy, it does make it easier. One of the biggest risks to
investing in the stock market is getting scared out of it at the wrong time.
Avoiding that deadly mistake is easier if you believe that at some point things will
turn around, because they always have.

Approaching investing based on the data from the past doesn’t require you to
ignore the tough economic challenges we face. It just requires that we believe we
will find a way through them. I have no idea how we are going to deal with the
massive public debt, the problems in Europe, and everything else CNBC is throwing
at us, but I do believe that we will get through it.

This reminds me of a quote from the British abolitionist, politician and historian
Thomas Babington Macaulay. Keep in mind that this was written in 1830:

We cannot absolutely prove that those are in error who tell us that society has
reached a turning point, that we have seen our best days. But so said all before us,
and with just as much apparent reason… on what principle is it that, when we see
nothing but improvement behind us, we are to expect nothing but deterioration
before us?

In some regard, investing based on the weighty evidence of history is the most
prudent thing we can do. So far it has always proven to be correct. Every time
someone has predicted the death of the stock market, they have been wrong. Given
this record, isn’t it reasonable to assume that stocks will continue to be better
than bonds, and that bonds will continue to be better than cash?

Read No. 102

Your Neglected Stock Market Backup Plan

The recent market decline, and the media (over)reaction that followed, reminded
me that we still have not learned a very simple lesson: the time to prepare for a
“crisis” is long before you find yourself in one. It’s not a good idea to figure out
how a parachute works after you jump out of the plane.

The stock market is doing what stock markets do. Yet we run around like it’s such a
shock. We don’t know when it will happen, and often it’s hard to tell why, but the
fact that the market went down shouldn’t have surprised anyone.

So if you were surprised, here’s what you need to ask yourself:

Why so shocked? Didn’t we just learn this lesson a few years ago?

To be clear: this is not a problem with the market. This is a problem with us. How in
the world can you invest your hard-earned money without a plan for both the good
and the bad days? Any plan needs to account for the reality that markets go down
as well as up. Part of the planning process must include a discussion about risk and
even include lifeboat drills to see how you will react before you hit the water.

Unfortunately for people who were surprised, the reaction came in one of two
flavors:

1) They didn’t have a plan.

2) They had a plan but didn’t factor in the possibility of a market decline.

In both instances, it’s too late to do anything now about what just happened. You
can’t hedge against the past. It’s like trying to get flood insurance after your
house floods.

This post originally started out as an explanation about why the market dropped,
but I realized that we don’t need to know why the market did what it did. In fact,
we will never know exactly why the market went down. But that doesn’t keep the
talking heads from speculating, a reality that Marketplace Radio’s Heidi N. Moore
illuminated last week: “Here’s what none of those people will tell you: they don’t
know. No one knows. There is no education, no M.B.A., Ph.D or even market
experience that can now or will ever pinpoint a reason or reasons for a market rout
that is not directly spurred by some piece of news.”

As humans, we like things to make sense in our little worlds, so we tell ourselves
stories. We want others to tell us stories as well, so we can make sense of it all.
Sorry, but no matter how many stories you listen to, the markets rarely make
sense, because “the market” is nothing more than the collective representation of
what we’re feeling right now … and now … and now.

Just look at how teenagers change the way they feel based on irrational stories
they tell themselves about something that happened at school or on Facebook. Now
times that by a million! That’s the market.

Again, this isn’t about predicting a particular moment in time or behavior for the
market. Instead, it’s about recognizing that big declines happen in markets, and we
shouldn’t be surprised when it happens again in the future. Since we seem to have
such short memories, I suggest writing yourself a letter or recording a video so
you can remember this past week. Use it to remind yourself that you need to learn
how to use the parachute before you ever get on the plane.

Read No. 103

The Federal Debt: When Compound Interest Is Crushing

The showdown over increasing the federal debt limit got me thinking about the
power of compound interest. It’s always been one of the most powerful forces in
the financial universe. And in the case of the debt ceiling, it appears that
compound interest has the potential to become a crushing enemy.

Some people fear that the United States will lose its AAA credit-rating or even
default temporarily, potentially increasing how much it costs the government to
borrow money. According to the Congressional Budget Office, “…a 4-percentage-
point across-the-board increase in interest rates would raise federal interest
payments next year by about $100 billion; if those higher rates persisted, net
interest costs in 2015 would be nearly double the roughly $460 billion that the
C.B.O. currently projects for that year.”

Think about that for a minute. If those worst-case-scenario interest rates came to
pass and persisted, we’d be approaching a trillion dollars in interest payments per
year. That’s what compound interest looks like when it’s working against you.
On a personal scale, you get a taste of it every month if you get careless with
credit cards. Take a look at a bill. For every month you carry a balance, there’s a
minimum payment required.

Many people only pay the minimum, not realizing that compound interest could make
that $3,000 television cost way more than that and take over a decade to pay off.
And that assumes you don’t add any additional charges to the balance.

New rules require that credit card companies include a section on each statement
that shows just how long it will take to pay off the balance if you only make the
minimum payment. Do yourself a favor and pay attention to the numbers. What you
owe will only compound over time, and paying the minimum just digs the hole that
much faster.

J. Reuben Clark, an undersecretary of state for President Coolidge, noted a long

time ago that, interest on debt “never sleeps nor sickens nor dies… Once in debt,
interest is your companion every minute of the day and night; you cannot shun it or
slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or
orders; and whenever you get in its way or cross its course or fail to meet its
demands, it crushes you.”

It also gets in the way of achieving our goals. Last week, one reader commented
that having a zero balance on your credit card was almost as good as saving money.
There is some truth to that because every dollar we spend on interest is one less
dollar that can be saved for the future.

Now it becomes a question of how to make compound interest work for you instead
of working against you.

Next week we’ll talk about the power of compound interest and the end of a long
period of savings. In the meantime, what have you done to protect yourself from
getting crushed by interest?

Read No. 104

To the People Who Haven’t Saved Anything Yet

We often hear about the importance of starting to save early. Usually the
examples are focused on saving whatever you can when you’re in your 20s to take
advantage of the power of compound interest.

But what if you were too busy trying to pay a student loan and other bills in your
20s, or like many of us, had to use all the savings you built up to get through the
last few years? Now you find yourself closing in on 40 and feeling like you missed
the boat.

I’ve thought about this problem ever since I read about the recent study that
found that nearly half of Americans wouldn’t be able to come up with $2,000 in 30
days if they needed it. This reality hits home every time I have a conversation with
people 35 to 45 who feel so far behind the savings game that they aren’t sure what
to do.
For that group the advice is no longer start early, but simply start now. The only
thing that matters at this point is that the longer you wait, the more painful it will
be. Compound interest can still work, but not until you start saving.

When we get behind on our savings goals, we start to feel more pressure to make
up for lost time. That pressure can often lead to spending hours looking for that
home-run investment. It’s a bit like a gambler doubling down to dig out of a hole.

I’ve also noticed that as we get “smarter” we start to overthink things and ignore
the simple advice about spending less than you earn, saving for a rainy day and
avoiding larger losses. The basics seem like kids’ stuff. So we spend hours talking
about saving and investing, but we never get started.

If you’ve found yourself in a financial situation that was less flush than what you
planned, it’s time to make some changes. Here are few ideas to help you get
started:

Review: Don’t spend too much time dwelling on the past, but it can be really helpful
to take a step back and look for patterns that have been harmful. This has to be
done in a “no shame, no blame” sort of way. Give yourself permission to use the past
as a springboard, not a bully club.

Give up on finding the home-run investment: Maybe it’s un-American, but finding
the next Apple is highly unlikely no matter how hard you work at it. Not impossible,
just highly improbable. So instead just start saving! Certificates of deposit are
fine. Broadly diversified mutual funds work as well. The point is to start.

Make a plan: It‘s eye opening to put a number on all your financial goals. Have you
looked at how much it will cost to put a child through college, for example? Any
good plan will start with a clear understanding of where you are today and end with
a where you want to go. Now you need to calculate the cost of getting there.

Remember that your plan is worthless unless you make the ongoing course
corrections required when you’re either off course or the destination changes.
Plans are full of guesses, but when done correctly, the ongoing process of planning
can provide the context for you to make decisions in the future. It’s a lot easier to
say no to the new car, if you are saying yes to a more important goal.

Maybe you have other ideas, but the point is to stop beating yourself up over what
you didn’t do in your 20s and start focusing on making today count.
So what have you done to get over the hump and make a plan for your future?

Read No. 105

Why You Avoid Your Most Important Financial Task

I’m not sure how it happened, but budgeting became a topic (along with life
insurance) that people will do almost anything to avoid talking about.

I’ve had my own issues with budgeting, viewing it as something people do when they
are overly focused on money or for people who have a difficult time being
disciplined. For me, being put on a budget felt like a punishment, comparable to
being grounded when I was little. So budgeting always seemed to land way down on
my list of financial priorities.
But I was wrong.

I recently spent time with J.J. Sessions, a really good financial planner in Maple
Grove, Minn., who changed my perspective on this issue. During our conversations, I
asked him what excited him most about his work. For him, it’s having a massive
impact on the cash flow of his clients, regardless of their income or net worth. He
pointed out that managing cash flow (budgeting) is the key to his clients’ goals (and
mine, too).

Financial goals get funded with dollars. Dollars tend to slip through our hands
unless we have a system for plugging those holes. We can only plug those holes if
we know they exist. So managing cash flow is not something that gets in the way of
reaching financial goals; it’s the key to reaching them.

Successful companies understand that managing their cash flow is key. It’s not
really any different for individuals. And no matter how stable your financial
situation, I doubt there’s ever a time that it’s no longer helpful to manage cash
flow.

So why does budgeting get pushed to the bottom of our financial priorities?

 Budgeting requires being disciplined by setting and tracking spending goals.

But being disciplined is hard, and we tend to avoid hard things.
 Budgeting is not complex. Remember how we say that we want the simple,
but still choose the complex? But it is not easy, so we keep looking for other
solutions that only appear to be easier.

 Budgeting is revealing. We talked about this last week. When we start to

examine how we spend our money, we learn things about ourselves, and
sometimes those things surprise us. Why did we buy that new television
instead of adding money to our children’s college fund? Why did we take the
trip when we knew it would take months to pay off the credit card bills?
When we set a budget we have to take questions like these into account.

If you’re wondering how to get started, there’s been plenty written about ways to
make budgeting easier, but here are a few of the ideas that Mr. Sessions shared
with me:

Automate your fixed expenses

Automate your long-term savings goals

Track and review your discretionary spending

In the end, I’ve learned that while cash flow management might be hard no matter
how much I do to make it easier, the outcome is worth it. The key to accomplishing
the goals I really care about (and the goals you really care about) is to spend the
time and make the effort to create a real budget. The hard work will be worth it in
the end.

If you’ve had success creating and sticking to a budget, what’s worked for you?
And what benefits have you experienced from committing to a budget?

Read No. 106

How Rising Stock Prices Can Fool You

Missed in the heated debate last week over my post about gold was a narrow but
crucial point: As the market value of an asset class increases, so does the risk.

While this may not apply to specific, individual stocks in all cases, it certainly
applies to the market as a whole. I know this might appear obvious, but we don’t
always act as if it is.

Think about this for a minute: Was the S&P 500 more risky on March 6, 2009,
when it was under 700, or is it more risky today, with the index over 1,300?

Now I realize, for example, that small-cap stocks are more risky than large-cap
stocks. But when you consider small-cap stocks as an asset class individually, as the
market value goes up, the risk of investing in that particular asset class increases.
The same thing applies to commodities, like gold. You’d be hard-pressed to convince
a rational person that gold at $1,500 per ounce is less risky than gold at $500 per
ounce.

It’s also fair to say that if we measure risk based on how we feel, almost all of us
felt like the market was far more risky in early 2009 than we do today. As prices
go up, the news seems better, people start to feel more comfortable and we equate
that feeling of comfort with less risk. But that makes no sense when we think
about it rationally, which is why investing based on our initial gut feelings can be so
dangerous.

No one wanted to touch stocks in early 2009. There was no appetite for initial
public offerings. Now money is flowing back into the equity markets and we’re all
clamoring for shares of LinkedIn. And this, after a historic 100 percent plus rise in
stock prices in a little over two years!

Please don’t misunderstand me. I’m not saying that the stock market is going to
crash. I’m not saying that social media stocks represent a bubble (though others
are suggesting it). I am trying to point out that as the market value of an asset
increases, so the does the risk, and that it makes sense to at least think about
that as you make important decisions about what you’re going to do with your life
savings.

Read No. 107

Gold is Not an Investment

Gold is not an investment. It’s a speculation.

Investments are made by evaluating underlying value. Speculative bets are made by
looking at the price of something and simply hoping the price goes up. Investing is
about value; gambling is about price.

Gold has no real underlying value. I know there is a market for it. I know it is real,
just like real estate was real in 2007.

But what is the value of a bar of gold?

It has no value except the one assigned by a herd of speculators. This is true for
most commodities. They don’t actually produce anything. They are raw material. No
value. No dividend. No cash flow.
Investing in gold is a very dangerous game right now. Whenever the price of
something rises as much, and as quickly, as gold has, we need to stop and consider
the end game. While in Florida last week, I was surprised to see guys standing on
the street waving “We Buy Gold” signs. They looked exactly like the guys I used to
see all over Las Vegas with the signs announcing open houses and touting real
estate as a sure bet.

Remember when your brother-in-law told you that you had to invest in real estate
because they weren’t making any more of it? Or the common justification people
used — that at least with real estate you could see, touch and feel it? It was real!
And how did that work out?

Now I hear people using the same argument for gold. It’s real. Tangible. And you
can enjoy it because it’s pretty. But what does that have to do with investing?

Keep in mind that there are huge institutional players in the gold market right now.
When they decide that the run is over, there won’t be time for you to run to your
safe in the basement, pack up all your coins and gold bars, run to the local pawn
shop and get rid of the stuff.

I have no idea where the price of gold is going, but for me it doesn’t matter. But if
George Soros is selling while your grandmother is buying, you have to wonder who’s
more likely to get hurt. The point here is that it (literally) pays to consider that
the time to bet on gold was 2007. At this point if you are counting on the gold
under your bed to fund your retirement, things could get very ugly.

Read No. 108

The Dangerous Allure of Distressed Real Estate

It was a rough first quarter for the housing market. While home sales were up 11.3
percent in March over February, they were down 21 percent compared to over a
year ago. And home values, well, they dropped again. Besides the difficulties with
getting credit, people are just uncomfortable buying real estate right now.

Compare this to the mid 2000’s when everyone was a real estate investor. Back
then, multifamily properties had multiple offers the day they hit the market, and
being a real estate investor seem like a sure thing. After years of being scared
away, more and more people started to think about real estate as an “easy”
investment.

Buying distressed properties might be tempting now, and it very well could be a
good idea. But it is far from a sure thing. Just because something has fallen 40 to
50 percent doesn’t mean it can’t fall further or stay down for a very long time.
There is, in fact, evidence that the housing market has further to fall. And
investing in real estate requires skill and careful analysis, not just a kit you buy on
late-night TV.

I don’t have anything personal against real estate. It may be a legitimate part of
your investing strategy. The problem happens when investors don’t stop to do the
math.

Too often, investors get sucked into the buying things they shouldn’t when they
fail to add up the real costs. In the case of real estate, how much in property tax,
upkeep and insurance will that “sure thing” cost you? How much time will be
required, and what is that worth?

Real real estate investors take the time to make sure buying an investment
property will “pencil” before they buy it, and they pass on plenty of deals that
won’t work. There are lots of calculators that can help, including the one here at
the Times.

But the point is that no matter how cool it might seem to buy distressed real
estate at this particular moment, if you lack the skill and experience, you might
want to consider a certificate of deposit. At least there you won’t lose money, and
with the time you save, you could focus on earning a side income or just enjoying
your life.

Read No. 109

The Best Investment Advice: Stop Losing Money

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.

Read No. 110

Three Fundamental Questions About Paying for College

This month marks the beginning of high school graduation season and the start of
something new for many families: college.

Over the years, I’ve learned how differently two parents (that is, when there are
two parents in the picture) can feel about sending their children to college and
figuring out how to pay for it. In recent conversations, I’ve heard more than once
that couples were surprised to discover that they didn’t agree when it came to
their children and education.

Why the surprise?

They just assumed that they both felt the same way and talked around the issue
for years instead of talking about it directly.

If you haven’t had this conversation and put together an education plan for your
children, take the time to do it now. We’ve heard story after story about the rising
cost of college, and planning can make a massive difference. But long before you
start doing the math, it’s important to talk about three things to make sure
everyone is in agreement.

1. Should They Go?

Often we just assume that everyone should go to college, but that goal may be
worth rethinking in some cases. There has been plenty written on the merits of
trade school, starting a business or going straight into the work force. For some
people, the best education may be real life.

I’m not advocating that your children skip college, but you do need to discuss all
the options, and those options may vary by child. A good friend always said he
believed his son would go to law school, but it became apparent later that it wasn’t
the best thing for him. The son went to work in a trade, but his two daughters did
go.

