Big Mistakes

I finished that book I mentioned a while back. Actually, I turned the last page the day after that post, but finally got around to reviewing it. It's interesting. Tells why our experiences, lack of knowledge (specifically knowledge of statistics) and over-inflated egos (all typical human traits which I share as well) can lead to big mistakes with money. I'm not saying that my days of screw-ups are over, but it's interesting to know where it might come from.

This book was a lot better than The Millionaire Next Door, which was an ex-post (backward-looking) analysis of success but unless you were an entrepreneur or have the temperament to do the things that their selection of wealthy people did then it's probably not the path for you. Also, some of the statistics in Millionaire were perhaps a little off. They said that most millionaires drive F-Series Ford trucks. Well, that it was not Ferraris was interesting enough, but to be F-Series trucks is not: they are the most popular kinds of truck on the planet; from the base F-150 to the Harley Davidson F-350s. That a millionaire might own one (perhaps for hauling his motorhome or boat or to go hunting in) is not all that far-fetched.

Anyhoo, back to Big Mistakes, as I'll call it. Two professors, Dr. Robert Grauer and Dr. Herbert Grubel introduced this to me in business school. Dr. Grauer was taught by Dr. William Sharpe (maker of the Sharpe Ratio we use so much in finance) and is so into Capital Asset Pricing Model (CAPM, as it's called) that we secretly called him Captain Cap-M. Dr. Grubel was so famous/infamous that I head about him before even going to one of his classes, when I was treeplanting, no less. An Austrian planter heard that I was into economics/business and he said I HAVE to learn from Herr Dr. Grubel: "He is one of the most famous economists in the world--but he is hated." Why? Well, he is from the neo-Classical camp that is not into government handouts and believes the free markets are pretty perfect mechanisms. I have to agree, to a large extent.

Crap, digressed again. So, the question put to the class by Dr. Grauer was, "Let's say I give you $5,000." "Yay!" everyone exclaimed. "No, not real money." "Boo!" "And you have a choice to take it or risk it in a coin-toss. Heads you get $10,000; tails you walk away with nothing." Some said take the $5,000 but I was one of the ones risking it on a coin-toss. He singled me out, of course. "Why? Why risk $5,000?" "Well, the $5,000 was not 'real money'...why not go for it? The probabilistic outcome is $5,000 anyways, but getting $10,000 would be cool. And, I have many earning years to make it back if I lose it and even if I get it I'll probably use it to paydown my student loans (which are interest-free, so no real short-term gain there)." "Yes," he replied, "but if you have a wife to go home to how can you explain that you lost $5,000?" "I don't have a wife, so I have only myself to live with, and I can live with that."

Thus, we see one of the major tenets of the book: when people 'think' they are not dealing with real money and only they will know about it then they seem to make bad mistakes. A few cases in point from my life in the last few weeks:

My father-in-law bought a new couch and loveseat. The cost was about $1,000. He also paid $30 for 'insurance' for it (in case of stains, that sort of thing). Foolish, as he sees now. Would he pay $30 for insurance for his older furniture (which is worth a lot more)? No way. But $30 on top of $1,000 and fearing the unknown with the new stuff made him think it was a good deal (actually, a massive portion, about 50%, of the $30 is commission for the salesguy, not for claims). Also, the color is chocolate: how can you get a stain on that? And, as if you'd have the receipts and the motivation to bring in your couch for whatever needs to be fixed with it should something occur. Just not a good idea. At least the lesson learned came at a cheap price.

Next: buying a car. Ever wonder why they have offices for salespeople (especially the guys flogging the high-margin ones like undercoating)? Well, I'm pretty sure it's not because they want to make things look fancy: it makes things intimate. When I started in brokerage we all had our own office and I wondered how guys in the 'bullpen' (are with just dividers for walls) had meetings. They didn't, they used side rooms, but it was not near as intimate as having your own office with your degrees on the wall. Back to cars, though. With an office there are fewer distractions, too (like no clocks or windows in a Vegas casino) so you might end up thinking it's not real money. Step back, though. My sis-in-law had one of these meetings and they added on $89 for floormats. FLOORMATS!?! They're bloody carpet!! And for the $30,000 you're paying for the car they better be bloody included. But, if they are in the list (which the salesguy usually just delivers orally, not written down--that would be too logical, and he wants emotion to rule) and just added on (plus 12% tax on everything!) then $100 for 4 pieces of carpet you could get for $10 seems ok. (Actually my old boss even took out all the floormats in his car and replaced them with like-colored carpet so he could have factory-new mats in it when he sold it: good idea.)

Or how about getting a draw at work. For those not in the business, a draw is a monthly cheque you get from your employer that goes against future commission income. If you make more then you get that; if not, then you get the draw until (i) you do make more or (ii) they fire your ass. Well, a draw is sometimes non-forgivable: if you quit or are fired you have to pay it back (it's a no-interest loan, not salary). My wife HATES the draw, but it's a part of the business in many firms/positions. She would rather we just spend savings instead of getting a draw because it is debt. Well, I figure that money is money. If we can get a draw and then bank most/all of it then it's not technically a debt (especially if all of it is in there). If the job doesn't work out I just pay it back (net of any earnings) and we're done. In the meantime 2 things have happened: (i) we've established an emergency reserve so we need not go into debt if something happens that we need to take care of and (ii) we have a forced-savings plan so when we do make money maybe (just maybe) that draw money just goes to savings forever and then we can be ahead of the game. Lesser mortals would spend the draw, but my wife is pretty swift...we won't be using it at all unless absolutely necessary.

So, I'd recommend this book. I got it from the library, so even more savings there. Page 57 has an error in it, though (already emailed the authors) in that they spelled Burnaby (an area of Vancouver) as Barnaby. Amazingly no one reported it to them. There's my mark on economics literature!