Personal Finance for Code2040
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The document provides an overview of personal finance basics according to Adam Nash, CEO of Wealthfront. It discusses 5 key points: 1) Behavioral finance basics, noting people are not truly rational with money due to biases. 2) Liquidity is undervalued despite its importance. 3) Cash flow matters more than most people realize; spending less than you earn is key. 4) The power of compounding interest over long periods of time. 5) Good investing is boring - index funds typically outperform actively managed mutual funds with lower costs. The presentation aims to educate about important personal finance principles that are often overlooked.
Personal Finance for Code2040
- 1. wealthfront.com Adam Nash CEO, Wealthfront @adamnash Personal Finance for Code2040
- 2. ©2014 Wealthfront, Inc. 2 Caveats & Preface ▪ I am not a financial planner ▪ This presentation is not financial advice ▪ You would be extremely foolish to make investment decisions based on the content of this presentation or discussion ▪ The opinions in this deck are intended to provoke discussion & further education
- 3. ©2014 Wealthfront, Inc. 3 Why Personal Finance? ▪ Poorly covered in traditional education, even top tier universities ▪ Not technically difficult, but the signal:noise ratio is terrible ▪ Massive impact on your life – Money is one of the top 3 reasons for marital problems
- 4. ©2014 Wealthfront, Inc. Fast Five Finance Basics 1. Behavioral Finance Basics 2. Liquidity is Undervalued 3. Cash Flow Matters 4. The Magic of Compounding 5. Good Investing is Boring 4
- 5. (show of hands) BEHAVIORAL FINANCE BASICS: How many of you think you are rational with your money?
- 6. ©2014 Wealthfront, Inc. ANCHORING MENTAL ACCOUNTING CONFIRMATION & HINDSIGHT BIAS GAMBLER'S FALLACY OVERCONFIDENCEHERD BEHAVIOR OVERREACTION & AVAILABILITY BIAS LOSS AVERSION (PROSPECT THEORY) YOU ARE NOT RATIONAL
- 7. ©2014 Wealthfront, Inc. Anchoring ▪ People estimate answers to new / novel problems with a bias towards reference points ▪ Example: 1974 Study ▪ Most common examples: – Price you bought a stock at – High point for a stock 7
- 8. ©2014 Wealthfront, Inc. Mental Accounting ▪ Money is fungible, but people put it in separate “mental accounts” ▪ Lost movie tickets example ▪ “Found Money” problem ▪ Vacation fund & credit card debt 8
- 9. ©2014 Wealthfront, Inc. Confirmation & Hindsight Bias ▪ We selectively seek information that supports pre-existing theories, and ignore / dispute information that disproves them ▪ We overestimate our ability to predict the future based on the “obviousness” of the past (example: real estate) 9
- 10. ©2014 Wealthfront, Inc. Gambler's Fallacy ▪ We see patterns in independent, random chains of events ▪ We believe that, based on series of previous events, an outcome is more likely than odds actually suggest ▪ Coin flip example ▪ It's because with human behavior, there are no “independent” events 10
- 11. ©2014 Wealthfront, Inc. Herd Behavior ▪ We have a tendency to mimic the actions of the larger group ▪ Crowd psychology is a major contributor to bubbles (believed) ▪ Easier to be “wrong with everyone” than “right and alone” ▪ No one gets fired for buying IBM? 11
- 12. ©2014 Wealthfront, Inc. Overconfidence ▪ In one study, 74% of investment managers believe they deliver above average returns ▪ Positively correlated with High IQ... ▪ Learn humility early 12
- 13. ©2014 Wealthfront, Inc. Overreaction & Availability Bias ▪ Overreact to recent events ▪ Overweight recent trends ▪ Studies demonstrate that checking stock prices daily leads to more trading and worse results on average ▪ Worse in high tech, because we are immersed in “game changers” 13
- 14. ©2014 Wealthfront, Inc. You have a 100% chance of gaining $500.B You have $1,000 and you must pick one of the following choices: You have a 50% chance of gaining $1,000, and a 50% chance of gaining $0.A OR
- 15. ©2014 Wealthfront, Inc. You have a 100% chance of losing $500.B Now, you have $2,000 and you must pick one of the following choices: You have a 50% chance of losing $1,000, and a 50% chance of losing $0.A OR
- 16. ©2014 Wealthfront, Inc. Loss Aversion (aka Prospect Theory) ▪ We hate losses more than we love winning ▪ Average loss aversion is 3:1 (!) ▪ Affects views on wide range of situations, including taxes, holding on to losing stocks, “sunk cost” mistakes 16
- 17. IT'S OK TO NOT BE RATIONAL
- 18. ©2014 Wealthfront, Inc. 18 It's OK to Not Be Rational ▪ The key is that humans are predictably irrational ▪ Know your own flaws, and you can set up systems to account for them ▪ Self-awareness is key (yes, my Mom is a psychologist...)
