Saving Money Better – Recurring Expenses

As a preliminary note: Thank you all for the well-wishes in response to my last post! I had a lovely month out of the country (although everyone everywhere wanted to talk about Trump and the American election). If you’d like to see some pictures from Johannesburg, Kruger National Park, Durban, Cape Town, and Barcelona, feel free to check out my wife’s Instagram page. I also have some articles on vacation and travel coming up, in which I will include some photos from the trip.

And now back to your regularly scheduled programming…

I recently wrote about how to save money better. I argued that you should focus first on housing, transportation, food, and taxes. My explanation was that these are the areas where we spend the largest amounts of money, and so they are also the areas where we could save the largest amounts of money. Continue reading “Saving Money Better – Recurring Expenses”

The Ostrich Effect

You may be familiar with the term “burying your head in the sand.”

The image comes from the myth that ostriches avoid danger by sticking their heads in the sand and pretending it doesn’t exist.

When we are accused of burying our heads in the sand, it means that we are ignoring bad things in the hopes that they will go away. This is usually not a useful strategy.

It is also not usually intentional. We don’t purposefully avoid opening the letter from the IRS because we think that it won’t exist if we don’t read it. We just naturally want to avoid conflict and so we set it aside until we feel more prepared to face the facts.

The problem of course is that sometimes we don’t get more prepared. Sometimes that letter sits on the table unopened for a few days before getting buried under some other mail. Eventually we miss a deadline we didn’t know existed and the whole situation gets worse.

As you can imagine, burying your head in the sand is usually a terrible approach to problem solving. But not always.

The Ostrich Effect and Money Problems

When dealing with money, people very often bury their heads in the sand.

Have you ever gotten mail from your credit card company and set it aside for later instead of opening it right away? Then you have buried your head in the sand.

That bill is not going to be smaller or easier to face when you eventually open it. Instead, you will just have a shorter period of time between seeing the bill and having to pay it.

And if, as described above, the bill gets shuffled under some other paperwork, you could miss the due date and end up paying interest and late fees. It’s an expensive mistake to make.

I have worked as a tax preparer. Most people get all of the paperwork that they need to file their taxes by the end of January. But do you think I get more clients in February or April?

The closer to the deadline, the busier the office. Everyone is putting it off, to no discernible benefit. Instead, by waiting until the last minute, the process becomes more stressful and the risk of missing deadlines and paying fees because you can’t find some piece of paperwork becomes pretty high. If I forget to bring my W2 to a tax preparer on February 14, I can go home, find it, and come back whenever I have some free time. If I forget it on April 14, I will have to go into panic mode.

Another area where people bury their heads in the sand when it comes to money is in dealing with end of life issues. Nobody wants to talk about death, and so we avoid conversations about life insurance and wills, as if we cannot die until after they are set up.

The reality is that if we avoid these discussions, then the premature death of a spouse becomes not only a heartbreaking event, but a potential financial catastrophe. A financial catastrophe that could have been pretty easily avoided.

The Ostrich Effect and Relationships

There is a similar psychological concept called the Ostrich Effect that deals with relationships. This concept suggests a predictable and common sequence of events that ends up ruining relationships.

1. People have difficult moments with one another
2. Something about those moments makes them anxious
3. People avert their gazes from the source of their discomfort
4. They fasten instead upon compelling distractions that allow them to express emotions triggered by the difficult moments – but not have to deal with those emotions or moments
5. This sets in motion waves of counterfeit problems among people whose sources and solutions remain unknown
6. People then work on the wrong problems, which escalate and spread to involve others.

The idea here is similar to what we discussed with money issues. People face a problem in their relationship that makes them uncomfortable. Instead of directly addressing that problem, they avoid conflict and bury their heads in the sand. This causes the problem to continue unabated and grow worse, infecting the rest of the relationship.

Relationships are legitimately ruined because people are burying their heads in the sand instead of having an uncomfortable conversation up front.

When Burying Your Head in the Sand is Useful

Burying your head in the sand is obviously harmful and should be avoided at all costs in most situations. But not all situations.

The most obvious example of where burying your head in the sand is useful is in investing. If you are paying too close attention to your investments and are trying too hard to address issues when they arise, it becomes very easy to panic and sell your investments during a downturn.

