Spending – Page 3 – CFP, representing Financial Alliance

The sunk cost fallacy

The one thing that stuck with me from my biz module back in NTU was the concept of sunk cost, and the sunk cost trap.In economic/business terms, a sunk cost is a cost that has already been incurred and thus cannot be recovered. And the sunk cost trap is about the psychological need to protect these past choices (and protect our prior monetary/emotional commitment). Here are some examples of this sunk cost fallacy.

1. Imagine you go see a movie which costs $10 for a ticket. When you open your wallet or purse you realize you’ve lost a $10 bill. Would you still buy a ticket? You probably would. Only 12 percent of subjects said they wouldn’t. Now, imagine you go to see the movie and pay $10 for a ticket, but right before you hand it over to get inside you realize you’ve lost it. Would you go back and buy another ticket? Maybe, but it would hurt a lot more. In the experiment, 54 percent of people said they would not. The situation is the exact same. You lose $10 and then must pay $10 to see the movie, but the second scenario feels different. It seems as if the money was assigned to a specific purpose and then lost, and loss sucks (www.youarenotsosmart.com)

2. On the same example of movie ticket, let’s assume you have bought a non-refundable ticket for the evening. When evening arrives, you realise that you no longer feel like watching the movie – but you still drag yourself to the theater because you have already paid for the tickets. It doesn’t really make sense because the money has already been spent. The real choice was a) be happy by staying at home b) put yourself in a worse mood by going for the movie.

3. Now imagine you are a business owner who have invested a substantial amount to build a factory. Due to unforeseen circumstances, the company will need to pump in more money to complete the construction. It is easy to justify the additional capital because without it, the initial investment and plans would go to waste. However, the more important question is if the future income will justify that additional capital. If not, the loss would simply be bigger

4. Of course, the same trap often happens in investment decisions. Time to time, I come across investors who would adamantly stick to their initial investment choices so as to avoid locking in losses (sometimes, even when it is just paper loss). This is in part due to the emotional commitment to the investment itself. But truth is, If you are holding on to a sinking stock, it would be much better to get out fast and get into another asset class/stock which is better positioned for recovery.

5. The sunk cost fallacy also happens in relationship. Imagine this: You are now 30 years old and have invested 7 years of your life to the man/woman you used to love. Both of you have gone through various experiences together and have invested much time and emotions to each other. Then at some point, you start getting the feeling that he/she may not the one you want to spend the rest of your life with… But you stay in the relationship anyway. Because of the aversion of loss – you do not wish for that 7 years to ‘go to waste’. Though in reality, what is really at stake is not the 7 years that have passed but the 50 years ahead.

It’s not easy to avoid the sunk cost trap.., But if we are able to, we would consistently be making better financial, business and life choices for ourselves and hence, likely to be much happier 😉

The Stranger Test

I have a horrible habit of making impulsive purchases during my travels. So this time round, I decided to take matters in my own hands and find some way of avoiding it- so that I do not end up with clothes that I will never wear or with souvenirs that will never see the light of day and so on.

After scouring the internet for tips, I decided to practice this ‘trick’ – The Stranger Test.

This is what you do: When you’re going to make a purchase, however big or small, picture a stranger holding your purchase in one hand and the cash it would take to buy it in the other – he is offering to give you one of the two, which would you choose? The $1,000 cheque or the new mobile phone? If you end up choosing the cash, then it would do good to keep that money in your pocket.

And it worked beautifully for me – granted I still spent a chunk, but it’s all on things I actually like, no junk purchases. Try it the next time you are overseas. It worked for me and it may, for you.

Till my next travel….

The concept of the Stranger Test first came up in 2009 on Five Cent Nickel

What Kind of Saver are you?

I came across an interesting article about the 8 different types of people who accumulate money, and how it is likely that we each have a dominant profile. I guess I can incorporate this into my advisory work moving forth!

October 19, 2010

By Richard Barrington| MoneyRates.com Senior Financial Analyst, CFA

The paper-clip saver. These are people who build their savings rates by never throwing anything out that they might possibly need again. If you see someone saving gift wrap to re-use, don’t look down your nose at them — they may have healthier savings accounts than the average American.

The master negotiator. The master negotiator loves to bargain, and saves money one haggle at a time. People who are good at this tend to do it second nature, for big and small purchases alike. When it comes to those big purchases, haggling is a skill that can really make a significant difference. If negotiating doesn’t come naturally to you, try not to look at it as an embarrassment. Instead, look at it the way the master negotiator does — almost as a game.

The singles hitter. This is a person who has committed to the slow-and-steady approach to saving. They put a little aside every paycheck, and succeed at saving because they follow a consistent course over a long period of time. Continue reading What Kind of Saver are you?

Cash is Prince, Cash Flow is King

Recently, a friend was referred to me for financial planning and it was an easy session because he already knew what he had to do- to first stop drinking (alcohol) so much, because he had other goals that he wants to pursue.
Here’s a breakdown on his cash flow (income allocation).

At the moment, he has $7k in savings and no investment. so honestly, you don’t need a financial planner to figure the following out

The downsides of his situation:

Not enough cash (Low liquidity/emergency cash)
Not investing enough
Not saving enough
Lack stability

It’s a zero sum game so there’s no magic to this. He will have to save more and likely from all his casual drinking sessions. It’s not gonna be a fast transition to financial freedom – he will have to first develop healthier cash flow management habits, and then gradually get into a healthier financial situation.

The upsides of his situation:

No liabilities
Dependents do not require his support at the moment.
Earns a decent income (he just started working not too long ago)

This is the edge of being an young adult. If you are lucky, you are not bogged down by any loans and your commitment to others (dependents) would still be minimal. So basically, you already have the ticket to fly – to start a business, explore opportunities, do something/anything crazy.
But very often, this comes with prerequisites, you need to have the confidence to embark on the above. That is, a basic level of financial stability is required before you get the ticket to the opportunities out in the world. After all, living on bread and water to pursue a dream is unlikely what you would choose to do, over a long-term basis.

And most importantly, as the old (cliche) saying goes, Cash is Prince, Cash Flow is King. Regardless of what you embark on, cash flow management could be one of the first and most important skill to acquire.

For the young adults, it’s really fairly simple (simple, not easy)

Know your future intentions and what you want to do with your life.
Work out the numbers and direct your saving efforts towards your intentions/goals
Choose the right vehicles.
For myself, I generally save for short term goals and invest for longer term goals. There are plenty of vehicles out in the market. Choose one that works for you.
Stick to it. That is, save first, spend what’s left.
Continue to enjoy life

That’s all folks, for my fellow young adults out there.

CASH DIET

For those who are in credit card debts, this could be a pretty good new year resolution: go on a cash diet.

one of the most common reasons people use credit cards is because of the rebates/discount. BUT, the usage of credit card is one common factor attributing to emotional spending – because you simply do not feel the pain of paying. It also explains how people are ‘able’ to pay for it. not.

And to put things into perspective, if you owe $5k on your credit card, do not charge anything further to it but only repay the bare minimum every month, the total interest you would have paid at the end of the final repayment is $2,957.

Have a debt? Go on a cash diet and clear the OS fast.

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