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?

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”

Your Emergency Fund

Everybody knows that they need an emergency fund (despite the fact that not enough people have them). Nobody wants the stress of being unable to handle a medical emergency, the loss of a job, or a car that needs repairs. But what priority level should your emergency fund be compared to paying off debt or saving for retirement? How much do you actually need to save? And should it be in all cash or invested? These are the issues we’ll be looking at today.

When to Start Saving

The loudest voice in personal finance is Dave Ramsey. Ramsey tells his readers and listeners to first save $1,000 in an emergency fund, then pay off all non-mortgage debt, then build the emergency fund to 3-6 months of expenses. And all of this before contributing anything to retirement savings.

If you’ve been around here for any length of time, you know from my framing of the last paragraph that I am about to disagree. Continue reading “Your Emergency Fund”

You Need to Be Investing!

Whatever bad things you want to say about them, Millennials are good at saving.

This is assumed to be due to being in their formative years when the 2008 recession happened. One expert noted that prior generations saw “plenty of boom times where the stock market was going up, home prices were going up, so they didn’t feel they had to save.”

Millennials saw that markets can go down and home prices can go down and placed more emphasis on emergency savings and a bit less on consumption.

That’s great news! The bad news is that Millennials aren’t investing the extra cash that they are stowing away. Continue reading “You Need to Be Investing!”

Understanding the 4% Rule

As we’ve already discovered, to retire comfortably you need around 25 times your annual expenses. This number comes from the 4% rule, which I briefly touched on (and which got a lot of attention in the comments because you all are apparently as nerdy as I am). Today we’re going to explore the 4% rule and determine whether it is still a viable retirement guideline. Continue reading “Understanding the 4% Rule”

Saving Time and Money – Avoiding the Sunk Cost Fallacy

Let me pose to you a scenario posed to subjects of a 1985 University of Ohio study:

Imagine that you spent $100 to book a ski trip to Michigan that seemed like it would be a lot of fun. You later spent $50 on a ski trip to Wisconsin that seemed like it would be even more fun. After spending your money on both (and finding out that they cannot be refunded or resold) you realize that the trips are for the same weekend. Which one do you go on? Continue reading “Saving Time and Money – Avoiding the Sunk Cost Fallacy”

Buying vs. Renting (Your House is a Really Bad Investment)

As an older Millennial (I liked it better when they briefly called us Digital Natives, but unfortunately I don’t control the generation-naming zeitgeist) I grew up with all of the Boomer authority figures drilling into my head that buying a house is a great investment.

Renting is just throwing money away. Nobody is going to be making any new land any time soon, so home prices can only go up!

And then 2008 happened. Continue reading “Buying vs. Renting (Your House is a Really Bad Investment)”

The Importance of Opportunity Cost in a Happy and Wealthy Life

One of the central concepts in decision-making is the concept of opportunity cost. Every decision we make on a daily basis, whether it is an involuntary part of our routine or an active choice, can be evaluated using this overarching concept.  Essentially, the idea behind opportunity cost is that oftentimes a choice that we make will close the door on other choices. If I go to the beach this weekend, I can’t also go to the mountains this weekend. If I spend $300,000 on a Ferrari 458 Speciale, I can’t invest that $300,000 in the stock market (or ever retire). Continue reading “The Importance of Opportunity Cost in a Happy and Wealthy Life”

Buffett’s Bet

There is a dispute over how you should be investing your money and Warren Buffett has lined himself up as the antagonist of hedge fund managers.

Before jumping into the fight, a quick primer on active and passive investing: Active funds are actively managed (and clearly creatively named) funds in which the fund manager tries to pick investments that will perform better than the market. Passive funds (or index funds) are funds that simply try to match an index rather than beat it. For example, instead of trying to pick the companies that will outperform the market, a passive S&P 500 index fund will purchase every company in the S&P 500.

Warren Buffett, the third richest man in the world, is a big believer in passive investing for the average investor. While he takes an active role in managing the investments of his company, Berkshire Hathaway, he believes that the vast majority of people are better off placing their money in low fee index funds and investing passively. Continue reading “Buffett’s Bet”