- 19. ©2014 Wealthfront, Inc. Liquidity is Undervalued ▪ Strictly defined: it's the quanti- fication of how much money you can get, and how fast ▪ Liquidity is the power to take advantage of great investment opportunities ▪ Liquidity is also, in the end, the only thing that matters when you need to pay for something 19
- 20. ©2014 Wealthfront, Inc. 20 Liquidity & Returns ▪ In almost all cases, liquidity is inversely correlated with returns ▪ Examples: – Cash = very liquid – Private equity = very illiquid ▪ Common mistake: Safety! = Liquidity
- 21. ©2014 Wealthfront, Inc. 21 Practical Outcome: Emergency Funds ▪ Standard recommendation is that you have 3-6 months of living expenses in cash / cash- equivalents ▪ That number increases if you are in highly volatile industry / career ▪ Worth considering length of time for potential job search
- 22. ©2014 Wealthfront, Inc. 22 Cash Flow Matters ▪ The ultimate secret to personal finance is quite simple: – Spend less than you make (on an ongoing basis) ▪ Very easy to measure, but few people do. Annual budget is a great idea. ▪ Don't forget to model in annual expenses & “personal spending”
- 23. ©2014 Wealthfront, Inc. 23 Savings Targets ▪ What's the right number? – There is no question - the more you save, the more secure you are. Income comes & goes, but expenses / lifestyle are sticky! ▪ A lot of models assume working 40 years, and producing savings to generate 80% of working income. – These models don't actually match anyone's real world experience. – There are a lot of models out there, and rules of thumb, but it's important to run the numbers yourself.
- 24. ©2014 Wealthfront, Inc. 24 The Magic of Compounding ▪ Not convinced that Albert Einstein said it was the greatest force in the universe. ▪ It's the key to almost all long term financial planning. ▪ Exponentials are bad in algorithmic cost, good in savings returns.
- 25. ©2014 Wealthfront, Inc. 25 Simple Model ▪ Rule of 72 ▪ In Sheets, for each year, just use =POWER(1+rate, year) ▪ 4% over 20 years is 2.19x ▪ 8% over 20 years is 4.66x ▪ Careful: it works on debt just as well as savings... in reverse!
- 26. ©2014 Wealthfront, Inc. The Benefits of An Early Start ▪ Compounding really takes off over long time periods ▪ In most retirement planning models, money saved between ages 25 - 35 produces more money than all savings between 35 – 65! 26 Years Return at 8% 10 2.16x 20 4.66x 30 10.06x 40 21.72x 50 46.9x
- 27. ©2014 Wealthfront, Inc. 27 The Dangers of Debt ▪ Bankruptcy is literally when you can't pay your debts. You can't go bankrupt if you don't have debt ▪ You will never find an investment that pays 8% guaranteed, let alone 20%+ ▪ You will find *tons* of credit offers out there that will charge you that ▪ “Bad” debt is toxic, your best return is to pay it off. But emergency fund takes precedence
- 28. ©2014 Wealthfront, Inc. 28 Good Investing is Boring ▪ No one wants to be average, but with investing, average is actually well above average. ▪ You will beat most mutual funds, and a large majority of your peers with simple, low-cost index funds. ▪ Asset allocation explains ~90% of the variance between fund performance
- 29. ©2014 Wealthfront, Inc. 29 Basic Asset Allocation ▪ Different types of assets (cash, bonds, stocks, etc) have different volatility & return characteristics ▪ Combinations can lower volatility significantly, with moderate impact to returns ▪ Complication: historical performance does not predict future performance
- 30. ©2014 Wealthfront, Inc. 30 Simple Operating Model ▪ 2 hours of work per year ▪ Pick an asset allocation that is appropriate for your emotional character & time frame & goals ▪ For each asset class, pick cheap index fund to represent ▪ Rebalance every 1-2 years ▪ http://blog.adamnash.com/2010/12/31/personal- finance-how-to-rebalance-your-portfolio/
- 31. ©2014 Wealthfront, Inc. 31 Recommended Books ▪ WSJ Guide to Understanding Money & Investing ▪ The Millionaire Next Door ▪ A Random Walk Down Wall Street ▪ The Essays of Warren Buffett ▪ Common Stocks & Uncommon Profits ▪ The Intelligent Investor ▪ Devil Take the Hindmost ▪ When Genius Failed ▪ Against the Gods: The Remarkable Story of Risk ▪ http://blog.adamnash.com/2007/02/14/ personal-finance-education-series-2- recommended-books/
- 32. ©2014 Wealthfront, Inc. 32 Disclosure Nothing in this presentation should be construed as a solicitation or offer, or recommendation, to buy or sell any security. Financial advisory services are only provided to investors who become Wealthfront clients pursuant to a written agreement, which investors are urged to read and carefully consider in determining whether such agreement is suitable for their individual facts and circumstances. Past performance is no guarantee of future results, and any hypothetical returns, expected returns, or probability projections may not reflect actual future performance. Investors should review Wealthfront’s website for additional information about advisory services.