This is the version of my talk, Personal Finance for Engineers, that I gave on February 20, 2014 at Stripe HQ in San Francisco. It has minor modifications to broaden the language for the whole company.
2. Caveats & Preface
â˘
I am not a ďŹnancial planner
â˘
This presentation is not ďŹnancial advice
â˘
You would be extremely foolish to make investment
decisions based solely on the content of this
presentation or discussion
â˘
The opinions in this deck are intended purely to provoke
discussion & further education
wealthfront.com | 2
3. Why Personal Finance?
â˘
Poorly covered in traditional education, even
top tier universities
â˘
Not technically diďŹcult, but signal:noise ratio
is terrible
â˘
Massive impact on your life
-
Money is one of the top 3 reasons â¨
for marital problems
wealthfront.com | 3
4. 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
wealthfront.com | 4
5. How many of you think
you are rational with
your money?
(show of hands)
7. Anchoring
â˘
People estimate answers to new /
novel problems with a bias towards
reference points
â˘
Example: 1974 Study
â˘
Most common examples:
â˘
Price you bought a stock at
â˘
High point for a stock
wealthfront.com | 7
8. Mental Accounting
â˘
Money is fungible, but people put it
in separate âmental accountsâ
â˘
Lost movie tickets example
â˘
âFound Moneyâ problem
â˘
Vacation fund & credit card debt
wealthfront.com | 8
9. Confirmation & Hindsight Bias
â˘
We selectively seek information
that support pre-existing
theories, and ignore / dispute
information that disproves them.
â˘
We overestimate our ability to
predict the future based on the
âobviousnessâ of the past.
(example: real estate)
wealthfront.com | 9
10. Gamblerâs Fallacy
â˘
We see patterns in independent,
random chains of events
â˘
We believe that, based on series
of previous events, an outcome is
more likely than odds actually
suggest
â˘
Coin ďŹip example
â˘
Itâs because with human behavior,
there are no âindependentâ events
wealthfront.com | 10
11. Herd Behavior
â˘
We have a tendency to mimic the
actions of the larger group
â˘
Crowd psychology is a major
contributor to bubbles (believed)
â˘
Easier to be âwrong with everyoneâ
than âright and aloneâ
â˘
No one gets ďŹred for buying IBM?
wealthfront.com | 11
12. Overconfidence
â˘
In one study, 74% of investment
managers believe they deliver
above average returns.
â˘
Positively correlated with High IQ...
â˘
Learn humility early
wealthfront.com | 12
13. Overreaction & Availability Bias
â˘
Overreact to recent events
â˘
Overweight recent trends
â˘
Studies demonstrate that checking
stock prices daily leads to more
trading and worse results on
average
â˘
Worse in high tech, because we
are immersed in âgame changersâ
wealthfront.com | 13
14. You have $1,000 and you must
pick one of the following choices:
Choice A: â¨
You have a 50% chance of gaining $1,000,
and a 50% chance of gaining $0.
Choice B:â¨
You have a 100% chance of gaining $500.
15. Now, you have $2,000 and you must
pick one of the following choices:
Choice A: â¨
You have a 50% chance of losing $1,000,
and a 50% chance of losing $0.
Choice B:â¨
You have a 100% chance of losing $500.
16. Loss Aversion (aka Prospect Theory)
â˘
We hate losses more than we love
winning
â˘
Average loss aversion is 3:1 (!)
â˘
AďŹects views on wide range of
situations, including taxes, holding
on to losing stocks, âsunk costâ
mistakes
wealthfront.com | 16
18. Itâs OK to Not Be Rational
â˘
The key is that humans are predictably irrational
â˘
Know your own ďŹaws, and you can set up systems to
account for them
â˘
Self-awareness is keyâ¨
(yes, my Mom is a psychologist...)
wealthfront.com | 18
19. Liquidity
â˘
Almost universally undervalued
â˘
Strictly deďŹned - itâs the
quantiďŹcation of how much money
you can get, and how fast.