2. When Should They Go?

My wife and I took extended breaks during our college years and believe we’re
better for it. In Europe, it’s common for many graduating students to take a gap
year before entering university.

This proactive break (I’m not encouraging your children to play video games for a
year) has started gaining some traction in this country as parents ask themselves,
“What’s the rush?” Maybe there’s an opportunity to work a bit or to volunteer for
some extended service. I remember returning to school more committed and
serious about college because of my experience.

3. Should You Pay?

People avoid or skip this discussion completely, often because it’s the one that
triggers the strongest emotions. Some people want to pay for any school where
their children win acceptance, regardless of cost. Other parents feel strongly that
their children need to earn and pay for their own education. Often these feelings
reflect personal experiences, and it’s worth talking about all of them to make sure
you understand what’s at the root of your instinctive reactions.

You also need to consider how paying for education impacts other financial goals.
Don’t take the cost of college out of context as you measure where you’re at now
compared to where you want to be in the future.
Just like every financial goal, preparing to meet the costs of college takes time for
most families. Your strategy may be different than your neighbor’s, but you
probably can’t afford to wait. Eighteen years passes a lot faster than you think.

Read No. 111

Confronting Your Personal Debt Ceiling

We’ve all made financial commitments like mortgages, rent payments, college
tuition and utility bills. When you combine those commitments, you end up with the
foundation for a budget. But what happens when those commitments exceed your
income?

After we become accustomed to a certain lifestyle, it can be difficult to make

adjustments when the amount of money coming in decreases. But unlike the federal
government, real people don’t have the option to take a vote and raise their
personal debt ceiling. In the real world, increasing your personal debt ceiling only
works for so long. At that point, there are only two options:

1. Earn more
2. Spend less

Simple math, tough choices.

Yet again we have another example of how painful it can be when the cold, hard
facts of arithmetic smash against the complex, emotional issues of money. The
math is simple: if you spend more than you earn, at some point things will have to
change.

But once we move beyond the math, things start to get fuzzy fast. Most of us can
relate to that sick feeling of comparing what we owe to the amount of money
sitting in the bank and knowing it isn’t enough, or the pain of telling children that
we simply can’t afford to do something that was incredibly important to them or
the awkward discussion with a spouse about which extra expense we have to cut to
make ends meet. These conversations aren’t easy, but they have to happen if we
want things to change. At some point we can’t continue to kick the can down the
road.

To add to the frustration, these decisions are intensely personal. We all want easy
answers from some personal finance guru who will tell us what to do. We want a
prescription, but this discussion doesn’t work that way.

Sure, there are books that will provide a framework, and learning from others
(including Elmo) that have been through this can be helpful. But in the end, your
situation is absolutely unique. It will require you to come up with a plan that works
for you. Often what one family defines as a need another will view as a luxury, and
neither one of them is wrong. In the end, they will both need to satisfy the
equation on the napkin: their income must be greater than or equal to their
expenses.

At some point in your life, you’ve done the math and realized that your financial
commitments were out of whack with your income. How did you fix your problem?
If you have children, how are you helping them understand the need for financial
balance?

Read No. 112

Confronting Your Personal Debt Ceiling

We’ve all made financial commitments like mortgages, rent payments, college
tuition and utility bills. When you combine those commitments, you end up with the
foundation for a budget. But what happens when those commitments exceed your
income?

After we become accustomed to a certain lifestyle, it can be difficult to make

adjustments when the amount of money coming in decreases. But unlike the federal
government, real people don’t have the option to take a vote and raise their
personal debt ceiling. In the real world, increasing your personal debt ceiling only
works for so long. At that point, there are only two options:

1. Earn more
2. Spend less

Simple math, tough choices.

Yet again we have another example of how painful it can be when the cold, hard
facts of arithmetic smash against the complex, emotional issues of money. The
math is simple: if you spend more than you earn, at some point things will have to
change.

But once we move beyond the math, things start to get fuzzy fast. Most of us can
relate to that sick feeling of comparing what we owe to the amount of money
sitting in the bank and knowing it isn’t enough, or the pain of telling children that
we simply can’t afford to do something that was incredibly important to them or
the awkward discussion with a spouse about which extra expense we have to cut to
make ends meet. These conversations aren’t easy, but they have to happen if we
want things to change. At some point we can’t continue to kick the can down the
road.

To add to the frustration, these decisions are intensely personal. We all want easy
answers from some personal finance guru who will tell us what to do. We want a
prescription, but this discussion doesn’t work that way.

Sure, there are books that will provide a framework, and learning from others
(including Elmo) that have been through this can be helpful. But in the end, your
situation is absolutely unique. It will require you to come up with a plan that works
for you. Often what one family defines as a need another will view as a luxury, and
neither one of them is wrong. In the end, they will both need to satisfy the
equation on the napkin: their income must be greater than or equal to their
expenses.

At some point in your life, you’ve done the math and realized that your financial
commitments were out of whack with your income. How did you fix your problem?
If you have children, how are you helping them understand the need for financial
balance?

Read No. 113

Just Ignore the Crisis du Jour

Unless you were under a rock on Friday, you had to endure endless chatter about
the impact of the looming government shutdown on our lives. By the time you woke
up Saturday morning, it was over, after a suspense-filled, last-minute deal averted
what had begun to seem like sure disaster thanks to all of the minute-by-minute
updates.

At its height, the chatter verged on comical. Venture Beat warned that initial
public offerings would be delayed. But the bright spot for the day was that the
Cherry Blossom Parade would go on even if there was a shutdown.

I know that the impact to federal employees would have been no joke, so here’s my
point:

1. The shutdown didn’t happen.

2. There was almost nothing any of us could have done on Friday afternoon to
change the outcome.

3. There will be something new to worry about today. Or tomorrow for sure.

It’s amazing how often we fall into this trap of worrying about things that are
simply not problems yet. Most of the problems we face are not even really
problems at the time we’re tying ourselves up in knots. Often these “problems”
serve only to call up regret about how we responded to a real problem in the past
or worry about something that has a small chance of happening in the future. But
none of these things are within our control. So why waste the time?

Because emotion plays such a huge role in our financial behavior, it’s critical that
we not act on irrational fears about the crisis du jour. History has shown us that
the best way to meet financial goals is to have a plan, get to work and avoid
reacting to each and every one of the latest crises.

Read No. 114

The Unasked Question at Berkshire Hathaway

Familiarity can lead to making decisions without thinking through the consequences.
The neighbors use their hands to unplug the snow blower or drivers are convinced
that they can text and drive at the same time. They all know better, but every
year 1,000 people lose a finger or two to snow blowers anyway, and 20 percent of
car crashes with injuries are due to distracted driving.

When it comes to money, we’re equally susceptible to letting the familiar get in the
way of making the smart decision.

For many money decisions, the consequences are small. A friend told me the story
about the time she paid her credit card bill online, but failed to realize that the
payment was coming out of the wrong account. She got the notice that the payment
was approved and didn’t discover the problem until she checked her bank balance
and saw that the account was overdrawn.

Over time, she had gotten comfortable making the payment without looking at the
details, and the system didn’t raise any warning flags. Now, after paying an
overdraft fee, she double-checks the account number every time she makes a
payment.

For every 100 small decisions that seem relatively painless, however, there are the
big decisions that change lives. This past week, Warren Buffett’s deputy, David
Sokol, resigned after it came to light that he made an unwise stock purchase
connected to a Berkshire Hathaway deal. Mr. Sokol is a smart guy, otherwise he
wouldn’t have held the position he did. But his actions are baffling. He should have
known better, and his failure to question the potential consequences of his
decisions seems to have cost him his job.

In Andrew Ross Sorkin’s DealBook post on the matter, he highlighted a quote by

Mr. Buffett that seems appropriate for everyone to remember:

“Contemplating any business act, an employee should ask himself whether he would
be willing to see it immediately described by an informed and critical reporter on
the front page of his local paper, there to be read by his spouse, children and
friends.”

Simple enough, but it’s advice that’s easy to forget. And sometimes all it takes to
avoid trouble is asking just one more question before you make a decision. It turns
out that the extra question could keep you from paying an overdraft fee, or
perhaps even losing your job.
Read No. 115

Why You Can’t Be Sure About Home Purchases

Since World War II, owning your home has come to symbolize the American
Dream. But the dream of owning a home has taken a beating during the last few
years. After everything that’s happened, maybe it’s time we pressed ourselves on
whether it really makes more sense to buy a home instead of renting.

In 2004, people were buying homes they really couldn’t afford because they either
expected home values to double in a year or believed they’d be priced out of the
market forever if they didn’t buy right then and there. Since then we’ve gone from
flipping a house in a month to watching them remain empty for months, if not
years.

When James Altucher stated last month that he would never own a home again, he
also made a valid, if uncomfortable, point regarding people’s expectations about
home ownership.

“Few are asking whether the dream was real or not, but rather are asking, when
will we be restored our proper rights as citizens – our right to once again own our
own homes?” During the last decade, the housing and mortgage industry, along with
the government, encouraged everyone to believe that not only could they own a
home, but that they should own a home. But this position ignored two ugly truths:
1. Home values won’t always go up. Home prices are not guaranteed to go up, let
alone stay there even if they do rise. The housing market has shown that it’s
susceptible to bubbles. In this case, we’ve seen the bottom drop out of housing
prices. Some experts said they believed that prices could drop yet another 5
percent this year.

2. Home prices don’t reflect the real cost of ownership. Mr. Altucher makes
the valid point that if you want to own a home, you can’t forget about the following:

 Insurance premiums
 Property taxes

 Maintenance

 Utilities

 Yard work

 Real estate agent costs

 Closing costs

 Initial remodeling costs

For most people, buying a house will be the largest financial decision they’ll ever
make. Caught up in that decision is a ton of emotional baggage, because when we
buy a house we’re buying a home, the place where we’ll live and perhaps raise our
families.We think it will lead to feelings of security. So the purchase is rarely just
about the dollars and cents, despite what we may tell ourselves about our homes
being an investment.

In 2004, home ownership hit an all-time high of over 69 percent. Since then that
number has dropped to 66.5 percent. The drop has been attributed to several
factors, most notably foreclosures and an inability to qualify for a mortgage now
that lenders actually have underwriting rules again.

With all the changes in the market, does that mean you shouldn’t buy a house?
Barry Ritholtz counters Mr. Altucher’s position with some of the benefits we still
associate with home ownership. When you buy a home, you can select school
districts. You also gain the ability to live somewhere as long as you want (as long as
you can pay the mortgage). Then there’s the possibility of a mortgage tax
deduction.

All those things aside, I think the entire issue comes down to two questions:

1. How long will you live in the house?

2. During the time you live in the house, how much will it appreciate or depreciate?

If you can answer those two simple questions, I can build you a spreadsheet that
will tell you whether you should rent or buy. (Or you can use the New York Times’s
calculator to sort it out.)

But there’s a catch. These simple questions are just about impossible to answer.

Many of us may have parents or know older friends who claim that buying their
house was the best financial decision they ever made. I suspect that a person who
makes that claim has lived in the house for 20, 30 or even 40 years. The reality is
that people my age and younger are moving more, so the idea of a settling in a
house for a long time seems unlikely.

Realistically, if you make buying a home solely about the dollars and cents, you
might not ever buy. Instead, I believe the only reason it’s worth buying a home is
because you believe just that: it’s your home.

At the moment, my family lives in a rental home. It doesn’t bother me that we rent,
but  my wife feels a deep need to live in a home that we own. So we’ve decided that
the next piece of property we buy is the home that we will assume that we are
going to live in forever. We’ll be making a big assumption about this idea of
“forever,” but at least we won’t be buying it as an investment.

The bottom line for you, me, and everyone else is that we have to stop making
assumptions that everyone should own a home. It’s not for everyone, and it’s not
something you can decide based solely on a spreadsheet. Over the next few weeks,
I’m going to revisit this topic, because I believe it’s on a lot of people’s minds.

So please, tell me what you think. When do you think it makes sense, if ever, to buy
a home?
Read No. 116

Don’t Confuse the Urgent With the Important

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.

Read No. 117

When Your Money Is the Dumb Money

By now you have probably heard about the growing evidence that “dumb money” is
entering the market. The dumb money is not my term, by the way; it’s how Wall
Street  refers to individual investors who repeatedly sell stocks at a low price, only
to turn around later and buy them for high prices.

If the mistake is so frequent that it actually has a name, why do we keep doing it,
and what can we do to stop?

When we make financial decisions we’re faced with a choice: Do we act based on
what we know or how we feel?
In an intellectual exercise, knowledge wins. But in the real world, we’re hardwired
to pursue the things that give us pleasure or provide security and run as fast as
possible from the things that cause us pain. This genetic trait means that we’re
often driven by how we feel instead of what we know.

Here is an example. In December 2008, The Economist published one of its classic
covers. I remember seeing this cover, and a year or so later being struck by how
well the image captured how I had felt. In fact, when I saw it again in 2010 I had
an emotional response that surprised me as I thought back to those feelings. The
picture made me feel like everyone else did during that time. I was depressed, sad,
hopeless and felt like I was a fool for not gathering what little gold I had left
before it too fell into the dark, bottomless hole pictured on the cover.

But how I felt at the time was exactly the opposite of how I knew (in an
intellectual sense, at least) I should act. Every investment decision should at least
be informed by what we know, instead of driven solely by what we feel.

So if you’re thinking about making a sudden change to your portfolio here are a few
things to consider:

1) Stop long enough to ask yourself if your decision is based on how you feel or
what you know. Is what you are about to do based on what is going on in the market
or is it based on an investment plan you put in place when you were thinking clearly?

2) Don’t just do something, stand there. When dealing with investments there is
often this feeling that we should be doing something. A lack of action implies we’re
missing an opportunity or making a mistake. Growing a garden takes lots of hard
work, but at some point you have to let the plants grow. If you have a plan, let it
work.

3) If you’re still convinced that you need to act, take a mandatory timeout. Write
yourself a letter that explains what you intend to do and why. Pretend like you are
trying to convince a wise friend that your proposed course of action makes sense.
It might help to actually meet with someone you trust and talk it through. Putting
it on paper can help you weigh knowledge versus emotion.

4) Please, ignore gut feelings when it comes to investing. I can’t tell you how many
times I have heard people use that as an excuse to do something dumb.
I know, I know. Believing that we can remove all emotion from our decision making
just isn’t realistic. But we can still take plenty of steps to make knowledge the
foundation of our financial choices.

Read No. 118

Charlie Sheen, Bernie Madoff and Your Money

While most of us don’t live an extreme life, we sure seem to be fascinated by those
with extreme lifestyles.

So when we see people like Charlie Sheen, Bernie Madoff and even the supposedly
staid bankers on Wall Street producing wealth at a level that we can’t fathom,
we’re often fascinated. While they may appear unrelated, all three are connected
by one thing: someone or something is enabling the extreme behavior.

Too often, money drives the enabling.

When a concerned friend approached one of Mr. Sheen’s inner circle about getting
him help, the friend was shocked to hear, “We make a lot of money from him. I
can’t be part of” helping him. How often have we heard a similar justification used
when it comes to reckless investing in the markets?
Consider the article that appeared in The New York Times highlighting the first
jailhouse interview with Mr. Madoff. What caught many off guard were his
assertions that an entire group of supposed experts turned a blind eye to their
suspicions of him.

Recently unsealed court documents could back up his claims. In a lawsuit filed to
recover funds, Irving Picard, the trustee representing Madoff victims, claims that
as early as 2007 a Citigroup executive analyzing Mr. Madoff’s fund concluded that
his strategy couldn’t generate the published returns.

At JPMorgan Chase, internal documents suggest that senior executives doubted

Mr. Madoff’s legitimacy more than 18 months before his Ponzi scheme collapsed,
but kept doing business with him. Were his actions enabled by people there who
benefited directly from his operation?

The everyday investor gets involved here too. Wall Street doesn’t make sense to
most people, so few people asked many questions when  supposedly conservative
bankers started offering new products to mainstream investors, like derivatives
and securities backed by mortgages (often subprime loans). These experts knew
better, but many of them were turning a blind eye to the problems they were
creating in the name of profits.

Nobody wanted the music to end. And we kept buying the products even as we
sensed that no-money-down mortgages made very little financial sense. You, me and
most everyone else struggles to work up the nerve to question things that appear
too good to be true and come with a financial benefit.

Just so you don’t think the world is populated solely by bad guys, I think it’s worth
highlighting Carl Icahn’s recent announcement that he’s giving back money to
investors in his hedge fund. There are some other issues that may be behind his
decision, including concerns about increased regulation of hedge funds. Still, Mr.
Icahn’s decision does seem a marked contrast to what we’ve previously seen in
financial markets.

Whatever his motives, Mr. Icahn’s actions are a reminder that “too good”
opportunities deserve our skepticism. Right now we seem to face another of those
times where we’re tempted to turn a blind eye to bad market behavior but probably
ought to think twice.
While potential borrowers with solid credit are struggling to get home loans, junk-
rated companies sold a record $287.6 billion in bonds in 2010. They’re on a pace to
top it this year.

