Saturday, August 23, 2008

Frugal, Frugal, Frugal

I stole this title from the title of one of Stanley and Danko's chapters in The Millionaire Next Door, reflecting the findings of their surveys of people who had accumulated over $1,000,000. It's counter intuitive to think of the wealthy as frugal, I know, since we've all seen "The Lifestyles of the Rich and Famous" and assume that all wealthy people continually indulge themselves with yachts and extravagant vacations.

But it makes sense when you think about it: to accumulate wealth, you've got to live beneath your means; to accumulate extraordinary wealth, you've got to live wayyyy beneath your means. What distinguished these people was not so much how much they made, since they were spread out among many ordinary vocations. They were distinguished, in part, by spending much less than they made - living in neighborhoods with those who made far less, buying conservative, reliable cars. They accumulated wealth by refusing to throw it away.

This is the way my parents lived, thus instilling in me a different mentality than most of the culture I sense around me. Mom's favorite place to shop for clothes is, to this day, her favorite thrift store. Her favorite car is the one she's owned for ten years. She has plenty of money saved for retirement, believe me. Yet, she detests spending money needlessly and relishes a great bargain.

In the spirit of mom and the millionaires surveyed by Stanley and Danko, I've kept my eye out for ski equipment over the months. I take some of my kids skiing once each Winter, but I detest paying such exhorbitant fees for equipment rental. If we could purchase our own equipment cheaply and avoid the rental, we'd only have to purchase a lift ticket. Enter the local Good Will store and Play It Again Sports (selling used sporting goods).

If I bought brand new ski equipment, it would be new only until I used it once. For the rest of my life, it would be used. If you can buy quality used equipment, why not skip that first "brand new" day and start off used?

(By the way, my wife's in full agreement about my frugality. We had a Saturday morning date to Goodwill and she was delighted. She picked up a small table we needed for the laundry room. Reference Stanley and Danko's findings on marrying a frugal mate!)

So I got a nice pair of skis, Saloman ski boots in my size, poles and nice carrying bag, all for under $30.00.

Looking at sporting goods sites, it appears that new skis cost anywhere from $125 to $700. Saloman Ski boots from $125 to $450, poles from $20 to $50, carrying bags starting at $50.

So it appears that, even if you took the cheapest prices, I've saved over $300 in ski equipment by shopping used in the off-season. I'm also in the process of helping my 14-year-old twins purchase snow boards. If they save a similar amount, we're talking $900 in savings as a family, which, if invested in a stock market index fund that might return the historic average (10%), would give me over $100,000 in 50 years!

It's just one item. But the impact can be huge. Doesn't it make Stanley and Danko's findings make sense? These first-generation millionaires understood the power of frugle and applied it to their cars, homes, clothes, vacations, etc. So don't be embarrassed to frequent thrift stores, shop off-season and peruse Craig's List. When you do, you're thinking like a millionaire!

Tuesday, August 5, 2008

Common Problems with Sudden Wealth

David Hultstrom is a financial planner and wealth manager for whom I have a lot of respect. His most recent newsletter was very insightful and I thought others would be interested. His contact information is at the end if you'd like to subscribe.

