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Caveats & Preface
âȘ I am not a financial planner
âȘ This presentation is not financial advice
âȘ You would be extremely foolish to make investment decisions
based on the content of this presentation or discussion
âȘ The opinions in this deck are intended to provoke discussion &
further education
3. ©2014 Wealthfront, Inc.
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Why Personal Finance?
âȘ Poorly covered in traditional education, even top tier universities
âȘ Not technically difficult, but the signal:noise ratio is terrible
âȘ Massive impact on your life
â Money is one of the top 3 reasons âš
for marital problems
4. ©2014 Wealthfront, Inc.
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
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ANCHORING MENTAL ACCOUNTING CONFIRMATION &
HINDSIGHT BIAS
GAMBLER'S FALLACY
OVERCONFIDENCEHERD BEHAVIOR OVERREACTION &âš
AVAILABILITY BIAS
LOSS AVERSION
(PROSPECT THEORY)
YOU ARE NOT RATIONAL
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Anchoring
âȘ People estimate answers to new
/ novel problems with a bias
towards reference points
âȘ Example: 1974 Study
âȘ Most common examples:
â Price you bought a stock at
â High point for a stock
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Mental Accounting
âȘ Money is fungible, but people put
it in separate âmental accountsâ
âȘ Lost movie tickets example
âȘ âFound Moneyâ problem
âȘ Vacation fund & credit card debt
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Confirmation & âš
Hindsight Bias
âȘ We selectively seek information
that supports pre-existing
theories, and ignore / dispute
information that disproves them
âȘ We overestimate our ability to
predict the future based on the
âobviousnessâ of the past
(example: real estate)
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Gambler's Fallacy
âȘ We see patterns in independent,
random chains of events
âȘ We believe that, based on series of
previous events, an outcome is
more likely than odds actually
suggest
âȘ Coin flip example
âȘ It's because with human behavior,
there are no âindependentâ events
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Herd Behavior
âȘ We have a tendency to mimic the
actions of the larger group
âȘ Crowd psychology is a major
contributor to bubbles (believed)
âȘ Easier to be âwrong with everyoneâ
than âright and aloneâ
âȘ No one gets fired for buying IBM?
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Overreaction & âš
Availability Bias
âȘ Overreact to recent events
âȘ Overweight recent trends
âȘ Studies demonstrate that
checking stock prices daily
leads to more trading and worse
results on average
âȘ Worse in high tech, because we
are immersed in âgame
changersâ
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You have a 100% chance of gaining $500.B
You have $1,000 and you mustâš
pick one of the following choices:
You have a 50% chance of gaining $1,000, and
a 50% chance of gaining $0.A
OR
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You have a 100% chance of losing $500.B
Now, you have $2,000 and you must
pick one of the following choices:
You have a 50% chance of losing $1,000,
and a 50% chance of losing $0.A
OR
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Loss Aversion âš
(aka Prospect Theory)
âȘ We hate losses more than we
love winning
âȘ Average loss aversion is 3:1 (!)
âȘ Affects views on wide range of
situations, including taxes,
holding on to losing stocks,
âsunk costâ mistakes
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It's OK to Not Be Rational
âȘ The key is that humans are
predictably irrational
âȘ Know your own flaws, and you
can set up systems to account
for them
âȘ Self-awareness is keyâš
(yes, my Mom is a
psychologist...)
19. ©2014 Wealthfront, Inc.
Liquidity is Undervalued
âȘ Strictly defined: it's the quanti-
fication of how much money you
can get, and how fast
âȘ Liquidity is the power to take
advantage of great investment
opportunities
âȘ Liquidity is also, in the end, the
only thing that matters when you
need to pay for something
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Liquidity & Returns
âȘ In almost all cases,
liquidity is inversely
correlated with returns
âȘ Examples:
â Cash = very liquid
â Private equity = very illiquid
âȘ Common mistake: Safety!
= Liquidity
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Practical Outcome: Emergency
Funds
âȘ Standard recommendation is
that you have 3-6 months of
living expenses in cash / cash-
equivalents
âȘ That number increases if you
are in highly volatile industry /
career
âȘ Worth considering length of
time for potential job search
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Cash Flow Matters
âȘ The ultimate secret to personal
finance is quite simple:
â Spend less than you makeâš
(on an ongoing basis)
âȘ Very easy to measure, but few
people do. Annual budget is a
great idea.
âȘ Don't forget to model in annual
expenses & âpersonal spendingâ
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Savings Targets
âȘ What's the right number?
â There is no question - the more you save, the more
secure you are. âš
Income comes & goes, but expenses / lifestyle are sticky!
âȘ A lot of models assume working 40
years, and producing savings to
generate 80% of working income.
â These models don't actually match anyone's real world
experience.
â There are a lot of models out there, and rules of thumb,
but it's âš
important to run the numbers yourself.
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The Magic of Compounding
âȘ Not convinced that Albert
Einstein said it was the greatest
force in the universe.
âȘ It's the key to almost all long
term financial planning.
âȘ Exponentials are bad in
algorithmic cost, good in
savings returns.
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Simple Model
âȘ Rule of 72
âȘ In Sheets, for each year, just use âš
=POWER(1+rate, year)
âȘ 4% over 20 years is 2.19x
âȘ 8% over 20 years is 4.66x
âȘ Careful: it works on debt just as well
as savings... in reverse!
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The Benefits of âš
An Early Start
âȘ Compounding really takes off
over long time periods
âȘ In most retirement planning
models, money saved between
ages 25 - 35 produces more
money than all savings between
35 â 65!
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Years Return at 8%
10 2.16x
20 4.66x
30 10.06x
40 21.72x
50 46.9x
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The Dangers of Debt
âȘ Bankruptcy is literally when you
can't pay your debts. You can't go
bankrupt if you don't have debt
âȘ You will never find an investment
that pays 8% guaranteed, let
alone 20%+
âȘ You will find *tons* of credit offers
out there that will charge you that
âȘ âBadâ debt is toxic, your best
return is to pay it off. But
emergency fund takes precedence
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Good Investing is Boring
âȘ No one wants to be average,
but with investing, average is
actually well above average.
âȘ You will beat most mutual
funds, and a large majority of
your peers with simple, low-cost
index funds.
âȘ Asset allocation explains ~90%
of the variance between fund
performance
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Basic Asset Allocation
âȘ Different types of assets (cash,
bonds, stocks, etc) have different
volatility & return characteristics
âȘ Combinations can lower volatility
significantly, with moderate impact
to returns
âȘ Complication: historical
performance does not predict
future performance
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Simple Operating Model
âȘ 2 hours of work per year
âȘ Pick an asset allocation that is
appropriate for your emotional
character & time frame & goals
âȘ For each asset class, pick cheap
index fund to represent
âȘ Rebalance every 1-2 years
âȘ http://blog.adamnash.com/2010/12/31/personal-
finance-how-to-rebalance-your-portfolio/
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Recommended Books
âȘ WSJ Guide to Understanding Money & Investing
âȘ The Millionaire Next Door
âȘ A Random Walk Down Wall Street
âȘ The Essays of Warren Buffett
âȘ Common Stocks & Uncommon Profits
âȘ The Intelligent Investor
âȘ Devil Take the Hindmost
âȘ When Genius Failed
âȘ Against the Gods: The Remarkable Story of Risk
âȘ http://blog.adamnash.com/2007/02/14/
personal-finance-education-series-2-
recommended-books/
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Disclosure
Nothing in this presentation should be construed as a solicitation
or oïŹer, 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
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 reïŹect actual future performance.Â
Investors should review Wealthfrontâs website for additional
information about advisory services.  Â