Archives For October 2009

Your Money & Your Brain:  How the New Science of Neuroeconomics Can Help Make You Rich       Jason Zweig, a senior writer for Money magazine, is the author of a very interesting book called Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich. The book talks about how your brain can affect your money decisions, often detrimentally, and how you can learn to spot the problems you can create for yourself. It isn’t heavy in technical discussion, but it also doesn’t practically lay out exactly how you should invest your money. You should use it more as a guide to understand why it’s foolish to keep reading the investment news all the time and to help you understand why active investing is so widely used even though it has no academic research to stand on.

       Today, I just want to talk about a few excerpts from this book so we can understand why we tend to make the mistake of seeing patterns where there are none. This is often the case for those who believe in technical analysis or market timing or many other tenets of active investing. I hope this example can help you begin to see how our brain tricks us into thinking we can predict the future based on some pattern we see.

Humans Are Great at Finding Patterns

       Zweig acknowledges that humans are very good at finding and understanding simple patterns. This ability was extremely important to our ancestors and still serves us well today.

       That’s what helped our ancestors survive the hazardous primeval world, enabling them to evade predators, find food and shelter, and eventually to plant crops in the right place at the right time of year. Today, our skill at seeking and completing patterns helps us navigate many of the basic challenges of daily life. (“Here comes the train I have to catch.” “The baby’s hungry.” “My boss is always a butthead on Mondays.”)

Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich – Jason Zweig

       It’s really great that we have this ability – but only when we actually need it. When it comes to investing, obsessively looking for patterns in random data can be extremely detrimental to our investment performance. By trying to find patterns and use them to our advantage, we often do much worse than if we had taken the statistically superior route.

Pigeons and Rats – Why They Can Often Be Smarter Than Us

another rat by asplosh on Flickr       Many people spend an amazing amount of time looking through tons of stock market information trying to find some kind of pattern they can use for a great new investment strategy. Even though the information is essentially random, we look for patterns that aren’t there so we can find a way to make even more money. In the process of doing all this, we often lose much more money than if we had just invested in a diversified portfolio of index funds.

       For decades, psychologists have demonstrated that if rats or pigeons knew what a stock market is, they might be better investors than most humans are. That’s because rodents and birds seem to stick within the limits of their abilities to identify patterns, giving them what amounts to a kind of natural humility in the face of random events. People, however, are a different story.

Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich – Jason Zweig

       Experimenters can test this by flashing one of two lights, green or red, onto a screen. The sequence is completely random, but 80% of the time they will flash a green light. They’ll flash the red light the other 20% of the time. (For example, a set of 20 flashes could be: GGRGGGGRGGGGRGRRGGGG. Another run might look like this: RRGGGGGRGGGRGGGGGRGG.) If you’re going to try to guess the next color to appear, your best strategy is to always pick green because it’s going to show up 80% of the time. Rats and pigeons generally use this optimal strategy when researchers reward them with some food for guessing the right color.

       Humans, however, tend to flunk this kind of experiment. Instead of just picking green all of the time and locking in an 80 percent chance of being right, people will typically pick green four out of five times, quickly getting caught up in the game of trying to call when the next red flash will come up. On average, this misguided confidence leads people to pick the next flash accurately on only 68 percent of their tries. Stranger still, humans will persist in this behavior even when the researchers tell them explicitly—as you cannot do with a rat or pigeon—that the flashing of the lights is random. And, while rodents and birds usually learn quite quickly how to maximize their score, people often perform worse the longer they try to figure it out.

Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich – Jason Zweig

To Get Better Results, Stop Trying So Hard

Lonely Hammock by *Micky on Flickr       Once you realize you have a tendency to seek patterns where they don’t exist, you can stop yourself from making stupid mistakes about your investments. Trying to pick stocks based on anyone’s predictions (yours or someone else’s) can easily lead to bad results. Companies can go down for a myriad of reasons you’ll never be able to predict no matter how much research you do. As Jason Zweig says, “No one can predict the unpredictable.” So relax, learn more about index fund investing, and spend more time doing the things you enjoy instead of worrying about your portfolio.

       If you find that you can’t tear yourself away from Jim Cramer or endless hours of researching companies, try this suggestion. Keep 90-95% of your invested money in a diversified portfolio of index funds. Use the other 5-10% to try out Jim Cramer’s predictions or your own hunches, but don’t use all of your money for these “strategies”. Having a play money account can help keep you from making serious mistakes with your entire nest egg—as long as you don’t start believing you’ve just found the best investment strategy in the world. Give it a few years and you’re likely to always see the index portfolio outperforming your play money.

