Two recent posts, one on Christian Personal Finance, the other on Consumerism Commentary, discuss ethical, or as it is known in the trade, socially responsible investing. For those of you blissfully unaware, this is the notion that when investing your money you avoid companies that do things you think are morally reprehensible.
Back when I was just starting out in the investment world I had some involvement in socially responsible investing. I worked for a large institutional money manager. Our clients were pension funds, endowments, and the like and each one had its own account, sort of like a mutual fund with only one shareholder. We had hundreds of them and almost all were perfectly identical, holding the same stocks in exactly the same proportions.
The non-identical ones had "client restrictions." Most of those were prohibitions against investing in certain industries to which the client, often on religious grounds, objected. I remember we had several accounts associated with the Catholic Church. They prohibited investments in any company even vaguely involved in abortion and in, for reasons I cannot recall, for-profit hospitals. We also had a few accounts associated with the Lutherans, who prohibited us from putting their money in companies that made alcoholic beverages or were involved in gambling. They were fine with abortion and hospitals, just as the Catholics were indifferent to booze and gambling. Another set of accounts prohibited arms makers and we had several different levels of prohibitions against tobacco.
It was an administrative mess and my job (well, a small part of my job) was to simplify and automate things so that the portfolio managers would not have to spend time adjusting each account to accommodate the restrictions. I built a clever system that boiled down to finding a second-choice stock in a similarish business to substitute for a forbidden stock. So, to cite the only example I can remember, when most of the accounts bought cigarette maker Phillip Morris, the no-tobacco accounts got McDonald's instead.
This was working well for some time when some genius in the marketing department discovered that not only did the restricted accounts have somewhat different returns than the normal account, but that on average they consistently did worse. He called me in a huff and I very patiently explained to him that of course they underperformed. They were supposed to. The normal accounts had the portfolio managers best picks in them. The restricted accounts not so much. Restrictions can only cost you money.
With utmost respect to the moral values of others, I personally think that ethical investing is bogus. To begin with, I have a lot of problems with the idea that one degree of separation from evil is evil but that two degrees of separation is okay. Investing in a company that pollutes is bad, but investing in companies that make money with the electricity made by the polluter is okay? And if it is, why isn't investing in a mutual fund that then invests in a polluter okay? Wherever the line gets drawn it is arbitrary. We have one big global economy and cleanly excising out the dirty money is not an option.
I am also very uncomfortable with the idea that by investing in a company I am necessarily endorsing everything the company does. I own some Treasury bonds. Does that mean that I endorse everything the Federal Government does? I really hope not.
That said, if you want to invest ethically, as you personally define it, go right ahead. It's your money and what makes capitalism work is that only you get to decide where it goes. But keep in mind that you are making a sacrifice. Your moral high ground will, over time, cost you money as you pass up unethical but profitable opportunities.
Saturday, January 31, 2009
Friday, January 30, 2009
Frugal Friday 1/30
Ah, Friday again. Instead of coming up with my own content, today I pass along the very best of the many frugality tips from the past week or so in the blogosphere.
Free Money Finance has a follow-up on their controversial post from last week, Can You Pay for a Costco Membership by Eating Free Samples? This one has tips on maximizing the free samples you get on each visit. Oddly, the author says that he "debated whether or not to publish this post or not." Apparently, he worries that "it's a bit over-the-line" because, according to him, "there should be a limit to what we're willing to do to save money." I guess it takes all kinds.
And as if the frugal world needed more controversy, Living Almost Large asks if it is more frugal to take home half your restaurant meal to eat the next day, or to split that meal between two people at the restaurant. I'm not sure that this sort of debate can ever have a resolution, but it is important to provide a forum for a free and open discussion of these issues.
There is an insightful post on How I Save Money. It is #8 in a series on ways to save money on your wedding. I haven't read the others, but this one suggests not feeding your guests so much food. The author makes clear that although she has no plans to get married, she does read bridal magazines, looking for ways to save money on a wedding. And that is not weird at all.
The group blog Queercents (The subtitle really is "We're here, we're queer, and we're not going shopping without coupons." I could never make that up.) has a post on making homemade deodorant. The results are mixed, and at $6 a stick not really a money saver, but it is more than worthwhile because of the stereotypes it shatters. I thought gay people were much more particular about personal grooming.
Real Life gives a whole list of ways to save money on groceries. The one that you haven't seen before is to save money on beef by getting together with a few other families and buying a whole cow from a farmer. Another list of tips comes from Debt Reduction Formula. He suggests saving on toiletries by shaving only once a week and ceasing to clean your ears altogether.
But this week's winner for the best new way to save money is from Money and Values, which provides a link where you can download a printer font that is designed to use up to 20% less ink. I am such an idiot for not thinking of this myself. But why stop there? The truly frugal could save money by using shorter words. Also, why not avoid letters with big "ink footprints" such as w, e, and k, and favor eco-friendly ones like i, c, and l?
And in these times of economic and ecological stress, I think we should all do our bit by saving ink that otherwise would have gone to non-essential printing. In the UK, Birmingham City Council has voted to drop apostrophes from traffic signs. Even that small step, supported by a grassroots anti-apostrophe movement, was bitterly opposed by pro-ink pressure groups such as The Apostrophe Protection Society. Of course, in a nation where they spell color as "colour" change will come slowly. Here at home, with the new beginning of hope and change in Washington, isn't it time that our nation's leaders stepped up and endorsed spelling simplification and the widespread adoption of texting abbreviations in standard written English?
b/c if u cn rd ths, u cn sav $. ;)
Free Money Finance has a follow-up on their controversial post from last week, Can You Pay for a Costco Membership by Eating Free Samples? This one has tips on maximizing the free samples you get on each visit. Oddly, the author says that he "debated whether or not to publish this post or not." Apparently, he worries that "it's a bit over-the-line" because, according to him, "there should be a limit to what we're willing to do to save money." I guess it takes all kinds.
And as if the frugal world needed more controversy, Living Almost Large asks if it is more frugal to take home half your restaurant meal to eat the next day, or to split that meal between two people at the restaurant. I'm not sure that this sort of debate can ever have a resolution, but it is important to provide a forum for a free and open discussion of these issues.
There is an insightful post on How I Save Money. It is #8 in a series on ways to save money on your wedding. I haven't read the others, but this one suggests not feeding your guests so much food. The author makes clear that although she has no plans to get married, she does read bridal magazines, looking for ways to save money on a wedding. And that is not weird at all.
The group blog Queercents (The subtitle really is "We're here, we're queer, and we're not going shopping without coupons." I could never make that up.) has a post on making homemade deodorant. The results are mixed, and at $6 a stick not really a money saver, but it is more than worthwhile because of the stereotypes it shatters. I thought gay people were much more particular about personal grooming.
Real Life gives a whole list of ways to save money on groceries. The one that you haven't seen before is to save money on beef by getting together with a few other families and buying a whole cow from a farmer. Another list of tips comes from Debt Reduction Formula. He suggests saving on toiletries by shaving only once a week and ceasing to clean your ears altogether.
But this week's winner for the best new way to save money is from Money and Values, which provides a link where you can download a printer font that is designed to use up to 20% less ink. I am such an idiot for not thinking of this myself. But why stop there? The truly frugal could save money by using shorter words. Also, why not avoid letters with big "ink footprints" such as w, e, and k, and favor eco-friendly ones like i, c, and l?
And in these times of economic and ecological stress, I think we should all do our bit by saving ink that otherwise would have gone to non-essential printing. In the UK, Birmingham City Council has voted to drop apostrophes from traffic signs. Even that small step, supported by a grassroots anti-apostrophe movement, was bitterly opposed by pro-ink pressure groups such as The Apostrophe Protection Society. Of course, in a nation where they spell color as "colour" change will come slowly. Here at home, with the new beginning of hope and change in Washington, isn't it time that our nation's leaders stepped up and endorsed spelling simplification and the widespread adoption of texting abbreviations in standard written English?
b/c if u cn rd ths, u cn sav $. ;)
Thursday, January 29, 2009
How Much is $887 Billion, Really?
Several blogs (Such as this one, this one, and this one) have attempted recently to put the orgy of pork-barrel spending known as the stimulus package into perspective by explaining just how much $887,000,000,000 is in practical terms. The consensus winner seems to be that it's about $3000 per American. That's not bad as illustrations go, and does have some practical merit, as each American will owe that much more as their personal share of the national debt, but I think that as bloggers we need to do better.
