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Psychology of Money: The Last Mile of Saving

jos — Mon, 21 Jun 2010 05:37:48 +0000

A few weeks ago, while I was at a conference in DC, I was attending a panel on email marketing when someone raised their hand and asked a question about advertisers and CPM vs. CPA. If you’ve ever been to a tech conference and waited for the Q&A period, this is about when you start contemplating different ways to commit suicide, including turning the conference program into a shiv to stick in your heart. People’s questions are that bad. But this one was good. Very good. After the panel, I walked over to meet the questioner, and I realized we’d been emailing for a year. Amanda Steinberg is the founder of Dailyworth, a newsletter targeted at women and personal finance. Yes, women and money are different than men. So it was refreshing to see someone openly acknowledging that and writing targeted material for them. I asked Amanda and her partner, MP Dunleavy, to write up a post on how we make a large cognitive error in our savings strategy. We’ll go through the enormous cognitive process of refraining from buying something, or negotiating a fee away…and then fail the last mile . Today, MP shows us how to complete that last mile — and lock in our savings. * * * The Psychology of Money: The Last Mile of Saving By MP Dunleavey, editorial director of DailyWorth DailyWorth is a daily email about finance (the perfect supplement to iwillteachyoutoberich) for women delivering practical tips on self worth, net worth and everything in-between. So you've cut back your car insurance, negotiated a lower interest rate on your credit card—or nabbed a great deal on a new TV. You're congratulating yourself for being a smart saver, and keeping more of your hard-earned money in your pocket. Not so fast. You haven't actually saved any money…until you've put the actual cash in the bank. You might say, “Well, duh.” But Peter Tufano, professor of consumer finance at Harvard Business School, says that many people confuse a lowered rate (on car insurance), or getting a discount (25% off a TV) with saving money. “It's not savings until you save it,” he says. You Need to Turn the Numbers Into Real Cash Sounds easy, but it's not. Making sure that mental savings morphs into tangible cash in your account is one area where your brain isn't your best financial friend. You can thank a psychological phenomenon that economists have dubbed malleable mental accounting .” Mental accounting stands in contrast to real-life number-crunching. If you transfer $100 from checking to saving, for example, there are clear-cut steps you have to take, from logging onto your accounts, selecting the transfer option, filling in the fields, etc. How Your Brain Manages Money Your brain takes a more flexible, sometimes freewheeling approach. Imagine that you just bought a TV on sale, marked down from $900 to $800. Or let's say that you negotiated $100 off your car insurance premium. Your brain now believes it has $100 to play with: “Hmm, I just saved $100. Score! That means I can spend a little extra on Jack's bachelor party next week. Or, I could sock it away into savings. Actually, I think I'll make an extra payment toward my credit card. Of course, Jill's birthday is coming up…” In reality, the money you've “saved” on the TV or premium is still theoretical. At this stage, because of the fuzzy nature of mental accounting—and because any reduction in price or fee simply means you're paying less, not saving more—action is required to transform this into savings. How? Take These Steps to Make Savings Happen At this point you need to take three steps: Decide how you want to handle the “savings”: as one-time or a recurring event. Decide how much you can save and when, then set up reminders, if necessary. Choose where you plan to save it, based on your goals. Don't Talk Yourself Out of Saving If you saved $100 off the purchase of a TV or 25% off a pair of shoes, aim to save some or all of that gain. This may require a negotiation. First, you might argue that you bought the item at a discount because that put it within your price range. You never would have paid full price, so you don't have extra to save. Nice try. Studies show that most people have a range in mind when they spend. You got the TV for $800, but you were probably willing to pay up to $850. Let's say you go for the big gain of $100; it's a single purchase, so you're going to handle it as a one-time event. How will you turn this into real savings? The last step is to look toward your goals. You can make a transfer to a savings account (personal, emergency, wedding, travel), put it toward debt (e.g. credit card, student loan, mortgage, etc.), or add it to your retirement account. Two Ways to Save A Recurring Amount If you negotiate a $25 reduction in your cell phone bill, say, the process is similar. Beware of sneaky mental accounting: It's tempting to believe that your bill has been lowered, so now you don't have to do anything. Left to its own devices, that $25 will sit in your checking account and GROW. Sorry. If you've “saved” $25 on a monthly bill, either add that amount to your automatic savings transfers each month—or be bold and add it up for the year ($25 X 12 = $300) and transfer that lump sum toward one of your goals. Once you've taken action, and the actual cash is building up, now you can sit back and congratulate yourself, maybe even brag a bit. Not only did you nail some savings, you went ahead and saved it. DailyWorth is a daily email about finance for women (the perfect supplement to iwillteachyoutoberich) delivering practical tips on self worth, net worth and everything in-between. Sign up for DailyWorth here .

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Psychology of Money: The Last Mile of Saving

The world’s best coupon clipper

jos — Thu, 27 May 2010 04:49:27 +0000

I got this amazing comment from a guy named Mike on a recent post: I have to disagree with all those who rail against coupons. My wife has the last 4 months of inserts filed in our filing cabinet with a spreadsheet that she downloads that inventories the contents of each weeks insert. She then compares our grocery list to the coupon inventory, pulls the correct coupons and goes shopping. the best savings are on the staples we use (cereal, shampoo, etc..). Our monthly grocery bill for a family of 4 is ~$320. I swear to god, as much as I make jokes about cutting coupons , I would like to first meet this person, then marry her. Ok, let’s play a game. Who is this person? Where does she live? What is her job (and her husband’s job)? What life experiences brought her to such a level of mastery? Let’s all just stipulate that she is Asian (who else would be so diligent?). The rest is fair game. Have at it in the comments. We can all learn something from my future wife.

