This document provides a summary of a presentation on personal finance basics for engineers. It covers several key topics: 1. Behavioral finance and how people are not truly rational with money due to biases like anchoring, mental accounting, herd behavior, and loss aversion. 2. The importance of liquidity and having emergency funds for unexpected expenses. 3. Ensuring spending is less than income by creating an annual budget and tracking cash flow. 4. The power of compounding returns over long periods of time, especially when starting to save and invest early in one's career. 5. That good investing is "boring" and focusing on low-cost index funds within an appropriate asset

1. Adam Nash
@adamnash
Personal Finance for
Engineers
February 9, 2018
Lambda School

2. ©2011-2017 Adam Nash
▪ 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
2
Caveats & Preface

3. ©2011-2017 Adam Nash
▪ 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
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Why Personal Finance?

4. ©2011-2017 Adam Nash
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. ANCHORING MENTAL ACCOUNTING CONFIRMATION &
HINDSIGHT BIAS
GAMBLER'S FALLACY
OVERCONFIDENCEHERD BEHAVIOR RECENCY &
AVAILABILITY BIAS
LOSS AVERSION
(PROSPECT THEORY)
YOU ARE NOT RATIONAL

7. ©2011-2017 Adam Nash
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
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8. ©2011-2017 Adam Nash
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
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9. ©2011-2017 Adam Nash
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)
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10. ©2011-2017 Adam Nash
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
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11. ©2011-2017 Adam Nash
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?
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12. ©2011-2017 Adam Nash
Overconfidence
▪ In one study, 74% of investment
managers believe they deliver above
average returns
▪ Positively correlated with High IQ...
▪ Learn humility early
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13. ©2011-2017 Adam Nash
Recency &
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”
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14. 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. 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. ©2011-2017 Adam Nash
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
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17. IT'S OK TO NOT BE RATIONAL

18. ©2011-2017 Adam Nash
▪ 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...)
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It's OK to Not Be Rational

19. ©2011-2017 Adam Nash
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
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20. ©2011-2017 Adam Nash
▪ In almost all cases,
liquidity is inversely
correlated with returns
▪ Examples:
– Cash = very liquid
– Private equity = very illiquid
▪ Common mistake: Safety!
= Liquidity
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Liquidity & Returns

21. ©2011-2017 Adam Nash
▪ 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
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Practical Outcome: Emergency
Funds

22. ©2011-2017 Adam Nash
▪ 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”
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Cash Flow Matters

23. ©2011-2017 Adam Nash
▪ 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.
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Savings Targets

24. ©2011-2017 Adam Nash
▪ 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.
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The Magic of Compounding

25. ©2011-2017 Adam Nash
▪ 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!
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Simple Model

26. ©2011-2017 Adam Nash
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!
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Years Return at 8%
10 2.16x
20 4.66x
30 10.06x
40 21.72x
50 46.9x

27. ©2011-2017 Adam Nash
▪ 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
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The Dangers of Debt

28. ©2011-2017 Adam Nash
▪ 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
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Good Investing is Boring

29. ©2011-2017 Adam Nash
▪ 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
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Basic Asset Allocation

30. ©2011-2017 Adam Nash
▪ 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/
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Simple Operating Model

31. ©2011-2017 Adam Nash
▪ 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/
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Recommended Books