How much is $887 Billion? It's $12,770 per Obama voter. It's every American's mobile phone bill for the next five years. It's 4.2 million new houses at last month's average selling price. (That's enough to give one to every family in Arizona, which, come to think of it, is awfully similar to how we got into this mess to begin with.) It's more than the total value of all US currency in circulation.
Those things are all true, but they lack a certain visual element. Try this one. If it were printed in one dollar bills, $887 Billion would be enough to cover the total land area of Rhode Island, Delaware, and New York City combined. Or, if you prefer, it could cover New York in tens. Or Manhattan in hundreds.
Unfortunately, dollar bills don't make a very practical floor/land covering, and at $9.60 a square foot for the ones, it's kinda steep. Lowe's has some decent looking vinyl tile at $1.08 each. It's much more durable, and at that price for $887 Billion we can cover South Carolina.
If covering up states doesn't help you feel how much money we are talking about, let me try and put it in terms of something you might buy. 8GB iPod Nanos go for $134 at Amazon. So the stimulus package is equivalent to ordering 6,619,402,985 of them. (Don't forget to click on free super-saver shipping.) At a shipping weight of 1 lb. each, and assuming an average weight of 177 lbs per person, that's more than enough to give every resident of California their weight in iPods.
Of course, iPods are relatively durable items. What about in terms of something that gets consumed by you, the average American? My local on-line grocery delivery service will sell me a 24 oz. jar of Chi-Chi's Fiesta Salsa Thick and Chunky Medium for $4.19. So the stimulus package is equivalent to 39.7 billion gallons of the stuff. And what could we do with it? Well, this is only a suggestion, but to stem the tide of illegal immigration from Mexico, we could dig a trench 4 meters deep and 10 meters wide along the entire 1,969 mile US-Mexico border and fill it with salsa. Because there is nothing that would repel an actual Mexican more than Chi-Chi's Fiesta Thick and Chunky Medium salsa.
But maybe this is all too impractical for you. How about something useful? For example, a 2009 Mercedes SLK55 AMG convertible? It's got a 355hp V-8 that will take it 0-60 in 4.9 seconds. We could buy one for every one of the 14.3 million college and grad students in the US. Or all the men divorced in the last ten years.
So now you know.
How much is $887 Billion? It's $12,770 per Obama voter. It's every American's mobile phone bill for the next five years. It's 4.2 million new houses at last month's average selling price. (That's enough to give one to every family in Arizona, which, come to think of it, is awfully similar to how we got into this mess to begin with.) It's more than the total value of all US currency in circulation.
Those things are all true, but they lack a certain visual element. Try this one. If it were printed in one dollar bills, $887 Billion would be enough to cover the total land area of Rhode Island, Delaware, and New York City combined. Or, if you prefer, it could cover New York in tens. Or Manhattan in hundreds.
Unfortunately, dollar bills don't make a very practical floor/land covering, and at $9.60 a square foot for the ones, it's kinda steep. Lowe's has some decent looking vinyl tile at $1.08 each. It's much more durable, and at that price for $887 Billion we can cover South Carolina.
If covering up states doesn't help you feel how much money we are talking about, let me try and put it in terms of something you might buy. 8GB iPod Nanos go for $134 at Amazon. So the stimulus package is equivalent to ordering 6,619,402,985 of them. (Don't forget to click on free super-saver shipping.) At a shipping weight of 1 lb. each, and assuming an average weight of 177 lbs per person, that's more than enough to give every resident of California their weight in iPods.
Of course, iPods are relatively durable items. What about in terms of something that gets consumed by you, the average American? My local on-line grocery delivery service will sell me a 24 oz. jar of Chi-Chi's Fiesta Salsa Thick and Chunky Medium for $4.19. So the stimulus package is equivalent to 39.7 billion gallons of the stuff. And what could we do with it? Well, this is only a suggestion, but to stem the tide of illegal immigration from Mexico, we could dig a trench 4 meters deep and 10 meters wide along the entire 1,969 mile US-Mexico border and fill it with salsa. Because there is nothing that would repel an actual Mexican more than Chi-Chi's Fiesta Thick and Chunky Medium salsa.
But maybe this is all too impractical for you. How about something useful? For example, a 2009 Mercedes SLK55 AMG convertible? It's got a 355hp V-8 that will take it 0-60 in 4.9 seconds. We could buy one for every one of the 14.3 million college and grad students in the US. Or all the men divorced in the last ten years.
So now you know.
Wednesday, January 28, 2009
Inflation, Deflation, and You
Every day, people come up to me and say things like:
Frank, what are these inflation and deflation things that I keep hearing about? Are they something I will enjoy? Do I need any special skills to participate?
Inflation is when the prices of everything go up. Put another way, it is when the value of money, US dollars for example, goes down, so it takes more of it to buy the same old stuff. Deflation is the opposite, when prices go down and the value of money goes up.
That sounds like fun for the whole family! What causes inflation and deflation? Are they something I can make at home?
Folks (by which I mean economics professors) used to think that inflation/deflation was caused by changes in things like the level of production and unemployment. Currently, the consensus is that it is a "monetary phenomenon" which means that it is really all about money itself. Inflation is caused by one of two things: an increase in the supply of money in the economy or an increase in the "velocity" of money, how fast it is changing hands in the economy. Deflation is the opposite, caused by a drop in the money supply and/or a fall in the velocity.
The money supply is what people usually watch to predict inflation/deflation because velocity is pretty constant over time. It really only drops in very extreme circumstances, such as the early 1930s and right now.
That sounds awesome. How can I spot inflation or deflation myself? What are some of the exciting things that will happen to me because of it?
Spotting inflation/deflation is easy. Look for prices of the things you buy to go up/down.
Under inflation, what will probably most concern you is that although the prices you pay have gone up, what you get paid may not go up as quickly.
In the long-run, the more significant effect is on the value of dollar-denominated assets you own and debts you owe. Since the value of dollars is decreasing, the value of bank deposits you have and bonds you own will decrease, possibly faster than the interest paid is growing them. On the other hand, the value of your debt also goes down in the same way. In principle, the value of "real" assets, such as your house and shares of stock in companies, do not decline under inflation. In practice, this is not so easy to see because periods of inflation are also often bad times for the economy so the value of assets tends to go down.
Deflation is similar but worse. You will notice things getting cheaper and the amount you get paid may not immediately go down, which will be fun while it lasts. But it is hard for companies to cut salaries. The last time we had meaningful deflation, at the start of the Great Depression, instead of cutting everybody's salary companies laid off some people and stopped hiring. If you were one of the lucky who still had a job, then things were fairly good since you could buy more with your salary. If you were one of the one third of Americans out of work, things were not good.
The same effect on dollar denominated assets happens under deflation as inflation, but backwards. The value of your bank deposits and bonds increases, but so does the value of your debts. If you have money in the bank you should be rooting for deflation, if you owe money you should be rooting for inflation.
They both sound like a blast. Is there a reason to pick one over the other?
Go with inflation. Deflation has really nasty effects on the economy. If the value of your dollars is increasing every day, you have less incentive to spend or invest them. And if today's dollars are worth a lot less than the dollars of a few years from now, borrowing money becomes expensive, even at zero percent interest. This can lead to a vicious spiral, with people hoarding money because of deflation, which causes a drop in velocity, which causes more deflation.
Okay, I'm ready to play. What should I expect first, inflation or deflation?
For the moment, we appear to be in a period of deflation. The fiasco in the financial system has caused a lot of people and companies in the economy to hold on to their cash, which has greatly reduced the velocity of money. But the Fed and the government have made it clear that they will go to whatever extremes necessary to keep deflation from setting in for long. Fed Chairman Bernanke has hinted that if he has to he will fly over cities in helicopters dropping cash. Bernanke believes that the Fed caused the Great Depression by not increasing the money supply when it should have (in fact it decreased it) and he has made it his life's mission that that particular debacle not be repeated.
The medium- and long-term effect of the massive increase in the money supply now under way should be obvious. Velocity will stabilize and/or rise and we will get inflation. Lots of it. Inflation is good news for debtors, those that owe dollar-denominated debts. And who is the largest dollar-denominated debtor in the world? Not at all coincidentally, the US Federal Government. Runner up are American homeowners, who could use a break.
Frank, what are these inflation and deflation things that I keep hearing about? Are they something I will enjoy? Do I need any special skills to participate?