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The world’s best coupon clipper

Attention annoying hypocrites: Stop being judgmental about your friends’ money habits

LivingCheaply — Mon, 24 May 2010 07:44:45 +0000

When was the last time you judged your friends for their poor spending choices? I do it. You do it. We all do it, saying “ YOUR spending is bad, but mine is good .” And chances are, we’re usually right — since most people are terrible with their spending, they probably can’t afford those shoes, trips, or restaurants they’re always buying. Yet each time we judge others’ spending, we’re less likely to actually look at our own spending and do something about it. And just as your friends probably overspend on “ridiculous” things, so do you . Today, I’ll illustrate several examples of how hypocritical we are in judging others’ spending. So come along — but hold on, because we’re going to be looking in the mirror for much of the ride. * * * “I can’t believe she spent THAT MUCH on her wedding…” One of the most popular posts I’ve ever written was called “ The $28,000 Question: Why We’re All Hypocrites About Weddings ,” where I pointed out how everyone is delusional about their weddings. People say things like, “Oh, I don’t want a big wedding…I just want it to be small and simple, with a few friends and family.” This lasts about 15 seconds until they start looking at wedding options and decide they want a a fancy wedding hall, nice china, huge flowers, and the best food and music, bringing the average cost of around $30,000 per wedding. Which is fine! Unlike other boring personal-finance pundits, who delusionally lecture you to have a small wedding (when you won’t), I’m a big fan of spending extravagantly on the things you love, if you cut costs mercilessly on the things you don’t. (Hint: If you’re 20 years old, you need to be saving $333/month for your wedding. 25 years old? $1,167/month.) And yet, there are always people who will judge you for your spending choices. Introducing the most annoying people on the planet On the wedding post, there was a group of commenters that were some of the most annoying people I’ve ever heard from: “$28,000 for a wedding is absurd. Most weddings end in divorce, why start your marriage financially cramped by a wedding? Yes, I realize you can plan to save that $28,000 in advance. However, wouldn’t it be more sensible to use that money for a down payment on a home (instant equity!). Or, to buy outright a late model used car? Just a few thoughts.” “28k for a wedding is utterly ridiculous The key is to NOT invite everyone you know. I spent about $2500 TOTAL on my wedding 4 years ago. Yes, you read that right…What a complete waste of money to spend 28k on one day! What about saving that money for the rest of your life?” “Wow, I don’t know where morons that spend $28K on weddings buy the stuff to do it, but I’ve got some left over paper plates I can sell you for $100 each.” You can find these annoying people criticizing others’ spending on virtually every post on weddings. Each of these people made it their mission to point out how “ridiculous” it is to spend $28,000, or $10,000, or even $2,000 for a wedding. ‘It’s outrageous! I did it for $100! Stop wasting your money,’ they angrily write. But there’s just one thing… They’re all hypocrites. What would they say if I examined their spending? In fact, here’s a new rule: Give me your budget and 10 minutes on the phone and I could identify 20% of your money being “wasted” on something useless and unnecessary. Now, an exploration on how hypocritical we all are about money. * * * We’re hypocrites for judging our friends’ spending When you judge others for their spending, you automatically assign YOUR values to them without even recognizing it. You think spending money on clothes, or first-class airfare, or expensive jewelry is wasteful? What about your own spending? Here’s one of my favorite examples because it’s so nutty: “That is just stupid. Unless the clothes are broken, there is no need to return it. If it is the wrong size, it can be exchanged for the right size. PS: I hate the mentality of people buying clothes for “fashion” or whatever. You are buying $100 for something that costs $10 dollars to manufacture in China! And about fashion trends – it is wasteful and stupid. If last season/year’s clothes are not broken, there is no need to buy new ones. Jeezz. As for “brand name” clothes – wake the fuck up.” Yes, I’m sure your computers and new XBOX and 30″ LED TV are so important, too. You think it’s ridiculous to buy $100 clothes? Let’s go beyond the knee-jerk reaction to understand what’s actually going on here. What if your friend who buys expensive clothes makes twice as much as you (say, $120,000)? Is it “wasteful and stupid” then? What if your friends don’t eat out as often as you, but they love buying a new shirt every month because it makes them feel good? What if you live in the midwest, but your friend lives in Manhattan? How does that change things? What if you’re 25 and your friend is 29? How does that change things? Judging others’ spending is emotional, not rational Think back to the last time you judged someone else for spending. Maybe you heard how much your friend pays for his apartment, or overheard your co-worker talking about yet another weekend vacation. When we judge others’ spending, we do it emotionally, not rationally. Let’s say you hear that your friend is going on a trip to Vegas and staying in the Bellagio for $800/night. Do you consciously evaluate his income, age, spending patterns, priorities, and debt levels? Of course not. We simply say, “Wow, I couldn’t imagine spending $800/night on a hotel room. Therefore, his spending is RIDICULOUS!” When it comes to judging spending, we consistently demonize others’ spending while rationalizing our own. Ironically, if you went back in time and asked yourself of 5 years ago if he could imagine spending what you spend on food/clothes/travel today, the younger you would scoff and think your modern-day spending would be “ridiculous,” too. What do you think you’ll be doing 5 years from now? But if someone dared point out your own spending on something — say, a new Macbook because your old one was “slow” — you’d have a multitude of reasons to justify it. “My old one was slow…and this one is important for my productivity…and I need it to run the new software I want, and….” This pattern repeats itself in virtually every article on others spending money online: In a terrific New York Times article on redecorating on a budget , a newlywed couple budgets $2,000 to renovate their apartment. Donna Alberico for The New York Times They end up spending $5,175 — a modest increase for their joint income — and the commenters go bonkers: “$2000 is more than I’ve had to spend on decorating my entire house for the past four years. Decorating on a budget? How about $500 or less…” “I made handsome, one-of-a-kind pillows, by taking embroidered dresses my brother purchased in the Middle East, that our mother never wore, and made covers for pillows I had tired of. (I didn’t even have to buy blank stuffers). ANY fabric store has even high-end design-house remnants that would be suitable and CHEAP.” “How many newlyweds can afford to spend this kind of money on revamping their apartment?