If you push them, many investors will admit that they’re unclear about the level of
risk they’re assuming, but their behavior seems to indicate that they think that
making money in this market requires that you turn off your brain and dance until
the music stops. At some point, we have to accept that enabling the bad behavior
of others will ultimately hurt us. To pretend that we are immune only makes the
fall that much harder.

Read No. 119

The Emotions That Get Lost in Budget Discussions

We’ve heard a lot recently from people who feel that we need to have more grown-
up conversations about the country’s financial situation.

But these adult conversations often fail to acknowledge how we actually feel about
money. In theory, making sacrifices and lowering government debt seems logical
until it comes to a program that affects us directly. Then we feel conflicted.
Logically, we know what should happen, but emotionally we’re torn.

We often do the same thing when it comes to personal finance.

We may know that it’s time to get serious about money, but nobody accounts for
our emotions when trying to whip us into shape. Part of how we feel about money is
the sense of security that can come with it. Our personal sense of security has a
lot to do with trust, and trust is often a function of reliability. Recent events,
however, are forcing us to ask questions about whom we can trust and what we can
rely on in a way that we may not be fully prepared for.

“The heart of the problem,” said one retiree in a Times story last week, “is the
rapid change that has left Americans confused, disoriented and struggling to
adapt.” Institutions we believed were worth trusting, like our employers, banks and
states, have made changes that undermine that trust.

That emotions don’t fit on a spreadsheet is one of the great paradoxes of personal
finance. We often have an expectation that making good money decisions is a
function of opening up Excel and making a formula or model. But good financial
decisions require more than a spreadsheet. They also require that we understand
our own behaviors and our emotional response to money.

We may want financial decisions to be a function of a mathematical equation, but

the reality we face is less straightforward. Often we have two potential answers
to the financial decision we’re trying to make: the spreadsheet answer and the
“allow me to sleep at night” answer.

So we are not cold and removed from emotion. If that was the case, we wouldn’t
feel a twinge when we have to tell a child that we can no longer afford a special
treat. And if we were that removed, we’d avoid heated arguments with spouses
about shrinking family budgets. It would be easy, since it’s only money, right?
There will be times when you may have to make financial decisions that don’t make
sense on a spreadsheet, but they may allow you sleep at night. How much is a good
night of sleep worth to you?

That said, we can’t always make every decision that lets us sleep better. That could
be a quick way to undermine financial security, which would only lead to more
sleepless nights. In the conversations I’ve heard of late, however, there’s more
acknowledgment that both kinds of answers exist. Knowing this fact can help us
adapt as we engage in the give and take between our spreadsheets and our hearts.

Read No. 120

Are We Buying High All Over Again?

We’re doing it again: Buying stocks after big gains in the markets.

In 2008, 2009 and most of 2010, mutual fund investors in almost every month took
more money out of stock mutual funds than they added. Then, in January, someone
hit a switch.

Investors decided that it was time to get back into the stock market. Keep in mind
this decision came after an almost 100 percent gain from the market bottom in
2008. So in December we pulled $10.6 billion out of equity mutual funds, and in
January we poured an estimated $30 billion into the market.

Do you see the problem here?

Unfortunately, investors are repeating past bad behavior. We broke records with
market inflows in December 1999 and for the first three months of 2000, right
after an enormous run-up in technology stocks and right before a nasty decline. We
have an uncanny ability to buy high and sell low, the opposite of what we are
supposed to be doing.

If you’re still not convinced, let’s take a look at the S&P 500. On Feb. 16, 2011, the
S&P 500 hit 1,334. That number matters because it represents a doubling of value
from the previous market low of 666.79 on March, 6, 2009. Great news, right? Do
the math:

…the S&P took less than 23 months to rise 100 percent, which appears to be its
fastest double since S&P started publishing the index in 1957.

So does it really make sense to chase the market at this point?

The tricky thing is that we don’t know how the market will do over the next six
months, the rest of the year and beyond. Maybe the $30 billion that poured into
equity mutual funds in January is just part of a rational asset allocation decision,
but our past bad behavior points to something else.

Unfortunately, we’re hardwired to want to move away from things that cause us
pain and move closer to things that give us pleasure or a sense of security. From
that perspective, wanting to sell when everyone around us is panicked and fearful
and buy when everyone starts feeling better and things have cleared up makes
perfect sense.

But what does cleared up mean? Does it mean people are less fearful? Does it mean
the news reports are positive? Does it mean our friends are investing again?

Keeping all of these signs in mind, do you you think the market will move higher or
lower when things clear up? Higher, of course. So this decision to wait until things
clear up sounds like a plan to sell low and buy high on purpose. It’s a bad idea and an
avoidable mistake.
Another reason we may jump back into the market is that we can’t take the pain of
watching it rise day after day. Maybe in early 2009, you decided that you were
done with the stock market forever. Then as the days went by and sustained
positive returns emerged, you started feeling like you were missing out. Your
friends were talking about investing it again. It was killing you. “O.K.,” you said to
yourself, “maybe it’s about time to get back in.”

So how do we stop the madness and avoid the same mistakes again next time the
market goes down? (And it will go down again, I promise.)

1) Have a plan. I am not talking about one of those worthless, two-inch-thick

books. I’m talking about the process of sitting down and deciding where you are
today, where you want to be in the future and how you plan to get there.

2) Decide if that plan means that you need to invest in stocks in the first
place. It might not.  Your plan could involve saving more, adjusting your goals or
retiring later. The rate of return you need to achieve your goals is just one
variable to consider.

3) Find investments to populate the plan. This comes at the end of the process
and is certainly not the first part. After all, you would never spend time deciding
what car to drive on a trip until after you decided where you were going.

4) Make changes only if the plan changes. Your plan, and not what the market is
doing, should drive your behavior.

We don’t know what comes next for the market, so we need to focus instead on the
process of getting from where we are today to where we want to go. It’s the only
part of the process that may give us some control.

Read No. 121

Bold Predictions: Always Enticing, Often Wrong

Last fall, Malcolm Gladwell predicted that “the revolution will not be tweeted.” He
took a lot of hits for this prediction, and, based on recent events in Tunisia and
Egypt, it seems like it may have been inaccurate. This questionable prediction
doesn’t cancel out Gladwell’s earlier work or the amazing ideas he’s shared with a
wider audience.

But what this does highlight is that experts are not right 100 percent of the time.
Yet we’re still held rapt by their predictions. And the bolder their calls, the more
we’re interested.

Last month, I talked about gurus and their forecasts. Based on questions I heard
from some readers, it might help to understand why these forecasts and
predictions are so tempting.

1) It’s fun. We like having something to talk about at the neighborhood barbecue
or around the proverbial water cooler. Now with Facebook and Twitter, the fun is
multiplied a hundredfold. As social animals, we love being in the know and place
value on being the one to break the news.

2) It’s genetic. Our natural instinct to survive makes us sensitive to the world
around us, and we’re constantly trying to predict dangers lurking in the bushes.
There is obvious value if you’re the person in your tribe who can successfully warn
others of danger or guide them to bounty. We rely on predicting and forecasting
for almost every decision we make, including the weather, our commute time and
even what to wear based on what we predict others will think or say.

3) We want control. We all want to control our environment and our futures if we
can. It’s very difficult to accept that much of what goes on is random and that the
only constant seems to be change. In fact, I recently heard a speaker at a
conference say that we’re becoming increasingly certain that the future will be
uncertain. Because of the value we place on being in control, we tend to gravitate
towards people we think can tell us what will happen in the future. After all, that
gives us a sense of control.

4) We forget quickly. Many of the currently famous market forecasters have

been wrong for years, but we quickly forget their incorrect forecasts from days
gone by and cling to the one big call they recently got right. If you carefully
analyze your history with market forecasters, you quickly realize that it’s a
revolving door. The forecaster who appears to be a prophet today will fade into the
distance and a new one will appear.

Our willingness to listen to predictions, despite research that dismantles the

notion that they’re worth much, is an example of why it’s so difficult to behave
correctly when it comes to our relationship with investments. It doesn’t seem to
matter that these predictions are worthless. We still look for them, and
genetically, we still want them. However, the best part of being human is that we
can overcome genetics and recognize predictions for what they really are: a 50/50
guess.

Read No. 122

The Odds of Picking the Next Apple

The odds of you picking the next hot performing stock like Google or Apple are
insanely low. Yet popular stories about the next “big” investment tempt us to
believe that this time we’re on to something far enough ahead of time to ride the
investment up.

Why do stories about Google and Apple make it so hard to behave? Because they’ve
delivered results, according to a recent YCharts post, that make the most cautious
of investors secretly wish they’d jumped on board.

“From August of 2004 to December of 2010, Google’s (GOOG) price increased from
$100 to $600 per share. And Apple (AAPL), from the end of 2000 to the end of
2010 returned 43.35X. Those are returns that put dollar signs in any investor’s
eyes.”
Who doesn’t want an investment that performs like Google or Apple? The problem,
and it’s a big one, is that we tend to look to the past when we’re seeking answers
about the future.

Nathan Pinger at YCharts describes this situation perfectly. “Trying to pick a

stock’s future growth path based on past growth is like trying to guess if a coin will
come up heads or tails when you know that the last toss was a heads. The previous
toss tells you nothing.”

Every so often I’ll get a phone call from a client. He has the next big stock, and to
him it makes perfect sense to dump his plan, ignore his goals and bet the future on,
well, a tip from his brother-in-law.

We grow up for a time believing that superheroes and magic are real. We root for
underdogs even though we know beating the favorite will take a miracle. So does it
really seem all that crazy to believe that the stars will align and that one financial
decision will change our lives forever?

The problem is that when you chase after a particular stock, you lose sight of the
things you actually can control. You lose sight of your goals and plans, for instance.

For 99.99% of us, chasing after the Googles and the Apples of the world will lead
to the investing version of dating rejection. Meanwhile, the odds of you achieving
financial success by behaving correctly are insanely high. So do you really want to
toss a coin and make such a big bet on the next big thing?

Read No. 123

The Case for Ignoring the Stock Market

When people learn that I run a wealth management business and write about
personal finance, often their first questions are about the stock market.

What did the market do today? Where do you think the market is going?

They are often surprised and even a bit frustrated when I reply that I don’t know
what the market did on a particular day. I also have no idea where the market is
going.

I remember a conversation with a family member where he replied to these

statements like so: “What do you do? Isn’t it part of your job to know where the
market went today?”

These questions led to a discussion about my job and the reality that it’s about
helping people make smart decisions about money that build and protect their
wealth over time. In fact, knowing what the market did today, or spending a bunch
of time thinking about where the market will be in the future, is actually the
opposite of what I want clients and readers to focus on.

Watching every market move, listening to CNBC in the background or spending a

bunch of time researching gurus’ forecasts takes a lot of time and generates a lot
of anxiety. And it almost always leads to behavior that results in big mistakes that
cost us (not make us) money.

Like what, you might ask? Well, these for starters:

 Buying high, selling low

 Confusing investing with entertainment

 Relying on the greater fool theory

 Investing based solely on familiarity

 Anchoring money decisions based on the past

There’s been a lot of chatter recently about the impact of being constantly
connected in our lives. More often we’re seeing suggestions that we need to take
time to unplug. The idea is that when we unplug and take the time to connect with
family, we’re more likely to feel a greater sense of community and happiness.
Indeed, one of my new year’s resolutions is to spend less time watching, worrying
and thinking about what the market is doing in the short term.

A recent Wall Street Journal article talked about the impact of technology on our
family relationships and one quote jumped out at me, “Technology should be on the
list of the top reasons why people divorce, along with money, sex and parenting.”
When it comes to relationships, I thought the only thing I had to worry about was
money, but it appears technology could be an issue, too. So what happens when you
combine technology and money?

To help counter the noise and the conflicting signs, I suggest that you take a media
fast. For example, when the Dow recently hit 12,000 (before it dropped again),
there was discussion about what this benchmark means for investors. From my
experience, making money decisions based solely on external factors, like the Dow
or an individual stock, isn’t the wisest way to plan for your financial future.
If investment success is truly about behaving correctly over the long term and
choosing investments within the context of your plan, what happens in the market,
day to day, should have no impact on your decision making.

Try it. See what happens when you turn off the noise and pay more attention to
what’s happening right in front of you.

Read No. 124

When to Sell Your Stocks

How do you know when it’s time to sell?

I’ve been thinking about this question based on the recent news about Apple’s
record-breaking quarterly results, the recent fervor over private equity takeovers
and the speculation about the coming initial public offerings of LinkedIn, Groupon
plus the quasi-private Goldman offering of Facebook.

This fevered speculation reminds me of many conversations I heard in the late

1990s. You remember the time. Everyone did well with their investments just by
picking technology stocks or companies whose name ended with .com.
During that time, if I had a conversation with people about selling, they balked
because they didn’t want to deal with the tax burden.

This approach is a little bit like letting the tax tail wag the investment dog. Sure,
considering potential taxes should be a part of the investment decision, but it
shouldn’t be the deciding factor.

Psychology plays a huge role in making the decision to sell. History is littered with
examples of greed or other bad behaviors that get in the way of what, in hindsight,
turned out to be a great opportunity to take some profit off the table.

Companies make this mistake often. Think about Microsoft’s offer for Yahoo at
$31 a share. Yahoo is now at $16 and change. Remember the News Corporation’s
purchase of MySpace? Now News Corporation is considering a sale of MySpace,
and Facebook is the dominant social network. Only time will tell whether Google’s
rejected $6 billion offer for Groupon will turn out to have been a mistake (and for
whom).

So if you find yourself in the enviable position of having chosen a few winning
individual stocks, how do you make the decision?

First, it’s often better to be lucky than smart, so it makes sense to be honest with
yourself if you invested, for example, in Apple. As you’ve watched the price go up,
did you make the decision to invest because you’re smart, brave or just lucky? If
you’re being honest, most people would acknowledge that when you pick an
individual stock or two and they subsequently triple in price, that outcome is more
often than not a result of luck and not some inherent skill.

Second, review how these investments fit within the context of your financial life.
Choosing to keep an individual stock just because it went up does not qualify as a
valid reason. So when you’re asking the question of whether it’s time to sell, take a
step back and consider the following:

1) Clearly identify your financial goals. A simple (but not easy) process, identifying
your financial goals should include defining what you think you want the future to
look like. Don’t spend hours or days on this task, and give yourself some slack. It’s
life, after all. Things will change, and it makes sense to revisit and redefine your
goals periodically. These goals really are nothing more than educated guesses, but
they’re at least a set of markers in the sand, something that you can use as a
reference point for your decision making.

2) Make a plan to get there. Again don’t spend too much time here because the
variables that go into building a plan are nothing more than guesses. Still, the
process is important. Using the information you have, estimate how how much you
can save for the next 36 months, make a guess at the rate of return you hope to
earn and carefully consider what risks you’re comfortable taking.

3) After you define some goals and build a simple plan, decide if your current
investments fit the plan.

4) If the investments don’t fit, sell! Now, you need to be prepared psychologically
to sell. I can promise you that if you make the decision to sell an investment,
because it aligns with your plan, the stock will triple over the next couple months
after you sell.

If you make the decision to continue to hold an investment because it does fit in
the context of your plan, it will lose 20 percent of its value over the next three
months. There’s no guarantee that comes with the decision to buy or hold, but be
prepared that your decision may be tested. That’s just Murphy’s Law.

Making the decision to sell or hold an investment is relatively simple when we’re
aware of the cognitive traps of fear and greed. It should be clear to anyone that if
you own an investment that has tripled in price, and you made that investment
based on luck, it would be wise to take some of the profit and go home.

Investment decisions like buying or holding are best made when you do so in the
context of your financial goals. Picking the next Apple is not a financial goal. Saving
for retirement or having enough money to send your kids to college are financial
goals. Once we’re clear about the why, about the goals, and we have a simple
framework to represent a plan to get there, making investment decisions becomes
much more simple.

Read No. 125

Investing With the Herd

Since March 2009, we’ve watched the market rebound by 80 percent. Whether
you’ve sat it out on the sidelines or think you can predict what comes next, I
recommend you take a step back and remember a few things.

You are not as smart as you think. Overconfidence is a huge behavior problem
for investors. Overconfidence is what happens precisely because we think we know
a lot about the subject, but overconfidence can lead us to make mistakes that in
hindsight will be glaringly obvious (but the tricky part is that we didn’t know it at
the time).

Following the herd doesn’t make it safe. I know it’s exciting and fun to be an
investor in Apple or Google right now. Then there’s the talk about getting access to
the private initial public offering of Facebook through Goldman Sachs. Buying
because everyone else is buying is not an investment strategy. These companies
may be great investments, but not just because everyone else is buying their stock.

We’re social animals who feel safer in numbers, but so do sheep. We take comfort
in doing what everyone else is doing, and in the back of our minds we know that
even if we’re wrong, at least we’ll be wrong with a bunch of other people. But it was
the same line of thinking that led us to do very stupid things in high school just
because “everyone else was doing it.”