Inflation is when the prices of everything go up. Put another way, it is when the value of money, US dollars for example, goes down, so it takes more of it to buy the same old stuff. Deflation is the opposite, when prices go down and the value of money goes up.
That sounds like fun for the whole family! What causes inflation and deflation? Are they something I can make at home?
Folks (by which I mean economics professors) used to think that inflation/deflation was caused by changes in things like the level of production and unemployment. Currently, the consensus is that it is a "monetary phenomenon" which means that it is really all about money itself. Inflation is caused by one of two things: an increase in the supply of money in the economy or an increase in the "velocity" of money, how fast it is changing hands in the economy. Deflation is the opposite, caused by a drop in the money supply and/or a fall in the velocity.
The money supply is what people usually watch to predict inflation/deflation because velocity is pretty constant over time. It really only drops in very extreme circumstances, such as the early 1930s and right now.
That sounds awesome. How can I spot inflation or deflation myself? What are some of the exciting things that will happen to me because of it?
Spotting inflation/deflation is easy. Look for prices of the things you buy to go up/down.
Under inflation, what will probably most concern you is that although the prices you pay have gone up, what you get paid may not go up as quickly.
In the long-run, the more significant effect is on the value of dollar-denominated assets you own and debts you owe. Since the value of dollars is decreasing, the value of bank deposits you have and bonds you own will decrease, possibly faster than the interest paid is growing them. On the other hand, the value of your debt also goes down in the same way. In principle, the value of "real" assets, such as your house and shares of stock in companies, do not decline under inflation. In practice, this is not so easy to see because periods of inflation are also often bad times for the economy so the value of assets tends to go down.
Deflation is similar but worse. You will notice things getting cheaper and the amount you get paid may not immediately go down, which will be fun while it lasts. But it is hard for companies to cut salaries. The last time we had meaningful deflation, at the start of the Great Depression, instead of cutting everybody's salary companies laid off some people and stopped hiring. If you were one of the lucky who still had a job, then things were fairly good since you could buy more with your salary. If you were one of the one third of Americans out of work, things were not good.
The same effect on dollar denominated assets happens under deflation as inflation, but backwards. The value of your bank deposits and bonds increases, but so does the value of your debts. If you have money in the bank you should be rooting for deflation, if you owe money you should be rooting for inflation.
They both sound like a blast. Is there a reason to pick one over the other?
Go with inflation. Deflation has really nasty effects on the economy. If the value of your dollars is increasing every day, you have less incentive to spend or invest them. And if today's dollars are worth a lot less than the dollars of a few years from now, borrowing money becomes expensive, even at zero percent interest. This can lead to a vicious spiral, with people hoarding money because of deflation, which causes a drop in velocity, which causes more deflation.
Okay, I'm ready to play. What should I expect first, inflation or deflation?
For the moment, we appear to be in a period of deflation. The fiasco in the financial system has caused a lot of people and companies in the economy to hold on to their cash, which has greatly reduced the velocity of money. But the Fed and the government have made it clear that they will go to whatever extremes necessary to keep deflation from setting in for long. Fed Chairman Bernanke has hinted that if he has to he will fly over cities in helicopters dropping cash. Bernanke believes that the Fed caused the Great Depression by not increasing the money supply when it should have (in fact it decreased it) and he has made it his life's mission that that particular debacle not be repeated.
The medium- and long-term effect of the massive increase in the money supply now under way should be obvious. Velocity will stabilize and/or rise and we will get inflation. Lots of it. Inflation is good news for debtors, those that owe dollar-denominated debts. And who is the largest dollar-denominated debtor in the world? Not at all coincidentally, the US Federal Government. Runner up are American homeowners, who could use a break.
Tuesday, January 27, 2009
Getting Rich and Losing Weight
There's a post today on WiseBread entitled "6 Ways that Dieting and Budgeting are Exactly the Same." This money-food analogy is remarkably common. It's in the title of the blog. Several personal finance books (e.g. Dave Ramsey's Total Money Makeover) are openly modelled on weight-loss books. And there's that old quip that you can't be too rich or too thin. (Which, let us remember, was once meant as a joke.)
To an extent, it is a valid analogy. A generic instruction for losing weight might be "Eat less, exercise more" which could easily be translated into "Spend less, earn more." Neither is likely to inspire a fat/poor person, but the inescapable underlying truth is there in both cases.
That said, the analogy is far from perfect and can lead to some unfortunate money behaviors.
The biggest difference between dieting and increasing wealth is that successful dieting comes from winning most, but not all, of many small battles, and successful personal financial management comes from winning a few big ones.
If you fall off the wagon one afternoon and have a big meal, you may feel terrible about it but it's still only one meal. It will not sink your weight-loss program. The goal is to keep from eating big meals almost all the time. On the other hand, if you succumb to temptation and buy that hot new convertible instead of the used sedan that you went into the dealership to look at, you really have done damage to your get-rich program. You can maintain a frugal lifestyle for a very long time and still not make up for one big financial sin.
The other big difference is that eating is a biological imperative. When you are hungry, your body creates hormones that have a physical effect on your brain and your judgement. You may feel that you desire the latest iPod in the same irrational way as you wanted that slice of pie, but it's really not the same thing.
Both of these differences, if ignored, can lead to serious problems. Living a frugal lifestyle but then making mistakes in the handful of financial decisions that really count is a tragic waste of effort. (Although you do get to feel good about yourself as you wash your Hummer with bucket and hose instead of taking it to the car wash.) And treating spending as an uncontrollable compulsion just makes the problem worse. The truth is that not spending is not exactly like not eating. It's easier.
To an extent, it is a valid analogy. A generic instruction for losing weight might be "Eat less, exercise more" which could easily be translated into "Spend less, earn more." Neither is likely to inspire a fat/poor person, but the inescapable underlying truth is there in both cases.
That said, the analogy is far from perfect and can lead to some unfortunate money behaviors.
The biggest difference between dieting and increasing wealth is that successful dieting comes from winning most, but not all, of many small battles, and successful personal financial management comes from winning a few big ones.
If you fall off the wagon one afternoon and have a big meal, you may feel terrible about it but it's still only one meal. It will not sink your weight-loss program. The goal is to keep from eating big meals almost all the time. On the other hand, if you succumb to temptation and buy that hot new convertible instead of the used sedan that you went into the dealership to look at, you really have done damage to your get-rich program. You can maintain a frugal lifestyle for a very long time and still not make up for one big financial sin.
The other big difference is that eating is a biological imperative. When you are hungry, your body creates hormones that have a physical effect on your brain and your judgement. You may feel that you desire the latest iPod in the same irrational way as you wanted that slice of pie, but it's really not the same thing.
Both of these differences, if ignored, can lead to serious problems. Living a frugal lifestyle but then making mistakes in the handful of financial decisions that really count is a tragic waste of effort. (Although you do get to feel good about yourself as you wash your Hummer with bucket and hose instead of taking it to the car wash.) And treating spending as an uncontrollable compulsion just makes the problem worse. The truth is that not spending is not exactly like not eating. It's easier.
Sunday, January 25, 2009
Lightbulbs and Lattes
Sometimes we confuse the number of visible acts we make working at something with the progress we actually make towards our goal. Let me explain what I mean with a story about what our leaders in Washington have been up to.
Did you know that Congress voted to ban the familiar incandescent light bulb? More than a year ago? It's true. Starting in 2012, no more 100 watt bulbs and by 2014 none of any wattage. Clever of them to pass something that doesn't take effect for 5+ years. The small number of folks who really care are happy, and everybody else won't even notice until after what must seem like an eternity to the guys inside the beltway.
And people will notice. Although the law does not, strictly speaking, ban the incandescent bulb, it only mandates energy efficiency standards that amount to a ban, the bottom line is that consumers will have to replace the familiar old bulbs with compact fluorescents. And earnest green hype aside, CFLs are not the same. The light they give off is a little bluer, they cost about six times as much (twenty times as much if you want to use a dimmer switch) won't fit in all existing fixtures, and, let's face it, look dumb. Oh, and also they contain mercury so are bona fide toxic waste. Not only can't you recycle them, putting them in the trash is illegal in many places.
