Tag: personal finance

A 50% Tax Rate

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Personal finance is tricky.

One aspect is that precise but not accurate plans feel right. Running a Monte Carlo portfolio analysis on a low-beta trend-following model to prove the robustness feels “more right” than buying Vanguard Target Date Funds. We feel agency, authority, and accuracy through action (even though it may be more wrong).

A second aspect is framing the choices rather than making the choices. Choosing from good options, 30 or 15 Year Mortgages?, takes less time and works just as fine. A list of pros and cons doesn’t make a lick of difference when it’s just bad options.

I forgot these things.

Talking to a friend about how to estimate income from CDs vs. other instruments (when rates were 5%), he advised assuming a 50% tax rate.

What?!?! I thought. With an effective income rate of around twenty-five, some capital gains, some sales tax, and miscellaneous fees that sounded way too high. It certainly wasn’t the assumption in my spreadsheet. Plus the friend lives in a high cost-of-living area.

His number will be “more wrong” but in some ways, it was “more right”.

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I’ve grown to see the world as less good and bad and more a series of tradeoffs. There are Good and Bad, but much is a bunch of tradeoffs. Myopia isn’t good or bad. It’s a tradeoff between now and later.

Behavioral psychology unearthed different biases, but how the field did that is a tradeoff too. Knowing about different biases is helpful (opportunity cost neglect, base rates, etc.), but just because one is “discovered” doesn’t make it a big deal. We can’t consider every other available option, something will be neglected.

Every choice is a tradeoff, like personal finance plans. My 25%+, like Price is Right, will be closer to the true amount without going over. But my friend’s 50% has a greater confidence interval. We know something is always happening and assuming you get half your money rather than 3/4ths means a lot less somethings can happen to you.

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There’s a book series called The Five Love Languages.

I like the books even though they may be completely wrong.

Author Gary Chapman proposes that each of us likes to be communicated to in some ways more than others. The love languages: acts of service, touch, quality time, gifts, and words of affirmation describe different ways our partners, teens, and children prefer communication.

Personal finance plans work the same way.

Some people prefer accurate plans while others prefer ones with a margin of safety. Some people can stomach volatility. Some people want to invest like their friends.

Preferences drive choices, choices illuminate trade-offs.

And I listened to my friend and changed my spreadsheet to 50%.

The Psychology of Money (book review)

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The Psychology of Money by Morgan Housel is a book of twenty money lessons but really it’s about two things.

Thing 1: How the world works.

There is the world and there is how we think about the world. The more these ideas overlap the happier more calibrated the person. People follow stories (chapter 18), pessimisms sells (17), and tails drive everything (6) are all explanations about the world.

It’s through a combination of evolution, social pressure, and a history of this-worked-for-me that we drift. Sure, we think, Tom lost so money in crypto but he didn’t listen and get in when I told him the candlestick fed cycle jump was coming (luck, chapter 2). When something bad happens to us we’re unlucky. When something bad happens to them they’re idiots (1).

Things 2: How you work.

So it’s not just outside that we misunderstand. It’s inside too. We move the goalposts (3), confuse consumption (8), and aim for the rational rather than reasonable (11).

Asking what do I really want out of this big trip is not easy.

So we don’t.

Thankfully Housel is here to help. Think of time as freedom (7), just save (10), and don’t confuse consumption for wealth (9).

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The Psychology of Money is a difficult book to review because it’s personal. It’s how you see the world and understand yourself. Oof.

While the chapters are short, don’t spend little time on them. Read them. Stop. Think. Reflect. Note. The book is a refreshing break from the digital cycle. You’ll read this and think: Oh yes, this is a breath of fresh air and one I needed.

That “start young” advice

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“If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away.”

— The Psychology of Money

Start investing young was the advice I got. At 22 I opened a Roth IRA.

But there was a nuance I failed to note. It’s not just about time horizons but also how to get there.

Young Mike opened a Roth knowing it should compound for a long time. But he didn’t think about how that might happen.

Save 3-6 months of living expenses was another piece of advice. This is an average lie. It’s not enough or too much. We should call them “repair funds” because emergencies are not covered.