Investing is about behavior, not skill. Maybe you’ll accuse me of beating a dead
horse, but successful investing is about how you behave. Buying high and selling low
is dumb, but it’s worth repeating given what I’m seeing in the market today. It’s
important to remember that you could own a “mediocre” mutual fund, and if you
behave correctly you can outperform 99 percent of your neighbors. On the other
hand, if you spend your whole life searching for the “best” investment, you’ll ruin
your entire lifetime return in one single behavioral mistake.

I know that what I’ve outlined sounds obvious and easy to scoff at, but the fact
that it’s obvious didn’t keep investors from loading up on tech stocks in the late
1990s, bonds in 2002, and real estate in 2006. As we enter 2011, and the
excitement of our financial New Year’s resolution starts to wear off, please
remember that it’s worth taking the time to stop and think before you invest.

Read No. 126

The Danger of Stock Market Forecasts

January marks the time of year where gurus come out of the woodwork with their
stock market forecasts.

I thought it would be valuable to review a few of them and try to understand what
they might mean to real people investing in the real world. I’ll cover two recent
forecasts and  one from a few months ago, too.

Let’s begin with Robert Prechter. In July, 2010, he said that based on his version
of something called the Elliott Wave principle, “the Dow, which now stands at
9,686.48, is likely to fall well below 1,000 over perhaps five or six years as a grand
market cycle comes to an end.” Since then, the Dow has been up sharply.

Then we have Robert Shiller of Yale. He recently put his price target for the
Standard &Poor’s 500-stock index at 1,430. (At this writing, the index is currently
about 1,280.) Before you get too excited, note that Mr. Shiller says that his
prediction is for 2020. That works out to less than a 1.5 percent increase a year
for the next decade!

Finally, there’s Laszlo Birinyi. According to a recent Bloomberg Businessweek

article, Mr. Birinyi believes the S.&P. can hit 2,854. And in an amazing display of
precision, he predicts this will happen on Sept. 4, 2013.

So there we have it. Three market gurus with three wildly divergent forecasts
that were all covered and reported by reputable, mainstream news outlets.

What’s a real investor to think or do?

The problem with gurus and their guesses is not that they’re always wrong. Part of
what makes these forecasts so tempting is that the gurus are right just often
enough for us to believe that there’s merit in listening. Unfortunately, it’s
incredibly difficult to identify which forecast will be right.

So what does a real person do with this information? I suggest you use it as
kindling, as a starting point. I know it’s fun to chat with friends or colleagues about
your opinion of the stock market. I also know it can feel like the duty of any self-
respecting American to have an opinion about the market and the economy.

Having an opinion is fine. But acting on it with real money is often incredibly
damaging. To move beyond opinion you can start by doing the following:
  Realize that investing is a means to an end and not the end in and of itself.
Take the time to define the end (your goals), and realize that good
investment decisions are only made within the context of your life.
 Once you define your goals, figure out what it will take to get you there.
Part of that will obviously include a rate of return that you need to achieve.
If that rate of return is unrealistic, then make adjustments to your goals.
For example, you can try to save more, you can spend less or you can delay
goals like retirement.

 Once you have a realistic set of goals, build the most conservative
investment strategy you can to get you there.

You need to realize that no one can tell you with any sense of precision where the
stock market (or any market) is going. If you’ve learned nothing else during the last
10 years, I hope you remember that the stock market won’t perform in a set way
indefinitely. At some point the market will go down, and it may be for a long period
of time.

Just as likely, the market will often go up a lot over a long period. So for the real
investors who are investing real money in the real world, take note that you should
build your investment strategy around your life and your goals and not the annual
guesses of gurus.

Read No. 127

Resolved: Think Less About Money

Carl Richards
My No. 1 financial goal for 2011 is to stop thinking about money so much. I realize
that may sound funny coming from someone who thinks and writes about money for
living, so let me explain.

It’s important for me to recognize that I’m not immune to financial mistakes just
because I spend a lot of time studying, writing and giving advice about money. In
fact, I’ve made a number of errors over the last five years that I regret.

One of my major goals for the coming year is to be very clear about those mistakes
and what led to them. Then, I want to practice radical self-awareness so I’m as
open and authentic as possible about my own financial life.

Often when I think about money, it’s either in terms of the past and the mistakes
that I’ve made or the future and the things that worry me. Both of them take me
away from focusing on the present. One of the things I want to do better in 2011 is
to move on and not spend an inordinate amount of time worrying about things I
could or should have done differently. Of course, I want to use those experiences
to help myself and others avoid similar mistakes, but I want to do it in a way that
doesn’t involve blame or shame.

I have a tendency, and it might be because of my occupation, to beat myself up

when I make a financial mistake. The reality is that I will continue to make
mistakes, and it doesn’t help me to spend significant time regretting the past. I
believe it’s much better for me (and you) to objectively look at the mistake, make
note of the lesson and move on.

Spending too much time worrying about the future can also be detrimental to our
enjoyment of the present. Personally, this is a tricky issue for me because a lot of
what I do involves encouraging people to have more meaningful conversations about
the role that money plays in their lives.

Normally when you discuss money, it can lead to making plans for the future. After
all, money is not the end goal but a means to accomplish other goals important to
us. Whenever we start thinking about important goals, we have a tendency to
obsess and worry about whether we’re going to be able to meet them.

Because I spend so much time helping others think about these things, I spend a
lot of time thinking about my own future. I’ve noticed that it’s important to draw a
line separating the time that you spend focused on planning for the future and the
time you spend living for today. Planning for the future requires a delicate balance
because it’s very important, but it needs to be done in isolation to avoid
overshadowing the joy of today.

To help me find my balance, I plan to set aside a specific time and place once a
month to evaluate what I’ve done during the last 30 days. I’ll identify any mistakes
I may have made, note the lessons that I need to learn and then let the past go.

During that same personal financial meeting, I want to think about where I’m
headed, the goals I have for the future and what I should do now to reach those
goals. Once the meeting is over, and I’ve had a discussion with my wife about what
we’ve both learned, I want to put those goals and mistakes away.

Controlling how much I think about money and maintaining my balance may be easier
if I remember to do a couple of things:

1) Take a media fast: A few days each month, I’ll specifically avoid thinking,
reading and maybe even talking about the financial markets and the economy or
anything related to personal finance.

2) Pay attention to my emotions: Money is an emotional subject for most of us. It

certainly is for me, and I believe it will be helpful to me in the coming year to be
more present and aware of my feelings about money. Doing so may be as simple as
considering how I feel when I get my monthly investment statement or when a
medical bill arrives in the mail. I’m not sure what I’ll do with what I learn, but I
think acknowledging those feelings and being aware of their potential impact will be
important.

I’m confident that if I can meet my goal of thinking less about money in 2011 the
result will be more clarity about my relationship with money and far more
meaningful conversations with my spouse, my family, my clients and readers here at
the Bucks blog.

Read No. 128

Couples’ Clashing Definitions of Financial Security

How do you define financial security?

With several lists floating around, it’s easy to get caught up in the idea of “should.”
The idea goes that if you just follow a list of “shoulds” you’ll automatically feel
secure financially. The reality is that what makes us feel safe depends on family
background, education, work experience and more general feelings about risk.

One conversation about financial security that I have repeatedly with clients
demonstrates this well. It’s the debate between couples over investing any extra
money versus paying down the mortgage.

Often one spouse says, “We should buy that stock.” Then, the other spouse says, “I
want to pay down the mortgage.” This cycle repeats itself with things like starting
a business or making some other investment instead of paying down a mortgage.

This conversation has also become more common following the real estate
meltdown. Because our circumstances have changed, we’re asking questions that we
might not have considered before. When people ask these questions, however , it
can cause conflict in relationships because security (or lack thereof) often sits at
their core. So when these questions come up, it’s usually a signal to stop and listen
to what your spouse is saying.
Instead of talking past each other, when you hear, “I want to pay down the
mortgage,” or “I want to buy more stock,” take a minute to follow up with, “Help me
understand why it’s important to you that we do that.”

These conversations are not simple, and as we’ve discussed before, many of us
don’t have extensive education or experience dealing with these complex issues. In
fact, if you were raised not to talk about money, it may feel very uncomfortable to
have detailed conversations about the things that make you feel financially secure.

It would be simple if we could make this discussion be only about dollars and cents
on a spreadsheet, and I’ve talked before about how viewing your home solely as an
investment can be a mistake. So depending on your situation (and your available
interest rate and long-term goals) one option may end up being the obvious answer
when we base the decision solely on numbers. For some couples, breaking down the
numbers offers enough certainty that they feel comfortable making a decision.

But as you may know from personal experience, what makes us feel safe may be
something completely different than what the spreadsheet tells you to do. Once
we start talking to each other instead of past each other, we can hopefully reach
decisions that not only make financial sense but make us feel safe too.

Read No. 129

There’s No Such Thing as the New Normal

One of the things that make humans human is the tendency to seek out patterns.
In fact, we often spot coincidences and call them patterns when none in fact exist.

Our pursuit of patterns can lead us to define the recent past as the “new normal,”
a definition that can vary greatly based on personal circumstance.

When we get focused on the new normal, we forget to think about the possibility
of surprises. After all, our brains naturally want to cut through the complexity and
settle into a routine.

But the reality is that surprises will happen no matter how we define normal
because life has no set or guaranteed pattern. Surprises interrupt our definition of
the new normal and cause us to reset our expectations.

If history tells us they will happen though, why are we so surprised by the
surprises?

There are at least two reasons:

1) The origin of the next surprise often looks different than the last one.

2) The longer and more pronounced a new normal seems, the less it takes to
surprise us.
Nassim Taleb illustrates this problem with the story of a turkey. For every day of
a turkey’s life, he’s fed on a regular basis and comes to expect that his daily
pattern of being fed is a general rule. Imagine this turkey’s surprise on the
Wednesday before Thanksgiving when this pattern changes.

The turkey had no reason to think the pattern would change. Yet it did just that
with no warning and with serious consequences for the turkey.

Clearly, you don’t want to be a turkey.

Granted, we’re often asked to make decisions, particularly financial ones, based on
a degree of uncertainty. To counter this uncertainty, we commit one of the classic
behavioral mistakes by looking to the recent past, identifying a pattern and
projecting it into the future. The danger of this behavior is that we’re making
decisions based on the new normal and often fail to include the potential for
surprise.

As you plan for 2011, it’s time to evaluate your current normal. How are you
spending your money? How much are you saving? How are you investing? Maybe you
don’t need to make any changes, but it’s worth considering if you have a backup plan
for the next surprise.

Because it will come, after all. We just have no idea what it will look like.

Read No. 130

Four Ways to Stop Gorging on Gratification

Six years ago, Amazon.com created a premium shipping program called Amazon
Prime. For a flat rate ($79/year), you can get free two-day shipping.

Business Week noted that “Amazon Prime may be the most ingenious and effective
customer loyalty program in all of e-commerce, if not retail in general.” It converts
casual shoppers “who gorge on the gratification of having purchases reliably appear
two days after they order, into Amazon addicts.”

The phrase that sticks out to me is “gorge on gratification.”

This is due in part to an article I read in Newsweek about how Americans are
spending again, whether they can afford it or not. Just two years ago there was a
belief that an entire generation of people had changed based on the economic
tumult we experienced.
I’m not sure I agree that Americans are spending like they were before, but there
does seem to be evidence that we’ve forgotten, or will soon forget, what it felt like
to be pushed to the brink.

We all know the old saying that old habits die hard, and nowhere does it seem to be
more true than our spending habits. They are awfully difficult to change.

Do you notice how often we’re referred to as the “American consumers?” At some
point, it seems that we stopped simply being citizens and became consumers too.
Along the way, we bought into the idea that shopping and spending money makes us
happy and helps form our identities.

We are better and smarter than that, but witnessing the Target stampede on
Black Friday makes it easy to see why we’re all lumped in together as consumers. It
also doesn’t help that we continue to hear the message that we need to spend more
money to get the economy going.

So delaying gratification seems to be ever more difficult. As for Amazon Prime,

how much harder is it to resist when you’re promised delivery of whatever you want
within 48 hours?

In the 1960s, a study at Stanford looked at our ability to delay gratification. The
results, which included follow-ups decades later, indicated that people who’ve
figured out how to delay, instead of giving in immediately, experienced greater
success than those who haven’t.

So how can you keep more money in your wallet?

1) Mandatory holding pattern. Before you buy something, stop. Add it to a list
and let it sit for three days. Then, revisit the list.

It’s amazing how something you absolutely had to have holds almost no interest to
you after three days. I find this especially true with books. When I first signed up
for Amazon Prime, I quickly found myself with a stack of books that I never
started.

Now I use the wish list or shopping cart and let them sit. I have a very long list of
books on my wish list that I have never ordered, and yet the world continues to
spin.
2) Multiweek buying fast. The idea is to see how long you can go without spending
any money beyond necessities.

This originally started for me when I entered every transaction into Quicken
manually, and I got sick of entering so many transactions. So I tried to reduce the
number of purchases.

In a crazy way, this can be fun. See how few transactions you can have in a 30-day
period. If you use a credit or debit card, see how short you can make your monthly
statement.

3) Tracking your spending. I know you’re sick of hearing this suggestion, but the
reality is that avoiding the same stupid behavior is quite simple: You need to
measure and track spending.

Simple, but not easy. Things that get measured almost always improve. Tracking
spending can also give you some sense of control, and that control can help build
confidence that you can make changes.

4) A price tag on your goals. Do you have any idea how much it will cost you to
send your child to college? How important is that to you? Is it more important than
the plasma television today?

These are not new ideas, but they do require hard-nosed discipline. So how has
your discipline changed in the last couple of years? Do you think of yourself as an
“American consumer” or have you decided to test your ability to delay
gratification?

Read No. 131

Spousal Chatter and Bankruptcy Terror

What I’m about to relate is a story I suspect many of you have experienced at
least once if you’re in a relationship.

My wife mentioned that her friend had recently redone her kitchen. As she
explained all of the renovations, I started doing mental arithmetic that quickly
added up to big dollars, dollars we couldn’t afford. Instead of engaging in a fun
conversation about why my wife liked the kitchen and what she thought was cool
about it, I responded with my typical “We can’t afford that.”

Of course when she heard my response, my wife gave me a confused look and said,
“What are you talking about?”

Clearly, after 15 years of marriage, I haven’t fully learned the lesson that just
because my wife is talking about a new kitchen she’s not implying that she wants to
remodel her kitchen. She was only discussing something of interest to her and
what she thought might be of interest to me.
So why did I make the leap and start to feel tension in my shoulders? After all, my
wife is no stranger to money. Her undergraduate degree is in finance, and she
served as the chief financial officer of a small development company. More
recently she’s taken over as our family C.F.O., which leads me to wonder why I’m
assuming she’s talking about money when in reality she’s just talking about life.

This conversation isn’t the first time that I’ve made the leap to money based on
things my wife tells me. For example, every time she mentioned someone she knew
that was planning a family trip to Hawaii, I immediately started calculating how
much such a trip would cost. Even something as simple as talking about where
friends plan to send their children to college makes me start thinking about money.

The reality is that my brain is wired to think differently when it comes to money.
Based on my experience, and the stories others have related, it’s clear that men
and women can have completely different approaches to how they talk about
money. What I took as code for, “I want a new kitchen,” was just my wife talking
about something she enjoyed. How many times has this happened between you and
your spouse?

Even if it happens a lot, this is not a question of who’s right and who’s wrong.
Rather, it’s an opportunity for us to recognize that when we’re dealing with people
who we care about, we can’t impose our money language and expectations on them.

I will probably continue to do mental arithmetic when I’m chatting with my wife,
but if I remember that 99 percent of the time she’s simply talking about subjects
that interest her, I can reduce my anxiety over money. How we were raised to view
money (let alone the other influences of gender, experience and education) all play
a role in how we talk and think about money. So it’s healthy to recognize that we all
bring baggage to these conversations. Hopefully it won’t take me another 15 years
to put it into practice.

Read No. 132

A Few Financial Matters You Can Control

The world is getting more complex, and with complexity comes confusion. We are
constantly bombarded by reports of things like quantitative easing and de-
leveraging. No one really knows what impact these things will have, given that we’ve
entered uncharted territory.

Whenever we are faced with things that we don’t understand, it can generate
anxiety and fear. Real people often do obsess over the consequences of future
events, even if they are almost always beyond our control.

So here three things to remember when you feel like you have no control or
understanding of how the world is about to change:

1) These things are not problems now.

When I start to worry about future events, I’ve found that it’s helpful to focus on
what’s going on right now in my life. Often, I find that I don’t have any problems
right now, at this very moment.
To be clear, I’m not pretending it means that I don’t have things going on that
could have a significant impact on my life. Without question, we all need to deal
with these types of concerns, but it helps to isolate that exercise from the reality
of everyday living.

