This is the version of Personal Finance for Engineers, covering behavioral finance, liquidity, savings, compounding, and long term investing. It was given at Pinterest HQ in San Francisco on Jan 23, 2014.
2. Who is Adam Nash?
pinterest.com/adamnash
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3. Caveats & Preface
ā¢
I am not a ļ¬nancial planner
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This presentation is not ļ¬nancial advice
ā¢
You would be extremely foolish to make investment
decisions based solely on the content of this
presentation or discussion
ā¢
The opinions in this deck are intended purely to provoke
discussion & further education
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4. Why Personal Finance?
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Poorly covered in traditional education, even
top tier universities
ā¢
Not technically diļ¬cult, but signal:noise ratio
is terrible
ā¢
Massive impact on your life
-
Money is one of the top 3 reasons āØ
for marital problems
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5. Why āFor Engineersā?
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Understand / Prefer Math
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Tend to make higher incomes early in life, thus face
questions sooner.
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Tend to have complicated instruments, like stock
options, as part of their compensation.
ā¢
Believe they are rational, which is actually a problem
when it comes to money
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6. 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
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7. How many of you think
you are rational with
your money?
(show of hands)
9. Anchoring
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People estimate answers to new /
novel problems with a bias towards
reference points
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Example: 1974 Study
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Most common examples:
ā¢
Price you bought a stock at
ā¢
High point for a stock
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10. Mental Accounting
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Money is fungible, but people put it
in separate āmental accountsā
ā¢
Lost movie tickets example
ā¢
āFound Moneyā problem
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Vacation fund & credit card debt
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11. Confirmation & Hindsight Bias
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We selectively seek information
that support pre-existing
theories, and ignore / dispute
information that disproves them.
ā¢
We overestimate our ability to
predict the future based on the
āobviousnessā of the past.
(example: real estate)
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12. Gamblerās Fallacy
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We see patterns in independent,
random chains of events
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We believe that, based on series
of previous events, an outcome is
more likely than odds actually
suggest
ā¢
Coin ļ¬ip example
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Itās because with human behavior,
there are no āindependentā events
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13. Herd Behavior
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We have a tendency to mimic the
actions of the larger group
ā¢
Crowd psychology is a major
contributor to bubbles (believed)
ā¢
Easier to be āwrong with everyoneā
than āright and aloneā
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No one gets ļ¬red for buying IBM?
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14. Overconfidence
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In one study, 74% of investment
managers believe they deliver
above average returns.
ā¢
Positively correlated with High IQ...
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Learn humility early
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15. Overreaction & Availability Bias
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Overreact to recent events
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Overweight recent trends
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Studies demonstrate that checking
stock prices daily leads to more
trading and worse results on
average
ā¢
Worse in high tech, because we
are immersed in āgame changersā
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16. You have $1,000 and you must
pick one of the following choices:
Choice A: āØ
You have a 50% chance of gaining $1,000,
and a 50% chance of gaining $0.
Choice B:āØ
You have a 100% chance of gaining $500.
17. Now, you have $2,000 and you must
pick one of the following choices:
Choice A: āØ
You have a 50% chance of losing $1,000,
and a 50% chance of losing $0.
Choice B:āØ
You have a 100% chance of losing $500.
18. Loss Aversion (aka Prospect Theory)
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We hate losses more than we love
winning
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Average loss aversion is 3:1 (!)
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Aļ¬ects views on wide range of
situations, including taxes, holding
on to losing stocks, āsunk costā
mistakes
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20. Itās OK to Not Be Rational
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The key is that humans are predictably irrational
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Know your own ļ¬aws, and you can set up systems to
account for them
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Self-awareness is keyāØ
(yes, my Mom is a psychologist...)
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21. Liquidity
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Almost universally undervalued
ā¢
Strictly deļ¬ned - itās the
quantiļ¬cation of how much money
you can get, and how fast.
