2. Caveats & Preface
⢠I am not a ďŹnancial planner
⢠This presentation is not ďŹnancial 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. Why Personal Finance?
⢠Poorly covered in traditional
education, even top tier universities
⢠Not technically different, but
signal:noise ratio is terrible
⢠Massive impact on your life
(Money is one of the top 3 reasons for
marital problems)
4. Why âFor Engineersâ
⢠Understand / Prefer Math
⢠Tend to make higher incomes early in life,
thus face questions sooner.
⢠Tend to have complicated instruments,
like stock options, as part of their
compensation.
⢠Believe they are rational, which is actually
a problem when it comes to money
5. Fast Five Finance Basics
⢠Behavioral Finance Basics
⢠Liquidity is Undervalued
⢠Cash Flow Matters
⢠The Magic of Compounding
⢠Good Investing is Boring
6. âAdvanced Settingsâ
⢠Calculating Returns in Excel
⢠Why Retirement Planning is Hard
⢠Why Do You Collect Coins?
⢠Understanding Derivatives
⢠Recommended Books
7. How Many of You Think You
Are Rational with Money?
(raise your hands)
8. You Are Not Rational
⢠Anchoring
⢠Mental Accounting
⢠ConďŹrmation & Hindsight Bias
⢠Gamblerâs Fallacy
⢠Herd Behavior
⢠OverconďŹdence
⢠Overreaction & Availability Bias
⢠Loss Aversion (aka Prospect Theory)
9. 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
10. Mental Accounting
⢠Money is fungible, but people put it in
separate âmental accountsâ
⢠Lost movie tickets example
⢠âFound Moneyâ problem
⢠Vacation fund & credit card debt
11. ConďŹrmation &
Hindsight Bias
⢠We selectively seek information that
support pre-existing theories, and
ignore / dispute information that
disproves them.
⢠We overestimate our ability to predict
the future based on the âobviousnessâ
of the past. (example: real estate)
12. Gamblerâs 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 ďŹip example
⢠Itâs because with human behavior,
there are no âindependentâ events
13. 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 âwrong with everyoneâ
than âright and aloneâ
⢠No one gets ďŹred for buying IBM?
14. OverconďŹdence
⢠In one study, 74% of investment
managers believe they deliver above
average returns.
⢠Positively correlated with High IQ...
⢠Learn humility early
15. 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 âgame changersâ
16. Loss Aversion
(aka Prospect Theory)
⢠You have $1,000 and you must pick one of the following choices:
⢠Choice A: You have a 50% chance of gaining $1,000, and a
50% chance of gaining $0.
Choice B: You have a 100% chance of gaining $500.
⢠You have $2,000 and you must pick one of the following choices:
⢠Choice A: You have a 50% chance of losing $1,000, and 50%
of losing $0.
⢠Choice B: You have a 100% chance of losing $500.
⢠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, âsunk costâ mistakes
17. Itâs OK to Not Be
Rational
⢠The key is that humans are
predictably irrational
⢠Know your own ďŹaws, and you can set
up systems to account for them
⢠Self-awareness is key
(yes, my Mom is a psychologist...)
18. Liquidity
⢠Almost universally undervalued
⢠Strictly deďŹned - itâs the
quantiďŹcation 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. Liquidity & Returns
⢠In almost all cases, liquidity is
inversely correlated with returns
⢠Examples:
⢠cash = very liquid
⢠private equity = very illiquid
⢠Common mistake:
Safety != Liquidity
20. 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.
21. Cash Flow
⢠The ultimate secret to personal ďŹnance
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.
⢠Donât forget to model in annual
expenses & âpersonal spendingâ
22. Savings Targets
⢠Whatâs the right number? 3%? 6%?10%? 20%?
⢠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 donât actually match anyoneâs real world
experience.
⢠There are a lot of models out there, and rules of thumb,
but itâs important to run the numbers yourself.
23. The Magic of
Compounding
⢠Not convinced that Albert Einstein
said it was the greatest force in the
universe.
⢠Itâs the key to almost all long term
ďŹnancial planning.
⢠Exponentials are bad in algorithmic
cost, good in savings returns.
24. Simple Model
⢠Rule of 72
⢠In Excel, 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!
25. The BeneďŹts of
An Early Start
⢠Compounding really takes off over
long time periods
Years Return at 8% In most retirement
10 2.16x planning models,
money saved
20 4.66x between ages 25 - 35
30 10.06x produces more
money than all
40 21.72x savings between
50 46.9x 35 - 65!
26. The Dangers of Debt
⢠Bankruptcy is literally when you canât pay
your debts. You canât go bankrupt if you
donât have debt.
⢠You will never ďŹnd an investment that pays
8% guaranteed, let alone 20%+
⢠You will ďŹnd *tons* of credit offers out there
that will charge you that.
⢠âBadâ debt is toxic, your best return is to pay
it off. But emergency fund takes precedence.
27. 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
28. Basic Asset Allocation
⢠Different types of assets (cash, bonds,
stocks, etc) have different volatility &
return characteristics
⢠Combinations can lower volatility
signiďŹcantly, with moderate impact to
returns
⢠Complication: historical performance
does not predict future performance
29. 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-ďŹnance-how-to-rebalance-your-
portfolio/
30. Calculating Returns in
Excel
⢠You can model as a cash ďŹow in Excel
⢠Two columns: Dates & Amounts
⢠Additions are negative, Withdrawals
are positive. (yes, thatâs right)
⢠XIRR function is magic, but solving
non-linear equations requires a hint
32. Why Retirement
Planning is Hard
⢠Saving is hard enough
⢠Reliably modeling future returns is
extremely difďŹcult (simple, monte
carlo, etc)
⢠Converting lump sum into annual
income is borderline impossible
⢠No do overs
33. Why Do You Collect
Coins?
⢠Obvious answer: I am a nerd
⢠Less obvious answer:
⢠Collectible gold/silver coins are a unique asset class
⢠Precious metals provide a backstop in value, but over
long term, coins trade like collectibles, indexed to the
incomes of higher income brackets
⢠Rewards long-term contrarian thinking (buy when
unpopular)
⢠Game mechanics are reliable / predictable, if you
understand collection games (collect them all, rarity /
desirability, subscriptions)
⢠Most likely correct answer: I am a nerd
34. Understanding
Derivatives
⢠Derivative is a ďŹnancial instrument that is
based on another ďŹnancial instrument.
⢠Date back to medieval Japan & rice futures.
Critical to managing risk.
⢠Most common types are calls & puts
⢠Call = right to buy a stock at a certain price
over a given time period.
⢠Put = right to sell a stock at a certain price
over a given time period.
52. 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 ProďŹts
⢠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-ďŹnance-education-
series-2-recommended-books/