Financial Foundations August 2008 Newsletter

This month I would like to talk about the psychology of "sudden wealth". While probably all of us have had pleasant daydreams about the possibility of suddenly coming into a large amount of money, in fact it can cause a great deal of stress. The source of sudden wealth doesn't necessarily have to be winning a lottery or receiving an unexpected inheritance. Many people face adjustment issues even from the sale of a business, or the rollover of a large 401(k) upon retirement. In those cases, even though net worth is unchanged, having the wealth more accessible and liquid somehow makes it seem more real. Following, in no particular order, are some comments that I think might be instructive:
1) People who are prudent with small amounts of money tend to be prudent with large amounts of money. People who are profligate before an unexpected inflow will be profligate with that inflow. Or, in other words, more income or wealth won't solve what is fundamentally a spending problem. This is undoubtedly the reason that studies have found between a third and half of lottery winners end up declaring bankruptcy.
2) Far too often people who come into sudden wealth seem to almost be trying to lose the money - and subconsciously, they might be. Most people become comfortable with a certain lifestyle, self-image, etc. When something happens to change that, they may try (perhaps subconsciously) to get back to where they were previously. This is the financial equivalent of the biological process of homeostasis.
3) People think that lump sums will go further than they actually will. Someone who has made $50,000 per year all their lives may see the $500,000 in their 401(k) at retirement as an incredible amount of money, when it really isn't. The most extreme example of this that I have seen is a very successful attorney who was approaching retirement. His main assets were about $1,000,000 in his 401(k) and the value of his partnership share which his partners would buy from him for about $500,000. I asked the couple how much they needed to live on in retirement and his wife replied, "We have a fairly modest lifestyle, if we continue to get what he makes now, we should be just fine." I asked the obvious follow up question, "What do you make now?" To which he responded: "About $500,000." I wanted to ask what they planned to live on in year four (but I didn't). I also didn't get them as clients. My guess is they went with an advisor who said they were in fine shape.
4) People sometimes try to "prove something" to someone such as a spouse or a parent (even if the parent is deceased). It is not uncommon for someone to lose a great deal of sudden wealth in investments or businesses trying to demonstrate how skilled they are at investing or business.
5) Sometimes people don't know what to do so they ignore the funds completely. I once did a financial plan for a schoolteacher who lived very frugally on her salary. Her primary concern was whether she could afford to buy a condo to live in rather than continuing to rent an apartment. Her father had left her some stocks when he died more than 20 years previously, and she not only didn't spend any of the money, she had never bought or sold anything in the account. It was untouched for more than 20 years and her net worth was just under $1,000,000.
6) The receipt of sudden wealth can also cause strains with existing friends and family members. Many wealthy people are treated differently and not uncommonly feel taken advantage of. Of course, new "friends" and "advisors" become prevalent as well.
So, what is the solution? The main thing is to proceed slowly. It is OK to leave the wealth in cash while becoming acclimated to the new situation. It may not be prudent to immediately move to a nicer area, a bigger house, etc. As a first step, paying off all debt, and committing to remain debt-free is probably prudent. In addition, thinking of the wealth as an income stream, rather than a lump sum may be helpful. As I covered in the July 2007 Financial Foundations, the sustainable withdrawal rate from a portfolio is about 4% per year. Thinking of a million dollar windfall as being able to pay off a $500,000 mortgage and then have $20,000 per year from the remaining portfolio to spend, may lead to vastly different decisions than thinking about what to do with a million dollars.
Note: Our clients are located around the country (and world), if you know someone we may be able to help, we would be happy to do so. While Financial Foundations is intended primarily for our clients, we are happy to expand our readership so feel free to pass this along. If you have received this from someone else in that manner and would prefer to get it directly from us each month, please let us know. Similarly, if for some reason you no longer wish to receive this (as unimaginable as that seems) simply let us know that as well.
David E. Hultstrom
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Financial Planning & Wealth Management
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Stumbling on Happiness (Summary and Applications)

Daniel Gilbert, Stumbling on Happiness (New York: Vintage Books, 2005).

Many of our money decisions, both investing and spending, involve imagining how these decisions will pan out in the future. Many of our plans and decisions are made by asking the question, "What will make us happy?" But how accurately can we predict what will make our future selves happy? Will working a different job, living in a different location, or trading in our present family for a new one really make us happy? Harvard Psychologist Daniel Gilbert contends that our brains often fool us into choosing wrong paths to our future happiness. By better understanding how our minds work to construct our often skewed visions of future happiness, perhaps we can aim better at finding true happiness. As Gilbert puts it:

"By the time you finish these chapters, I hope you will understand why most of us spend so much of our lives turning rudders and hoisting sails, only to find that Shangri-la isn't what and where we thought it would be."