…I would rather put that money in a savings account for a house, or put it away for a nice vacation.” Notice the presumptuous commenters condemning the couple for spending on their home decorations, and suggesting that their way — making pillows by hand or putting the money away for a vacation — is “better.” Again, give me these comments’ budgets and 10 minutes on the phone, and I could identify hundreds of dollars per month that they’re “wasting” — according to my tastes. Yet few people — even those who lob financial judgments at others — would ever subject themselves to scrutiny of the same kind. What is going on here? Are these people simply angry or jealous at hearing about other people spending on items they consider luxuries? Or is there something more going on? In few other areas of our lives are we so adamant about us being “right” and others being “wrong,” particularly since most of us are terrible at managing our own money. When you dig deeper, you’ll discover the fascinating psychology of self-serving biases and other psychological mechanisms we use to judge others — but protect ourselves. The psychology of judging others The first phenomenon in judging others is called a “ self-serving bias ,” which we use to protect ourselves from judgment: A self-serving bias occurs when people attribute their successes to internal or personal factors but attribute their failures to situational factors beyond their control…For example, a student who gets a good grade on an exam might say, “I got an A because I am intelligent and I studied hard!” whereas a student who does poorly on an exam might say, “The teacher gave me an F because he does not like me!” If your friend buys a $500 coat, you might say, “That’s nuts…Jack is really bad at managing his money. He can’t even control his spending!” But when I asked you about the $500 coat in your jacket, you might say, “Oh, that’s because I had to go to a wedding last month.” Second, we employ the Fundamental Attribution Error to judge others: In social psychology, the fundamental attribution error…describes the tendency to over-value dispositional or personality-based explanations for the observed behaviors of others while under-valuing situational explanations for those behaviors. In other words, “She bought those Jimmy Choos because she’s financially irresponsible” instead of “She bought those Jimmy Choos because she recently earned more money or negotiated her salary .” When judging others, we believe people make decisions because of WHO they are, rather than the SITUATION they’re in. Third, we use the powerful strategy of downward social comparison: Downward social comparison is a defensive tendency to evaluate oneself with a comparison group whose troubles are more serious than one’s own. This tends to occur when threatened people look to others who are less fortunate than themselves…For example, a breast cancer patient may have had a lumpectomy, but sees herself as better off than another patient who lost her breast Wondering where you’ve seen this? Turn on any talk show or radio show. Try to monitor your emotions during the episode. You might notice your internal voice saying something like, “Oh yeah, I have $5,000 in credit card debt… but at least I don’t have $45,000 debt like that guy . This actually feels good — one of the chief reasons that talk shows and Money Diaries do so well. Yet the feeling of satisfaction is short-lived. Fourth, we have the Shrug Effect : We see a famous CEO and point how “he took 5 companies public and got a Harvard MBA.” We see a successful children’s book author and point out how she already knew 4 publishers, so her book got published immediately. We point to Donald Trump and talk about how he had billions, so of course he could buy half of Manhattan, and we note that we’re already older than Michael Dell was when he was running Dell out of his dorm room. And then we shrug. “What can we do?” “She has a Harvard MBA.” “They made it big, but they’re different than me.” You see someone spending a lot of money on something that you consider “crazy.” Instead of trying to figure it out, we often shrug and say, “Well, they have [SOME ADVANTAGE YOU DON'T HAVE] and that’s how they do it. There’s no way I could ever do that.” Since this is psychologically painful and difficult, we demonize their behavior. Easier than understanding it. A prime example: Demonizing a CEO for her spending experiment Let’s examine a recent example of this. Alexa Von Tobel, the CEO of a personal-finance site called Learnvest, wrote an article called, “How I Went 24 Hours Without Spending Any Money…In New York City.” (Interestingly, the article is now gone, and so is the Google cache. You’ll see why in a second. Fortunately, I grabbed a screenshot before it was taken down. ) Now, it may not have been the most tactful article, especially in this economic climate. In fact, the tone was somewhat condescending. But I intentionally chose this extreme example to make a point. The problem is that Americans hate people who write about how they spend money on anything that’s not directly focused on the bare necessities of living. The one wedding day of your life? You’re spending too much. Taking a luxurious vacation that you saved up for? You could feed 2,000 foreign children. Buying a couch for your living room? You should invest that in your Roth IRA. How do you think people responded to Alexa’s article? Did they make thoughtful comments on the economy or different ways to earn money? Of course not. Commenters from around the web were absolutely livid. On Reddit : “She spends more money in one day than I do most weeks. Why does she feel walking twenty minutes to work, cooking dinner, and packing a lunch are unsustainable? This broad obviously lives in a completely different class than I do.” “The part that pissed me off was that she seems completely auaware that some people have no money to spend. I was hoping that she would decide to volunteer at a soup kitchen or donate her extra cash to a charity. In terms of her spending habits…retarded. It’s like she’s never heard of a budget, a kitchen, or a grocery store. What is not sustainable is spending $100 a day on nothing.” “Who the hell spends $30 on pasta and a salad?” “What the fuck?!? $80 in one day? That’s food for me, my wife, and my dogs for two weeks.” Even on the normally reasoned discussion board, Metafilter, the top comment says this: “Please tell me this is joke. If it isn’t, I want to murder this writer in the face.” (The Metafilter comment that made me laugh out loud: “This person would not have lasted long on the Oregon Trail.”) What is going on here? Instead of condemning her, the commenters should have asked another question Condemning someone for their spending is easy. But it’s not productive. We’ve already covered the protective mechanisms we use when judging others’ spending: “Their” spending is always out of line (“She can’t control her spending”), while our spending is always easily explainable (“Oh, that ring was for a special occasion…besides, I work hard, so I deserve to reward myself”). But there’s more. You may not like to hear this, but I’m going to say it any way. Instead of automatically condemning the author for her spending habits, the angry commenters above should have tried to figure out how she affords such a lofty lifestyle in the first place. “But Ramit,” you might say, “she went to Harvard. She’s clearly a wasteful trust-fund baby who’s living off mommy and daddy’s money.” Maybe. Maybe not. Who knows? But if that’s your first thought, you’re guilty of the Shrug Effect . A better way to approach the question would be to acknowledge that she probably has a few advantages you don’t, but focus on the things she DOES control — which you can learn from. For