â˘
Liquidity is the power to take
advantage of great investment
opportunities
â˘
Liquidity is also, in the end, the
only thing that matters when you
need to pay for something.
wealthfront.com | 19
20. Liquidity & Returns
â˘
In almost all cases, liquidity is inversely
correlated with returns
â˘
Examples:
-
â˘
Cash = very liquid
Private equity = very illiquid
Common mistake: Safety != Liquidity
wealthfront.com | 20
21. Practical Outcome: Emergency Funds
â˘
Standard recommendation is that you
have 3-6 months of living expenses in
cash / cash-equivalents.
â˘
That number increases if you are in
highly volatile industry / career.
â˘
Worth considering length of time for
potential job search.
wealthfront.com | 21
22. Cash Flow
â˘
The ultimate secret to personal ďŹnance is
quite simple:
-
Spend less than you makeâ¨
(on an ongoing basis)
â˘
Very easy to measure, but few people do.
Annual budget is a great idea.
â˘
Donât forget to model in annual expenses
& âpersonal spendingâ
wealthfront.com | 22
23. Savings Targets
â˘
Whatâs the right number? 3%? 6%?10%? 20%?
-
â˘
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.
wealthfront.com | 23
24. The Magic of Compounding
â˘
Not convinced that Albert Einstein said it was the
greatest force in the universe.
â˘
Itâs the key to almost all long term ďŹnancial planning.
â˘
Exponentials are bad in algorithmic cost, good in
savings returns.
wealthfront.com | 24
25. Simple Model
â˘
Rule of 72
â˘
In Excel, for each year, just use â¨
=POWER(1+rate, year)
â˘
4% over 20 years is 2.19x
â˘
8% over 20 years is 4.66x
â˘
Careful: it works on debt just as well as savings...
in reverse!
wealthfront.com | 25
26. The Benefits of An Early Start
â˘
Compounding really takes oďŹ 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
wealthfront.com | 26
27. The Dangers of Debt
â˘
Bankruptcy is literally when you canât pay your debts.
You canât go bankrupt if you donât have debt.
â˘
You will never ďŹnd an investment that pays 8%
guaranteed, let alone 20%+
â˘
You will ďŹnd *tons* of credit oďŹers out there that will
charge you that.
â˘
âBadâ debt is toxic, your best return is to pay it oďŹ.
But emergency fund takes precedence.
wealthfront.com | 27
28. Good Investing is Boring
â˘
No one wants to be average, but with investing,
average is actually well above average.
â˘
You will beat most mutual funds, and a large majority of
your peers with simple, low-cost index funds.
â˘
Asset allocation explains ~90% of the variance between
fund performance
wealthfront.com | 28
29. Basic Asset Allocation
â˘
DiďŹerent types of assets (stocks, bonds, etc) have
diďŹerent volatility & return characteristics
â˘
There is an eďŹcient frontier of combinations that
can maximize return for a given volatility
â˘
Complication: historical performance does not
predict future performance
wealthfront.com | 29
30. Simple Operating Model
â˘
2 hours of work per year.
â˘
Pick an asset allocation that is appropriate for your
emotional character & time frame & goals.
â˘
For each asset class, pick the cheapest index fund with
the lowest drift and best liquidity.
â˘
Rebalance every year.
wealthfront.com | 30
31. Recommended Books
â˘
WSJ Guide to Understanding Money & Investing
â˘
The Millionaire Next Door
â˘
A Random Walk Down Wall Street
â˘
The Essays of Warren BuďŹett
â˘
Common Stocks & Uncommon ProďŹts
â˘
The Intelligent Investor
â˘
Devil Take the Hindmost
â˘
When Genius Failed
â˘
Against the Gods: The Remarkable Story of Risk
â˘
http://blog.adamnash.com/2007/02/14/personal-ďŹnanceeducation-series-2-recommended-books/
wealthfront.com | 31
32. 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 reďŹect actual future
performance. Investors should review Wealthfrontâs website for
additional information about advisory services.  Â
wealthfront.com | 32