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5 things to ask your friends who think “this time is different”

I love to make fun of economists and engineers, who get really mad when you point how humans act irrationally and how their “models” are therefore wildly off-base because they never deign to talk to psychologists in all their infinite wisdom. In fact, here are some of my favorite links on investor psychology and psychology book recommendations.

To show you what I mean, here’s another thought-provoking guest post from Carl Richards at behaviorgap.com.

Carl Richards: 5 things to ask your friends who think “this time is different”

“Given the decade we just finished, the question about what to do now is becoming part of our national conversation. With the insane amount of noise in the press, here are a few things to think about.

First some assumptions:

1. Your long-term investments are super diversified and low cost (broad-base, index funds, for example).
2. You are only investing money in stocks (see #1); that is long-term.
3. You have a plan for meeting short-term needs.

With that out of the way, here are a few things to think about:

1. The Sunk Cost Fallacy: We all have a tendency to look at the money we have already lost and think that we need to sell because we have lost so much. How much we are down has nothing to do with what the best decision is NOW. What is important is that we focus on making the best decision now, looking forward.
2. Anchoring: We are wired to take the recent past, anchor to it, and project it into the future. You start to do calculations like, “If the next decade is like the last I would be better off putting my money under my mattress.” We do this when times are good (in late 1999, eight out of every 10 dollars invested went into tech funds, right after a 80% run), and now we are doing it in bad times. Do we really think that this is the end? Are we really never going to solve these problems? Should we all move to the hills to grow our own vegetables? This is one whopper of a cycle, BUT IT IS STILL A CYCLE.
3. Why are stocks the only things that Americans buy when they are marked up and sell when they are on sale? If you thought stocks were a good investment in 2006 and 2007 (and we all did), then wouldn’t they be even better when they are a lot cheaper?
4. The question of the day is do you think that stocks will outperform cash and bonds for the next 10 years? The U.S. government is offering to pay 3% on a 10-year treasury. After taxes and inflation that will cost you money to own. Do we really think that if you bought a broadly diversified portfolio of stock mutual funds and then committed to completely ignore it for 10 years (not 10 days or 10 months) you would be better off sitting in a CD?
5. What we are talking about is expected future returns. The fact that we just had one of the worse decades ever, means that expected future returns went up, not down.

Just a few things to think about as you make changes to your 401(k) or your investment plans. It is scary out there right now, but it seems irrational to assume that this will be the first time ever that a bear market never ended.”

Check out more about investor psychology at Carl’s blog behaviorgap.com.

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I’m guest writing at the New York Times this week

Last week, I wrote about the Guest Post Strategy to get people to read your stuff.

This week, I’m a guest writer at the New York Times. Here’s a quote from something I wrote:

“Your friends will try to convince you that target-date retirement funds aren’t as high-returning and exciting as their fancy stocks (which they probably picked using a dartboard, three beers and a sponge cake). Ignore them. You’re focused on growth, not impressing your friends…”

As you can see, I toned it down for the paper of record. No curse words this time.

There are lots of questions & answers for recent graduates, including college loans, Roth IRAs, and buying a house.

Check out the Money Q&A at the New York Times.

Popularity: 26% [?]

Automating your money — especially entrepreneurs and freelancers

How can entrepreneurs and freelancers with irregular income automate their money?

Lots of people have been interested in the section of my book on irregular expenses and income — like entrepreneurs or freelancers –so I thought I’d go into some more detail on how I handle automation.

Brian D. writes:

I’m just wondering when you deposit money into your account does it automatically put 5% into savings, 10% into 401(k) …etc or is this a manual process. Also when the 5% goes into savings do you automatically split that into your savings account sub accounts, or is this manual?

Brian probably read my monster post on The Psychology of Automation: Creating a Bulletproof Personal-Finance System, which included this image:

Here are the answers:

1. It’s automatic (see how to automate it). But in your sub-savings accounts, you have to specify an absolute number, such as “withdraw $150/month from my checking account and put it in my sub-savings account for the new iPhone”)

2. Brian then wrote a followup: “What if you got $500 for your birthday and deposit this into your checking. Does it automatically spread itself out or do you do this manually?” While my bank (and most) require an absolute number, you can still semi-automate this. I deposit the money into my checking account, as usual, and then execute a monthly sweep on the 25th of each month, where I tidy up all loose ends.

You’ll remember my sub-savings account (how to use a sub-savings account):

Here’s how the monthly sweep looks in Google Calendar:

Note that I don’t recommend you sock away 100% of unexpected earnings. In fact, I force myself to spend 25%-50% of any unexpected money within a month, a technique I developed to keep motivating myself to earn unexpected income. (For that, I keep a “tobuy” tag in delicious.)

Just like GTD, the key with your personal finances is to set up structures to catch the wild one-offs and put them aside for a regularly scheduled time, usually once/month.

Once you set this system up, your money will flow from your paycheck to your investment accounts (401(k), Roth IRA, etc), sub-savings accounts (like for the new iPhone), and down to your checking account for guilt-free spending — all automatically.

Read more about automating your money.

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