example, you could stipulate that yes, she likely has some advantages in life (maybe wealthy parents, some inheritance money, whatever)…but focus on the things you can control. She started her own company. She made friends with XYZ. She got internships at XYZ, which led her to XYZ2. If you want to live her lifestyle, it pays to ask: How could she be earning SO MUCH that she could afford to take cabs every day? What is she doing that I don’t know about? Who can I talk to to learn more ? How can I earn more money ? To many people, this is too much work. It’s easier to throw your hands up, accuse her of being a rich trust-fund kid, and then feel better about yourself since you don’t waste money on cabs every day. Witness virtually every comment accusing the writer of being wasteful and spending outlandish amounts of money on food and other supposedly wasteful items. It’s much harder to actually consider the details of the situation. For example, one Reddit commenter notes that, “Often very highly paid workers have very little free time so it makes sense to spend some money to buy back some time, such as getting in a cab to get somewhere quicker.” Instead of criticizing her spending, wouldn’t it be more productive to ask, “Damn, this woman obviously makes a lot more money than I do. How did she do it and what can I apply to my situation?” We’re more than happy to criticize others’ spending. Yet few people ever try to ask themselves what they can learn from someone whose spending outpaces their own — and even fewer open up their own finances to such scrutiny. A huge caveat: Most people are terrible with their money There is one upside to judging others’ spending: Since most people are absolutely terrible at managing their own money, when you judge them, you’re probably right. An excerpt from my personal finance book : So yes, judging others is surprisingly accurate and you’re probably right in criticizing your friends’ spending. But at the end of the day, you’re probably debating minutiae and wasting your time. Examples: Annoying critics Since I’ve written hundred of articles about personal finance, I see a lot of kooky people criticizing others’ spending, including mine. Yet it’s gone from being annoying to fascinating: You can get true insights into people’s belief systems about money by watching what they say. When I launched my Earn1k course to help people earn more money , I got many comments about how crazy others would be to spend money on my course — and how dare I charge for an online course. A while back, Henry Blodget wrote a a semi-satirical article on the Huffington Post called “ Easiest Job on Planet: Bank CEO . And in a separate thread, internet commenters took the bait , writing that being a bank CEO is all about luck and secret connections. This is classic Shrug Effect from armchair businesspeople who have never run a company. Even more interestingly, the comments reveal several limiting beliefs about money, such as “money=evil” and “anyone who has money must have done something bad to get it.” Another personal finance blogger, FMF, wrote a guest post about making 6 figures in 7 years. The result? People hated him . Themes include jealousy, “not everyone can do it,” excuses like “I’m too old,” and “Yeah, but $100k means you hate your job.” Funny, few people say, “Wow, this guy did a lot of hard work to earn six figures and now he’s writing a free blog post to share how he did it. What can I take away from this to improve my life?” Easier to criticize others’ spending — or earning — rather than do something different in our own lives. Erica Douglass, who sold her company for over $1 million at age 26, writes about outsourcing part of her life. The commenters go nuts , accusing her of being irresponsible with her money, racist, and virtually every other financial criciticism you can imagine. What can you learn from judging other people’s spending? First, when you judge other people for poor spending, you’re probably right, since most people are horrible at managing your money. This judgment is profoundly rewarding — and also wasteful — since we employ psychological techniques to distort our judgments in favor of our own spending. Think back to the last time you gossiped about a friend’s new pair of shoes or iPhone: It felt good for a few minutes. But it didn’t produce any positive behavioral change for you to change your spending. Second, it’s easy to judge others, but hard to honestly evaluate our own spending. When we judge others, we assign “dispositional” reasons like, “He is just really bad at managing his money.” But when it comes to ourselves, we use “situational” explanations like, “It’s my birthday…I deserve it!” Third, you WILL go up the hedonic treadmill and increase your spending as you earn more money — it’s only natural. When we judge someone else, we rarely take their income, savings, and other largely invisible factors into account. Fourth, in America, we have a special hatred of people who earn significant amounts of money — especially when they fall from grace . If someone earns $250,000/year and spends $10,000/year on clothes, is it really “ridiculous”? In the above examples, you saw numerous examples of people earning six figures, spending on things that were very much in their reach — but people criticize without context. Fifth, judging others is toxic. It’s not enough for us to make money — as a University of Texas researcher writes Psychology Today , “What makes me happy is that I make more money than you. It isn’t enough just to make a lot of money, you need to make more than the people to whom you compare yourself.” But judging others goes even deeper. Have you ever noticed that co-worker who always complains about his boss, job, salary, etc? Think back to the last time you sat next to him — did you start complaining, too? Soon afterward, you feel worse about yourself. This negative emotion is the same thing that happens when you listen to a radio host skilled at evoking your emotions. You get outraged, you get angry….and the short-term emotion retards long-term behavioral change — it literally robs you of energy. Judging others’ spending is a natural phenomenon. It’s also destructive and wastes time focusing on others, when you could focus on yourself. About to judge someone’s spending? First, use this 5-step process Whenever you find yourself about to judge someone else’s spending, ask these simple 5 questions first. How much do they earn? How much do they save, on a percentage and absolute basis? What do they consciously spend on and what do they NOT care about spending on ? How long will they be keeping this purchase? (For example, are they buying a car to keep it for 10+ years? Or are they buying shoes to keep for one season?) MOST IMPORTANT: Are my own finances automated and optimized? If not, automate your personal finances and implement the STFUDF Technique — against yourself. Since few people will do this, my hope is that you’ll distract yourself enough to stop the insidious process of judging someone else before looking at yourself. Personally, I’ve been trying to get better at this recently. To do so, I have to remind myself that personal finance is personal. You don’t know your friends’ financial situations — although they are likely not very good. But each time we judge someone else, we make it less likely of taking action on our own finances. * * * Automate your finances : Get the 6-week plan used by thousands of people . Earn more money : My Earn1k course to help you earn your first $1,000 on the side .