       There’s a ton more discussion and examples of how our brain can mess up good financial decisions in Jason’s book. So if you’re interested, check it out at your local library or purchase a copy from Amazon or another book retailer.

       There are many ways to create a budget and track your spending. The only “right” way is the way that works for you. This is a short list of some ways you can track your spending and create a budget.

Paper & Pencil or a Spreadsheet (Microsoft Excel, OpenOffice Calc, or Google Docs Spreadsheet)

Pencils and Moleskines 04 by Paul Worthington on Flickr       Creating your own method of tracking and categorizing your spending and then creating a budget can give you a much better understanding of your situation. It takes a bit of time and is not the easiest way by far, but it is free and keeps all of your information private. You simply create categories for all of your expenses, track them manually, and then create or update your budget as your situation changes. If you don’t have the discipline to track all of your expenses and continue to update the spreadsheet, then I don’t recommend you try this method.

Quicken

       Quicken has been the standard personal money management software for quite some time, but many competitors are emerging and offering better products. Quicken can import data from your financial institutions, track your spending and help you create a budget, and offers various reports so you can get a better picture of your financial situation. Quicken Online is currently free (but that could change), so if you’re comfortable storing all of your login information online in one spot you might want to check it out. If you want an alternative that keeps all your information on your computer, you can try Quicken Deluxe for $59.99. (You might be able to find a better deal elsewhere online, so shop around!) My own personal experience with Quicken Deluxe wasn’t especially great. It takes a while to set it up and you’ll have to get familiar with how the program works. However, if you need a way to automatically track your spending it may be worth the initial effort.

Mint

Mint       Mint is a free, online money management program that can pull together all of your bank, credit union, and credit card data to help you track your spending and budget for your expenses. To get all that information in one place, you’ll have to give them your user names and passwords. While Mint uses the same kind of data encryption as your bank, there is still risk in putting all of your financial information in one place online. If that data were ever compromised, you’d have to change the information on all your accounts to protect yourself. I’m OK with using Mint because I researched their security measures and feel comfortable with it, but you might not. I recommend you look into it for yourself and make your own decision. Also, Mint’s computer algorithms look at your spending patterns to offer you specific deals through their sponsors so you may or may not be comfortable with that as well.

Mvelopes

Mvelopes       Mvelopes is another online money management program that has received good reviews around the web. You get a free 30 day trial, but after that it will cost you anywhere from $7.90/month to $13.20/month depending on the membership period you select. Like Mint, Mvelopes gathers data from your bank, credit union, and credit card accounts to help you track your spending and create a budget. Again, I personally wouldn’t feel comfortable with having all of my account logins stored in one place regardless of the encryption and security used. But if you’re comfortable with it, Mvelopes might be another easy way to start tracking your spending and keeping a budget.

My Method

Google Docs       Personally, I just use a Google Docs Spreadsheet to create a budget so I can have an idea of what my spending should look like. Every so often, I check over different categories to make sure I’m not overspending. However, I don’t really track my spending closely because I have my spending well under control, my savings is automatic, my bills are on auto-pay, and I have a sizable emergency fund. Unless all of those apply to you, I recommend you track your spending. The Spreadsheet method also isn’t for those who don’t have the discipline to dig in and do most of the dirty work themselves (as opposed to a computer program doing the grunt work for you). Here’s a template of the Google Spreadsheet I use. You can save a copy for yourself if you have a Google account and use their “Save” feature under the “File” menu. You should be able to save a copy to your computer, too. You’ll have to edit it for your own situation, as I can’t list every possible expense category a person might have.

There’s More Than One Way to Skin a Budget

       There are many other ways you can track your spending and create a budget. I didn’t even mention You Need a Budget or PearBudget. You can also do variations on any of these methods. For example, for the paper & pencil method you could use envelopes to split up your money and make sure you don’t overspend. What are some other methods you use to track your spending or maintain a budget? Leave your tips in the comments!

Changing Your Name after Marriage

Corey —  October 8, 2009

       After you get married, there are several places you’ll need to update your name (if you’re taking your married name) or address (if you’re moving). Here’s a quick checklist you can use to make sure you don’t forget anything:

  1. Social Security Card – You’ll need to go to your local Social Security office to update your name on your Social Security card. You’ll need your marriage license or certificate for proof. If you don’t know where your closest Social Security office is located, you can find out here. It will take a week or two before you get your updated Social Security card in the mail.
  2.        