Gilbert is a great writer, entertaining as he educates. Almost every page gives me something to smile about. Often I find myself laughing aloud. Sure, he does his homework, pulling together research from psychology, cognitive neuroscience, philosophy, and behavioral economics. But then he presents it in a captivating, humorous style. That's my kind of book!

So far (I'm on p. 178) he's big on describing the problems but short on suggesting solutions. I'll concentrate on my proposed solutions to the problems.

Here are my takeaways:

1. Happiness is one of, if not THE, most fundamental want in people's lives. p. 36 - "Everyone who has observed human behavior for more than thirty continuous seconds seems to have noticed that people are strongly, perhaps even primarily, perhaps even single-mindedly, motivated to feel happy. If there has ever been a group of human beings who prefer despair to delight, frustration to satisfaction, and pain to pleasure, they must be very good at hiding because no one has ever seen them. People want to be happy, and all other things they want are typically meant to be means to that end. Even when people forgo happiness in the moment - by dieting when they could be eating, or working late when they could be sleeping - they are usually doing so in order to increase its future yield."

Freud put it this way, "What do they (humans) demand of life and wish to achieve in it? The answer to this can hardly be in doubt. They strive after happiness; they want to become happy and to remain so."

Blaise Pascal said, "All men seek happiness. This is without exception. Whatever different means they employ, they all tend to this end. The cause of some going to war, and of others avoiding it, is the same desire in both, attended with different views. The will never takes the least step but to this object. This is the motive of every action of every man, even of those who hang themselves."

I'm trying to explore the many and varied implications of this. Here are a few:

  • Educators, employers and parents have tremendous leverage to use here! We can't assume that every child wants to be a great athlete, great intellectual, amass great wealth, be married, or have a nice house in a nice subdivision. Assuming that these ends are desired and trying to motivate on those bases will make you miss your motivational mark. "But I don't want to have a big house," many youth will mentally object when you try to use that end as a motivation to do their homework or save their money. But we CAN assume that they want to be happy, so find studies and people stories that connect doing homework or saving money to finding happiness and you just might have their attention!
  • Study and analyze and debate about and reflect upon the things that lead to happiness and misery. Isn't this, in the final analysis, more important to our future success than memorizing the presidents of the United States or Kings of England?
  • Find ways to put our understanding of happiness into handy acrostics and hook them to devices that embed them in our minds and make them easy to apply.
  • Take specific lifestyle issues that we want to influence people about and reflect upon them with relation to the ultimate happiness. Example: many studies show that the best sex happens in the context of a secure, committed, long-term relationship - what we traditionally call marriage. Early sex with multiple partners can put a lifetime of good to great sex in jeapardy, with the threat of STD's, etc.

2. Acquire a healthy skepticism about my assessment of past events. In order to save brain space and allow us to make quick decisions, our brains tend to assign a title to an experience and save that title rather than the entire experience. Thus, if I heard an orchestra and thought afterward, "It was generally good but I felt it ended poorly," I might remember only that it was second rate. I can't rewind to experience it again and retrieve all of my original feelings.

Thus, when I say that "I hated Middle School" or that "my high school years were the best of my life," I've probably wiped out huge blocks of experience which, if I could bring them back, would cause me to reassess.

Additionally, we tend to remember past emotions and events in the light of today's emotions. When college students changed their minds about an issue due to a persuasive speech, they "remember" that they always felt that way about the issue.

3) People can experience high levels of happiness in seemingly difficult circumstances. Lori and Reba Schappel are Siamese twins, joined at the forehead. Yet, they are joyful, playful, and optimistic. They say emphatically that they do not wish to be separated. That's not weird among Siamese twins. An exhaustive search of the medical literature reveals the "desire to remain together to be so widespread among communicating conjoined twins as to be practically universal." They truly enjoy being together and don't pine for privacy.

You might object, "But they don't know what it's like to experience independence and privacy. If they experienced it, they would realize that they're not nearly as happy as they could be."

Gilbert argues against this view, saying, in part, that although Lori and Reba can't know what privacy would be like, neither can we know the depth of communion and sharing that they experience. They certainly show every outward sign of happiness, with Reba having recorded an award-winning country music album and Lori being "outgoing, wisecracking" and following her dreams as well.