So what's the benefit for this inconvenience? Why, we reduce greenhouse gas emissions, of course! By how much, you ask? Good question. For that I will have to do actual research, as none of the news articles seem to cover that. According to the EPA, burning fossil fuels to generate electricity accounts for 38.9% of CO2 emissions in the US. And according to the Energy Information Administration (which is a real government agency, even though it sounds like I made it up) residential use of electricity is 37% of the total, so 14.4% of CO2 is due to the electricity we use in our houses. And how much of electricity used at home is for lighting? Only 8.8%. To put that in perspective, 13.7% goes to the kitchen refrigerator. 3.5% is for stand-alone freezers. The total percentage of our national CO2 output due to household lighting is 1.27%.
And how much of this 1.27% will we eliminate by doing away with Edison's greatest work? That's not so clear. But let's get real, even cutting it in half isn't going to move the CO2 needle much. Banning stand-alone freezers would probably be just as effective and much less annoying. There is even the argument to be made, which I don't buy, that switching to CFL will not reduce CO2 emissions at all because CFLs don't give off heat, so people will burn more oil and gas heating their houses.
This is bad policy. Even if you accept that looking to take out CO2 from the 14.4% of it that goes to household electricity makes sense, then looking at the 8.8% of that that goes to lighting is nuts. So when this law kicks in people will rise up and protest and force its repeal? I doubt it. Most people really like the idea of saving the planet and the fact that this particular way is a little bit of a sacrifice just makes it that more attractive. The best part is that it is so everyday. You get to remind yourself that you are saving the planet every time you see that funny looking bulb in your living room.
What this has to do with personal finance is that it is exactly the same dynamic as the idea that you can save your way into wealth by giving up a minor daily expense or two. Give up the lattes at Starbucks and you will be rich when you retire. The fact that the math doesn't really work doesn't stop millions of people from embracing the principle. Its attraction isn't so much that you save money but that it's something tangible that you can do starting tomorrow and everyday. As with the light bulbs, it is as if progress towards the actual goal is less important than maximizing the number of noticeable acts in the right direction.
Meanwhile, I'm buying light bulbs to stash in my basement. Look for them on eBay in 2014.
Did you know that Congress voted to ban the familiar incandescent light bulb? More than a year ago? It's true. Starting in 2012, no more 100 watt bulbs and by 2014 none of any wattage. Clever of them to pass something that doesn't take effect for 5+ years. The small number of folks who really care are happy, and everybody else won't even notice until after what must seem like an eternity to the guys inside the beltway.
And people will notice. Although the law does not, strictly speaking, ban the incandescent bulb, it only mandates energy efficiency standards that amount to a ban, the bottom line is that consumers will have to replace the familiar old bulbs with compact fluorescents. And earnest green hype aside, CFLs are not the same. The light they give off is a little bluer, they cost about six times as much (twenty times as much if you want to use a dimmer switch) won't fit in all existing fixtures, and, let's face it, look dumb. Oh, and also they contain mercury so are bona fide toxic waste. Not only can't you recycle them, putting them in the trash is illegal in many places.
So what's the benefit for this inconvenience? Why, we reduce greenhouse gas emissions, of course! By how much, you ask? Good question. For that I will have to do actual research, as none of the news articles seem to cover that. According to the EPA, burning fossil fuels to generate electricity accounts for 38.9% of CO2 emissions in the US. And according to the Energy Information Administration (which is a real government agency, even though it sounds like I made it up) residential use of electricity is 37% of the total, so 14.4% of CO2 is due to the electricity we use in our houses. And how much of electricity used at home is for lighting? Only 8.8%. To put that in perspective, 13.7% goes to the kitchen refrigerator. 3.5% is for stand-alone freezers. The total percentage of our national CO2 output due to household lighting is 1.27%.
And how much of this 1.27% will we eliminate by doing away with Edison's greatest work? That's not so clear. But let's get real, even cutting it in half isn't going to move the CO2 needle much. Banning stand-alone freezers would probably be just as effective and much less annoying. There is even the argument to be made, which I don't buy, that switching to CFL will not reduce CO2 emissions at all because CFLs don't give off heat, so people will burn more oil and gas heating their houses.
This is bad policy. Even if you accept that looking to take out CO2 from the 14.4% of it that goes to household electricity makes sense, then looking at the 8.8% of that that goes to lighting is nuts. So when this law kicks in people will rise up and protest and force its repeal? I doubt it. Most people really like the idea of saving the planet and the fact that this particular way is a little bit of a sacrifice just makes it that more attractive. The best part is that it is so everyday. You get to remind yourself that you are saving the planet every time you see that funny looking bulb in your living room.
What this has to do with personal finance is that it is exactly the same dynamic as the idea that you can save your way into wealth by giving up a minor daily expense or two. Give up the lattes at Starbucks and you will be rich when you retire. The fact that the math doesn't really work doesn't stop millions of people from embracing the principle. Its attraction isn't so much that you save money but that it's something tangible that you can do starting tomorrow and everyday. As with the light bulbs, it is as if progress towards the actual goal is less important than maximizing the number of noticeable acts in the right direction.
Meanwhile, I'm buying light bulbs to stash in my basement. Look for them on eBay in 2014.
Saturday, January 24, 2009
Predicting Stock Market Returns
Amongst the nice things about blogging is that you get to write your own headlines. I imagine that Jason Zweig isn't all that happy with his editor's "hed" for his column today in the Wall Street Journal. It reads "Why Market Forecasts Keep Missing the Mark." I was a little disappointed, but not really surprised, to find that the column doesn't really address that good question at all.
So I will try. How hard could it be?
Market forecasts, such as "the Dow will be up 14% in 2009" are doomed to failure because the market is impossible to forecast.
That was easy.
Some things are forecastable. The weather, for example. Or how many votes a candidate will get in an election. You can look at certain data, do a little math, account for a special factor or two, and presto, a useful estimate of the near future.
But for other things you really can't create a useful estimate. The score in the next Super Bowl. The next roll of the dice. It is not that you are stupid or lack data. And it is not that you don't understand what is going on. You can say some useful things about these unforecastable future events. The Steelers are heavily favored. Seven is the most likely dice roll, and fourteen just ain't gonna happen. But these are not predictions, they are statements about likelihoods and probabilities.
So it is with the stock market. (And for that matter, the bond market, commodity markets, etc.) Occasionally somebody will throw out a prediction like "the Dow will be up 14%" but nobody, the speaker included, expects it to be taken very seriously.
Sober predictions about the stock market are really estimates of the so-called expected outcome, the probability weighted average of all possible outcomes. E.g. seven is the expected outcome of a roll of two dice. The most common way to come up with an expected outcome for a year in the stock market is to average historical performance. Depending on which years are used, and which indexes, the answer is usually something like 10-12%.
So a personal finance pundit will tell you to expect 10% average annual returns in the stock portion of your investment portfolio. That's a reasonable thing to say, but I think that too many people, possibly including the pundits, misunderstand what it means.
Imagine that on January 1, 2006, based on being told to expect 10% annual returns in the stock market, you invested $100. With the help of Microsoft Excel, you work out that you should have $672.75 on January 1, 2026. But over the next three years the investment actually goes down, so your January 1, 2009 balance is $81.88. Now what is your expected 2026 value?
Way too many people would say $672.75 or something like it. They think that the 10% number they were given was a forecast of what was actually going to happen over twenty years, rather than an estimate of the expected outcome for each year. Put another way, they think that the market has a memory, that it will remember it had some bad years and make up for it in the future, in order to return to the "normal" long-run average.
Well, sorry kids, it just don't work that way. The 10% number may still be sound as an annual estimate. Assuming it is, then 17 years at 10% compounds to 405.44%. Starting with $81.88, the expected value on January 1, 2026 is now $413.86. Sorry 'bout that.
So I will try. How hard could it be?
Market forecasts, such as "the Dow will be up 14% in 2009" are doomed to failure because the market is impossible to forecast.
That was easy.
Some things are forecastable. The weather, for example. Or how many votes a candidate will get in an election. You can look at certain data, do a little math, account for a special factor or two, and presto, a useful estimate of the near future.
But for other things you really can't create a useful estimate. The score in the next Super Bowl. The next roll of the dice. It is not that you are stupid or lack data. And it is not that you don't understand what is going on. You can say some useful things about these unforecastable future events. The Steelers are heavily favored. Seven is the most likely dice roll, and fourteen just ain't gonna happen. But these are not predictions, they are statements about likelihoods and probabilities.
So it is with the stock market. (And for that matter, the bond market, commodity markets, etc.) Occasionally somebody will throw out a prediction like "the Dow will be up 14%" but nobody, the speaker included, expects it to be taken very seriously.