  3. Driver’s License – You’ll have to check out your DMV’s website for the steps you should take. Once you’ve updated your Driver’s License and Social Security card, you should have no problem updating the rest of these things.
  4.        

  5. Forward Your Mail – You can have your mail forwarded by picking up the form at your local Post Office or by going to the USPS website (though it will cost you $1 to do it online). You’ll want to forward your mail for your old name and your new name to cover all your bases.
  6.        

  7. Passport – If you already have a passport, you’ll want to get that changed as well. You can find the appropriate form on the Department of State’s website.
  8.        

  9. Auto Title & Registration – You’ll also want to change your name on your auto title and registration if you own a car. This may or may not require a trip to your DMV. Many DMV’s offer this service through the mail or on their website.
  10.        

  11. Employment & Professional Licenses – Let your employer know you’ve changed your name. If you have a professional license, you’ll want to update your name with the appropriate agency.
  12.        

  13. Bank, Investment, and Credit Card Accounts – If you’re combining your finances, you’ll also want to look at consolidating these accounts or adding each other as joint account holders.
  14.        

  15. Insurance Policies
  16.        

  17. Doctor’s Offices
  18.        

  19. Utilities (Electric, Phone, Internet, Cable, etc.)
  20.        

  21. Cell Phone
  22.        

  23. Student Loans
  24.        

  25. Library Card

       This list doesn’t cover everything you’ll need to do, but it should cover most areas. Are there any other big things you should include? Leave your suggestions in the comments!

Use it up, wear it out, make it do, or do without!
       “Use it up, wear it out, make it do, or do without!” This saying from the Great Depression shows the way to true frugality. If you want to get the most out of your money, follow the steps outlined in this little rhyme.

Use It Up

       Don’t let anything go to waste. Before you throw something out ask yourself if there’s anything else you could use it for. Many frugality tips revolve around repurposing materials for new uses. Bread bags can be cut in half to use as sandwich bags. Old towels can be cut into washcloths. With a little thought and creativity, you can reuse the things you’ve bought and save yourself from buying again.

       I’d also apply to this to food. Don’t let your leftovers go to waste. Plan your meals well so you use up leftovers before fixing another meal. Or create a new meal from your leftovers. Many leftover items can be combined to make a soup, stew, or casserole with just a few additions.

       On your next trip to the trash can, ask yourself, “What else could I do with this?”

Wear It Out

       Make sure you get the full use out of anything you have. This is a lot like the first step above, but we should also include maintenance in this category. Take good care of the things you own so you can get the full use out of it. This especially applies to appliances and automobiles. Find out how to properly take care of these items. Then make sure you do the things necessary to keep your stuff in good shape. Don’t skimp on maintenance, but try to see if you can save money by doing some things yourself.

       This also means you shouldn’t buy cheap just for the sake of getting a bargain. Quality items will last much longer making them worth the extra cost. You’ll also save time by not having to shop for a replacement as often. Getting the most value for your dollar doesn’t necessarily mean paying the lowest price.

Make It Do

       Before throwing something out, see if you can fix it. Many things that wear out or break can often be repaired for a fraction of what it costs to buy new. Do a little research or ask someone you know who is knowledgeable and find out if it can be fixed. If you can, fix it yourself. You’ll learn valuable skills and likely save money over paying someone else to do it. If not, find a trustworthy person to do the repairs for you.

       Other strategies you can use to “make it do” include buying it cheaper, making it last longer, and using less of it. Combine those three strategies to get the most savings possible. We can often use less of something and still be just as happy. Take toothpaste for example. Do you put enough on to cover all the bristles? Try using half as much. If your teeth and mouth still feel clean and refreshed, then you don’t need to use any more than that. If not, bump it up a little. Little steps like this require no extra time on your part, but they can reap you significant savings when applied over many areas of life. And that’s all with no decline in quality of life.

Do Without!

       Contentment is the key to the final aspect of this wise saying. Knowing how to separate your needs and wants gives you powerful control over your finances. Learning what is “good enough” for you will help you delay purchases and get the maximum use out of the stuff you already have. Ignoring the cultural expectations to keep up with the latest fads will save you more money than you can imagine.

       This instruction has a hidden benefit as well. When you learn contentment, you break free of materialism and consumerism. You can choose to stop serving Money and start serving God. You can increase your giving because you’ve learned to spend less on yourself. The truth is – contentment is wealth. It’s the most powerful way you can combat the blatant attempts by the media and corporations to control your mind and your wallet. Finding your satisfaction in Christ will help you value things appropriately in this life so you can make the right decisions for the next one.