4) New experiences can influence our future assessment of happiness. Gilbert first smoked a cigar in high school. Although he doesn't smoke regularly, he can't get the full blast of pleasure out of kicking back and relaxing in a lounge chair at a beach resort without having a cigar in his mouth. It makes one wonder...had he never experienced a cigar, could he experience the same amount of happiness at the beach without one? It reminds me of alcoholics, or any fans of alcohol, who can't imagine a social event without a drink in their hands. Are they really having more fun than the others at the social, or have they simply acquired a habit that they now have to continue in order to experience the level of happiness that others are experiencing without the alcohol? The bottom line? Be careful what you experience even once!

5) Question my ability to picture my ideal future. Every day we're making big and small decisions based on what we think will give us the greatest amount of happiness. "If I can win 'Teacher of the Year' I'll be happy." If I marry her, I'll be happier than if I marry her. If I order the Big Mac, I'll be happier than if I order the Quarter Pounder." "I'd be happier as CEO than as a labor union activist."

Gilbert puts that last statement to the test with a real-life example. Adolph Fischer's labor union challenged Chicago's powerful industrialists and he found himself facing a hangman's noose as a result of trumped-up charges. He surprised everyone by declaring with his last words, "This is the happiest moment of my life."

George Eastman became one of the richest men in the world by developing the revolutionary Kodak camera. "On March 14, 1932, the beloved inventor and humanitarian sat down at his desk, wrote a brief note, neatly capped his fountain pen, and smoked a cigarette. Then he surprised everyone by killing himself."

Before Eastman's suicide, how many people would have longed for his life of super-wealth and success. Apparently, our dream of what life would be like in his situation doesn't match what life was actually like in his situation.

"Mr. Destiny" is one of my favorite films. James Belushi plays Larry Burrows, a man who married a sweet by slightly dingy girl who can't seem to keep enough of his favorite cereal in the cupboard. His working class home and working class wife and working class job and working class friends are OK, but he blames his mediocre existence on one event: the day he struck out on the last play of the biggest game of the season in front of a crowd that contained everybody that was anybody. "If I'd only hit that ball," he often found himself musing, "my life would have turned out differently."

So the controller of destiny mixes up a drink that puts Larry into the other life - the one he would have lived had he hit the ball out of the park. He married the homecoming queen, who's dad made Larry the CEO of his company, which allowed him to live in a mansion with all the toys and cars he could dream of.

At first, Larry was ecstatic. But soon he found downsides to his new life. His workers hated him, including the best friend and wife from his former life. A power-hungry associate was out to destroy him. Rich folk's wines sucked in comparison with his "Brewski" beer.

When he got the life he always wanted - the one he always envisioned bringing him the ultimate happiness - he discovered that the new circumstances didn't bring about the expected happiness.

Solomon once said that we never know another man's joys or sorrows. How apt! Before you envy the CEO, the movie star, the guy all the girls like - remember that you see a small portion of that person's life. If you saw the whole, you might thank God daily that you don't have that life.

So how do we recognize the potential flaws in our dreams and tweak them to make them more accurately represent what would really make us happy?

6. Understand how my dreams of the future get skewed. (more to come)

One More Thing I'd Like to Know

The books I've read on this issue (how our brains fool us) often summarize studies with statements like, "people in this study tended to be more optimistic than their available facts warrant." That's interesting, but I'd like to know what percentage of the people were too optimistic. Fifty-one percent? Ninety-nine percent? Both percentages could be described by the statement that people "tended to be more optimistic," but it makes a huge difference in how I assess the extent of the problem. Surely some of us are more objective about our abilities and assessing our futures than others. If not, shouldn't we all assume that we're being too optimistic when we assess the odds of our new business succeeding? If so, we should all adjust our expectations accordingly when making decisions.

