When the mob makes you lose your sanity

by Pop on April 12, 2011

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This may be the last time you trust “reason” in a crowd.

There are many psychological defects that make us do dumb things with money. We chase performance in the stock market and feel pressure from the next house over to buy fancy cars.

If you’ve read any personal finance blog for more than a week, you’ve probably heard some sort of encouragement to “be different” and separate wants from needs, etc., and all that sounds like good advice.

Personally, I’m not so sure it is. Personal finance advice too often focuses on telling you what to do and encouraging you to do it. It sets up the “Do I buy a new Lexus?” scenario as a rational dilemma with a clear answer and path to follow while summarily dismissing wanting to look good in front of the neighbors as the silly purview of broke cattlemen with big hats.

I’m a much bigger fan of avoiding those defects, through using defaults (automatic savings, auto bill pay, auto portfolio re-balancing) rather than trying to counteract the defects will all that positive thinking. This post is meant to show why.

In short, I’m not so sure we can fight the herd.

ABC runs a show called “What Would You Do?” on Fridays. It’s one of those rare shows that’s actually lasted more than a few episodes, but you really only need the plot of one to know how the rest work.

In an episode I saw a few months ago, a few men and women were put through a mock frat or sorority initiation on a public street. The activities were rather extreme with over-the-top physical and verbal abuse. Hidden cameras were rolling to see if anybody would try to stop it or if, instead, people might even join in.

Most people simply ignored the spectacle, one or two joined it, and I can only remember a couple actually trying to stop the abuse. The show, of course, is meant to make all of us think “Of course I would make them stop!” while showing that most people don’t.

To a social psychologist, the show’s probably not surprising one bit. If you put the onlookers alone in a room with the abuse going on, they might speak up, but in a crowd, suddenly all sense of individuality disappears. If the rest of the mob is doing nothing, best to not stand out. If the mob seems OK with an activity, it must be normal to be OK with the activity yourself.

What Would You Do? was a set-up, but there are several infamous examples of the same phenomenon.

You see a murder from your apartment window. What would you do?

In 1964, Kitty Genovese was stalked and stabbed to death in Queens, New York. The murder didn’t happen at once. She was attacked, left to stumble around, and finally killed about an hour later. Neighbors heard screams, might have seen the attacker, but did nothing. A famous New York Times article began with this chilling line: “For more than half an hour 38 respectable, law-abiding citizens in Queens watched a killer stalk and stab a woman in three separate attacks in Kew Gardens.”

Some parts of the story were later discredited, but it’s since been taught in social psychology classes as evidence of the “bystander effect”. A few years after the Genovese murder, John Darley and Bibb Latane attempted to replicate seeming indifference to emergency situations in the lab.

In the Darley/Latane experiment, an undergraduate would be put into a room, alone, with an intercom. He or she was supposed to talk about difficulties of student life with other members of the group (who were supposedly in other rooms, kept private to protect their anonymity). As they took turns talking, one of them would mention that he suffered from seizures. Later in the conversation, the test subject would hear this:

I-er-um-I think I-I need-er-if-if could-er-er-somebody er-er-er-er-er-er-er give me a little-er-give me a little help here because-er-I-er-I’m-er-er-h-h-having a-a-a real problem- er-right now and I-er-if somebody could help me out it would-it would-er-er s-s-sure be-sure be good . . . because-er-there-er-er-a cause I-er-I-uh-I’ve got a-a one of the-er-sei–er-er-things coming on and-and-and I could really-er-use some help so if somebody would-er-give me a little h-help-uh-er-er-er-er-er c-could somebody-er-er-help-er-uh-uh-uh (choking sounds). . . . I’m gonna die-er-er-I’m . . . gonna die-er-help-er-er-seizure- er-[chokes, then quiet].

Seriously. It was in the script.

So guess how long it took the students to, you know, leave the room and tell somebody that someone else on the conference was having a seizure?

First problem: If there were 6 people on the call (subject, victim, and four others), only 31% ever reported it.

Second problem: Even if they did, it took the subject a full 2 minutes and 46 seconds on average after hearing that to go seek help.

If there were fewer people on the conference, the rates and speed of reporting went up. Being in a group of non-doers is was kept people from intervening.

You see someone about to jump off a building. What would you do?