2. Focus on your personal economy and stop worrying about the global one.

There’s much that’s still in your control if you focus on your personal economy.
That’s why I love this quote from Jim Rogers: “Any economy which saves and
invests and works hard always wins out in the future over countries which consume,
borrow and spend.”

When things get really complex, I find that it often helps to focus on my personal
situation. I can still figure out a way to spend less than I make and invest in myself
or my business (over which I have a little bit of control). And I absolutely can get
out there and work hard.

3. Forget about finding the best investment.

Most of us spend too much time scouring the planet for great investments when we
could be working or trying to figure out how to earn a little more.

Making wise decisions about how you invest your money is important, but it doesn’t
have nearly the impact of working hard and saving more. I’ve found that it helps to
think of earning money as my job and investing as a tool to protect the money I’ve
earned.

Of course that means that I might have to watch from the sidelines as the
markets scream to new highs. (Then again maybe not, and that is the point!). But if
taking this approach allows me to focus on earning more, starting a side business or
even just worrying a bit less, it may lead to a better result in the long term.

It’s also important to remember that you have zero control over what the market
does and at least some control over what you do.

So the next time life starts to feel too complex and out of control, remember that
you can get re-centered by focusing on the simple things (note: I didn’t say easy)
you can do to impact your personal economy.
Read No. 133

Avoid the Investing Trap of Familiarity

Real people like things that they’re familiar with. We often pick the same thing off
the menu (even if it wasn’t great), and we like to invest in the familiar as well. This
preference for the familiar, often referred to as the “familiarity bias,” leads us to
the faulty assumption that just because we’re familiar with something, it must be
safe.

One of the more common examples is when people buy the stock of their employer
even though doing so rarely makes sense. Most people can’t afford the risk of
receiving their income from the same company that they have bet their retirement
on. That leads me to the dominant business story of the past week: the General
Motors initial public offering.

From Detroit to Washington, D.C., this I.P.O. has been hailed as everything from a
sign that the government did the right thing in bailing out G.M. to an indication
that the economy is finally recovering. There have also been a number of articles
about G.M. retirees who were debating whether to participate in the I.P.O. In case
you missed it, many of these retirees lost a significant amount of their savings
when G.M. filed for bankruptcy and their old stock tumbled to cents on the dollar.
Yet almost 18 months later, some of these retirees are clamoring to be involved in
the I.P.O. That raises some interesting questions.
Beyond the familiarity bias, retirees need to be asking an even more fundamental
question: Should someone who has probably faced serious financial setbacks invest
in the individual stock of any company? Imagine the response if you proposed to
these same retirees that they buy individual shares of another company. They’d
probably reply that such a choice was far too risky. But somehow that same feeling
of risk doesn’t apply to the company they spent years working for and watched
crash and burn.

Now that we’ve considered the individual stock issue, we can’t ignore the
questionable choice of participating in an I.P.O. Regardless of what company that
I.P.O. is for, I.P.O.’s are a risky investment. If the I.P.O. was for any company
other than G.M., can you imagine the response if you suggested to older, retired
people that they invest? Just because it’s G.M., and just because you worked there
your whole life, doesn’t make it less risky.

This discussion isn’t about whether G.M. stock is a good or bad investment. The
real issue is whether potential investors decided to buy the stock because it makes
sense based on their financial plans or because they feel loyalty to a company. We
saw what happened to the people who worked at Enron and Tyco. In some cases,
employees at those companies were invested 100 percent in their employer. In a
matter of hours, entire portfolios were zeroed out and people were left with no
savings and no job.

These weren’t the first companies, and they won’t be the last, to fall prey to the
ups and downs of a market economy. The last thing you want to happen is to lose
your job and all your wealth. So be careful to avoid thinking of it as “our” company
when you make your investing decisions.

Read No. 134

Too Many Investors Are Actually Collectors

Over- or under-diversifying your investments remains one of the classic behavioral
mistakes.

Over-diversification happens when we become collectors of investments instead of

simply being investors. Think of the people who buy the mutual funds they read
about in Smart Money magazine. Next year they buy the Top 10 Funds
recommended by Money magazine. A year later they buy two or three new
international funds because that’s what’s on the home page of Forbes.

Before they know it, they have a smorgasbord of unrelated investments, with no
cohesive strategy at work. Then there are all of the taxes and transaction costs —
and the impact on your life of having to keep track of it all.

For anyone with a portfolio that looks like this, consider a relatively simple
suggestion: Each individual component of a portfolio should be there for a reason.
Think of each investment that you own as a thread in a larger tapestry.
Being under-diversified is an equally troublesome problem. Under-diversification
can take the form of owning only a single stock, or too much of one. For instance,
maybe you work at Apple, and you’re convinced that Apple stock can only go up, so
you put your life savings into Apple stock. We’ve seen why this choice can be a bad
idea; ask anyone who had a lot of stock in A.I.G., Enron, Wachovia or Lehman
Brothers.

Many people now know better than to put too much money into a single stock. But I
still often meet people who own a number of mutual funds and believe they’re
properly diversified. The reality is that fund overlap can leave you heavily invested
in a relatively small number of individual stocks.

This happens because many mutual fund managers have similar ideas, or they
create funds based on what’s popular at the time. If you look carefully at many of
the largest mutual funds (the ones people are most likely to buy), they have
significant overlap among the top 10 stock holdings.

Whether you’re under- or over-diversified, you are probably only doing what you
thought you were supposed to do. You’ve spent a lot of energy, time and even money
trying to pick the right investments. Unfortunately your efforts may have created
the exact opposite of what you wanted to accomplish.

Remember, you’re not a collector. You’re an investor. You want stocks (or funds)
that get you closer to the financial goals you’ve set for yourself. You also need to
make sure that what you own doesn’t expose you to greater risk than you can
handle, again based on your goals.

The end result should be a portfolio that reflects those goals, not the collection of
magazines on your coffee table.

Read No. 135

Hope Is Not a Budgeting Strategy

Maybe you’ve already learned the truth the hard way, but the universe is not going
to pay for that BMW you want.

In case you missed it, I’m referring to one of the teachings from the best-selling
book that goes by the ingenious name “The Secret.”  The premise relies on the law
of attraction. The idea is that you can create your own reality through your
thoughts. If you focus intently enough on something, it will happen.

Most of us believe in some version of this law because we recognize that thinking
good thoughts will generally make us happier and more attractive to other people.
We also see some logic in the fake-it-until-you-make-it strategy. After all, how
many of us are really qualified for the jobs we apply for?

Where “The Secret” takes us off track, however, is in telling us that changing our
physical reality only requires us to will it to happen. This attitude gets particularly
dangerous when applied to money.

Using positive thinking to motivate ourselves to make healthy financial decisions is

one thing. It’s something else entirely to lease a BMW you can’t afford and hope
that the universe will make your payments because you thought about it really
hard.

Maybe this sounds silly to most of you, but I see something similar happen on a
regular basis. It starts out simple enough. I’ll see someone who believes that
getting to the next level, however they define it, requires faking it at an
unsustainable level using material goods as part of the ruse.

For example, think about the people you know who believe that more expensive
clothes or a flashier car will help them appear more successful and thus lead to
closing more deals. The real question is whether there’s anything to back up the
flash, like hard work, patience and discipline.

There is indeed some evidence that focusing on the positive does bring about
positive change in our lives, both at work and at home. But the positive change
happens and lasts because of hard work. And that’s the part left out of “The
Secret.” If it were all about thinking, we’d all be billionaires. Instead, when we
apply the law of attraction to our financial lives, it’s important to realize that
patience and discipline over long periods of time make the biggest difference.

Read No. 136

Foolish Investors Dancing Naked

Remember in the late 1990s when everyone was taking cash out of their homes to
buy technology stocks?
That buying frenzy was not based on in-depth analysis, and it continued for so long
simply because the market seemed to go nowhere but up. It didn’t make any sense.
In fact, it was dumb. But it was too easy to just jump in and count on someone
dumber coming along to take the the investment off our hands at a higher price.

Putting hard-earned money into questionable investments just because they’re

going up at a given moment doesn’t make sense, but that hasn’t kept us from making
the same mistake time after time. During this last decade, we did it again with real
estate.

There is a name for this behavior.

The Greater Fool Theory was best exemplified in the now infamous statement
made by Citibank’s Charles Prince in the middle of 2007: “When the music stops …
things will be complicated. But as long as the music is playing, you’ve got to get up
and dance. We’re still dancing.”

The housing bubble was the Greater Fool Theory on a bigger scale than any of us
may ever see again. And now we know that at the time Mr. Prince made his
statement, the music had already stopped. And therein lies the risk of investing
based on the Greater Fool Theory: It’s awfully difficult to know when the music
will stop.

There is even an investing strategy based on the Greater Fool Theory. Sometimes
referred to as “momentum investing,” you’ll hear investors say things like “The
trend is your friend,” and “You can’t fight the Fed.” In the case of not fighting the
Fed, which we’re hearing a lot about right now, the idea is that as long as the Fed is
providing liquidity, the market will continue to go up.

You might have heard this referred to as the “carry trade.” If you can borrow
money at basically zero percent interest and invest it in assets that rise in value,
you have to stay on that train. But again, as soon as the Fed hints that the music
will stop, the party will end quickly.

A few very smart (or lucky) investors may be able to get out before the music
stops. But for the vast majority of us, it’s far too difficult to know when that will
happen. Again think of Mr. Prince, Citibank and all the other investment banks that
are supposed to represent the smartest talent money can buy. Like Warren E.
Buffett said, “When the tide goes out, we find out who was swimming naked.”
History made it clear that when the music stopped, the folks that were supposedly
the smartest were left dancing (while naked).

The question I have now is whether we’re doing it again. Are we continuing to dance
because Ben Bernanke and the Fed have pledged to keep the music playing? Are we
all ready to pile into the market simply because it is going up?

These are the things you need to ask yourself when you go to invest your hard-
earned money. Are you making a particular decision because you think it’s a good
investment? Or are you doing it because you’re ultimately relying on a greater fool
to come along?

Read No. 137

Maybe You Shouldn’t Invest Like Harvard

Correction: The original version of this sketch had the axes of the graph
reversed.

I had a discussion recently with somebody who was unhappy with the results of his
investing strategy. (Surprise!) We discussed one way he could do it differently and
he asked me, “If that is such a good idea, why doesn’t Harvard do it that way?”

I get this question a lot, and I understand why people ask it, given that endowment
managers like David Swenson from Yale have tried to explain to individuals what
they can learn from their own successes. But I still think it’s the wrong question
entirely. Since investing success is often about asking the right questions, here are
a few for consideration and discussion:

1) How do we know Harvard doesn’t do it that way? We know quite a bit about how
many of the large university endowments invest, but there is still plenty that we
don’t know.

2) Why would you want to do what Harvard or Yale’s endowment has done? The
question isn’t whether Harvard’s endowment has done well or poorly; the question is
what does it matter? Your investing goals as an individual or family will be
different from the goals of a large university endowment.

3) There’s a lot we can learn from the successes and failures of the largest
university endowments, but can we really get the same kinds of deals as they can?
One practical implication of this reality is reflected in the fees we pay for access
to alternative investments and hedging strategies, for those of us who use them.
They cost us individual investors a lot. And we should never forget that those fees
make an enormous difference in our performance.

This is a little bit like Groucho Marx saying that, “I refuse to join any club that
would have me as a member.” If high fees are our only option, we may be better
buying certificates of deposit. But that is not the case with Harvard.

4) You and your portfolio are not the same thing as a university endowment.
Expecting that the same investing strategies will work for you is a little bit like
shopping at a big and tall store if you’re only 5 foot 9. It isn’t a good fit.

I understand the temptation to try to replicate the investment process of any

large institutional investor, but I think it is much better to focus on finding the
investing strategy that works for you and your life, and not what has worked for
Harvard.

Read No. 138

All of Our Warped Financial Expectations

We all know people who make a lot of money yet always seem to struggle to get by.
(Or we read about the now famous University of Chicago professor who blogged
about the trouble he and his family were having making ends meet while earning
more than $250,000 a year.)

At the same time, there are plenty of people who manage to be content on much,
much less.

How can that be?

Part of the problem is centered on what we expect from money. Our expectations
drive many of our financial decisions, and often we don’t even think about why we
do the things we do with money. There are at least three things to think about
here.
1) Family Expectations This is where it all starts. Many of us have complicated
feelings related to the expectations of our families. There might be a desire to
live up to a standard set by older siblings or parents, and the expectations of a
spouse or children have a lot of influence on us too. Anyone who has looked a child
in the eyes and told her she can’t have something really important to her because it
costs too much can appreciate just how complicated feelings and expectations
about money can be.

2) Peer Expectations I think this one is a subtle twist on the classic problem of
keeping up with the Joneses. We like to think that we don’t walk around overtly
trying to keep up with our friends in terms of what we buy, but there is no doubt
that what our friends do has an impact on how we act.

If we continually spend time around people that are taking expensive trips to the
beach, it’s very easy to start telling ourselves that we should be going, too. After
all, if they can do it, then why can’t we? And will we be able to remain friends with
them if we don’t do what they do?

3) Societal Expectations The message everywhere is that spending will make us

happy, so we start to expect that to be true. It reminds me of the Zen story about
the old, wise fish that asks two young fish, “Boys, how’s the water?” And they
reply, “What water?” The expectation that spending leads to contentment has
become the water we swim in. But most of the time, we don’t even know we’re
swimming.

Regardless of income, we need to take the time to inspect what we expect from
money. This is true for all of us, but it might be especially true if you make plenty
of money and still feel like you’re struggling to get by.

Read No. 139

Whining Is Not a Financial Strategy

While I can’t prove it scientifically, I’m pretty sure there’s a correlation between
our personal financial situation and the amount of time we spend complaining about
the practices of big banks, Wall Street, credit card companies and mortgage
lenders.

The more time we spend whining about big banks and demanding someone make
them pay, the worse off we are.

I realize that people at these institutions have done things that were flat-out
criminal, and they deserve to be punished. But unless you are involved in that
process, what good does it do you to focus on it? Wouldn’t we all be better off to
just take all that energy and devote it to getting ourselves to a better place
financially?

Focusing on the actions of others and the impact they had on us does little good.
Sure, it might make us feel better for a while, or give us something to talk about
at parties. But if we’re not careful, blaming others can lead us to continue many of
the same habits that got us in trouble in the first place.
It’s a bit like the moral hazard problem that Wall Street faces in the era of
bailouts; when we start to believe that someone will save us from the consequences
of our actions we act differently than we normally would. We engage in more risky
behavior, thinking all along that someone will  rescue us if we get in over our heads.

Bailed out once by friends, family or government, we tend to repeat the same
behavior again, believing that someone will come to the rescue. Then, if things do
go wrong and no one comes to the rescue, we complain and blame others. The
whining ensues, and we repeat the process.

Please don’t get me wrong — I know there are situations where it really is someone
else’s fault. I realize that in many cases of financial hardship family, friends and
the government need to step in to help. I have been on the receiving end of that
kind of assistance myself.

But the point I’m trying to make is that until we make the conscious decision that
we alone are usually responsible for our financial situation, nothing material will
change. Even in those cases where someone else was clearly at fault, our energy is
far better spent applying whatever lessons we can and moving on.

This seems especially true when it comes to credit card debt. In a recent Q&A
with CreditCards.Com, Lynnette Khalfani-Cox talked about the turning point in her
journey to pay off over $100,000 in debt she had racked up (despite earning a
great salary). Things started to change when she stopped complaining about the
big, bad credit card companies, learned the tough lessons and took responsibility
for her actions.

While it might be most visible with credit card debt, this lesson applies to all areas
of personal finance. Instead of complaining about where we have been or currently
are, we are much better off focusing our energy on things that will get us to where
we want to go.

Read No. 140

The Odd Relationship Between Money and Happiness

You may have heard about the recent study out of Princeton University, in which
Daniel Kahneman, a winner of the Nobel in economic science, and co-author Angus
Deaton found that people reported an increase in happiness as their incomes rose
to $75,000 a year. Then, the impact of rising income on happiness levels off.

I found this study fascinating. Happiness seems like such a complex issue, filled
with individual and cultural differences, so putting a number on it strikes me as
odd.

Can it really be that simple? Is there a relationship between money and happiness?

I understand that not having money to cover basic needs causes stress. Real
stress. But we have seen plenty of crazy (but real) examples of how varied the
definition of basic needs can be. Maybe it is more about expectations, desire and
constant “wanting” than it is about actual income. We all know people who make
more than we do and are still not happy with their income level.
If you believe that happiness can be reduced to a functional equation up to
$75,000, then how do you explain all those stories of people around the world with
very little money and a whole lot of happiness?

I have a friend — recently returned from an extended trip to Nepal — who was
struck by how little people had and how happy they seemed. Of course she was only
there a few weeks and that might not be long enough to draw any conclusions, but
you get the point.

The moment we accept the idea that there is a magic income that maximizes
happiness, we have to deal with the reality that there are plenty of people who
seem to have very little money and lots of happiness.

Sure, I would be equally leery about a claim that there was a relationship between
having less and being happier. But it does make you wonder.