Sober predictions about the stock market are really estimates of the so-called expected outcome, the probability weighted average of all possible outcomes. E.g. seven is the expected outcome of a roll of two dice. The most common way to come up with an expected outcome for a year in the stock market is to average historical performance. Depending on which years are used, and which indexes, the answer is usually something like 10-12%.
So a personal finance pundit will tell you to expect 10% average annual returns in the stock portion of your investment portfolio. That's a reasonable thing to say, but I think that too many people, possibly including the pundits, misunderstand what it means.
Imagine that on January 1, 2006, based on being told to expect 10% annual returns in the stock market, you invested $100. With the help of Microsoft Excel, you work out that you should have $672.75 on January 1, 2026. But over the next three years the investment actually goes down, so your January 1, 2009 balance is $81.88. Now what is your expected 2026 value?
Way too many people would say $672.75 or something like it. They think that the 10% number they were given was a forecast of what was actually going to happen over twenty years, rather than an estimate of the expected outcome for each year. Put another way, they think that the market has a memory, that it will remember it had some bad years and make up for it in the future, in order to return to the "normal" long-run average.
Well, sorry kids, it just don't work that way. The 10% number may still be sound as an annual estimate. Assuming it is, then 17 years at 10% compounds to 405.44%. Starting with $81.88, the expected value on January 1, 2026 is now $413.86. Sorry 'bout that.
Friday, January 23, 2009
Frugal Friday
Fridays sometimes put me in a certain mood. I thought I might highlight a few frugality tips from this week in the blogosphere:
Free Money Finance asks can you pay for a Costco membership by eating free samples? That is, if roaming the store and snarfing up food samples can substitute for a meal, would that savings be enough to cover the annual membership fee? I've read this post several times now, and I really think it's a serious question.
The Frugal Mom Blog has a list of even more amazing ways to save money on food. My favorite is saving the wrappers from your sticks of butter to grease baking pans. If you baked enough, I estimate that you could save the equivalent of an entire stick of butter in a year. Now that's real money.
The Frugal Duchess had two posts listing ways to watch the inauguration for free, assuming you do not own a TV. The answer is that you could have watched it on any one of several obvious websites, e.g. CNN.com or CSPAN.org. (You may not have a TV, but you've obviously got high-speed web access, right?) Also, it turns out that it was on every TV in every public area in the nation. Come to think of it, a post listing ways to manage to spend money watching the inauguration would have been more interesting.
Rounding out the week's insights, The New York Times' Frugal Traveller reports that Cape Cod is cheap to visit in January. How true. In a similar vein, I will add that admission to Fenway Park is much cheaper on days that the Red Sox are not playing.
Free Money Finance asks can you pay for a Costco membership by eating free samples? That is, if roaming the store and snarfing up food samples can substitute for a meal, would that savings be enough to cover the annual membership fee? I've read this post several times now, and I really think it's a serious question.
The Frugal Mom Blog has a list of even more amazing ways to save money on food. My favorite is saving the wrappers from your sticks of butter to grease baking pans. If you baked enough, I estimate that you could save the equivalent of an entire stick of butter in a year. Now that's real money.
The Frugal Duchess had two posts listing ways to watch the inauguration for free, assuming you do not own a TV. The answer is that you could have watched it on any one of several obvious websites, e.g. CNN.com or CSPAN.org. (You may not have a TV, but you've obviously got high-speed web access, right?) Also, it turns out that it was on every TV in every public area in the nation. Come to think of it, a post listing ways to manage to spend money watching the inauguration would have been more interesting.
Rounding out the week's insights, The New York Times' Frugal Traveller reports that Cape Cod is cheap to visit in January. How true. In a similar vein, I will add that admission to Fenway Park is much cheaper on days that the Red Sox are not playing.
Thursday, January 22, 2009
The Great Life Cycle of Risk Aversion Fallacy
If there is a single bit of established personal finance wisdom that is most popularly accepted and most wrong, it is what I call the Life Cycle of Risk Aversion. I have to name it myself because it is so widely assumed to be so obviously true that hardly anybody even notices it.
The Life Cycle of Risk Aversion is the idea that as you get older you should take fewer risks in your investment portfolio. When young, you should invest aggressively in stocks and similar exciting things. As you age, you temper your investments gradually into bonds and the like, until in retirement you have an all-boring portfolio.
This unspoken assumption of retirement planning is so pervasive that right about now you are probably wondering if I am really crazy enough to challenge it. Before clicking away, imagine the following “thought experiment.”
Suppose you are 25 years old and your great-uncle leaves you a very strange bequest. You get a million dollars, but only to be used for your retirement in 40 years. The terms of the will say that you must hire a money manager and, although you can talk to him all you want now, once he gets the money no communications are allowed until you are 65, when you get full control over the money.
What instructions would you give the manager before he sets off on his 40 year mission? Would you, for example, tell him to invest aggressively at the start but taper down to conservative investments in the final decade? If that makes sense to you, consider that investment results are multiplicative. The returns from each of the forty years are equally important to the final value of the portfolio. (Annual returns of +10%, -5%, +22% and -3% will always result in a four year return of +23.7% no matter what order they came in.) So as far as you know, starting out risky and ending safe has exactly the same expected result as starting safe and ending risky.
If risky-start-safe-end doesn’t make sense as a plan for this blind investment plan, then why would it make sense as generic advice to those saving for retirement? Well, of course, it doesn’t.
To be clear, there are many reasonable circumstances in which a person might want to reduce risk as they got older. A 55 year-old who has done well in his investments and is on an easy glide path to retirement might not want to jeopardize that to possibly make more money than he really needs. Alternatively, the same guy who has done poorly might want to reduce his risk so as to hold on to what he has left and fund at least a modest lifestyle.
If those two examples of rational risk reduction in late middle age have you convinced that maybe I am wrong, consider that a desire to increase risk in both those situations could be equally rational. The richer 55 year-old could decide to swing for the fences, reasoning that either he can live large in his golden years or, at worst, even if he loses half his kitty he can still be pretty comfortable. The poor 55 year-old might reason that he has some serious catching up to do and he is willing to accept the risk of possibly having to live off Social Security.
The point is that how much risk you should take on has a little to do with how much money you have got, a lot to do with your level of risk aversion, and just about nothing to do with your age. And risk aversion, even though it can be described with fancy math, is ultimately simply a personal matter of psychology. There is no logical argument to make that the 55 year-old who wants to increase risk is wrong, and therefore no reason to advise 55 year-olds in general to reduce risk in their investments.
So why is this universally accepted wisdom? My theory is that it is because in the late 20th Century, when this idea took over, risk aversion was well correlated with age. Folks born in 1915, who came of age in the depression, were much less willing to invest in risky things than those born in 1945, who in turn were considerably more cautious than my cohorts born in 1965, who learned about investing in the ‘80s and ‘90s.
If present trends continue, I expect that my kids’ generation will be much more risk averse than mine. So in a decade or two personal finance blogs (and books, if they still exist) will drop the idea that you should reduce risk as you get older. Or, possibly, they will come up with a reason why you should take on risk in mid-life but not before or after, to accommodate the inclinations of the various generations in their readership.
The Life Cycle of Risk Aversion is the idea that as you get older you should take fewer risks in your investment portfolio. When young, you should invest aggressively in stocks and similar exciting things. As you age, you temper your investments gradually into bonds and the like, until in retirement you have an all-boring portfolio.
This unspoken assumption of retirement planning is so pervasive that right about now you are probably wondering if I am really crazy enough to challenge it. Before clicking away, imagine the following “thought experiment.”
Suppose you are 25 years old and your great-uncle leaves you a very strange bequest. You get a million dollars, but only to be used for your retirement in 40 years. The terms of the will say that you must hire a money manager and, although you can talk to him all you want now, once he gets the money no communications are allowed until you are 65, when you get full control over the money.
What instructions would you give the manager before he sets off on his 40 year mission? Would you, for example, tell him to invest aggressively at the start but taper down to conservative investments in the final decade? If that makes sense to you, consider that investment results are multiplicative. The returns from each of the forty years are equally important to the final value of the portfolio. (Annual returns of +10%, -5%, +22% and -3% will always result in a four year return of +23.7% no matter what order they came in.) So as far as you know, starting out risky and ending safe has exactly the same expected result as starting safe and ending risky.