Emergencies need a year or more.

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In Nomadland, Jessica Bruder writes about “house-less” Americans. With RVs and campers, these ‘nomads’ travel the country for work. Do you know how busy Amazon gets at the holidays? It’s these people working there. Seasonal National Parks? That’s them too.

Generally, four events precede someone becoming nomadic: health, house, job, spouse. Mary Smith or her significant other lost their _____ and now she’s nomadic. Three months of savings for that? Get out.

But that’s tough. So much time horizon is eaten up by savings accumulation – which an individual may never need! In hindsight I see all of Young Mike’s mistakes. But he didn’t think they were mistakes at the time.

This balance is what makes Morgan’s book so good. It’s not black and white numbers. It’s messy. It’s color. It’s holistic, it’s an ecosystem. You never do just one thing.

I didn’t read The Psychology of Money when it came out because I’ve read a lot of Morgan’s memos, followed him online, and written about personal finance. But the book is good. It’s not about money as much as it’s about morals.

You don’t need to ___ because you are already ___.

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“You have to be careful,” warns Clayton Christensen in How Will You Measure Your Life?

When things are going well with your friends and family. When your kids are doing well. When your spouse is happy. You have to be careful. 

“When it seems like everything at home is going well, you will be lulled into believing that you can put your investments in these relationships onto the back burner. That would be an enormous mistake.” 

I’m in good shape for forty-one. In December I ran a 1:37 half-marathon, impressing myself. 

But my neighbors say I don’t need to run because I’m already fit. 

The causality is backward. 

The Millionaire Next Door profiles people with large net worths and how they did it. They invested, worked smart and hard, and checked their expenses. They wore simple watches, drove older cars, and traveled simply. You don’t need to live so cheaply, their nosey neighbors might note, you’re already rich. 

Parts of How Will You Measure Your Life? are about the “dilemma” between short and long-term incentives. Measuring your life is a long-term game that needs long-term incentives. And “you don’t need to… because you are already…” is backward logic. 

You need to.

‘Typical’ monthly mortgages (1971-2022)

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This is the ‘typical’ house payment for the last fifty years. ‘Typical’ being the median sale price and average thirty year rate.

If my parents had bought when I was born they paid $982. But if they bought when my brother was born, it would be almost two-hundred dollars less each month. A huge difference for a young family.

The sweet spot for modern buyers was October 2011 when payments flirted with $1,000. 

The Covid-19 drop and surge can be seen toward the right. It wasn’t until August of 2021 that payments crossed the trend line into wild heights. 

What difference does it make for someone now? Since the end of 2020, the ‘typical’ payment increased seven-hundred dollars a month. 

Interest rates are a headline metric, but are not the most important thing for buyers. The fall 2022 ‘typical’ monthly payment is: $2,580. A $50,000 decline on the purchase price is equivalent to 1% lower interest payments. Not only that, home prices have a .9 correlation with monthly payments whereas interest rates have a -.55 score.

Housing is easy news to consume. The bad is about rising prices and rates. The good is about remodels, flips, and luxury. The truth is somewhere in the middle, here it’s in color.

How “off track” are housing prices? The red line is the 2016- March 2020 trend line relative to the graph of median listing prices. Currently prices are a 33% premium to what the historical growth suggests.

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United States figures only.

Enhanced Savings Rates

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This is from our HSA. It’s good copywriting. ‘5X’ is easy to understand. ‘You may be missing out’ is great too. 

The chart excels as well. It’s easy to understand and those Enhanced Rates do look bigger. They look bigger because of level one numeracy. 

We level one think all the time. It’s knee jerk and first blush. We see something and some combination of evolution and experience fit what we see with what we know. Big red ‘Sale’ signs are examples. We first compare the sale price with the previous price rather than the item’s intrinsic value. This makes sense as our first reaction is immediate, requires no additional effort, and is something we are used to doing because it mostly works just fine. 

The posts here, about average, focus on this idea too. Average is easy to compute and conveys certainty about an uncertain (often heterogeneous) world. Average is level one numeracy but we can do better. 