I’m not foolish enough to believe that money plays no role in happiness. In my work
as a financial planner, I have seen that money can certainly relieve stress, and
reduced stress can certainly lead to increased happiness. So there is some
correlation, but it seems pretty fuzzy to me. It is way more complex than a simple
formula based on income.

I wonder if linking happiness to money might be part of this continuing obsession

we seem to have with measuring, comparing and competing.

As far as I can tell there is no unit of “happy.” We have no standard, quantitative

way to measure it. But if we link happiness to money, that is something we all
understand. It gives me a way to compare my level of happiness to yours.

Maybe we just have to accept that happiness is more complex than that. Perhaps
the more we try to define, measure and compete for happiness, the harder it is to
find.

Read No. 141

Market Forecasts Are Just Guesses

With very few exceptions, market and economic forecasts are really nothing more
than guesses. But as we continue to reckon with an uncertain economic future, it is
more tempting than ever to seek out a guru. We want someone to tell us what is
coming so we can plan accordingly.

As you read these forecasts here are a few things to keep in mind:

1. No one knows what the future holds. History doesn’t really help except to tell us
that it’s hard to forecast accurately.

2. If people make enough guesses, they are bound to get at least one right.

3. If you nail a big guess as a market forecaster, you can milk it for a long time.
Think of all the people that have come out of the woodwork claiming to have
forecast the collapse of 2008. Sure a few of them actually did get it right, but the
dilemma for us is trying to figure out if they got it right based on skill or if they
were just lucky.

4. Forecasters who got one big guess right might not be right the next time. In
fact, the process they used to diagnose a problem in the past might increase the
chance they will be wrong in the future. After all, the next big problem probably
will not look like the one in the past that they managed to spot.
Just to be clear, I’m sure that there are thoughtful economists that provide useful
insight. I just don’t know of anyone that can reliably tell me who they are. So little
history, and so many guesses.

Next time you are tempted to make very important decisions based on the latest
guess by the media’s current favorite guru, remember the old saying that even a
broken clock is right twice a day.

Read No. 142

The Folly of Tracking Investor Sentiment

Investors feel like buying again!

According to the weekly survey of investor sentiment done by the American
Association of Individual Investors, investors haven’t been this bullish since April
15, 2010 (only days from the high for the year).

But wait, according to the exact same survey done just two weeks ago, investors
were more bearish than they had been in over a year.

I’m confused. What changed in two weeks? The only thing I know for sure is that
the market was up 5 percent between the time investors wanted to sell and the
time they wanted to buy.

This whole thing is crazy.

Why in the world is there a weekly survey of investor sentiment?

We know that real people have a tradition of buying high and selling low. We’ve
been doing it for a long time (read about the tulip bulb craze for a reminder). We
do it over and over, despite knowing better. And we do this because we make
investing decisions based on how we feel instead of what we know. This is natural,
maybe even genetic. We run away from things that cause us pain, and we want more
of the things that give us pleasure or safety.

But we need to stop it if we’re going to get a different result!

I’m not sure what the answer is. In fact I am pretty sure it’s never going to
change. No matter how many people throw facts and figures at us about holding on
for the long term, no matter how many rational arguments people make, we’re going
to run if we get the sense we’re about to get hurt.

So what can we do about it? Here are a two ideas:

1. Swear off the stock market forever. Look, the reality is that making money in
the stock market is hard. Most of us just don’t have the emotional makeup to do it.
That’s OK. If during the last 10 years you’ve found yourself making big behavior
mistakes over and over, then stop. You might be  better off just committing
yourself to a life of owning only certificates of deposit, given how poor your stock
returns could be if you trade too much.

2. Act like you have a blind trust. Find someone you trust, give them your money,
tell them to buy you an index fund and then have them update you again in five
years. This could be a financial planner like me, but you could also enlist a
trustworthy friend who won’t charge you anything for the privilege.

I know that there are people who have been successful, people who behaved
correctly. If you are one of them, congratulations and keep doing what you’ve been
doing.

But we have to recognize that the way most of us have been doing things hasn’t
worked, and it probably won’t work in the future.

Read No. 143

Bonds: Higher Returns Equal Greater Risk

For the first time in 10 years, according to a recent report by Market Rates
Insight, we’re seeing the average interest rate drop below 1 percent on checking,
savings and other deposit accounts. You’re intimately aware of this fact if you’re
trying to generate income or live off the interest from your savings or money
market account. The issue applies to the short-term bond market, too.

If this interest represents your fixed income, you’re facing a reality of living on
less and less each month. If you’re searching for short-term income investments,
you’re probably feeling a growing sense of frustration, wondering whether your
money may be better off under the mattress.

Without question, this situation is a serious problem. But you need to be aware of
potential issues before you start chasing higher returns.

During your search for other options, you need to understand that if someone
offers you a “safe” bond investment but promises higher yields or interest, you will
be increasing your risk. In general, if you want to earn a higher yield, you are
almost always going to take some sort of additional risk to do it.

There are really only two ways to get a higher yield, and both of them come with
increased risk:

1. Go down in credit quality. In other words, you buy investments from lower-
quality issuers. A bond is really just you lending money to someone else in exchange
for an agreed-upon interest rate. If I lend to the shady neighbor to start a
pawnshop, I will absolutely expect to get a higher interest rate than if I lend to
the United States  government. After all, there is clearly a greater chance that
Mr. Pawnshop will not pay me back.

2. Tie your money up long term. Right now, things look bleak, with interest rates
below 1 percent. So the investment that’s offering you 2 percent may look really
appealing. So appealing, in fact, that you ignore that it ties up your cash for five
years. This means that if rates perk back up a year or two from now, you’re locked
in at 2 percent even if there are other options at that point that would offer a
greater yield on a bond.

These decisions aren’t easy ones to make, and I understand how tempting it may be
to take the leap to greater risk. But you could end up with much more serious
issues if you fail to weigh the true costs of chasing after yield.

Read No. 144

Four Secrets of a (Money) Happy Home

Over the weekend, Ron Lieber walked through some of the reasons that you should
still consider homeownership. Because this has been on my mind a lot lately, I
wanted to highlight one very important issue Mr. Lieber brought up, the idea that
there is much more to homeownership than a line item on a net worth statement:

“It is possible, as a homeowner, to make very little money but still buy plenty of
happiness.”

With that in mind, consider the following:

1. Buying a home solely as an investment is a bad idea.

Treating your primary residence as a good, old-fashioned home (and forgetting

about the possibility of its being an investment) leads to greater happiness. I am
not saying that owning a home always makes you happier than renting, which is
another discussion entirely.

2. If you aren’t thinking long term when you buy a home, your odds of
disappointment are high.

I have often heard people from my parents’ generation say that their home was the
best investment they ever made. But that is simply because it was the only thing
they bought and held on to for 30 years. Often when you do the math, the home
barely keeps pace with inflation. However, because they avoided making many of
the classic behavioral mistakes (buying high and selling low) that we make when we
invest in the stock market, it was still the best investment they made during their
lifetimes.

3. Don’t treat your home like a piggy bank.

Before the the last 10 years, people thought of the family home as a sacred place
and not something they thought about flipping at the first sign of profit. People
didn’t treat what the last house in the neighborhood sold for as a quote for their
own home, and they didn’t get an appraisal every six months so they could get a new
line of credit. In fact, I think it is fair to say that most of the time people didn’t
know or care what the family home was worth. They lived there and didn’t plan on
leaving.

4. Owning a home isn’t for everyone.

Not everyone is suited to owning a home. For many of us, times are different. We
might be required to move more often for work, and that introduces some
complexity that didn’t exist for previous generations. In those cases, it might be
better to rent instead of playing the buy-and-hope game. If you find yourself in
the fortunate situation that you can buy a home someplace where you plan on
staying for a long time, treat it as a home and not as an investment. You will be
happier for it.

Read No. 145

Overestimating the Safety of Bonds

Most of us invest in bonds or bond mutual funds to keep our principal safe and to
earn a bit of income. People think bonds are safe because when you buy an
individual bond, like a U.S. government bond, you have a stated interest rate and a
known maturity. In other words, you know exactly what income you will earn and
exactly when you will get your principal back, much like a certificate of deposit at a
bank that is backed by the F.D.I.C.

(I know bonds are ultimately much more complex than that, but for the sake of
making a very narrow point, I am going to limit the discussion to U.S. government
bonds and assume zero default risk.)

In search of safety, investors have poured money into bond funds, and bond funds
are a different animal than an individual bond. Because the fund owns hundreds of
individual bonds, as a shareholder in the fund you don’t have a known interest rate
or a known maturity date. What you do have is an average interest rate and
average maturity for all the bonds in the fund.

It seems like a subtle difference, but it becomes very important when interest
rates change.

When interest rates go up, the value of a bond will go down. If you own an
individual bond you will see that difference in the value of the bond on your
monthly statement, but you will keep getting the promised interest and know that
all you have to do is hold the bond until it matures to get your principal back.

But if you own a bond fund and interest rates go up, it’s another story entirely.
Just like the individual bond, you still see a decline on your monthly statement. This
time, however, you don’t know exactly what interest rate you will receive and you
don’t know when you will get your principal back.

It is this potential to see your bond fund go down in value, sometimes dramatically,
that I think people have forgotten. The key to understanding the impact a change
in interest will have on your bond fund is in finding out the duration of the bonds
the fund tends to buy. In simple terms, duration turns out to be a measure of the
fund’s (or an individual bond’s) sensitivity to a change in interest rates. For every 1
percentage point change in interest rates, the value of the fund will change by the
amount of the duration. So if your fund holds bonds with an average duration of
eight years, and interest rates go up by 1 percentage point, the value of your fund
will drop by 8 percent.

Watching your monthly statement decline by 5, 10 or 15 percent is not what most

people have in mind when investing in bond funds for safety. But it is a real
possibility.

With money market funds paying almost nothing, C.D. rates in the toilet and
everyone scared of the stock market, people are looking for higher yields (and
safety too). The issue is that one of the ways to get more yield is to hold longer-
term bonds. A longer-term bond means longer average duration. And longer
duration means huge risk if interest rates go up.

While this is not a prediction that interest rates are going up (although it is hard
to imagine them going much lower), it is a warning that you need at least to
understand the risk you might be taking when you are trying to be safe. Take a look
at the duration of the funds you own and recognize that the yield you are getting
won’t mean much if you find yourself with 10 or 15 percent less money.

Read No. 146

Mutual Funds: Getting What You Don’t Pay For

Tara Siegel Bernard’s post, about a recent Morningstar study that highlighted the
enormous role that expenses play in mutual fund performance, reminded me of a
story.

Early in my career, I spent most of my time trying to find a repeatable way to

identify mutual funds that would do well in the future. It’s easy to identify funds
that did well in the past, but past performance is of little value when it comes to
mutual funds. So we brokers (along with the rest of the industry) looked for
anything we could find that might give us a clue as to whether a certain mutual
fund would do well.

We looked at how the fund was managed. A team or a solo star manager?

We looked at the manager’s age, education and experience.

We looked at the research team the fund had in place.

We looked at everything. And in the end, the only thing that I’ve ever found that
has any predictive value at all was the underlying expenses of the fund. The lower
they are, the better you’re likely to do.

It seems a bit ironic that after all that time and money spent searching for the
secret, it turns out that it’s just basic arithmetic: the fund with the lowest
expenses wins. Over the years, study after study finds the same thing. When it
comes to mutual funds, you often get what you don’t pay for.

Read No. 147

Mutual Funds: Getting What You Don’t Pay For

Tara Siegel Bernard’s post, about a recent Morningstar study that highlighted the
enormous role that expenses play in mutual fund performance, reminded me of a
story.
Early in my career, I spent most of my time trying to find a repeatable way to
identify mutual funds that would do well in the future. It’s easy to identify funds
that did well in the past, but past performance is of little value when it comes to
mutual funds. So we brokers (along with the rest of the industry) looked for
anything we could find that might give us a clue as to whether a certain mutual
fund would do well.

We looked at how the fund was managed. A team or a solo star manager?

We looked at the manager’s age, education and experience.

We looked at the research team the fund had in place.

We looked at everything. And in the end, the only thing that I’ve ever found that
has any predictive value at all was the underlying expenses of the fund. The lower
they are, the better you’re likely to do.

It seems a bit ironic that after all that time and money spent searching for the
secret, it turns out that it’s just basic arithmetic: the fund with the lowest
expenses wins. Over the years, study after study finds the same thing. When it
comes to mutual funds, you often get what you don’t pay for.

Read No. 148

Investors Are Still Behaving Badly

Every year the research firm Dalbar does a study that tries to quantify the impact
of investor behavior on real-life returns by comparing investors’ earnings to the
average investment (using the S&P 500 as a proxy).

The latest study looks at the 20-year period that ended Dec. 31, 2009:

 Average investment return = 8.20 percent

 Average equity investor return = 3.17 percent

If you had put money into an S&P 500 index fund 20 years ago and just left it
there — no buying, no selling, just investing and forgetting about it — you would
have earned (minus fees) about 8 percent.

But real people don’t invest that way. We trade. We watch CNBC and listen to Jim
Cramer yell. Despite knowing better, we give into the genetic tendency to get more
of those things that give us pleasure — buy high — and get rid of things that cause
us pain — sell low. We’re just wired that way.
What is really interesting is how little this seems to change over the years. When
it comes to investing, the tendency to behave badly is not going away.

So what do we do about it?

1. Admit it. Like any destructive behavior that first step to fixing it is to admit
that there is a problem in the first place. Being honest with yourself and reviewing
past decisions will help:

 Did you get caught up in the tech bubble in 1999?

 Real estate in 2006?

 Did you sell in 2002, late 2007, or early 2008?

2. Develop a checklist. Then go through that checklist before you make major
investment decisions. It works for pilots and doctors. It will help you avoid
mistakes in investment behavior, too.

Try writing down the proposed change and then let it sit for 24 hours, or call a
trusted friend or adviser and walk them through your thinking before you make the
change. Often just hearing yourself explain why you want to make the change will
convince you to forget the whole thing.

3. Don’t play. Sometimes the answer might be to take our money and go home.
There is nothing that says you have to invest in the stock market to be considered
an intelligent human being. It is fine to recognize that it might work better to
follow Will Rogers’s advice and focus on the return of your money instead of the
return on your money.

The reality is investing successfully is hard. But hopefully by focusing on our

behavior, we can close this gap in the next 20 years.

Read No. 149

Outliers Matter: Why Average Is Not Normal

Most of the traditional wisdom that we follow when we are making investment
decisions is rooted in models referred to as modern portfolio theory. One of the
theory’s basic assumptions is that stock market returns are normally distributed.
In other words, when graphed, the returns will form a traditional, bell-shaped
curve.

The idea is that you can expect an average return to be your average experience.
Returns either greater or less than the average are less and less likely as you move
further and further from the average. At extreme tips of this nice little bell are
positive or negative returns that are so unlikely to happen that they are thought to
be almost statistically impossible.

We have heard a lot about these little guys lately. They have been called Black
Swans, fat tails and, most often, outliers. In theory, an outlier is something that is
so unlikely that it is thought to be unrepresentative of the rest of the sample. In
this case, these outliers generate returns that, according to the theory, we are
almost never supposed to see.

When something is never supposed to happen, we don’t spend much time thinking
about it. Instead we focus on the average. This is certainly true when it comes to
investing: we focus on the stock market average over time. It is the average that
we plug into our calculators when we project into the future. It is the average that
we talk about. The problem is that average is not normal and focusing on it leads us
to greatly underestimate the impact that these outliers can have when they do
show up.

The reality is that they have such a huge impact that they actual obscure the
importance of the average. Last year, The Wall Street Journal discussed a study
that shows the significant impact that outliers have had in history.

If you take the daily returns of the Dow from 1900 to 2008 and you subtract the
10 best days, you end up with about 60 percent less money than if you had stayed
invested the entire time. I know that story has been told by the buy-and-hold
crowd for years, but what you don’t hear very often is what happens if you were to
miss the worst 10 days. Keep in mind that we are talking about 10 days out of
29,694. If you remove the worst 10 days from history, you would have ended up
with three times more money.

To be clear, this is not a suggestion to try to time the market, but an attempt to
make a simple and narrow point: outliers matter. In fact, they matter so much that
they almost make the average meaningless. Because most of our lifetime return is
determined by how many of these outliers we experience, it is time we stop
ignoring them.

Read No. 150

The Mental Anchor of Money Mistakes

One of the more common behavioral mistakes we make when it comes to investment
decisions is the tendency to anchor to a certain value or price. When we focus on,
or anchor to, a price, it can lead to costly blunders. Here are a few examples:

1. You pay $800,000 for your home, and a few years later you need to sell it. We
have a tendency to feel like we should at least be able to get what we paid for it.
So you insist upon listing it for $800,000, even though the market value is less
than that. You pass on offers around $775,000 and then ride the market all the
way down to the point where you are just hoping to get $650,000 a year later. Now
that first offer looks like a dream.