If risky-start-safe-end doesn’t make sense as a plan for this blind investment plan, then why would it make sense as generic advice to those saving for retirement? Well, of course, it doesn’t.
To be clear, there are many reasonable circumstances in which a person might want to reduce risk as they got older. A 55 year-old who has done well in his investments and is on an easy glide path to retirement might not want to jeopardize that to possibly make more money than he really needs. Alternatively, the same guy who has done poorly might want to reduce his risk so as to hold on to what he has left and fund at least a modest lifestyle.
If those two examples of rational risk reduction in late middle age have you convinced that maybe I am wrong, consider that a desire to increase risk in both those situations could be equally rational. The richer 55 year-old could decide to swing for the fences, reasoning that either he can live large in his golden years or, at worst, even if he loses half his kitty he can still be pretty comfortable. The poor 55 year-old might reason that he has some serious catching up to do and he is willing to accept the risk of possibly having to live off Social Security.
The point is that how much risk you should take on has a little to do with how much money you have got, a lot to do with your level of risk aversion, and just about nothing to do with your age. And risk aversion, even though it can be described with fancy math, is ultimately simply a personal matter of psychology. There is no logical argument to make that the 55 year-old who wants to increase risk is wrong, and therefore no reason to advise 55 year-olds in general to reduce risk in their investments.
So why is this universally accepted wisdom? My theory is that it is because in the late 20th Century, when this idea took over, risk aversion was well correlated with age. Folks born in 1915, who came of age in the depression, were much less willing to invest in risky things than those born in 1945, who in turn were considerably more cautious than my cohorts born in 1965, who learned about investing in the ‘80s and ‘90s.
If present trends continue, I expect that my kids’ generation will be much more risk averse than mine. So in a decade or two personal finance blogs (and books, if they still exist) will drop the idea that you should reduce risk as you get older. Or, possibly, they will come up with a reason why you should take on risk in mid-life but not before or after, to accommodate the inclinations of the various generations in their readership.
Wednesday, January 21, 2009
Never Sell a Used Car
Yet another blog post from the personal finance mainstream that I must grudgingly acknowledge is good and useful. This one is on the advantages of driving a car until it is an inert pile of rust, rather than trading it in for something new. Get Rich Slowly guest blogger Joel Berry describes the financial benefits of driving a 1995 Geo Prizm, which has got to be just about the least impressive set of wheels imaginable.
That you should always buy cars used rather than new is a common and cliched bit of advice. Like many cliches, it is generally true. But I have always been amazed that the relatively obvious corollary, that you should never sell a used car, is rarely mentioned.
The crux of the matter is a bit of insanity that we all take for granted without reflection. New cars lose something like 25% of their value the moment they get an owner and continue to depreciate rapidly over the next year or two. Step back and think about this. The physical attributes of the car do not change when it is driven off the lot and generally do not deteriorate very much at all in the first years. So why does the market price for the car plummet?
There are basically two explanations. The first is that people are crazy. They will pay good money for the new car smell. Or they think that a newer car will attract members of the opposite sex. Much as I am biased in favor of any explanation based on the mental deficiencies of my follow man, I do not think this is all that is going on.
There is an inherent information asymmetry in the used car market. The owner of a car knows its true condition while the buyer does not. So the market price for a particular used car is based on the average value of similar cars for sale, not the specific value of the car in question. An owner considering selling a car will compare what he knows the car really to be worth to what he could get if he sold it. If it is worth more than the going rate, he holds on to it, if it is worth less, he sells. Which means that the used cars for sale tend to be the bad ones, which in turn reduces the average selling price, which means even fewer good cars are for sale, and so on. This is from a truly seminal paper published in 1970 called The Market for Lemons: Quality Uncertainty and the Market Mechanism.
On any rationally objective measure, used cars are cheap as compared to new ones. Moreover, and this is the point that most personal financial advisers miss, the average value of used cars that are for sale is far less than the average value of similar cars that are not for sale. So unless you have a real clunker, that car in your driveway is almost certainly worth more to you than you could get if you sold it.
It would be hard/impossible to get real numbers, but I am of the opinion that you take a bigger hit selling a used car than you do buying a new one, at least on a percentage basis. The optimal car strategy is to buy two- or three-year-old used cars and drive them until they are scrap metal. Which is what the experts recommend. But the real benefit is on the back end, not the bargain you get up front. Given the choice, and here is where I part company with the established wisdom, buying new and driving the thing until it stops running makes more sense than buying youngish used cars and selling them again when they are not so young.
That you should always buy cars used rather than new is a common and cliched bit of advice. Like many cliches, it is generally true. But I have always been amazed that the relatively obvious corollary, that you should never sell a used car, is rarely mentioned.
The crux of the matter is a bit of insanity that we all take for granted without reflection. New cars lose something like 25% of their value the moment they get an owner and continue to depreciate rapidly over the next year or two. Step back and think about this. The physical attributes of the car do not change when it is driven off the lot and generally do not deteriorate very much at all in the first years. So why does the market price for the car plummet?
There are basically two explanations. The first is that people are crazy. They will pay good money for the new car smell. Or they think that a newer car will attract members of the opposite sex. Much as I am biased in favor of any explanation based on the mental deficiencies of my follow man, I do not think this is all that is going on.
There is an inherent information asymmetry in the used car market. The owner of a car knows its true condition while the buyer does not. So the market price for a particular used car is based on the average value of similar cars for sale, not the specific value of the car in question. An owner considering selling a car will compare what he knows the car really to be worth to what he could get if he sold it. If it is worth more than the going rate, he holds on to it, if it is worth less, he sells. Which means that the used cars for sale tend to be the bad ones, which in turn reduces the average selling price, which means even fewer good cars are for sale, and so on. This is from a truly seminal paper published in 1970 called The Market for Lemons: Quality Uncertainty and the Market Mechanism.
On any rationally objective measure, used cars are cheap as compared to new ones. Moreover, and this is the point that most personal financial advisers miss, the average value of used cars that are for sale is far less than the average value of similar cars that are not for sale. So unless you have a real clunker, that car in your driveway is almost certainly worth more to you than you could get if you sold it.
It would be hard/impossible to get real numbers, but I am of the opinion that you take a bigger hit selling a used car than you do buying a new one, at least on a percentage basis. The optimal car strategy is to buy two- or three-year-old used cars and drive them until they are scrap metal. Which is what the experts recommend. But the real benefit is on the back end, not the bargain you get up front. Given the choice, and here is where I part company with the established wisdom, buying new and driving the thing until it stops running makes more sense than buying youngish used cars and selling them again when they are not so young.
Tuesday, January 20, 2009
WSJ Article on New Advice Books
Today's Wall Street Journal has a great item on the wave of new personal finance books now hitting the shelves and how the tone has changed from how to get rich to how to avoid going broke. In fact, it is more than tone, the content has shifted. There's a great skewering of David Bach in the last few paragraphs for nearly pulling a 180 on his advice about home financing.
Further evidence of my thesis that these books just serve up what the readership demands, rather than any sort of objective reality.
Further evidence of my thesis that these books just serve up what the readership demands, rather than any sort of objective reality.
Not Profiting on Home Improvement
WalletPop's Zac Bissonnette has a great post on what a poor investment home remodeling is. Every year the folks at Remodeling Magazine (yes, really) publish a survey of the impact on a house's value of various types of home improvements. Helpfully, they do this as a percent of what was spent, so if you blew $20,000 on a new bathroom that only increased the value of your house by $15,000, then that's a score of 75%.
The survey breaks out 19 types of projects, across nine regions. Most of the recoup values are in the 60%-80% range. The best from this year seems to be the 97% of your money you get to keep if you are adding a wooden deck onto a midrage house on the Pacific Coast. As far as I know, the survey has never found a value over 100%.
To be fair, this does not quite mean that all home improvements are money losers. These are averages, so almost half of those West Coast decks actually did add value. And the survey only covers relatively large projects, the kind for which you would hire a contractor. If you ask a good real estate agent how to make your house more valuable he will suggest cosmetic improvements, e.g. a new paint job. I am guessing that those sorts of fixes really do turn a profit.
But the basic observation, that home remodeling is a terrible investment, still holds. In a more perfect world, this would be so obvious that nobody would bother to mention it. Buying something at retail and hoping to sell it used at a profit, essentially what we are talking about here, is rarely a winning strategy.
