Beware the New Math and Your 401K

by Ouida on April 1, 2010

I’m tired of reading in the financial press that my 401K is recovering. I have only to look my the statement to know the lie of it. But then maybe if I apply the New Math it really has recovered and is on its way up.

New Math was conceptual mathematics popularized in the United States after the Soviet launch of Sputnik. After a decade, it was widely considered a failure. Teachers were afraid to teach it and parents were afraid they wouldn’t be able to help their children with their homework.

A humorous illustration of New Math can be found at
http://www.straightdope.com/columns/read/1529/what-exactly-was-the-new-math

The following examples may help to clarify the difference between the new and old math.
1960: A logger sells a truckload of lumber for $100. His cost of production is 4/5 of this price. What is his profit?

1970 (Traditional math): A logger sells a truckload of lumber for $100. His cost of production is $80. What is his profit?

1975 (New Math): A logger exchanges a set L of lumber for a set M of money. The cardinality of set M is 100 and each element is worth $1.

(a) make 100 dots representing the elements of the set M

(b) The set C representing costs of production contains 20 fewer points than set M. Represent the set C as a subset of the set M.

(c) What is the cardinality of the set P of profits?

1990 (Dumbed-down math): A logger sells a truckload of lumber for $100. His cost of production is $80 and his profit is $20. Underline the number 20.

1997 (Whole Math): By cutting down a forest full of beautiful trees, a logger makes $20.

(a) What do you think of this way of making money?

(b) How did the forest birds and squirrels feel?

(c) Draw a picture of the forest as you’d like it to look.

Popular financial wisdom tells us that because the Dow is up 67% as of today from its 2009 nadir that we should cheer up, our finances are on the mend and the 401K is still a great long term financial strategy. But I keep remembering a troublesome concept taught by William O’Neil, entrepreneur, owner of Investor’s Business Daily and author of How to Make Money in Stocks and 24 Essential Lessons for Investment Success.  If the markets tank 50% how much of a gain is required to get back to baseline? 100%.

Now here is some real math: You invest a dollar and lose half of it. You now have 50 cents. You would have to double your money or get a 100% return to get back to 1 dollar. From its October 9th peak in 2007 of 14,164.53 to its trough of 6547 on March 9th, 2009, the Dow shed 54%. To get back to even, the Dow would have to gain 104%. In other words for you and me to break even and get back to where we were in 2007 at the market peak, the Dow would have to gain 104%. Historical tables show that the S&P lost 36% in 2008. To get back to zero, the S&P would have to gain 72%. The S&P gained 19.7% in 2009. New contributions, even if there is an employee match, are not a legitimate part of our overall investment return. Investment returns are based on the growth of a dollar over time, not the growth of a dollar because you added another dollar to it. In looking at my statement, my 401K is now worth just over what it was at its 2007 peak. That is if I include my ongoing contributions and employer match in the mix. If I don’t and I shouldn’t I am still down 12.2% fortunately I am not exclusively in stocks so the losses were mitigated. Only new math would allow me to think I am on track and can build a secure retirement with returns like that.
Amazing! Fortunately I have investments outside of the market, investments I have greater control over to ensure my retirement.

What is your belief in the stock market as a retirement vehicle?  Please comment.

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The Trouble with Tribbles, The Trouble with Goals

by Ouida on March 30, 2010

Tribbles are cute, fuzzy creatures as are goals in the sense that they create the warm fuzzies when you set one.

Tribbles reproduce like bunny rabbits as do goals.  Set one goal and pretty soon you are  drowning in a sea of goals unsure which one to tackle next.

Tribbles produce a sense of calm when you hold one and the initial pursuit of a goal produces the senses of calm and elation.

Tribbles are the mortal enemies of Klingons.  Goals…..okay that is where the analogy ends.

Tribbles tell a tale about balance.  Out of control and without natural predators on a starship they invade and consume the wheat intended to address a planet-wide food crisis.  Goals can do the same thing.  We set goals for everything.  Want to be wealthy set a goal.  Want to get married, set a goal.  Want to learn a language, set a goal.  Want to travel, have better teeth, a better body, get better grades, pass a test, almost anything you can think of, set a goal, for goal setting is the first step to actualization.  Or is it? Common mythology is that by just setting a goal, you will be magnetized to its achievement. But anyone who has ever set a goal and had their target date whiz by knows better.  Bazerman, et al, in their controversial paper, Goals Gone Wild:  The Systematic Side Effects of Over prescribing Goal Setting argue that goal setting  can be quite detrimental in a corporate setting. They conclude:  “rather than being offered as an ‘over the counter’ salve for boosting performance, goal setting should be prescribed selectively, presented with a warning label and closely monitored.”

I have found that having no more than two or three goals at a time, whose achievement I have absolute control over are the appropriate goals for me to set.  I have also found when considering a goal, I have to decide whether or not I want to pay the price to achieve that goal.  All goal achievement requires time, yet setting aside the time to achieve a goal may seem like an impossible task.  In fact I have found that when I ask most folks how much time they plan to devote to achieving their goal, I generally get a blank stare.  Setting a goal to become wealthy means deciding to develop certain disciplines to attain that goal, like learning to save, learning to live on less than you earn, developing a new skill, becoming financially literate.  Setting a goal to learn a language may mean taking a class, actually attending the classes and studying the material once you’ve signed on for the course, taking a home study course, traveling to the country where the language is spoken primarily or staying at home and putting yourself in socially uncomfortable circumstances where your desired language in only spoken.  Goal achievement also requires having a set of priorities.  Do you really want goal x or would you rather be doing something else.