The reality is the market doesn’t care what you paid for you house. It doesn’t care
how much you put in to it or what it cost you to landscape. All that matters is what
it is worth today.
2. You buy a stock for $50 a share, and six months later it is $30. You decide that
you really shouldn’t own it anymore but you want to wait until you “get back to even”
before you sell. This idea of holding on to an investment that is no longer
appropriate, or may have been a mistake in the first place, until you get back to
even makes no sense. The fact that you paid $50 has no bearing whatsoever on
what you should do now.

In fact, I think it is fair to say that getting back to even is never a good reason to
hold on to an investment. If you find yourself saying that, it’s time to re-evaluate.

3. Your portfolio was worth $500,000 at the top of the tech bubble in early 2000,
and you still think about that value each time you open your statement and see that
it’s worth less than that. You just want to get back to your high-water mark of
$500,000.

This may not have any impact on your decisions, but it sure is affecting your life. I
know people like this, still holding on to a value in the past. It is like that guy next
door who is still telling stories of his glory days in high school football.

The past is the past. All that matters now is making the correct decision for today.

Read No. 151

Learning to Live With Conflicts of Interest

Goldman Sachs can’t seem to stay out of the news, and I keep thinking about the
amazing first quarter they had. In case you missed it Goldman made money on its
own trades every single day in the first quarter. Meanwhile in the real world,
people who followed Goldman’s recommended top trades for 2010 lost money on
seven of the nine recommended trades.

There is a lot that goes into understanding the difference between Goldman’s own
trading and the advice that it gives to its clients, but it is hard not to feel like
something is wrong with this picture.

It helps to understand that conflicts of interest are inherent in the traditional

financial services industry. And Goldman is certainly not alone. A few things to
keep in mind:

1. Goldman (and the rest of Wall Street) is in the business of selling stuff. That is
its purpose on earth. It has a duty to shareholders to maximize profit, not
necessarily share it with its customers.
2. Goldman is required to disclose information its customers need to make
educated decisions. This seems to be at the heart of the Securities and Exchange
Commission’s accusation of fraud against the company.

3. Goldman’s job is to sell, but it’s our job to read and interpret. It sells and
discloses (at least we hope it discloses). We read and decide to buy or not to buy.
Goldman is not giving impartial, independent advice. It is trying to sell something.

4. Goldman’s interests are often in direct conflict with ours. And that’s fine, as
long as we recognize it. There is nothing illegal about trying to sell someone
something. This happens all the time in other industries. You would never walk into
a Toyota dealership and expect them to tell you that what your family really needs
is a Honda.

This gets messy when you have been led to believe that the relationship is
something other than “Let the buyer beware.” So much of the advertising from the
traditional financial services industry makes you think you are getting independent
advice. For the most part, you are not. There are exceptions, but to pretend that
the people on the other side of the desk have a duty to put your interests in front
of those of the firm that they work for is wishful thinking.

There is an old saying that the person with the valuable real estate collects the
rents. In this case, Goldman is apparently the owner of some very valuable real
estate, and the sooner we realize that the company is not about to share the rent
with the rest of us the better off we will be. So next time you walk into a
traditional financial services firm looking for impartial advice, remember that the
best you can really hope for is complete disclosure so that you (or someone you
trust) can decide if what the company is selling you is right for your situation.

Read No. 152

Ignore Generic Financial Advice (Except This Post)

It is dangerous to mix investing with entertainment. The classic example is thinking
that Jim Cramer is your investment adviser rather than some sort of circus clown.

But what can be even more dangerous is taking what’s meant to be general financial
information and acting on it, without first taking the time to figure out if it applies
to your particular situation.

Making important decisions about how to invest your life savings seems to be
getting more and more complex as the amount of information continues to grow.

Take this article, “A Market Forecast That Says ‘Take Cover,’” that appeared in
the The New York Times this weekend. It offers up advice from a market watcher
who suggests that individual investors “move completely out of the market and hold
cash and cash equivalents, like Treasury bills, for years to come.”
The article has been among the most e-mailed articles for several days, so it’s
clearly getting a lot of attention. But the question is what you’re supposed to do
with information (general advice) like this. Should you follow this advice to “take
cover,” regardless of your age, unique goals and family situation?

What about the wisdom handed down by the more popular personal finance gurus
like Suze Orman? Does the generic advice she gives apply to you? I can’t tell you
how many times I have seen people make mistakes because Ms. Orman said to do
something that did not apply to their situation. She may be a genius. She may even
provide some good, general advice. But she is not your financial planner.

The financial press, personal finance bloggers and best-selling authors are all
sources of information. But don’t confuse information with the real work of
figuring out how it applies to your very unique situation. I know many of the best
personal finance bloggers. As good as many of them are at providing a filter for
information, and even providing general rules of thumb, you are the only one who
can figure out how it applies to your life.

The reason is simple: planning for your financial future is personal. It has to be. A
good plan will be unique to your situation, and what is right for your situation may
be a disaster for your neighbor. So read as much as you want, but then make sure
you spend the time to figure out how it applies to you before you make important
decisions about your life savings.

Read No. 153

The Great Debt Reset

In early 2009, I was already sick of hearing the media, our elected officials and
most economists call what we were experiencing a recession. Recession calls to
mind a temporary slowdown and hints that we will get back to where we were
before it all started.

How many times have we heard about the need for policies to “revive the economy”
and “get the consumer spending again?”

I must be missing something, but it just doesn’t make sense to me to try to get
back to the 2005-7 version of “normal.”

We all had that sick feeling in our guts that the path we were on back then was
unsustainable. How long could we continue spending at a level that required our
houses to increase in value so we could use the equity as an A.T.M. machine? If
that is “normal,” does it make sense to get back there?

Getting back to that version of normal would require us to spend at unsustainable

levels, and all the Real People I know aren’t spending like that because we either
learned a lesson or no one will lend to us. Businesses aren’t spending because most
business owners are Real People. So, who is left? The government.
So then we get really smart people like David Levy of The Jerome Levy Forecasting
Center saying in a recent interview that not only is deficit spending a good idea but
that we should continue until we “revive the economy.”

I know that the alternative is some really tough medicine, but it seems to me that
we’ll have to take that medicine either take now or later, and taking it later will be
much worse.

What we need is a great reset. We need to stop spending more than we earn, pay
down our debt and then rebuild from there.

Nassim Taleb (of Black Swan fame) never has a problem with telling it like it is, and
he compares the idea that we should fix a debt problem by throwing more debt at
it to giving a heroin addict more heroin because he doesn’t want to deal with the
withdrawals.

Whenever I get worked up about this, I have to take a step back and remind
myself what I can do about it. The key for me is to focus on my personal economy.
Continue my own personal austerity plan (in the real world we call that spending
less than you make), pay down my debt, save as much as I can and never forget the
lessons of the great reset.

Read No. 154

One Big Thing We Don’t Know About Stocks

The only reason we invest in stocks is to earn more than we would get from cash or
bonds. The amount you are supposed to earn by taking the additional risk of owning
stocks is called the risk premium. If you don’t get paid more for taking the risk,
you should put your money in bonds.

Over the last 207 years you got paid 2.5 percentage points more each year (on
average) to invest in stocks than you did in bonds.

But you know what they say about statistics, right? In the real world, we have to
deal with the fact that, like all averages, this one has some serious problems.
Sometimes the risk premium is higher than 2.5 percent, and sometimes it goes
away or is hugely negative (say, in a bear market).

Until recently, most of us thought of bear markets as those three- to five-year

periods where you grit you teeth and hang on. But recent experience is more
painful than that.

In an article by Robert Arnott in The Journal of Indexes, he highlights multiple

20-, 30- and even 40-year periods where we would have been better off in bonds.
In other words, the risk premium did not exist.
This starts to get ugly when we admit that we have no idea when these types of
prolonged bear (or sideways) markets are coming. Where are we right now in the
cycle? I have no idea, and I wouldn’t bet my life savings on anyone who claims to.

So earning this mythical risk premium of 2.5 percent is largely a function of timing,
and it’s not the kind of timing we can control. This is the purely random luck kind of
timing: when you were born, when you sell your business, when you retire or receive
a large lump sum to invest. And if the risk premium is a function of timing, and
timing is a function of luck, it doesn’t take much to realize that earning the
mythical risk premium is a function of pure luck, too.

This is why so many of us who have been investing for 15 years feel as if we are
about back where we started, even if we did everything right (assets allocated,
properly diversified, didn’t bail out at the bottom and so on).

Let me be clear, I am not saying that the risk premium is dead, or that we should
run out and sell everything. But I am suggesting that with the Dow bouncing around
10,000, it might be time to consider what you define as long term. Ask yourself if
you can you live through a prolonged period where you earn no risk premium at all,
and make adjustments accordingly.

Read No. 155

All Investment Mistakes Are Investor Mistakes

I am more convinced than ever that all invest ment mistakes are really investor
mistakes.

For the most part (fraud being a notable exception), investments don’t make
mistakes, investors do.

There’s a reason why what we’re doing is referred to as investing. When you invest,
you’re making a choice. A commitment. That’s the part we often forget. At some
point, we said yes to the investment. Everything leading up to that point was
something we had control over, including whether we asked about more than just
the investment’s past performance.

We’re quick to focus on the reward but fail to appreciate the consequences of our
choice. If an investment performs well, we like to think, “I picked a winner.” If it’s
the reverse, and the investment fails, it’s someone else’s fault.

This reminds me of the time that I was mowing the lawn as a child and I hit a
sprinkler head with the mower. I remember running inside to tell my mom that the
lawnmower had hit the sprinkler head. She patiently taught me that lawnmowers
don’t hit sprinklers, 10-year-old children do.
We do the same thing when it comes to investing. If we haven’t done our research
(figured out where the sprinklers are) and we behave poorly (run over the
sprinklers), we’re not going to like the results.

And we can’t blame the investment for our decisions. At some point, we must
accept responsibility. Otherwise we’ll keep making the same mistake since we’re
blaming the investment rather than accepting responsibility for our choices. And if
that’s the case, we’d be better off in a certificate of deposit.

Read No. 156

The Temptation (and Danger) of Past Investment Performance

Whenever a mutual fund advertises performance, the Securities and Exchange
Commission requires that it includes the disclaimer that “past performance does
not guarantee future results.”

A new study by researchers at Arizona State University and Wake Forest Law
School suggests that this warning is not enough. They recommend something a bit
stronger: “Do not expect the fund’s quoted past performance to continue in the
future. Studies show that mutual funds that have outperformed their peers in the
past generally do not outperform them in the future. Strong past performance is
often a matter of chance.”

Despite the warning from the S.E.C. and pretty conclusive evidence that past
performance has very little predictive value, most of us still use performance as
the predominant factor in choosing our investments.

This is one of those times in investing where our experience in almost every other
area of life works against. If you’re going to hire contractors to remodel your
house, one of the first things you do is look at other houses they have done. It
seems reasonable to expect that the work they do on your house will be at least as
good, if not better.

When it comes to mutual funds, however, the past has almost no predictive value.
People have spent years looking for a way to identify mutual funds that will do well
going forward. They have looked at almost every factor you can think of: education,
experience, hair color and, of course, past performance.

The only factor anyone has found with any predictive value was the internal costs
of the fund. The higher the costs, the worse the performance. This is a case where
you often get what you do not pay for.

Despite all the evidence to the contrary, we still scour the annual lists of “Ten Hot
Funds to Own Now,” which are often based on past performance, looking for a place
to put our life savings. We still look in the rear-view mirror. Think about the last
time you made an investment decision. Did you look to the past for some prediction
of the future? After all, how much sense would it make to invest in a fund that had
performed poorly?

But finding the next Peter Lynch is an almost impossible task. Focus instead on
finding a low-cost investment that you can stick with over the long haul.
Read No. 157

Risk, Emotion and the Extra Mortgage Payment

The question of when to pay extra toward your mortgage is a very complicated one,
and the issue has come up everywhere from MSN Money to the Five Cent Nickel
blog to Ron Lieber’s “Your Money” column.

The idea that you can think of your mortgage as an investment that pays you a
risk-free return equal to your interest rate (adjusted for taxes) is fairly common.
Where this becomes more complicated is when people start comparing that risk-
free return to what you might make if you invest in a stock-based mutual fund
instead.

Comparing the return you earn by paying down your mortgage to a chance at a
higher return using  mutual funds that have a significant risk (see 2008) is not an
apples-to-apples comparison. This is a choice between a lower (but guaranteed)
return and a chance at earning a higher return using investments with exposure to
the stock market.

They are not the same thing!

When people encourage investing money in lieu of making extra mortgage payments,
you often hear phrases like: “Historically you would have done better in the mutual
fund,” or “You have a reasonable shot at,” or “It seems like a logical assumption.”

What is often glazed over or ignored altogether, however, is that this chance at
higher returns comes with the chance to lose a lot of money. Even some of the
more conservative balanced funds declined more than 20 percent in 2008.

If you are going to compare paying down your mortgage with investing in the stock
market or even in balanced mutual funds, you better make sure you are
comfortable with the additional risk you are taking.

On top of the normal challenge of behaving correctly during scary markets, I have
found that people get very emotional about investing with money that they had
earmarked to pay off the house someday. Investing and emotion do not mix well.

So among all the other factors that go into this decision, make sure you do not
ignore risk and emotion. If you do, chances are you will regret it.

Read No. 158

The Future May Not Resemble the Last 6 Months

Boom-and-bust cycles are largely a function of our collective expectations.

Expectations are very tricky because they are almost always wrong. But our
expectations drive our behavior anyway.

Our view of the future is the fundamental basis for how we act today. Since our
expectations about the future are regularly based on our recent experience, we
act as if the next week, month and year will be just like the last one.

We are programmed that way. In fact it is a genetic trait of humans to base our
view of the future (our expectations) on the past; we have very little else to base
it on. But we have very short-term memories, so our natural inclination is to define
the past as the very recent past.

Unless we train ourselves differently, we think that what just happened will
continue into the foreseeable future, and we will act based on that expectation.

When every house you buy is worth 10 percent more six months later, you start to
expect that to continue. If you expect home values to rise 10 percent every six
months, then you buy a bigger house or use your home equity to buy a boat.

Then one day something changes.

When behavior reaches extremes it does not take much to surprise us. One day
your neighbors’ house doesn’t sell. They lower the price, and it still doesn’t sell.
Things have changed.

After awhile, we adjust our expectations and begin to think these declining values
will continue into the foreseeable future. And we start to behave differently
based on those expectations.

Of course, that behavior will eventually reach extremes as well. These boom-and-
bust cycles seem to overshoot what seems rational in hindsight. Looking back, it is
almost always painfully obvious that we allowed our expectations to get out of
whack.

The solution is simple but not easy to execute. We need to train ourselves to
lengthen our definition of the past.

That is why history is so important. It has been said that the three most important
words in the English language are remember, remember, remember.

So we need to remember those times in our lives when things changed. Think of the
times when you expected things to happen a certain way based on your recent
experience. You then changed your behavior to reflect those expectations. Then,
just at the point where that behavior reached an extreme, something changed and
you found yourself wishing you had behaved differently.

I would imagine we will not have to look too far into the past to see examples. The
concern I have is that most of us have already forgotten the very things that
would help.

Read No. 159

Magazine Covers Are Lousy Investment Signals

I love magazine covers about the markets and the economy.

Newsweek’s most recent foray into the dangerous territory of predictive covers
comes in the April 19 issue, which boldly declares that America Is Back. In the
cover article, Daniel Gross points to a number of positive (but short-term)
indications that the economy is recovering: job creation, productivity and the Dow’s
70 percent rise.

Not long after the article was published, Henry Blodget and Mr. Gross had a great
conversation on Yahoo’s Tech Ticker about the predictive value of magazine covers.

And here’s my word of caution: Be very careful about making investment decisions
based on what you see at the newsstand. Magazine covers are not vehicles for
investment advice. I’m sure ones like the Newsweek cover are not even intended to
be investment advice. Maybe cover stories like these have good information, and it
certainly can make for good entertainment, but I’m not sure what it all means for
real people trying to make decisions about how to invest real money.

Let’s think about this for a second. If you sold when things were bad (Remember?
Back when almost all the magazine covers were declaring the end of the world?),
does the fact that Newsweek says “America Is Back” mean that it’s time for you to
move your money back into the market?
If you’re considering getting back in because things look better, be careful. The
fact that you sold when things were bad (many others did too) is valuable
information that can help you avoid an interminably nasty cycle of buying high and
selling low. No matter how good things look right now, the time will come when the
market corrects again. What are you going to do then? Maybe what you learned
about yourself when you sold the last time is that you should build your investment
plan with less risk … permanently.

On the other hand, if you didn’t sell because you make your investment decisions
based on your financial goals, does the fact that a magazine cover is now declaring
that the coast is clear mean you should change your investment plan?

This is not meant to be a debate about whether now is a bad or good time to invest.
The point is that it’s time we stop the cycle of selling low and buying high. It’s time
we stop doing the same thing over and over, expecting a different result. It’s time
that we get to a place where we just focus on our goals. Who cares what Newsweek
says? Focus on your goals. Build a plan that has the best shot to get you there, and
then turn all your attention to living now.