But as Bissonnette points out, there is an entire category of cable TV shows based on the premise that you can make money remodeling. How can it be that home experts on responsible networks can advocate something so contrary to reality?
Because these are only TV shows. The people who make and broadcast TV shows are successful if people watch the shows, not if the shows are factually correct. And people want to see video of gleaming new kitchens and hear what a great investment they are. Ending a show saying "And Bob and Sue's new sun room only vaporized $10,000 of their net worth." would not help ratings.
Which brings up an important point about personal finance advice. We all make an unspoken assumption that successful givers of advice must give good advice, otherwise people would stop listening. This is not (quite) true. Popular givers of advice tend to get that way because they say what their audience wants to hear and wants to believe is true. People want to believe that they can become millionaires relatively easily by skipping the lattes or that they can work only four hours a week. That doesn't mean it's true.
The survey breaks out 19 types of projects, across nine regions. Most of the recoup values are in the 60%-80% range. The best from this year seems to be the 97% of your money you get to keep if you are adding a wooden deck onto a midrage house on the Pacific Coast. As far as I know, the survey has never found a value over 100%.
To be fair, this does not quite mean that all home improvements are money losers. These are averages, so almost half of those West Coast decks actually did add value. And the survey only covers relatively large projects, the kind for which you would hire a contractor. If you ask a good real estate agent how to make your house more valuable he will suggest cosmetic improvements, e.g. a new paint job. I am guessing that those sorts of fixes really do turn a profit.
But the basic observation, that home remodeling is a terrible investment, still holds. In a more perfect world, this would be so obvious that nobody would bother to mention it. Buying something at retail and hoping to sell it used at a profit, essentially what we are talking about here, is rarely a winning strategy.
But as Bissonnette points out, there is an entire category of cable TV shows based on the premise that you can make money remodeling. How can it be that home experts on responsible networks can advocate something so contrary to reality?
Because these are only TV shows. The people who make and broadcast TV shows are successful if people watch the shows, not if the shows are factually correct. And people want to see video of gleaming new kitchens and hear what a great investment they are. Ending a show saying "And Bob and Sue's new sun room only vaporized $10,000 of their net worth." would not help ratings.
Which brings up an important point about personal finance advice. We all make an unspoken assumption that successful givers of advice must give good advice, otherwise people would stop listening. This is not (quite) true. Popular givers of advice tend to get that way because they say what their audience wants to hear and wants to believe is true. People want to believe that they can become millionaires relatively easily by skipping the lattes or that they can work only four hours a week. That doesn't mean it's true.
Monday, January 19, 2009
Big Ben Franklin
The blog Get Rich Slowly had a post two days ago celebrating Benjamin Franklin's 303rd birthday. I'm sorry I missed it. (The date; not so much the post.) Little Ben came into the world right here in Boston, about where the Claire's store is now.
I'm a big fan of Ben's, although not for the reasons that attract the Get Rich Slowly crowd. (And wouldn't calling the blog Get Rich Slow be more parallel with get rich quick? It's a great name anyway.)
Franklin was a very successful entrepreneur on what was then a wild frontier. In his spare time he was the leading American statesman and diplomat of his generation. And that stuff they told you in school about his discovering electricity is more true than not. Three centuries later, one end of your AA battery is labelled "+" and the other "-" because that's what Ben decided to call them.
But for the adherents of the frugal faith, Franklin is known for the aphorisms he published in his Poor Richard's Almanack and rehashed in Father Abraham's Sermon, a.k.a. The Way to Wealth. These were wildly popular works in 18th Century America. You might say they are the beginning of our personal finance advice genre.
The Way to Wealth is all the more convincing because it is from a notably wealthy man. But just like the personal finance gurus of today, Franklin did not get rich from following his own advice so much as from selling it to others. It is not clear how frugal he was in his own life; he certainly understood that making a good show of being thrifty was good for business.
It is clear that getting rich slowly and quietly was not his thing. At 17, he skipped out of his apprenticeship to his brother in Boston (after learning the printing trade) and settled in Philadelphia. He fathered an illegitimate son that same year. By age 24 he was publishing a newspaper of his own and agitating for political reform in Pennsylvania. He managed to found most of the civic institutions the city needed, including a university, a public library, a volunteer fire department, and the militia. And then on to a bigger stage. In 1757 he got himself appointed the colony's representative in London. He stayed there more or less continuously until the revolution broke out in 1775. If things hadn't gotten nasty he probably would have lived in the big city for the rest of his life. His wife was back in Philadelphia the whole time.
Like I said, I love the guy. But those aphorisms of his, many, if not most, borrowed from others, may not relate all that well to his life. He did not, it bears pointing out, ever sign his own name to them. Get Rich Slowly quotes one of them as "Who is rich? He that rejoices in his portion." That's not in The Way to Wealth. As far as I know, it is in one of the 25 issues of the Almanack, but it's originally from the Jewish Mishna, quoting Shimon ben Zoma two thousand years ago. (Pirkei Avot 4:1) Authorship aside, I am pretty sure that in real life my man Ben was not the kind to be satisfied by what he had already.
I'm a big fan of Ben's, although not for the reasons that attract the Get Rich Slowly crowd. (And wouldn't calling the blog Get Rich Slow be more parallel with get rich quick? It's a great name anyway.)
Franklin was a very successful entrepreneur on what was then a wild frontier. In his spare time he was the leading American statesman and diplomat of his generation. And that stuff they told you in school about his discovering electricity is more true than not. Three centuries later, one end of your AA battery is labelled "+" and the other "-" because that's what Ben decided to call them.
But for the adherents of the frugal faith, Franklin is known for the aphorisms he published in his Poor Richard's Almanack and rehashed in Father Abraham's Sermon, a.k.a. The Way to Wealth. These were wildly popular works in 18th Century America. You might say they are the beginning of our personal finance advice genre.
The Way to Wealth is all the more convincing because it is from a notably wealthy man. But just like the personal finance gurus of today, Franklin did not get rich from following his own advice so much as from selling it to others. It is not clear how frugal he was in his own life; he certainly understood that making a good show of being thrifty was good for business.
It is clear that getting rich slowly and quietly was not his thing. At 17, he skipped out of his apprenticeship to his brother in Boston (after learning the printing trade) and settled in Philadelphia. He fathered an illegitimate son that same year. By age 24 he was publishing a newspaper of his own and agitating for political reform in Pennsylvania. He managed to found most of the civic institutions the city needed, including a university, a public library, a volunteer fire department, and the militia. And then on to a bigger stage. In 1757 he got himself appointed the colony's representative in London. He stayed there more or less continuously until the revolution broke out in 1775. If things hadn't gotten nasty he probably would have lived in the big city for the rest of his life. His wife was back in Philadelphia the whole time.
Like I said, I love the guy. But those aphorisms of his, many, if not most, borrowed from others, may not relate all that well to his life. He did not, it bears pointing out, ever sign his own name to them. Get Rich Slowly quotes one of them as "Who is rich? He that rejoices in his portion." That's not in The Way to Wealth. As far as I know, it is in one of the 25 issues of the Almanack, but it's originally from the Jewish Mishna, quoting Shimon ben Zoma two thousand years ago. (Pirkei Avot 4:1) Authorship aside, I am pretty sure that in real life my man Ben was not the kind to be satisfied by what he had already.
Sunday, January 18, 2009
Prof. Shiller and Financial Advice
Robert Shiller (he of Irrational Exuberance fame) has a column in today's New York Times linking the current financial crisis with fundamental mistakes made by the financially illiterate masses. Well, golly.
I am a fan of Prof. Shiller's. His books are worth reading (if a bit dense for the non-economist) and he is an engaging public speaker. He is one of the very few who can look at the global recession and rightly say "I told you so."
But the good professor is still a college professor. Academics can be very smart and insightful but they tend to have difficulty with the realities of the world that the rest of us live in. Shiller's basic suggestion is that some of the government bailout money be used to start "a major program to subsidize personal finance advice for everyone." This, I suppose, because the Federal Government has such a stellar track record on education.
He cites a "paper" presented at a recent academic conference that he says shows that people who fail "financial literacy tests" tend "to make serious investment mistakes."
First off, the paper looks like a PowerPoint presentation to me. Second, it doesn't say much about bad decisions, in fact it concludes that the financial illiterates were no more likely to take out an ARM than a fixed rate mortgage. (Although they were a lot less likely to understand the difference.) And thirdly, the test of financial literacy is really just a few fourth grade math problems that happen to be about money. It's not a literacy test, it's an intellegence test.