How Do You Follow This Slogan?

       How do you “use it up, wear it out, make it do, or do without” in your own life? Share your examples in the comments!

       There are only three reasons you would need permanent life insurance coverage. If these situations do not apply to you, then you shouldn’t buy or keep a permanent life insurance policy.

Do These Situations Apply to You?

       You may need permanent life insurance if any of these situations applies to you:

  • You Have a Special Needs Child. – If you have a child with special needs who will still need income after your death and is unable to earn it themselves, you should consider permanent life insurance. You’ll want to set up the policy to pay out into a Special Needs Trust, and you should work with a qualified attorney with specific experience in this area.
  •        

  • Your Estate Will Be Illiquid and You Will Owe Estate Taxes. – If you will have an estate that exceeds the estate tax exemption amount and will not have enough liquid assets to cover those taxes, you should consider permanent life insurance to cover that need. You’ll want to work with an experienced estate attorney and accountant or financial planner to estimate how much you’ll owe in taxes and determine how much insurance you should buy.
  •        

  • You Own a Business with a Partner or Partners. – Permanent life insurance can be used to set up a buy-sell agreement between you and your partner(s). The life insurance will provide the cash needed to buy out a partner after his death. Again, you’ll want to work with an experienced attorney and accountant to value the partner’s share and set up the agreement.

       Those three situations are very specific and apply to only a small percentage of people. That’s why permanent life insurance is a bad idea for most people. If those situations don’t apply to you, then you should only be looking at term life insurance – if you need life insurance at all.

Consider the Source

       If you have a life insurance salesman pressuring you to buy a permanent life insurance policy, ask yourself why he’s recommending that product. If you don’t have a true need for permanent life insurance, there’s a good chance he stands to make a huge commission on the policy and that’s why he’s making the recommendation. The commissions on permanent life insurance policies can be 4-8 times higher than commissions on term life insurance policies, so it’s easy to see the conflict of interest.

       Be open to permanent life insurance if you really need it, but be very wary of anyone who recommends it when you only need term life insurance. Ask why and consider if those reasons are applicable to you. Only make your decision after careful consideration.

Cash It Out If You Don’t Need It

       Finally, if you have a permanent life insurance policy but you don’t need it, then cash it out as quickly as possible. I don’t care if your dad bought it for you when you graduated high school. If you don’t need it, it’s a waste of money. Call up the insurance company and tell them you want to cash out the policy and cancel the coverage.

       Don’t buy something just because it seems like a good idea. Make sure it fits your needs and your situation first. If it doesn’t, then stay away!

       Budgets are good. That’s right. I just said a budget is good. We hate the sound of that word, don’t we? It reeks of denial, hardship, restraint, and, for most people, boredom. But failing to create a budget and stick to it (to some degree) is one of the primary reasons so many people have a hard time managing their personal finances. So here are a few reasons why it’s good to have a budget and track your expenses.

You can easily figure out if you’re spending too much money.

       By tracking and totaling your expenses over one or two months, you can easily figure out if you’re spending too much money. Add up your monthly income, subtract your monthly expenses, and if the result is negative then you’re spending too much money. There are other ways to tell if you’re spending too much money (is your debt increasing every month?), but this is one surefire way to double check it.

You can see where your money is going.

       It’s easy to lose track of all your bills and remember where you spent the cash you had in your wallet or purse. By creating a budget and continuing to track your spending, you can keep a comprehensive list of all your expenses and how much they cost. From there, you can see where your biggest outflows are and find ways to save money in those areas.

You can target specific areas for improvement.

       Once you’ve tracked your spending for a bit and are comfortable with the numbers, you can decide on budget goals. Where do you want to cut back and by how much? If you don’t have your budget written down (on paper or electronically), it’s much more difficult to set these goals for yourself.

You’ll start spending less.

       The mere act of tracking your spending is likely to cause you to spend less. Why? You’ll become more conscious of your spending habits and begin to carefully examine your purchases. Once you start to question whether or not you need to spend money you’ll start spending less. Be careful – Corporate America doesn’t want you to do this!

You can have less stress and make better decisions.