September 2008. A 17-year old, suffering from a bad breakup, threatens to jump from a parking garage. Police negotiators spend three hours trying to talk him down. The crowd acts a bit differently. Here’s a quote from a security guard who was there: “The police did a fantastic job at the incident and were not helped by a baying crowd, some with children, calling for the lad to jump.”

The teenager jumped.

Or how about August 2001. A 26-year old jumped from the Seattle Bridge, after some members of a crowd taunted “Jump bitch jump!” Or February last year, the mob taunted a jumper in San Francisco.

It’d be easy to pass off the cases as meanness or a lack of awareness of how serious the situations were. Part of it, however, is just herd mentality. If someone individually ran across a jumper, he’d probably call the police. Put in a group, that sense of responsibility dissipates. And once one person starts yelling out at the jumper, the rest feel more inclined to do it themselves.

I have the same visceral, disgusted reaction that you probably do. But sometimes I wonder if but for the grace of God, I could have been in that crowd.

(For a great post on the subject, check out You Are Not So Smart.)

And you think you stand a chance in personal finance?

John has a hot stock tip. Everyone at the barbecue nods in agreement.

Mary guilts you into coming to a charity auction. The bidding gets pretty heated.

You hear about money pouring into stocks or gold or whatever. And you wonder if you should come along too.

Or conversely, you feel like too much of your money is at risk in the stock market, but no one else seems to be concerned.

So tell me, what would you do? And are you so sure now that you see even in extremely terrible situations, so many people checked reason at the door and surrendered to the herd?

All the self-motivating, I-can-learn-my-way-out-of-anything things you think are going to bring you to financial fulfillment don’t hold a candle to the deep, deep psychological underpinnings that separate us from the machines.

You’re not going to reason your ways out of these problems. You need to learn why “reason” has nothing to do with them.



Can you save too much for retirement?

by Pop on April 6, 2011

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And can I contradict myself in a week?

When I was in college, I dressed like a homeless person. Now, I dress like I’m in college. It’s not that I can’t afford nicer clothes. Thankfully I’m well beyond the “no money” years. It’s just that I never really “upgraded” to the stuff most of my peers are wearing nowadays.

So I should be patting myself on the back, right? Living like a poor person—when you’re not—is one of those tried and true personal finance adages that mark classics like The Millionaire Next Door. The millionaires live like they’re not rich. They buy used cars. They eat at home. Then they retire early or spend retirement travelling the world because they’ve saved so much gosh darn money.

But sometimes left out of the discussion of saving, is how much is too much when you’re retirement planning.

To take it to an extreme and keep things simple, let’s say we’ve got a 25-year old making $60,000. He’s totally bought into saving like a madman and maxes out a Roth IRA and a 401k every year until he retires. Based on one, mainstream retirement calculator, that would give him about $8,900 per year per month once he retired at age 66—almost two and a half times what he used to live on at age 65.

He could fund two of his retirements, and still have half a retirement left over. Should we celebrate that?

The concept of “consumption smoothing”

I think most people would say “No.” The 25-year-old self was cheated out of current pleasures…his trip to Norway, his “grown-up” clothes…that would have been perfectly fine for him to buy. Instead, his 80-year-old self either goes on a spending binge, leaves a large inheritance, or tries to pay off St. Peter.

Instead, many economists consider the ideal savings amount to be that which “smooths” your consumption over your lifetime. In short, you want your quality of life in your 60s and beyond to be about as high as it was in your 30s.

At some point and to make things simple, personal finance gurus started to back out savings targets—like 10% or 20%—that would achieve consumption smoothing as long as the stock market hit certain rates of return.

Laurence Kotlikoff, a Boston University economist, a few years ago took it so far as to create an extremely comprehensive retirement calculator, that can show you how much you should consume every year into and through retirement based on the assumptions you put in. (Here’s the more basic, free version.)

Can you save too much for retirement? Yes! But in personal finance circles, it’s generally not “cool” to spend. A recent Wall Street Journal column derided people who buy iPad 2s (or is it iPads 2?). The logic: It’s really costing you $2,000 since you could have invested it instead! By that logic, I should really feel bad about my $5 lunch today—that could have been $20, after inflation, in 2041. This year, I will blow $7,200 of my future money on lunch. I’m such a moron.