One way to get past this reactionary thinking is to change the what we know part of our lives. Books like The Data Detective (2021), How to Lie with Statistics (2010), Fooled by Randomness (2008), and Factfullness (2018) are wonderful. 

A fast fix comes from Sir David Spiegelhalter. Don’t look at relative comparisons, look at absolutes. Rather than the relative rate, look at the dollar difference.

That’s what I did. 

If someone saves the $2,000 in an ‘enhanced’ HSA account they have sixteen more dollars after twenty years. A lot of years for not a lot of money. For accounts of ten-thousand dollars, the difference is almost eight hundred dollars ($11,543 vs $10,745). Fine, a Series I Savings Bond accrued that same dollar value in six months. 

The don’t look at relative comparisons, look at absolutes is a good starting place – but there are further levels. 

First is to think about the costs. The enhanced HSA rates are an annuity, likely with some new terms. There’s the switching costs too. That’s a potential headache and unwanted contract in exchange for not much money. We will pass. 

Actual health rather than health savings is different. 

For people 25-34, their chance of dying from Covid-19 is about the same as pulling the ace of spades from a shuffled deck – twice in a row. 

For people 55-64, their chance of dying from Covid-19 is about the same as flipping heads eight times in a row. 

For people 75-84, their chance of dying from Covid-19 is about the same as pulling any heart from a random deck of cards – three times in a row. 

Those are low absolute risks but seriously consequential. 

The world is complicated and messy. Not only that, but it changes too. Numbers are helpful, but we have to ask the right questions to start. 

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The Covid-19 odds are rough estimates. There are about forty million people in any ten year age group. The number of deaths in the 25-34 group is 11,451. I divided the deaths by size of the group to get the percent chance of death. Odds are multiplicative, three heads in a row are 12.5%, 0.5*0.5*05. Two ace of spaces are one in fifty-two times one in fifty two, or about 0.04%. 

Post-it note math

MIKE

It was October 2000 or thereabouts and Jacob Lund Fisker wanted to know if someone could live a sustainable and rich life.

“I did a little back of the envelope math. We physicist restrict ourselves to post it notes typically. I took the global GDP, divided it by the global population, and took our ecological footprint number and divided by it as well. If everyone did what I was setting out to do, the maximum each person could spend was six thousand dollars per person per year.” – Jacob Lund Fisker, Through Conversations, November 2021

He did it and Fisker retired early.

There’s a few things going on with FIRE. One is attention grabbing, everyone has a means to share their story and the atypical gets attention. Another is the financial conditions, it’s easier (though not easy) than ever to make a large amount of money, in a short amount of time, and invest in a mostly up market. The last and staying part of FIRE is the intentionality. It is impossible to FIRE without prioritizing one’s life.

Fisker’s philosophy is my favorite because he’s a system thinker. Early Retirement Extreme is a book that starts with systems and ends with personal finance. Saving half of one’s income is the act but you can’t do just one thing.

We’ve looked at spreadsheets for emergency funds, 401Ks, and how many touchdowns a quarterback will throw. Spreadsheets offer precision with numbers but don’t address our systems. Basic math is fine if the system is great but it doesn’t matter how great the math if the system is shit.

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My two favorite books about systems are Fisker’s book Early Retirement Extreme and The Systems Bible.

20,000×1 != 1×20,000

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Alchemy is about taking existing or marginal resources and deploying them for non-linear effect. Sometimes small changes go boom.

One way to see this is in the expression 20,000×1 != 1×20,000. Rory Sutherland introduced this idea through travel. A new rail line, Sutherland said, that saves many people a few minutes is worth less than a change that saves a few people many minutes.

Another example Rory gave was airline lounges. A sole traveler visiting a lounge many times a year gets a small benefit whereas that traveler with their family twice a year gets a huge benefit. In each case the same number of scones are consumed, but the effect to the consumer is different.

A real life example is the Credit Karma Save program.

“One of the things we noticed was that there’s strong deposit behavior around paydays and we wondered if there was a way to do nudging around paydays. So we created a savings boost program where just by depositing a dollar that month you’re eligible to win twenty thousand dollars that month.” – Kyle Thibaut, The Science of Change, October 2021

That’s not all. Credit Karma also offers Instant Karma, a cash reimbursement program for their debit card users. Every transaction is a chance to win that amount back.