Monday, August 4, 2008

On Money and Happiness

The final chapter of my book, Enjoy Your Money, addresses the relationship between money and happiness. When does more money make us happier? When does it not? I pulled part of my research from psychologist David Myers. Here's a summary of one of his books:

David G. Myers, The American Paradox: Spiritual Hunger in an Age of Plenty (New Haven: Yale University Press, 2000)

Why do we have more stuff and comforts than we've ever had, yet people report more misery and dissatisfaction with life than when people had much less? Thus the paradox that Myers, a respected social psychologist, tries to explain.

Citing abundant studies and reflecting on their accuracy and meaning, Myers concludes that, although money helps our happiness when it lifts us above the poverty line, it doesn't really help our well-being when it grants us more than we need. Supporting this thesis are studies that find lottery winners initially exuberant, but later adjusting to their former level of happiness. Similarly, accident victims who lose their eyesight or find themselves suddenly quadraplegic, initially fight depression but eventually find themselves with about the same level of happiness as before the accident.

Who finds themselves less happy than others? Those who strive most for material wealth. How fascinating! While many give lip service to the religious teachings and wisdom of the wise who insist that "it's better to give than to receive" and that "real happiness comes more from caring relationships than accumulating lots of stuff," Myers demonstrates from study after study that these teachings are true.

Myers comes with sound credentials. As professor of Psychology at Hope College, his research and writings can be found in over sixty periodicals. His psychology textbooks are used in nearly one thousand colleges and universities.


1. Poverty isn't good. Some may cry "duh!", but many hold a noble ideal of leaving the corporate rat-race, working minimum wage or part-time and earning minimum wage and playing their guitar on street corners for spare change. Others are so mission-minded that they want to live in the ghetto and serve those around them. While this may be fine for singles, it's not good for raising children. They'll likely grow up in fear, choosing the wrong role models in a crack neighborhood. Plan on making enough money to live in a decent neighborhood, send your children to decent schools, and have decent health care. Find ways to help those who are in poverty and support policies that help people out of poverty.

2. Materialism leads to misery. Studies show that those who strive most for wealth are less happy than those who put relationships first.

3. Do everything we can to promote stable families. The sexual revolution that started in the 60's brought more misery than happiness. The best sex happens in the context of a committed, long-term relationship - what we traditionally call marriage. Much of the depression and anxiety and maladjustment and violence of youth can be traced directly to their unstable homes. Sure, we all need a village - but we also need a family. Much, much research shows the power of the stable family unit to produce productive, happy children. A huge amount of today's poverty can be a attributed ruptured families that must survive with single parents. Promote government policies that promote stable families. Stay faithful to your spouse and children.

4. Promote living for others and community rather than radical individualism. Myers identifies the latter as one of the most remarkable characteristics of the present age. It's also the root of much of today's misery. This has been a huge shift in attitude since the 50's. Today, people typically seek personal peace and affluence above all else. Paradoxically, those who strive hardest to satisfy me, me, me end up less satisfied with life than those who are more concerned with others. The most obvious place we see this is in marriage. Those who go into it for what they can get end up unfilled and often divorced. Those who go into it with more selfless aspirations get the most fulfillment.

5. Character education must continue to grow and prosper in our schools. Communities agree on many traits they want to see in their students, such as honesty, diligence, concern for others, etc. Schools have the responsibility to partner with parents and community leaders to reinforce these traits in the school.

6. Religion is a positive force in the world. Sure, there are plenty of examples of religious people and organizations who've been negative. But when you look at the big picture, religion has been extremely positive for the world. The vast majority of work with the poor and down and out is done directly by religious organizations or done through secular organizations by religous people. Deeply religious people also report significantly greater happiness than the irreligious.

7. Involvement in corporate worship is essential for spiritual growth. The individualism of our age impact many people's approach to religion. They see little need to meet with other religious people when they feel they can just as easily worship and please God on their own. Yet, Myers sites numerous studies that find that meeting with people of similar beliefs strengthens your own beliefs. Also, studies find that those who don't meet with other believers neither serve nor give like believers who take corporate worship seriously.