       Do you want to take your significant other out to dinner but you’re not sure if you can afford it? Check your budget. Friends invite you on a weekend road trip but you’re worried about money? Check your budget. If you can fit the expense into the appropriate budget category, then you can spend without guilt. (Assuming, of course, that you are meeting your savings goals.) Finally, you’ll have a good idea of how much money you should have in your emergency fund. Take your necessary monthly expenses and multiply by some number between 3 and 12. (You can’t do this if you don’t know your monthly living expenses!)

My Budgeting Confession

       With all that said, I have to tell you that I no longer stick to a strict budget. I track my expenses in Mint, but I don’t restrict my spending in any certain categories. I do have a budget, but it’s mostly because I like numbers. I don’t manually keep track of what I spend. I have all my bills set on auto-pay (except heating oil), my savings is automatic, I have a sizable emergency fund, and I have my spending under control. If you can say the same about your own situation, then I actually encourage you not to track your spending too closely. It’s a waste of time if you don’t need it. But I would still recommend periodically reviewing your spending with a tool like Mint to make sure you don’t get too far off track.

       On the other hand, if you aren’t paying yourself first (automatic savings), haven’t established an emergency fund, or don’t have your spending under control, then you absolutely need a budget until you get to that point. If you really hate the idea of budgeting and tracking your expenses, just remind yourself that eventually you won’t have to do it anymore. It’s only temporary!

       Once you’ve established your emergency fund and built it up a bit, you’ll need to decide when you should and shouldn’t use your emergency fund. If you don’t set guidelines for yourself, you’ll find a reason to use it for non-emergencies. And when you need it the most (after losing a job), you won’t have as much saved up to cover the real emergencies. Define boundaries for what you consider an emergency and what you don’t.

Job Loss/Income Buffer

       Depending on your situation, you’ll want 3 to 12 months of your living expenses saved up as an emergency fund. This money is to help you cover your expenses while you’re looking for your next job. You need this money because relying on debt takes a stressful situation and amplifies it ten times over. You don’t want to find yourself digging out of debt as you start your new job. This can also apply if you are self-employed or depend on commissions for your income. You can use your emergency fund as an income buffer while times are tough so you can focus on getting more business instead of how you’ll pay the next bill.

Other Stuff

       This is where you need to decide how you’ll use your emergency fund. It’s clear that a job loss counts as a real emergency, but it’s not so clear for everything else. Medical emergencies, family emergencies, and household emergencies do happen, but there are also many situations for each of those examples that we can plan and save for ahead of time. We know that cars break down over time, so we should be saving up for car repairs even if our car is paid off. We know that household appliances break and things will need to be fixed, so we can save up for those problems.

       It doesn’t really matter how you lump together or separate your savings, as long as you know they’ll cover your unexpected expenses. For example, you can have an emergency fund that covers everything. Or you can choose to have an emergency fund that’s really only for when you lose a job while you have a car fund, house fund, medical fund, and “other” fund for those costs. It doesn’t matter how you break it up, as long as you know what you’ve decided to do.

       So if you’re going to have a catch-all emergency fund, you’ll want enough to cover your living expenses for a certain number of months plus some extra for all the other emergencies that will come up in life. Plus, you’ll need to keep replenishing it as you spend the money. You might decide to keep six months of living expenses plus another $3,000 in your emergency fund while continuing to add $50 or $100 every month.

       Or you can go with separate accounts for everything. The number and type of accounts you use will be very dependent on your personal situation, but let’s say you have a job loss fund, medical fund, car repair fund, house fund, and “other” fund. If you own, you’ll want a larger house fund than someone who rents. If your car is older, you’ll want more in the car repair fund than someone with a newer car. If you have children or a high-deductible health insurance plan, you’ll want more in your medical fund than someone who’s single with great health insurance. Think about your own situation, the cost of a typical emergency in each category, and how frequently those emergencies occur. Then set up a savings plan to build those funds and keep them replenished when you spend the money.

Avoiding the Double Emergency

       Without an emergency fund (or however you decide to do it), any emergency becomes a double emergency. Not only do you have to deal with the car breaking down, but you also have to worry about how you’re going to get the money. Every crisis adds a financial crisis because you don’t have a clear plan to deal with those money issues. Take the time to think about how you’re going to set up your emergency fund(s), what you’ll use them for, and how you’ll rebuild them after using them. It won’t eliminate the stress of the emergencies, but at least you won’t have to worry about where the money will come from. God can and will care for you in any emergency, but prudence teaches us to prepare for the emergencies we know we’ll face.

       The prudent sees danger and hides himself, but the simple go on and suffer for it.

Proverbs 22:3 (WEB)