I’d wager that the Credit Karma accounting for “customer reward” or “interest paid” or such, is similar in scope to the competition – but having a few large chunks rather than many small ones is a golden idea.

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It’s always nice to validate an idea with an “out of sample test”. Does this work elsewhere? Marc Andreessen riffed on the idea that there are only bonds and call options.

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March 28, 2022 update. Previously this idea was in the Landslide post which covered: sun and skin damage, landslide prevention, and Marc Andreessen on the culture of work.

“I’m your financial advisor”

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In the early 2010s I listened to Dave Ramsey nearly every day. The Nashville based personal finance (personal accountability) radio host is still on the air, holding court. There’s a few things that make Ramsey popular.

First, he’s great on the radio. The content fits the medium, and Ramsey’s basic explanations, stories, and approaches combined with the delivery works.

Second, he gives good advice rather than perfect advice. There’s a difference between precision and accuracy, usually between the world of a model and the real world. It’s why Ramsey suggests beginning with the debt snowball:

“Start by listing all of your debts except for your mortgage. Put them in order by balance from smallest to largest—regardless of interest rate. Pay minimum payments on everything but the little one. Attack that one with a vengeance. Once it’s gone, take that payment and put it toward the second-smallest debt, making minimum payments on the rest.” – Dave Ramsey (link)

A great behavioral angle. We like feelings of progress and by focusing on the smallest balance we get that, especially given the financial conditions we may be in.

A third thing Ramsey does well is filling an answer gap. One time a woman called into his show and asked a question. He answered. She protested that her friends and family wouldn’t understand. He suggested telling them her financial advisor advised it. I don’t have a financial advisor she said. “I’m your financial advisor!!”, Ramsey retorted.

In another instance he told someone it didn’t matter how much their income was, the purchase wasn’t “in the budget”. Could they afford it? Yep. But framing it against the contrived ‘budget’ change the conversation. (I’ve used this one, it works.)

Both “I’m your financial advisor” and “it’s not in the budget” fill in an answer gap. Having ready answers can change our fast thinking. It works for drinking too much, a diet, or any kind of behavior we’re trying to stick with.

The ready answers can be pretty arbitrary too. If you offered “meatless Monday” would anyone actually comment? I’d wager not. So it’s not the validity of an explanation but merely the existence of one.

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Some people don’t like Ramsey’s advice but I’m reminded of the Tyler Cowen expression: opposed to what? If not this then what?

Where are the notifications?

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One difference between the human brain and the laptop computer is that location matters. A human thinks differently, a computer compiles the same. This makes alchemy possible.

This also makes academia tough.

In behavioral science information presentation is everything. Order your tickets in the next 14:59. Put another way, what we see is all there is. Researchers will find that calorie labels work (!!), conditionally.

To humans, conditions matter. This, is a creativity canvas.

For instance, payment medium matters. People tend to spend differently because the feedback, the salience of paying with a twenty dollar bill is much higher than with a credit card.

“Certain payment systems leave a weaker trace in your memory. When I’m facing a purchase I ask, ‘How much have I spent in the recent past on things like this?’ If the answer is a lot then I’m less likely to make a new purchase, and if I’m paying by credit card I don’t remember those past purchases.” – Dilip Soman, The Decision Corner, October 2021

So, Soman created an app where people could spend and see feedback on their recent purchases. They spent less! Success!! But in 2010 South Korea created a text-message-for-purchases-alert-system and they found the opposite. “On an average,” Soman said, “people who opted in to receive the notifications spent more instead of less.”

The mechanism seems to be that text message information registers in a different way. “When we interviewed people they would say things like, ‘Oh if I ever needed a record I know my phone has it.’ Instead of being more vigilant they outsources that to the phone.”

The replication crisis in behavioral sciences makes me more hopeful about the tool’s potential. Human beings are goofy. Being one place and not another doesn’t matter how hungry I am, but you wouldn’t know by our actions.

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Bottom line: the easiest behavioral tool is dialing friction up or down. Thanks for reading and supporting.