This is tempting because you feel like you are doing something to protect yourself from further losses. But it isn’t a good idea.

If you had invested in a total stock market index fund in 2008, you would have lost quite a bit of money by 2009 and it would have been quite tempting to sell. But if you held on to it, you would have made it all back and more by 2012.

Markets go down, but they have always come back up. If you are trying to sell to avoid losses and buy back in to capture gains, then you need to get your timing right twice – once when you sell and once when you buy. Most people fail at this. Hard. It’s much easier and smarter to bury your head in the sand and ignore the ups and downs until you actually need the money.

In fact, a senior economist at the Federal Reserve Bank of St. Louis found that from 2000 through 2012, burying your head in the sand would have netted you an average annual return of 5.6%, while trying to buy and sell netted investors only 3.6%.

There is a story that has made the rounds that illustrates this point well. On an episode of the Masters in Business podcast, James O’Shaugnessy told the audience that Fidelity had once done a study to find out what their best performing individual accounts had in common.

They called the owners of the best performing accounts and asked them about their investing. It turns out that the best performing accounts were those of the people who had forgotten that they had an account with Fidelity.

I will note that I cannot confirm the veracity of the story. Every telling of the story that I could find was either unsourced (come on, people), cited the podcast episode, or cited some other source that cited the podcast episode.

That said, it fits with everything else that we know about the benefits of passive, buy-and-hold investing. Even without the Fidelity study, we can say that when it comes to riding out down markets, burying our heads in the sand is a strategy that works.

So what about you? Where do you find yourself burying your head in the sand? Can you think of other instances where it is beneficial?

Your Instinctive Thinking Is Losing You Money

Imagine for a moment that you are in the market for a new suit. You find one that you like for $200. A fellow customer then tells you that the same exact suit is on sale across town for only $100. Do you go?

Imagine that you are buying a new car. You’ve done your test drives and made a final decision on which make and model you want. You go to the dealer near your home to find that the car costs $30,000. A salesman sees you eyeing the car and says, “My manager would kill me for saying this, but the dealer on the other side of town has this model for $29,900.” Do you go? Continue reading “Your Instinctive Thinking Is Losing You Money”

Dealing with Disappointment

There has been a lot of ink spilled discussing the results of the recent presidential election here in the States. I’m going to add to it today.

You can relax, though, because I will not be talking about politics directly.

Instead, I want to talk about dealing with loss and disappointment. Continue reading “Dealing with Disappointment”

Why We Have Trouble Making a Change

When faced with a tough decision, most people choose to do nothing.

This is the basis of the Status Quo Bias, first proven in a series of experiments in 1988 out of Harvard. The general idea is that people are emotionally attached to the current state of affairs and are skeptical of any change from that baseline.

This means that we tend to need overwhelming proof to make a change, even when that change would be the better option. Continue reading “Why We Have Trouble Making a Change”

Defeating Decision Fatigue in a World of Choices

We live in a world where decisions abound. We have a plethora of options when it comes to just about everything. The alarm goes off and we decide whether to get up or hit the snooze button. We decide what to eat for breakfast. We decide which shampoo and soap and toothpaste to use. We decide which clothes to wear. We decide what method of transportation to use to get to work. We decide which route to take.

And that’s all before getting to our desk on a simple morning. Continue reading “Defeating Decision Fatigue in a World of Choices”

The Downside of Keeping Your Options Open

When given an option between a reversible decision and an irreversible decision, we tend to prefer the former. We like money back guarantees. We like no strings return policies. There is something comforting about knowing that we can change our minds in the future.

There is less pressure on us to make the perfect choice. We are not stuck if we make a bad decision.

We’re also inadvertently undermining our own happiness.
Continue reading “The Downside of Keeping Your Options Open”

The IKEA Effect

I like to spend a lot of time exploring cognitive biases. I firmly believe that if we spend the time to get familiar with the natural flaws in our thinking we can avoid those flaws, make better decisions, and live a richer and happier life.

Previously we have explored confirmation bias and the sunk cost fallacy. Today I want to talk about the cognitive bias with my favorite name. Continue reading “The IKEA Effect”