You will be happier for it.

Read No. 160

Why Life Insurance Is Not an Investment

Life insurance is one of those things that most of us need but none of us enjoy
talking about. When it does come up in conversations, it’s mostly because someone
is complaining about being sold something that is both expensive and complex.

I think the problem is confusion about the purpose of life insurance. So let’s clear
that up right now. For most of us life insurance has one purpose — to replace an
economic loss.

That’s it.

It’s not for education savings. It’s not for retirement savings, or to provide a tax-
free loan later in life. No matter how much you buy (or are sold) it will never
replace an emotional loss.

Once we are clear about the purpose, buying the right kind of life insurance
becomes much easier. Most of us don’t need a variable life insurance policy that
also acts like an investment. We have investments for that.

No, what most of us need is a simple term insurance policy, one that will protect us
against what could otherwise be a financial disaster.

So, to buy term life insurance you “simply” need to calculate what the economic loss
would be if you lost a loved one and then buy the best insurance you can to replace
that loss. If there is no economic loss, or you can afford to absorb that loss
yourself, there is no need for life insurance.

You can start by asking or finding the answers to two questions:

1. What amount of insurance would I need to replace the economic loss?

2. How long do I need that protection?

Keep in mind that the amount of insurance you need may change over time. For
most people, it seems to decline over time, as obligations to family change and the
value of your investments hopefully grow. At some point, it is a reasonable goal to
be at the point where you are secure enough financially that you no longer need life
insurance.

So why the wink with the word “simply” up above? Because these aren’t always easy
questions to answer. But they are the best place to start.

Now, just so we’re clear, there are valid reasons to use permanent insurance. In
some estate planning, asset protection, or charitable planning situations it is the
only tool for the job. But these situations are certainly the exception and not the
rule. For the vast majority of us a simple term policy will do.

Read No. 161

Why There Are No ‘Best’ Investments

You make good financial decisions only within the context of your goals.

This may seem obvious, but think about the amount of time and energy spent trying
to find the “best investment.” Magazine covers are devoted to it, and books are
written about it. There seems to be an entire industry built around this wild goose
chase.

But the reality is that there is no such thing as the best investment.

The idea that there is some mythical investment that we can label the best,
without first considering how it fits into the context of your life, is crazy. It’s like
getting in a debate with a friend about which car you should drive on a trip before
you’ve even decided where you’re going. How can you decide on the vehicle before
you determine the destination?

This is true for all financial products. Life insurance, mutual funds and even bank
accounts can be judged only based on how well they help you reach your goals.
Since your goals are unique, what might be right for you could be a disaster for
someone else.

Instead of spending so much time searching for the best financial product, we’re
much better off taking the time to reflect on what is really important to us and
then aligning our use of capital with those values. What good would it do to find the
mythical best investment and end up with a bankrupt personal life? David Brooks
recently highlighted a similar issue: most of us are focusing on the wrong things if
our goal is happiness.

So rather than reading the latest list of the “10 Best Investments for a Post
Credit Crisis World,” try asking yourself some questions to discover what is really
important to you. Here are two sites to spark some thought:

1) A discussion of George Kinder’s three questions about life planning on the Get
Rich Slowly blog.

2) Krista Tippett’s discussion about the economic crisis and the questions it forces
us to ask ourselves.

I have to warn you that this can be a painful process, because it forces you to
think about things outside the confines of a spreadsheet. Be patient with the
process and realize that in the end it’s not about the money. It’s about your life.

Read No. 162

The False Safety of Bonds

One of the things that I’m most worried about right now is people taking money
that they want to keep safe and trying to find investments that earn a yield that’s
a little higher. This is called “stretching for yield,” and it can be be a dangerous
game, especially if you don’t understand the rules.

The problem starts innocently enough. People realize that their safe money is
earning about zero sitting in a money market fund. So they begin looking for a
better place to put it, leading them to a bond fund. The common perception of bond
funds is that they are safe. But as yields in bond funds have come down, people
have searched for funds with higher yields.

This is where things get dangerous. Remember this is “safe” money, and the last
thing you want is to lose any of that money. Watching the value of your stock funds
go down is painful, but watching the value of investments that you thought were
safe fall is a real bummer. In some ways, it’s worse, because you didn’t think it
could happen.

So please remember this one point: Bond funds can (and do) lose money!
In fact, when you are comparing bond funds, it’s often helpful to replace the word
“yield” with the word “risk.” So when you read “High-Yield Bond Fund,” you should
start by thinking “High-Risk Bond Fund.” This does not mean that high-yield bond
funds are bad, but it does mean that you should be very careful about trying to
find a bond with a high yield to buy with your safe money.

The moment you try to get a higher yield, you’re taking on more risk, and
sometimes the level of risk can be surprising. You don’t have to go back far to see
examples of this. In 2008, there were plenty of bond funds that were down more
than 20 percent, and others that were almost flat. Just because it says “bond”
does not mean it will be “safe.”

Let me be clear: I’m not saying that high-yield bond funds are bad. I’m not saying
that investing in bond funds is bad. I’m trying to make it clear that as soon as you
start looking for a higher yield, be aware that you’re probably taking on more risk.
So don’t be surprised when you lose money in what you thought was a safe
investment.

Read No. 163

How Greed and Fear Kill Returns

Most of us make the same mistake with our money over and over again: We buy
high out of greed and sell low out of fear, despite knowing on an intellectual level
that it is a very bad idea.

The easiest way to see this behavior in action is to watch money flow in and out of
mutual funds. Let’s go back to early 2000. The dot-com market had reached a
fevered pitch. People were using their home equity to buy tech stocks right after
the NASDAQ had a single year return of better than 80 percent!

Then, in January 2000, investors put close to $44 billion dollars into stock mutual
funds, according to the Investment Company Institute, shattering the previous
one-month record of $28.5 billion. We all know the story from there. Money
continued to pour into stock funds, breaking records for February and March and
pushing the NASDAQ to 5,000, only to lose half its value by October 2002.

This gets worse. That same October (at the low for the cycle), as investors were
selling stocks as fast as they could, where was all the money going? Into bond
funds, at a time when bond prices were near record highs.

Think about this pattern for a minute. At the top of the market we can’t buy fast
enough. About three years later at the bottom, we can’t sell fast enough. And we
repeat that over and over until we’re broke. No wonder most people are unsatisfied
with their investing experience.

Now we might be doing it again. Over the last year, investors have put an estimated
$506 billion into mutual funds, but $409 billion of that went into bond funds. Let
me repeat that: Of the total of over $506 billion, $409 billion went into bond
funds.

No one is sure how this will turn out. But with interest rates again near record lows
(meaning bond prices are near record highs), you could end up losing money in that
bond fund you bought for the purpose of making sure you don’t lose money.

To be clear, the solution here is not to sell your bond funds. It is not to buy stock
funds. The point is to recognize that, in aggregate, investors tend to be very bad
at timing the market.

It makes far more sense to ignore what the crowd is doing and base your
investment decisions on what you need to reach your goals, then stick with the plan
despite the fear or greed you may feel. To do otherwise would be following a
pattern that has proven to be extraordinarily painful.

Read No. 164

Why Financial Plans Are Worthless

I read somewhere that average Americans will spend more time planning their
vacation to Disneyland than they will planning their financial future.

I’m not sure that’s correct, but it wouldn’t surprise me. There are a number of
reasons why we are hesitant to spend time planning for our financial future, but
the biggest one is that we have confused the process of planning with the end
product, a plan.

Financial plans are worthless, but the process of planning is vital. Let me explain
the difference.

Creating a traditional financial plan starts by making a bunch of assumptions. These

assumptions can be about inflation, what the stock market will do, how much you
will save, when you will retire, how much you will spend in retirement and even when
you’ll die.

If you have been through this process, you know that it’s very uncomfortable. We
know that no matter how hard we try, we will definitely be wrong.

This is one of the cruel ironies of any plan: You don’t have the information you need
when you start. This is true when you start a restaurant, a business or are planning
the rest of your financial life.

If we accept the fact that even the best plan will be wrong, we can focus our
energy on the process of planning instead of obsessing over the assumptions.

Sure we need to chart a course where we think we are headed, and this will involve
making some assumptions about the future. But they are just guesses; make them
and move on.

Think of this as the difference between a flight plan and the actual flight. Flight
plans are really just the pilot’s best guess about things like the weather. No matter
how much time the pilot spend planning, things don’t always go according to the
plan.

In fact, I bet they rarely go just the way the pilot planned. There are just too
many variables. So while the plan is important, the key to arriving safely is the
pilot’s ability to make the small and consistent course corrections. It is about the
course corrections, not the plan.

Once you have a general idea of your own destination, the focus should shift to
what you can do over the short term to get there. Focus on the next three years.
Thinking in shorter time frames inspires us to act instead of worrying about all of
the things that are out of our control.

So set a course quickly. Realize that you will be wrong, and plan on making course
corrections often.

Read No. 165

How to Handle Your Investing Overconfidence

Overconfidence is a very serious problem, but you probably don’t think it affects
you. That’s the tricky thing with overconfidence: the people who are most
overconfident are the ones least likely to recognize it. We tend to think of it as
someone else’s problem.

When it comes to investing, however, we all have a problem.

As we become more and more confident we become willing to take on more and
more risk. Why? We start seeing risky behavior as, well, less risky. But the reality
is that as the level of overconfidence increases, the cost of our mistakes increase
as well.

The classic example is Long Term Capital Management. A hedge fund run by
extremely smart people (Nobel Prize winners in fact) ended up losing $3 billion in
1998 and was bailed out by a group led by the New York Fed. The geniuses at Long
Term were positive that the most they could ever lose in a single day was $35
million, and then on Aug. 21 they lost $553 million.
Consider more recent events. Alan Greenspan, chairman of the Federal Reserve for
19 years, could do no wrong, and his overconfidence was supported by four
presidents. Mr. Greenspan’s faith in his models contributed (some say it caused)
the worst market crash since the Great Depression. In October 2008, Mr.
Greenspan admitted to Congress that he was “shocked” when the model he had
used confidently for over 40 years turned out to be “flawed.”

This is a big issue. It affects Nobel Prize winners, Fed chairmen and individual
investors as we make allocation decisions in our 401(k) plans.

But we can do something about it. We need to recognize that we’re not as smart as
we think we are. In fact, the smartest investors (and frankly the smartest
financial advisers) are the ones that acknowledge that they’re dumb.

So the next time you’re about to make an investment decision because you’re sure
you’re right, take the time to have what I call the Overconfidence Conversation.
Find a friend, spouse, partner or anyone you trust and walk them through your
answers to the following questions:

1) If I make this change and I am right, what impact will it have on my life?

2) What impact will it have if I’m wrong?

Considering the consequences of being wrong might lead you to make more careful
decisions and to a greater appreciation of the enormous potential costs.

Read No. 166

Your Experience in Stocks Is Probably Meaningless

So often we base our sense of risk on our own experience. The mistake, of course,
is failing to realize that our experience is often so limited as to be of almost no
value.

If you visit Seattle two summers in a row, and it’s sunny during both your stays,
you may start to think that all the talk about constant rain is just a ploy by the
locals to keep you from moving there. So the next time you go, you decide not take
your umbrella because it never rains in Seattle. And you get wet.

In statistics, this is called having a small sample size, and the information you get
from such a small sample is often worthless. Even worse, that information can be
dangerous.

I have climbed the Grand Teton in Wyoming a few times, but I learned the most
from the first two trips. The first was a warm, sunny day. In fact, I remember
taking a nap on the summit in shorts. Based on my experience, all the talk of
dangerous afternoon thunderstorms was just overcautious worrying.

So I wasn’t too worried when it came time to climb it again the following summer.
This casual attitude led to getting a late start and arriving late to the summit
ridge. Once there, we found ourselves caught in the middle of a thunderstorm. It
was the scariest experience I have ever had in the mountains.
Some of my most important decisions, like what gear to take and when to leave,
were based on my one and only experience. As a result, I was actually lucky to get
off the mountain alive.

Forming our sense of the future based on our own limited experience is just part
of being human. But when it comes to investing, this wiring leads to some major
mistakes, starting with these:

1. Selling after a major decline, because “at this rate I will lose all my money.”
2. Buying after the market is up 50 percent, because “stocks always do better than
bonds.”

So next time you’re thinking about making a major change to your investment
strategy, try expanding your sample size and looking beyond your own limited
experience. Remember, just because it was sunny on top of the mountain last time
doesn’t mean it will be this time.

Read No. 167

Why Balance Is More Important Than Returns

The act of planning for your financial future is all about making trade-offs. It’s
essentially a question of dealing with the constant tension between living for today
and saving for some future event.

What seems like a complicated process (so much so that we often give up before
we even start) is really just a balancing act. I’ve found that it helps to put a
framework around this process, which we can do by asking a few questions:

1. How much can you reasonably save?

2. What is your rate of return?
3. How much do you need?
4. When will you need it?

While these questions may sound simple, they’re not necessarily easy to answer. 
Certainly there are more questions that you can ask, but think of these four as
different choices that you can make to keep things in balance.
Notice that only one of the questions has to do with investments. Yet most of what
we read, most of our anxiety and most of what we think about involves the rate of
return. But rate of return is only one small part of the equation. If you don’t want
to deal with the risk of investing in the stock market, you can make another trade-
off. Save a little more if you can. Or if you can’t, consider retiring a little later or
pursuing a second career.

The idea is that it’s a balancing act rather than a single-minded pursuit of the
highest return. Planning for your financial future requires thought, frequent course
corrections and above all, an effort to keep things in balance. Again, while these
questions may be simple, they certainly aren’t easy. The reality is that finding the
balance is going to be a different process for everyone.

Read No. 168

The Case for Slow Money

I know that this is not a new idea, for we have all heard the story of the tortoise
and the hare since we were little. Slow and steady always wins the race.

But it is so easy to forget it when most of what we read in the financial press is
written to sell magazines. Slow and steady does not sell magazines.

Having seen the damage that is caused by always looking for the next hot
investment, I have been really interested in this idea of slow and steady investing.
I love the term “slow capital” that I first heard from Fred Wilson. I would also add
“steady.” Slow and steady capital comes as close as possible to describing my ideal
investment process.

1. Slow and steady capital is far more concerned with avoiding large losses than
with chasing the next great investment. Being slow and steady means that you are
willing to exchange the opportunity of making a killing for the assurance of never
getting killed.
2. Slow and steady capital means you can have a life. If you accept the fact that
slow and steady wins the race and you find a way to invest that way, you can turn
off all the noise of Wall Street.

A client of mine in emergency medicine used to tell me that he never knew whether
to laugh or cry when he would go run in the mountains behind the hospital during
lunch while all the other physicians were huddled around CNBC, as if Jim Cramer
was about to reveal the secret to endless wealth. Slow and steady capital allows
you to ignore that noise and enjoy your life.

3. Slow and steady capital knows that the goal of investing is to have the capital
you need to fund your most important goals. If your goal is to have something to
talk about at the next neighborhood party, try something else.

4. Being slow and steady is hard because it always seems that someone is getting
rich quick. I had a conversation recently with a client-to-be who told me that he
had done pretty well with an aggressive trading strategy. Now, I have heard that
enough times over the years to know that we all have selective and short-term
memories. Sometimes it only takes a few winning trades for someone to forget the
losers.

That was the case here. After talking about it for while, we discovered that in just
the last few months things had gone well. But it was on a much smaller capital base,
because the client-to-be had lost around 50 percent in 2008. So if you decide to
be slow and steady, remember to take all stories of people getting rich quick with
a huge grain of salt.

Slow and steady capital: short-term boring, long-term exciting.

Read No. 169

Investing Is Not Entertainment

One of the biggest mistakes we make is confusing investing with entertainment.

Somewhere along the line, investing became America’s favorite spectator sport.
Everywhere you went people were talking about finding the next hot stock, mutual
fund or alternative investment. Magazine covers like “10 Hot Funds You Have to
Own Now” and “Five Stocks that Sizzle” made investing sound fun, and you couldn’t
go anywhere without seeing Jim Cramer screaming “Buy! Buy! Buy!”

All this reinforced the idea that investing is all about action and that taking bold,
swift action is fun. But the idea that investing is fun and entertaining can lead us
to make costly mistakes.

Despite knowing at some level that market timing, stock picking and day trading are
hazardous to our wealth, people end up doing them anyway. At some point you need
to take a deep breath and ask yourself a question: Am I investing to meet my most
important financial goals or am I investing as a form of entertainment? For almost
all of us, it can’t be both.

Sure, investing is fun while you’re making money. But bear markets serve as a
painful reminder that we don’t always make money, and I’m sure that no one enjoys
losing money. We need to remind ourselves that this is not Monopoly. This is real
life. We’re dealing with real money and real goals. And by confusing investing and
entertainment, you almost always end up with bad results.
So next time you are tempted to “play the stock market” maybe you should go to
the movies instead. It will be far cheaper and mostly more entertaining.