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Attention annoying hypocrites: Stop being judgmental about your friends’ money habits

The 5 groups to blame for our financial illiteracy

cheapo — Mon, 03 May 2010 15:20:52 +0000

Blaming everyone for being dumb is one of my most enjoyable activities. Today, a delightful foray into the world of why we’re financially illiterate — and whose fault it is. Let’s start with a Freakonomics article by Stephen J. Dubner: “1. Do you consider yourself financially literate? 2. If so, how did you get that way? And now, a third question: 3. How important is widespread financial literacy to the health of a modern society? Before you answer the first question, take this little quiz, borrowed from the website of Annamaria Lusardi, a professor of economics at Dartmouth who knows and cares more about financial literacy than anyone else you’re likely to encounter: 1. Suppose you had $100 in a savings account and the interest rate was 2 percent per year. After 5 years, how much do you think you would have in the account if you left the money to grow? a. More than $102 b. Exactly $102 c. Less than $102 d. Do not know 2. Imagine that the interest rate on your savings account was 1 percent per year and inflation was 2 percent per year. After 1 year, would you be able to buy more than, exactly the same as, or less than today with the money in this account? a. More than today b. Exactly the same as today c. Less than today d. Do not know 3. Do you think that the following statement is true or false? “Buying a single company stock usually provides a safer return than a stock mutual fund.” a. True b. False c. Do not know The correct answers are … a., c., and b. I am guessing that the vast majority of this blog’s readers got all three answers correct. But there’s probably money to be made in betting the opposite way. Those three questions are the ones that Lusardi, along with Olivia Mitchell of Penn, have been inserting in a variety of major U.S. surveys. In a new working paper titled “Financial Literacy: An Essential Tool for Informed Consumer Choice?” (abstract here, download here), Lusardi writes that among respondents age 50 and older, only half of them got the first two answers right and only one-third of them got all three answers right.” * * * So what’s going on here? It’s easy to point at others and say, “Duh, those are so easy. EVERYONE knows about interest rates! Haaha ha ah ahahaaha!!!” But if we’re honest, we can all acknowledge that our finances are not as optimized as they should be. We over spend. We don’t save and invest enough. When it comes to spending, we claim certain things are important (“investing for the long term!”) but our behavior doesn’t reflect it. And it’s incredibly hard to change our behavior. Whose fault is it? Lots of people, especially anonymous online nerds, love to claim that our entire financial situation is our responsibility. In “ Ugh, why don’t fat people just eat less? ” I showed why this is patently false. Others like to debate minutiae and blame the economy, Wall Street, and everyone but themselves. You’ll notice this especially among commenters on newspaper sites. Book excerpt: 5 groups to blame for our financial illiteracy In my personal finance book , I put together a targeted list of people to blame. Here’s an excerpt: “Why does just about everything written about personal finance make me want to paint myself with honey and jump into a nest of fire ants? Personal-finance advice has been geared toward old white men and taught by old white men for far too long. I don’t understand why newspaper columnists continue to write about tax-optimization strategies and spending less on lattes, hoping that young people will listen. We don’t care about that. We care about knowing where our money’s going and redirecting it to go where we want it to go. We want our money to grow automatically, in accounts that don’t nickel-and-dime us with fees. And we don’t want to have to become financial experts to get rich. Now, I fully recognize that I’m a big fancy author (that’s right, ladies) and am therefore part of the “media.” Perhaps it’s uncouth to mock my brethren. Still, I can’t help myself. Pick up any major magazine and chances are you’ll see an article called “10 No-Hassle Tips for Getting Ahead with Your Finances.” Amusingly, the same writers who breathlessly encouraged us to buy real estate in 2007 are now advising us on “what to do in the downturn.” I’m sick and tired of the same old boring, tired, and frankly horrible financial opinions that are paraded around as “advice.” More on this in Chapter 6. Other People We Can Blame for Our Money Problems There are other common excuses for why we don’t manage our money. Most of them are complete B.S.: “Our education system doesn’t teach this,” people whine. It’s easy for people in their twenties to wish that their colleges had offered some personal-finance training. Guess what? Most colleges do offer those classes. You just didn’t attend! I also often hear the cry that “credit-card companies and banks are out to profit off us.” Yes, they are. So stop complaining and learn how to game the companies instead of letting them game you. “I’m afraid of losing money,” some of my friends say. That’s fair, especially after market losses during the global financial crisis, but you need to take a long-term view. Also, you can choose among many different investment options—some aggressive, some conservative— it depends on how much risk you’re willing to take. (Because of inflation, you’re actually losing money every day your money is sitting in a bank account.) Fear is no excuse to do nothing with your money. When others are scared, there are bargains to be found. “What if I don’t know where to get an extra $100 per month?” It doesn’t have to be $100. And you don’t need to earn another penny. I’ll show you how to streamline your existing spending to generate that money to invest. Remember, $1 saved per day is $30 saved per month. Too many of us are paralyzed by the thought that we have to get every single part of our personal finances in order before truly getting started managing our money. Should I use my 401(k) from work or open an IRA? Should I go for mutual funds or individual stocks? Do I need a variable annuity? Here’s my answer: Do you need to be the Iron Chef to cook a grilled-cheese sandwich? No, and once you make your first meal, it’ll be easier to cook the next most complicated thing. The single most important factor to getting rich is getting started, not being the smartest person in the room.” Want the full 6-week program? Get my book here for about $10. Who did I miss? Is there anyone else we should blame? And how come we spend so much time blaming other people, but not doing anything about it?