The columnist’s logic assigns little to no value to present enjoyment, in favor of future enjoyment. That makes no sense.

Don’t get me wrong, this doesn’t apply to most people. Most Americans will retire with little to no savings. And those people shouldn’t be buying iPads. But given that you’re reading this blog, I’m betting you’re putting at least a bit away already, or at least thinking about putting a bit away.

Throw uncertainty into the mix, and suddenly saving “too much” seems impossible.

The idea of consumption smoothing has a major flaw, of course: uncertainty. We don’t know what stocks will return over the next decades. We don’t know where tax rates will be or if we’ll be in a car accident or if the roof will need to be replaced, etc.

Or perhaps a more dire situation: Imagine you’re a 53-year old staring down the newly proposed Republican budget. In 12 years, you were expecting Medicare. Bzzzzz. Wrong. Maybe you could have seen some sort of Medicare reform coming, but you probably didn’t predict the fairly random age-55 cutoff that would probably allow you to save thousands in insurance costs if you had only been born in 1956.

There are two ways to react to that uncertainty: To save as much as you can in case a worst-case scenario comes along or to save for a best-guess scenario and risk having to cut consumption if the dice come up snake eyes.

I’m saving for a “best guess”, with the reasonable safety measures of a year-long emergency fund, an annuity, etc. Sure, fate could frown on me, but I’m not willing to make a guaranteed sacrifice of reasonable happinesses today just to prepare for a possibly scary future. There’s a chance, my 66-year old self might be unhappy with the current me, but he’s going to have to deal with it.



How to retire with no savings

March 27, 2011
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Thousands of Americans are doing it. Have you read the news lately? Soon-to-be retirees have saved almost nothing for retirement. No doubt that means we’ll soon have homeless Baby Boomers begging for change on the subways! Ok, the second part might not happen. But given the press that this recent Employee Benefit Research Institute report [...]

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Don’t let the “great” be the enemy of the “good”

March 20, 2011
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Or, why I still haven’t bought a mattress I’ve intended to buy a new mattress for, oh, about a year now. I’ve actually gone to Macy’s and lain down on probably 20 or so mattresses to figure out what I like and don’t like. I’ve looked at reviews of mattresses online, and at one point [...]

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Why we’re going to stop caring about the unemployed

March 11, 2011
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The difficulty with an improving economy Every once in a while, I run across a comment on a blog or news story that reads something like this: “If you’ve been unemployed for more than a year, you’re not looking hard enough.” It’s mean, but I’m sure the writer believes what he says. They probably have [...]

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How much do you value your time?

March 6, 2011
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Hello Get Rich Slowly visitors! I’m flattered J.D. sent you here, and I’d be even more thrilled if you stopped by on your own! Here are a few reasons why you should:   1. This ain’t your typical personal finance blog. I don’t often tackle the basics of a Roth IRA or how to choose [...]

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The brilliant idea: How “focus” can destroy creativity

February 22, 2011
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Daydreamers, distractions, and new ideas I once worked at a company that had a computer policy from the dark ages. Dozens of websites—from Gmail to Amazon and even some news sites like Huffington Post—were banned. If you tried to access one of them, you’d get a warning message that continuing would automatically send a note [...]

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Thinking about the deficit as you invest

February 18, 2011
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The “crisis” that never comes The recent deficit talk has people rightly concerned about whether or not Congress and the President have the cojones to bring our fiscal house in order. There are basically four ways to cut the deficit: grow the economy, cut spending, raise taxes, or print money. Option one is the fun [...]

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The role of confidence in success

February 13, 2011
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Do you think God wills you to succeed? Lady Gaga thinks she’s been chosen by God for fame. So do Eminem, Aaron Rodgers (Packers QB), and Snoop Dog. At least, so says a story in the Wall Street Journal this weekend. The article posits that the presumption of some that they are God’s chosen ones [...]

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Anchors aweigh? Staying mobile to maximize opportunity

February 4, 2011
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The yard and white picket fence have lost their sheen. I don’t own a home and don’t think I ever will in the extremely expensive city in which I live. That’s more a happenstance than a conscious decision. But it seems I lucked out. Owning a home has always made some people less mobile. Now, [...]

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