So it turns out that dumb people sometimes do dumb things. Fascinating. I think the most important realization from this is that there are banks that will give a mortgage to somebody who doesn't know the price of a $300 sofa marked down 50%.
What Shiller is missing is that there is no need to subsidize the production of personal financial advice. We've got lots of that already. Foolish choices were not made because of a lack of access to advice. They were/are made because of a lack of access to good advice.
I am a fan of Prof. Shiller's. His books are worth reading (if a bit dense for the non-economist) and he is an engaging public speaker. He is one of the very few who can look at the global recession and rightly say "I told you so."
But the good professor is still a college professor. Academics can be very smart and insightful but they tend to have difficulty with the realities of the world that the rest of us live in. Shiller's basic suggestion is that some of the government bailout money be used to start "a major program to subsidize personal finance advice for everyone." This, I suppose, because the Federal Government has such a stellar track record on education.
He cites a "paper" presented at a recent academic conference that he says shows that people who fail "financial literacy tests" tend "to make serious investment mistakes."
First off, the paper looks like a PowerPoint presentation to me. Second, it doesn't say much about bad decisions, in fact it concludes that the financial illiterates were no more likely to take out an ARM than a fixed rate mortgage. (Although they were a lot less likely to understand the difference.) And thirdly, the test of financial literacy is really just a few fourth grade math problems that happen to be about money. It's not a literacy test, it's an intellegence test.
So it turns out that dumb people sometimes do dumb things. Fascinating. I think the most important realization from this is that there are banks that will give a mortgage to somebody who doesn't know the price of a $300 sofa marked down 50%.
What Shiller is missing is that there is no need to subsidize the production of personal financial advice. We've got lots of that already. Foolish choices were not made because of a lack of access to advice. They were/are made because of a lack of access to good advice.
Saturday, January 17, 2009
Why This Blog
This is not an advice blog, really. It is a blog about advice, and as a side-effect it contains some advice of its own. But the main topic here is the advice given by others and how bad it is. And not just any advice. I mean to talk about advice on a single subject of almost universal interest: money.
Money, or to use its proper name, personal finance, is one of the major genres of advice in the media, up there with dieting and sex. Of course, I’ve never read a dieting book and I’ve never flipped through a sex manual without a smirk, so for all I know the advice given on those topics is similarly lousy. But I have read a lot of personal finance books, articles, and blogs, and I’ve even managed to sit through some TV shows and heard some rather tedious radio call-in shows on money. Some are better than others. Some have good production values and a few are even entertaining. But they all seem to fall down on content. The best ones give advice that is only approximately sound and the worst say things that are just flat out wrong.
My qualifications for giving personal financial advice, and for criticizing the advice of others, are thin. Then again, the qualifications of the established experts in this field seem no more substantial. Mostly, what they have that I do not is the circular proof that they are qualified to give advice because that is what they do professionally.
I am an unemployed finance guy. To be more specific, I used to run a hedge fund. (The fund’s end was not dramatic, BTW. No frauds or spectacular losses. We had a mediocre year and my partner decided he wanted to do something else with his life, so we closed up shop.) I studied economics at an Ivy League college, got an MBA in finance at another Ivy, and have the usual assortment of licenses and letters after my name. All told, I have spent twelve years being paid rather nicely to invest other people’s money. So listening to what I have to say about personal finance is not the craziest thing you could do, even if I do not have my own TV show. Yet.
Then again, I am unemployed. That’s not exactly a unique situation right now, particularly in my line of work, but still a person might reasonably wonder: if I was really as smart about this stuff as I apparently think I am, would I have the free time to write this blog? That’s a good question for which I have no answer. But it does bring up a fundamental difference between advice on money and advice on, for example, dieting and sex.
Writing a book or blog is a natural next step for a person who is very good at dieting or sex. There is only so much weight a person can lose and only so much sex a person can have. (So I am told.) Opportunities to do either of those things at a higher or more advanced level are limited. So sharing the secrets with others in exchange for fame/money is about all you can do.
This is not the case with money. A person good at money generally keeps working at adding zeros to his net worth until he can buy an island to retire to. So who, you might reasonably ask, writes all those books and gives all those seminars? People who are clever about money but so naturally generous that they want to share their insights with others rather than profit by them personally? Can I interest you in a bridge I have for sale over the East River?
There is another, much more serious, difference between advice on dieting or sex and advice on money. If the advice everybody got on dieting and sex was faulty, that would be somewhat unfortunate for the nation. We would be a little chubbier and a little less happy in bed. But if bad advice on money is widespread and followed we’re all in big trouble. If, to imagine a far-fetched example, millions of people were told to buy more house than they could afford, the inevitable housing price bubble might set off a crisis in the capital markets that could plunge the whole world into a recession.
Left wing types like to fantasize that the economy is controlled by a small and sinister elite. That might have been true somewhere at sometime, but it is very far from the reality of the here and now. Ours is an economy controlled by millions of ordinary people, each with responsibility for a tiny bit of it. If a lot of them do a bad job of running their slice of the pie, then we all suffer, even those of us who are clever and thoughtful about money.
The premise of this blog is twofold: that personal finance advice ought to be taken seriously and that it needs to be a lot better than it is now.
Money, or to use its proper name, personal finance, is one of the major genres of advice in the media, up there with dieting and sex. Of course, I’ve never read a dieting book and I’ve never flipped through a sex manual without a smirk, so for all I know the advice given on those topics is similarly lousy. But I have read a lot of personal finance books, articles, and blogs, and I’ve even managed to sit through some TV shows and heard some rather tedious radio call-in shows on money. Some are better than others. Some have good production values and a few are even entertaining. But they all seem to fall down on content. The best ones give advice that is only approximately sound and the worst say things that are just flat out wrong.
My qualifications for giving personal financial advice, and for criticizing the advice of others, are thin. Then again, the qualifications of the established experts in this field seem no more substantial. Mostly, what they have that I do not is the circular proof that they are qualified to give advice because that is what they do professionally.
I am an unemployed finance guy. To be more specific, I used to run a hedge fund. (The fund’s end was not dramatic, BTW. No frauds or spectacular losses. We had a mediocre year and my partner decided he wanted to do something else with his life, so we closed up shop.) I studied economics at an Ivy League college, got an MBA in finance at another Ivy, and have the usual assortment of licenses and letters after my name. All told, I have spent twelve years being paid rather nicely to invest other people’s money. So listening to what I have to say about personal finance is not the craziest thing you could do, even if I do not have my own TV show. Yet.
Then again, I am unemployed. That’s not exactly a unique situation right now, particularly in my line of work, but still a person might reasonably wonder: if I was really as smart about this stuff as I apparently think I am, would I have the free time to write this blog? That’s a good question for which I have no answer. But it does bring up a fundamental difference between advice on money and advice on, for example, dieting and sex.
Writing a book or blog is a natural next step for a person who is very good at dieting or sex. There is only so much weight a person can lose and only so much sex a person can have. (So I am told.) Opportunities to do either of those things at a higher or more advanced level are limited. So sharing the secrets with others in exchange for fame/money is about all you can do.
This is not the case with money. A person good at money generally keeps working at adding zeros to his net worth until he can buy an island to retire to. So who, you might reasonably ask, writes all those books and gives all those seminars? People who are clever about money but so naturally generous that they want to share their insights with others rather than profit by them personally? Can I interest you in a bridge I have for sale over the East River?
There is another, much more serious, difference between advice on dieting or sex and advice on money. If the advice everybody got on dieting and sex was faulty, that would be somewhat unfortunate for the nation. We would be a little chubbier and a little less happy in bed. But if bad advice on money is widespread and followed we’re all in big trouble. If, to imagine a far-fetched example, millions of people were told to buy more house than they could afford, the inevitable housing price bubble might set off a crisis in the capital markets that could plunge the whole world into a recession.
Left wing types like to fantasize that the economy is controlled by a small and sinister elite. That might have been true somewhere at sometime, but it is very far from the reality of the here and now. Ours is an economy controlled by millions of ordinary people, each with responsibility for a tiny bit of it. If a lot of them do a bad job of running their slice of the pie, then we all suffer, even those of us who are clever and thoughtful about money.
The premise of this blog is twofold: that personal finance advice ought to be taken seriously and that it needs to be a lot better than it is now.
Subscribe to:
Comments (Atom)