Goals used strategically can spur achievement, but used unwisely, they like Tribbles can proliferate and become abundant evidence of one’s failures.

Please comment.  What are your thoughts about goals?

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The Cook, The Thief, His Wife, Her Bank Account (understanding economic outpatient care)

by Ouida on March 29, 2010

Because of chronic employment problems your daughter and her husband are struggling for cash you decide to let them live with you until they can recover. The weeks turn into months, turn into years and they never do seem to recover. Your granddaughter needs a cosigner for her student loans. You decide to do it. Your brother is between jobs and needs help with the rent. You do it. Your boyfriend is between jobs and needs help with the mortgage, you do it.  Your brother’s marriage is breaking up, his business is in the tank and he asks you for a “loan” of a few thousand dollars to help with the mortgage.  Do you do it?  Your brother calls needing thousands of dollars in dental work, but he doesn’t have the money.  Do you do it?  All of these situations are examples of Economic Outpatient Care (EOC), a term coined by Stanley and Danko in their book, The Millionaire Next Door. According to Stanley and Danko EOC refers to the substantial economic gifts and acts of kindness some parents give their adult children and grandchildren.  While Stanley and Danko refer to actions of parents when using this term, EOC can occur in any family in which large economic gifts pass from one family member to another.

What is the ultimate impact of EOC? The recipients as a group produce much less than non-recipients and they are much less likely to become economically independent.  EOC does not refer to isolated one-time gifts intended to help a person get through a rough patch, but to recurrent and ongoing gifts to family members in perpetual need.  Because chronic recipients of EOC tend to remain dependent they tend to drain or consume the resources of the giver attaining a disproportionate share of any inheritance.

How can something intended for good, produce harm?  Because simply solving someone’s immediate economic problem does not create the skills that foster independence but what it does do is set the stage for the expectation of ongoing economic assistance. Stanley and Danko found that investing in a child’s education and fostering an environment of independent thought, leadership and personal responsibility actually assists adults in becoming independent.

With this information, how do you decide whether or not to provide assistance to a relative when asked? First ask yourself if the person asking is chronically in need.  If so, your gift may not have the positive effect you intend.  Painful as it is, it may be better to decline to help.  It is not clear that giving the assistance in the form of a loan produces better results therefore, to ensure peace in the family, it may be wise to give assistance as a loan only if you will need the money back at some future date.  Second, can you afford to lose the money? If you are thinking of assisting someone with money you cannot afford to lose, you should decline to help.  Third, if you decide to help, set a limit on your assistance by limiting the dollar amount or the total number of times you intend to help.

It is hard to see the people we love in trouble and it is hard not to want to help.  I have certainly benefited from parental support as a young adult and am grateful for it, but there comes a time when we have to grow up and live independently of our parents, grandparents, sisters and brothers.

Please share your thoughts.

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Understanding How We Decide

by Ouida on March 28, 2010

Where is the horse and the rider?
Where is the horn that was blowing?
They have passed like rain on the mountain,
like wind in the meadow. The days have gone
down in the West behind the hills into shadow.
How did it come to this?

Theodin King, Two Towers

I do not understand what I do.
For what I want to do I do not do,
but what I hate I do.

Romans 7:15

Our decision making process is a mystery. Bummer that because that process impacts everything from how we choose to spend, save, invest our money, to how a doctor counsels a patient, how a lawyer counsels a client, how a pilot lands a plane. Knowledge isn’t enough, skill isn’t enough. Our decision-making process is complex and fallible. In the world of personal finance there is Why Smart People Make Big Money Mistakes by Belsky and Gilovich. In general decision making there are Blink by Malcolm Gladwell and How We Decide by Johan Lehrer. In the world of medicine there is The Checklist Manifesto by Atul Gawande, MD and How Doctor’s Think by Jerome Groopman, MD. As a society we think about how we think and with good reason. How we think, what we decide and the actions that flow from those decisions will ultimately determine where we land in life. Dr. Richard Friedman’s essay Sabotaging Success examines a tendency that some people have to engage in masochistic behavior.

As a physician I am especially concerned with medical errors. Gladwell’s thesis is that decisions occur on a near intuitive level defying explanation. That intuition is influenced by experience. Lehrer proposes that it is emotion that occurs on an unconscious level that informs our decisions and Dr. Gawande argues and, I tend to agree, that the decision process is flawed so we need to have a system of simple and efficient checklists to facilitate good outcomes.

In the world of personal finance it is easy to say that we don’t save because we don’t know we should save or how to do it once we understand that we need to do it. You cannot walk into a book store without running into a personal finance book. You read, not one, but 10 and you have the knowledge that you should save and even a clear idea of how to do it, but you don’t. Now you are up against how you decide to do what you do. This is the hardest thing to accept: knowledge is not enough to affect the decisions we make or the actions we take.

In the world of medicine it is easy to counsel a young physician who makes a mistake because we can chalk his mistakes up to both ignorance and lack of experience. What do we do with a physician
with over 20 years of experience who makes a basic error that leads to patient harm? Because decision making is complex, the answer to what do do is equally so.

We may never understand how we decide. Our brains are a series of neuronal connections awash in chemicals. Knowledge, though necessary, is not enough and neither is repetition. Yet we cannot make good decisions without them. Is developing emotional intelligence, the ability to govern our emotions and act in the face of them, the answer? It is certainly an answer, but, in all likelihood is not the answer. What do we do, then? We should accept how complex our decision making process is and that it may represent a complexity that “passeth understanding”. We should continue to gain knowledge and skill. Finally, we should understand that faulty decisions will occur and try to learn from them.

What are your thoughts? Please comment.

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