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Liquidity is the power to take
advantage of great investment
opportunities
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Liquidity is also, in the end, the
only thing that matters when you
need to pay for something.
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22. Liquidity & Returns
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In almost all cases, liquidity is inversely
correlated with returns
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Examples:
-
ā¢
Cash = very liquid
Private equity = very illiquid
Common mistake: Safety != Liquidity
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23. Practical Outcome: Emergency Funds
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Standard recommendation is that you
have 3-6 months of living expenses in
cash / cash-equivalents.
ā¢
That number increases if you are in
highly volatile industry / career.
ā¢
Worth considering length of time for
potential job search.
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24. Cash Flow
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The ultimate secret to personal ļ¬nance is
quite simple:
-
Spend less than you makeāØ
(on an ongoing basis)
ā¢
Very easy to measure, but few people do.
Annual budget is a great idea.
ā¢
Donāt forget to model in annual expenses
& āpersonal spendingā
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25. Savings Targets
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Whatās the right number? 3%? 6%?10%? 20%?
-
ā¢
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 donāt actually match anyoneās real
world experience.
-
There are a lot of models out there, and rules of
thumb, but itās important to run the numbers yourself.
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26. The Magic of Compounding
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Not convinced that Albert Einstein said it was the
greatest force in the universe.
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Itās the key to almost all long term ļ¬nancial planning.
ā¢
Exponentials are bad in algorithmic cost, good in
savings returns.
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27. Simple Model
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Rule of 72
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In Excel, for each year, just use āØ
=POWER(1+rate, year)
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4% over 20 years is 2.19x
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8% over 20 years is 4.66x
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Careful: it works on debt just as well as savings...
in reverse!
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28. The Benefits of An Early Start
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Compounding really takes oļ¬ over long time periods
Years
Return at 8%
10
2.16x
20
4.66x
30
10.06x
40
21.72x
50
In most retirement planning
models, money saved between
ages 25 - 35 produces more
money than all savings between
35 - 65!
46.9x
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29. The Dangers of Debt
ā¢
Bankruptcy is literally when you canāt pay your debts.
You canāt go bankrupt if you donāt have debt.
ā¢
You will never ļ¬nd an investment that pays 8%
guaranteed, let alone 20%+
ā¢
You will ļ¬nd *tons* of credit oļ¬ers out there that will
charge you that.
ā¢
āBadā debt is toxic, your best return is to pay it oļ¬.
But emergency fund takes precedence.
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30. Good Investing is Boring
ā¢
No one wants to be average, but with investing,
average is actually well above average.
ā¢
You will beat most mutual funds, and a large majority of
your peers with simple, low-cost index funds.
ā¢
Asset allocation explains ~90% of the variance between
fund performance
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31. Basic Asset Allocation
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Diļ¬erent types of assets (stocks, bonds, etc) have
diļ¬erent volatility & return characteristics
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There is an eļ¬cient frontier of combinations that
can maximize return for a given volatility
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Complication: historical performance does not
predict future performance
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32. Simple Operating Model
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2 hours of work per year.
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Pick an asset allocation that is appropriate for your
emotional character & time frame & goals.
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For each asset class, pick the cheapest index fund with
the lowest drift and best liquidity.
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Rebalance every year.
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33. Recommended Books
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WSJ Guide to Understanding Money & Investing
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The Millionaire Next Door
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A Random Walk Down Wall Street
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The Essays of Warren Buļ¬ett
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Common Stocks & Uncommon Proļ¬ts
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The Intelligent Investor
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Devil Take the Hindmost
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When Genius Failed
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Against the Gods: The Remarkable Story of Risk
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http://blog.adamnash.com/2007/02/14/personal-ļ¬nanceeducation-series-2-recommended-books/
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34. 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
Text
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 reļ¬ect actual future
performance.Ā Investors should review Wealthfrontās website for
additional information about advisory services.Ā Ā Ā
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