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The 5 groups to blame for our financial illiteracy

Automation: Add a “Stupid Mistakes” sub-savings account

LivingCheaply — Wed, 21 Apr 2010 05:55:09 +0000

Let me show you how I handle stupid mistakes like traffic tickets in my automation system for personal finances . One of the most common reasons people can’t get ahead is expenses they just didn’t expect. I constantly hear things like this: “I was just about to pay off my credit card debt FOREVER, and then I had to get a new ___ for my ___” “God, I didn’t expect to get that traffic ticket.” “Every time I think I’m getting ahead, my car breaks down or I have to replace some appliance.” These “unpredictable” expenses are very predictable Here’s the trick: A lot of what seems unpredictable is extremely predictable — over the long term. What seems like surprise expenses is actually not a surprise if you analyze your spending for the past 5 years. Which of course nobody does. For example, that “surprise” car repair? It might not happen in the same month, but every year, you might average spending about $400 on car repair. That’s $33/month. Once you know that, set up an automatic deposit into your sub-savings account and you’re done. Keep a “Stupid Mistakes” sub-savings account I keep a sub-savings account called “Stupid Mistakes” in my ING account . I’ll explain some of the other ones later What I use “Stupid Mistakes” for: Traffic tickets Late fees or penalties that I can’t negotiate out of Re-buying things that I lost I save $100/month into it. If there’s anything left at the end of the year, I take out 20% to reward myself, and roll the rest back into my main savings account. Keep a “Stupid Mistakes” sub-savings account. Just the simple fact of having one will sharpen your focus on avoiding the mistakes in the first place. And when you do make a stupid mistake, you’ll be able to use your sub-savings account as a buffer to keep your automation system on track. Get the complete automation system in my book .

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Automation: Add a “Stupid Mistakes” sub-savings account

Clueless friends giving you money advice? Use the STFUDF Technique

cheapo — Thu, 15 Apr 2010 07:07:28 +0000

How many people in your life lecture you about finances, but don’t have their own finances under control? Nothing is more infuriating than someone telling me I’m “ throwing away money on rent ” when they haven’t spend even 2 hours running the numbers. Or someone who proudly proclaims that they found a higher interest rate on a new bank, which is giving them 2%!!! When you politely say, Wow! How much is that worth? they get very very quiet…because (1) they never thought about it, and (2) you know that an extra 1% is only worth $8/month for a $10,000 balance . Or people who bragged about their hot tech stock being up 80%…but then don’t mention it 2 years later when they realize it crashed and they are actually not very good at picking individual investments. I’m guessing that on their idiotic penny-stock-picking website, they probably didn’t learn the two most important words for choosing investments: asset allocation . Introducing the STFUDF Technique So it’s with great pleasure that I introduce the STFUDF Technique. DF stands for Dumb Friends. One of my newsletter subscribers, Chris S., inspired this when he told me how he uses tax refunds strategically. “I get the lecture from just about everyone I know. However, I purposely have my employer take an additional amount out of my paycheck so that I get a bigger refund each year. I know the government gets to use it interest free for a year, but…. I also get a little “bonus” every year to spend on whatever I want. I’ve automated the rest of my finances so I don’t miss the money a bit. And if the government gets to use it for a year…. we’ll call that patriotism. My paycheck gets split between my “bill paying” checking account and my “spend on whatever the fuck you want” account. That way I don’t have to budget. My bills all get paid automatically out of my bill paying account (including automatic contributions to my Roth IRA), and about $50 per month goes into an Orange Savings. So…. whenever I get the lecture, I ask the person how much they’ve contributed to their Roth that year and when they can’t answer me honestly I tell them to STFU. “ * * * 3 important rules for the STFUDF principle First of all, when people give you advice on finances, let’s be honest: They’re probably right. That’s because most people are horrible at finances, so just statistically, you probably are, too. You’re not allowed to use this technique until your finances are reasonably automated and optimized. HOWEVER — since you read this site and have presumably automated your money using my book , chances are you know more than this person. In this case, it’s permissible to implement the STFUDF Technique. Do not simply shout out “STFUDF STFUDF STFUDF” repeatedly. That would be uncouth. Instead, use subtle questions like this: – “That is really interesting advice. So should I think about this first, or my asset allocation?” – “Really? Woah…I never thought of that. What do you think should come first? [Their advice] or maxing out my Roth IRA? (Wait while they make something up, then say this): How come?” – “Nice! So how do you do this AND hit your 401(k) employer match AND your Roth IRA AND stay debt-free? I just don’t think I could do it.” This one is particularly clever as you’re employing a self-admission of inadequacy, which will make your friend writhe in pain since it’s impossible to counter. Use the STFUDF Technique with care. It is powerful.

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Clueless friends giving you money advice? Use the STFUDF Technique

My $100,000 friend

LivingCheaply — Mon, 22 Mar 2010 04:01:00 +0000

Quote of the day: “I had more spending money in college when I was a student working a part-time job.” –A friend who earns over $100,000/year. How does this happen? Factor in the following: Urban living, including going out frequently Expensive apartment Credit card debt from spending on things like going out frequently, shopping, travel Student loans It’s a combination of high fixed costs (think $1k+/month in student loans) plus poor spending habits. But it’s too easy to simply scoff and point fingers. In social psychology, there’s a phenomenon called pluralistic ignorance . The prototypical example is of college students, who almost uniformly believe that their peers drink and have sex more often than they actually do. This causes all kinds of odd attitudinal and behavioral responses, like increased risk taking. The same is true of people, especially high-earners, in credit card debt. After all, if you’re earning six figures in your 20s, you’re “supposed” to know how to manage your money, right? And since you work so hard, don’t you deserve to spend a little on yourself? These are classic scripts employed by high earners in debt. To be blunt, nobody would be surprised by someone making $35,000 who has some credit card debt. But it’s difficult to understand when someone earns over $100,000 (especially when I’ve written that a high income solves most problems ). Spending matters, of course. I have a lot of friends who earn this kind of money in their 20s, and a surprising number of them are in credit card debt. Yes, spending matters. But there are intensely important psychological factors at work for high earners in debt. Since nobody talks about it, none of my friends suspect that some of their other high-income friends are in debt. It’s a terribly secretive and taboo situation.

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My $100,000 friend

Why do so many personal-finance sites focus on spending LESS?

cheapo — Wed, 27 Jan 2010 07:21:49 +0000

I’m in the middle of my private Earn1k course this week before announcing something next week. I was doing a live webcast last night and I was trying to make a point, but I wasn’t sure how to say it. It seems like 98% of personal-finance material (blogs, magazines, books) focus on spending LESS — keeping a budget, saying “no, no, no” to lattes, jeans, and vacations. Why? Why don’t they cover earning more, or negotiating, or increasing your responsibilities at work, or understanding the psychology of your own behavior, or all the other things besides cutting down on spending? I’m trying to formulate 3 crisp answers. So, what do you think? Why is the vast majority of personal-finance material focused on cutting down on spending?

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Why do so many personal-finance sites focus on spending LESS?

7 lies we tell ourselves about money

cheapo — Mon, 21 Dec 2009 07:26:06 +0000

See the 7 lies below — plus a holiday gift at the bottom. 1. “I want to make passive income” I love when people say this because you can tell they have no idea what they’re talking about. It’s kind of like trying to identify people with bad taste: Just go to the local Hometown Buffett. They’re all there. I hate to say it but most of us don’t need to focus on passive income, we need to focus on improving our active income — our jobs. How? By becoming more skilled, solving more problems for our bosses, and basically out-hustling co-workers. A lot of people don’t like to hear this because it means that instead of reaching for some dream of $500/day in passive income, they actually have to do some work right now at their jobs. But your job is the most likely place you can significantly increase your income. Solution : Get better at your job and negotiate your salary. Here’s how: 2. “If I just try harder, I can save more.” This is like a fat man swearing off sugar and delicious Taco Bell. Not even swearing it off, just saying he can swear it off “some day.” The truth is, we all know we need to save money, exercise more, call our family regularly…but there are serious barriers to doing all of these. There is significant research indicating that simply trying harder will not help you get started investing. Solution : Automate your finances so you’re not dependent on your willpower. Personal finance is not about more willpower , including specific details on my automation system for your finances & a 12-minute tactical video The psychology of passive barriers (why we can’t seem to do things we “know” we need to do) 3. “I’m going to start keeping a budget” Do you guys remember when I made fun of stupid frat-boy business ideas , the worst one being when a bunch of dudes get together and decide to start a t-shirt company? This is like that, only for grownups. At some point in our lives, each one of us will get motivated and decide, “Yes! I’m going to track my spending.” This will last about 10 minutes until we realize it’s (1) really hard, (2) we don’t like ourselves when we objectively analyze our spending, and (3) it’s much easier to do nothing than to subject ourselves to the pain of budgeting. In fact, I am going to quote a very wise man on this one: myself. Here, directly from my book , are my thoughts on budgeting: “Create a budget!” is the sort of worthless advice that personal-finance pundits feel good prescribing…Who wants to track their spending? The few people who actually try it find that their budgets completely fail after two days because tracking every penny is overwhelming. Amusingly, in a 2007 survey by bankrate.com, 75 percent of Americans said they have a budget—which is complete nonsense. “There’s probably a lot of wishful thinking in this response,” says Jared Bernstein, director of the Living Standards Program of the Economic Policy Institute. “It’s probably more accurate to say that three-quarters think they should work on a monthly budget.” My kind of man: exposing the delusions of people everywhere!” Solution : Create a Conscious Spending Plan that will let you spend extravagantly on the things you love, as long as you cut costs mercilessly on the things you don’t. Conscious Spending: How my friend spends $21,000/year going out Full Conscious Spending Plan (with specific recommendations on percentages for each category) is available in my book 4. “My friend goes on vacation 4x a year and he makes less than me!” Your friend is either a highly skilled practitioner of Conscious Spending, or an idiot. What’s funny is this becomes more true as you get older, yet we get even more jealous. Think about it: How many times have you heard one of your parents ask the other one, “Why can’t we go on vacation like they do?” without understanding how their spending breaks down? Odds are, they’re not conscious spenders, but rather overspenders. The single-best book on this is the Millionaire Next Door , where we learn surprising facts about the average millionaire: 80% are first-generation affluent, invest 15 of household income, buy used cars, and rarely buy expensive watches or suits. They’re the ordinary neighbors who are saving money instead of spending it on a new Mercedes. Solution : Would you look at a bunch of blue whales for advice on losing weight? Then why would you look at your ordinary friends, who are making ordinary money decisions, and will end up with ordinary results — not having enough money — as role models? Refocus your financial aspirations to people you value and their conscious decisions, not showy displays of wealth from people who are poor role models. If you suspect they can’t afford it, they probably can’t. 5. “I’m different than everyone else…I don’t need to save up for a wedding/kids/car/life insurance” This is also known as, “Ugh, Ramit, I’ve already done all the stuff you’ve told me…now what?” People are delusional about what will happen in the next 10 years. For example, if you’re in your 20s, the next 10 years will bring kids, a new car, a mortgage, taxes, insurance, maintenance, travel, life insurance, medical insurance….etc. Every day I get frustrated people who tell me they’ve implemented all my strategies, yet when I tell them the next step is to implement the Ten Year Savings Strategy — where they save for the most likely things they’ll encounter within ten years — they become oddly dismissive. Why? Because it’s not sexy. They want advanced “tips” and “tactics” to do something cool…even though saving money for the things they will almost certainly need is the most pragmatic thing to do. They actually say things like this (a real comment): “First of all, I’m not getting married. No, this isn’t just the talk of someone who can’t see far enough into the future. We all know the only benefit of getting married is in avoiding divorce.” Solution : If you think you’ve already optimized your finances 100%, use my Ten Year Savings Strategy and ask a few people 10 years older than you what they wish they’d saved for. Then do it. Oh yeah, and if you’re “sure” you’re not going to have kids or get married because it always ends in divorce, just go hang out with your 14-year-old friends and come back here in 10 years. The Ten Year Savings Strategy: Saving money after you’ve already handled the basics Why do delusional people think their spending will be different than other people’s? 6. “I’m going to invest in stocks” I am getting so mad typing this that I don’t even know where to start. First of all, let me acknowledge that fewer than 5% of people will probably ever say this, since most people don’t invest at all, then turn 40 and get scared, call their HR rep, set up some kind of mis-allocated 401(k) plan, and then go on their merry way whistling and eating walnuts. So if you’re thinking about this, it’s actually a good thing — it means you’re probably thinking about investing far sooner than others. Unfortunately, “investing” does not mean picking stocks. It also does not mean buying a house , but that’s another story. Even the fanciest portfolio managers fail to beat the market most of the time, which is why I argue for target-date funds, where you simply pick a fund determined by your age, set up automated payments, and get on with your life. It’s also critically important to note that your asset allocation is more important than the individual investments you make. Think about it like this: If you write a book, your Table of Contents is more important than any individual word you write. Yet people obsess about the words instead of spending the bulk of their time on the TOC. Solution : Stop trying to pick stocks. Instead, automate your investments with target-date funds or, if you really want to control your investments, a group of low-cost index funds. Behavioral psychology/economics on why you are not a good stock-picker Full chapter on why investment “experts” are overrated and hilariously wrong in my book, along with another chapter on specific ways to automate your investments with sensible, long-term investments 7. “Money is just for greedy people…I don’t need to worry about this stuff” No it’s not. This is the excuse of lazy people who don’t want to spend a weekend learning about money, but instead worry and complain about it for the rest of their lives. I’ve said it since this site came out: “Rich” isn’t just about money, it’s living a rich life, whether it’s buying nice clothes, traveling around the world, spending extravagantly on your hobbies , or spending as much time with your friends/family as possible. But part of that is money. If you haven’t optimized your money — whether you earn $35,000 or $350,000 per year — it doesn’t mean you’ve taken a principled stand against consumerism. It means you’re lazy. Solution : Take one weekend to learn about your personal finances. Once you automate your money, you’ll never worry about it again. Automate your money Some of my favorite books on money My Scrooge Strategy premium tips , which will save you hundreds of dollars per year * * * Save hundreds and get a last-minute holiday gift . I’ve recently added new premium tips to The Scrooge Strategy to help you save money, including: How to save $940 on domestic flights Using cognitive dissonance to force yourself to save money, Specific phone calls to make once/year to save hundreds …and lots more. Sign up for a 1-month free trial at The Scrooge Strategy . Once-a-year gift : Sign up by December 24th, 2009, and you’ll get a free gift Scrooge Strategy subscription to give to a friend, including proven tips to save, earn more, and optimize spending on day-to-day purchases. Sign up for Scrooge Strategy You’ll receive an email with instructions on adding a complimentary subscription for a friend. As long as you’re a member, they’ll stay a complimentary member. They’ll receive their subscription on Christmas day.

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7 lies we tell ourselves about money

Why do immigrants save so much more money than you?

cheapo — Mon, 07 Dec 2009 02:36:22 +0000

Why has “Raj,” an immigrant who’s lived in the USA for 10 years, saved $150,000 in cash, while few of us born here would ever be able to do the same? I’m fascinated with the differences in how people around the world spend and save money. Having grown up around a lot of immigrants, I can tell you that their spending patterns are wildly different than people who were born and raised in America. I was reminded of this a few days ago, when I got this email from an immigrant — let’s call him “Raj” — who’s been in the USA for 10 years. “I live here in Fremont now and I have about $150K with me in my bank, most of it stored away like that for more than 1 year now because I needed it to buy a house. Now I have stopped thinking hard about the house, since I still dont know where I will settle down, especially after reading your book to avoid buying a house as an investment. I have started diverting most of the money to LifeCycle funds and I also opened an IRA. In my case , as a Immigrant I still send a lot of money to India where somehow I have good contacts and usually earn much much more than 8% on my money. That is a strong reason I never bothered to learn about investing here. But now I am diversifying and investing both in the US and in India.” This is extremely common, especially in the Bay Area: You get a single, highly skilled guy who moves from India to a well-paying job in the US. He works his ass off, lives in a small apartment, and sends some of his income back to his family in India. In a few years, he’s saved well into the 6 figures, at which point he either (1) goes back to India to find a bride and returns to continue working, or, less commonly, (2) moves back to India with a nice bit of cash. This got me thinking. Why do immigrants save so much? A few easy reasons come to mind: They’re more educated (see the Wikipedia entry on Indian Americans ) They earn more (another Wikipedia link ) Their culture encourages higher savings rates (see this Atlantic Monthly article ). Culture is also why some immigrants are stereotyped as being poor tippers…which is often very true. I’m especially interested in the cultural factors that affect financial habits. Here’s a fascinating one I didn’t know about from University of Michigan Retirement Research Center (PDF link). Data from the EBRI Retirement Confidence Survey indicate that Hispanic-Americans who immigrate to the U.S. exhibit different savings behavior than other Americans. They tend to save more for short-term goals such as education or a home purchase rather than retirement, and are extremely risk avers e, placing greater importance on safety than rate of return on investments, relative to others (Kamasaki and Arce, 2000). In addition, they are more than twice as likely as natives to have provided financial assistance to family members (both in and out of the U.S.) and they are more likely to expect their retirement years to be financed by income of other family members (Kamasaki and Arce, 2000)…for many households these intergenerational transfers may be a major component of retirement saving and planning . If you can’t understand those words, please go find an immigrant and ask him to translate for you. I’m sure there are several other reasons that are far more complex. We’ve read the New York Times article on how obesity can be contagious , and I’ve long since argued that personal-finance behaviors are contagious, too — suggesting that maybe you should spend time around immigrants so their financial habits rub off. In your experience, how do spending patterns differ between immigrants and (native) Americans? Personally, I remember growing up and taking roadtrips to LA. With six of us, lunch at even a fast-food place would be expensive, so my mom packed lunch and we’d stop somewhere to eat it. We never had a summer home — the whole concept was foreign to us. We never had the most fashionable clothes, but my parents would spend a LOT of money on activities for my siblings and me, and didn’t bat an eye at an SAT prep course that cost thousands of dollars. Like I said, immigrants have incredibly different spending patterns than most of us. What’s your best example of the difference in financial behavior between immigrants and (native) Americans?

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Why do immigrants save so much more money than you?