Crazy mind games that mess with your money

A friend of mine once asked me to loan him cash to clear his mother’s medical bills. He promised to pay back from his salary over the next three months. When I reminded him about the money tucked away in his bank account, his reply: “That is for the down payment for a bike, I cannot touch it.”

What my friend possessed, besides oodles of chutzpah (and a good heart, I must add), was a case of bad mental accounting.

Let me make my point by narrating a famous story known as the “Legend of the Man in the Green Robe”.

A newly-wed couple head to Las Vegas for their honeymoon. They set aside $1,000 as play money for gambling. They predictably lose all of it. On the last night, the groom notices a $5 gambling chip on the table. Unable to sleep, he gets up, puts on a robe (a green one, of course) and heads to the roulette tables. 

Roulette is a game in which a ball is dropped onto a revolving wheel (known as the roulette wheel) which has numbered compartments. The players bet on the number at which the ball will come to rest.

The groom bets on 17 and bingo, that’s where the ball lands. He gets $175 (the odds are 35:1). He lets it ride, which means that the winning chips remain on the table. His lucky streak continues and he gets $6,125. This goes on till he has a few millions credited to him. Virtually delirious with exuberance and optimism oozing out of every pore of his being, he decides to take one more chance thinking his luck will never run out. He bets his millions.

He loses.

Everything!

In a daze, he stumbles back to his room dejected.

“Where were you?” his bride asks.

“Playing roulette,” he says.

“How did you do?”

“Not bad. I lost just $5”.

Talk of being delusional! 

He logically avoided the horror of his loss by believing that he began with $5 (which he paid for) and since he returned to his room with nothing, he lost just $5.

He might have tricked his wife but that’s not true, is it? The millions he lost was real money. If he stopped and cashed his earnings, he would have been a millionaire (even after the IRS was done with him). 

You may think this story as strange, but you cannot deny that it is bang on as far as a reality check goes. A dollar is not always a dollar (or rather rupee, in our case). Money is always viewed differently depending on the source.

Not convinced?

Take a look at your own behaviour. 

Have you not noticed that you view an unexpected bonus at work, a sudden investment windfall, a tax refund, a gift from a relative, a surprise inheritance or a lottery win with a different perspective from how you would view your earnings? 

Or, if you got a freelance assignment which did not interfere with your work and the remuneration not clubbed with your monthly salary, you would tend to be more liberal in spending it?

Yet again, if you made a killing in a rampant bull run, chances are you would be more than enthusiastic to put some of the earnings in a stock tip or a volatile sector fund which you would have shirked in your regular monthly investing plan. 

John Allen Paulos in his book A Mathematician Plays The Stock Market says that we categorise money in odd ways and treat it differently depending on what mental account we place it in. He goes on to give an example.

Let’s say someone lost a $100 ticket on the way to a concert. He is much less likely to buy a new one, unless he is desperate to watch the show.  

Let’s say he did not lose the ticket but lost $100 on the way to buying the ticket. Chances are he would still buy the ticket.

Why? In both scenarios he lost $100.

In the former, he would tend to think that $200 is too large an expense for entertainment. While in the latter, $100 is for entertainment, $100 just turned out to be an unfortunate loss.

Paulos sums it well: Personal accounting can be plastic and convoluted.

I remember reading an anecdote by psychologist Hal Arkes. Employees of a firm were taken to the Bahamas on a retreat and each were given a cash bonus for bagging a contract. I don’t remember how much but I think it was $50. Almost all of them headed to the casino to blow it up. What was interesting was that none lost more than the allocated amount ($50). The moment it crossed that, they got more cautious and slowed down or stopped altogether because they felt they were playing with their “own” money rather than the “free” money.

Ironical is it not? The $50 was their “own” money too.

In Why Smart People Make Big Money Mistakes & How to Correct Them, authors Gary Belsky and Thomas Gilovich talk about an experiment conducted where 24 students of Harvard University were told they were receiving $25 windfall as part of a research project and could spend as much as they wanted at a particular store. The unspent amount (from $25) would be sent to them by cheque.

Here’s the clincher.

• 12 of them were told that $25 was a bonus
• 12 of them were told that $25 is a rebate 
• 84% of them who were told it was a bonus, spent some or all of the amount
• From the group that was told it was a rebate, only 21% spent any money at all

The authors conclude: Like it or not, mental accounting is a powerful driver of our actions.

Mental accounting is a psychological phenomenon that causes us to mentally separate money into different accounts. So lottery winnings, refunds and surprise bonuses are invariably counted as “free money” while our salaries is what we must be frugal and most responsible about. In actuality, we must be responsible for all our money, irrespective of the source. 

Along the same lines, a vacation allowance is presumably treated with less gravitas than the same amount of money socked away in a retirement account. And this need not be a bad habit. In fact, if used wisely, it could prevent you from being illogical and irrational. Because even die-hard spenders will tend to halt themselves from recklessly poaching from their retirement kitty. 

The way forward? Don't be a slave to your thought process. Use the ability to corral money into different mental accounts to effectively save for future goals. In the end that is what will give you the biggest kick.

Are economists idiots?

Paul Krugman is very much in the news for his views on fighting the fiscal phantoms. And from the bottom of my heart, I wish this economist a long life. But when the inevitable does happen, I wonder what he will be most remembered for? 

1) Winning the 2008 Nobel Prize in Economics

2) Suggesting that America prepare for a non-existent alien invasion to fix her fiscal woes (apparently it will get people working)

3) Calling some of his fellow economists idiots on radio ("There are some idiots who've won Nobels")

Source: http://school.discoveryeducation.com/clipart/clip/dunce2.html

I will certainly remember him for referring to some of the Nobel laureates as certifiable idiots. Martin Fridson in Forbes, questions whether Krugman should tip off the presidents and prime ministers of various countries in case their governments are pursuing the policies of these imbeciles. But then again, one wonders how many of the economists, whose reputations are now questionable thanks to Krugman, will in turn call him an idiot. 

I am sure Krugman won't take offense. In fact, in that very interaction on air, Krugman did say that winning the Nobel prize did not shut up his critics but it certainly stopped people from calling him an idiot for 2 weeks. 

I wonder if Alan Greenspan regarded Krugman as an idiot? Krugman certainly thought he was one. Years ago, Krugman wrote this: "If you want a simple model for predicting the unemployment rate in the US over the next few years, here it is: It will be what Greenspan wants it to be, + or - a random error reflecting the fact that he is not quite God." Last year in a blog post, he stated that "the exceptional Mr Greenspan continues his efforts to cement his reputation as the worst ex-Fed chairman in history".

What about Paul Volcker? In another blog post, Krugman stated that "Volcker is worrying about re-fighting the 1970s when we're actually re-fighting the 1930s. And fighting the wrong war is a good way to lose the one we're in." 

So what does this mean? While we widely regard economists as brilliant, they tend to regard each other as boneheads.

Justin Wolfers in Freakonomics.com speaks of one of the best-kept secrets amongst economists. According to him, there is remarkable agreement among economists on most policy questions. This consensus is obscured by 2 laws of punditry. 
First, for any issue, there's always at least one idiot willing to claim the spotlight to argue for it.
Second, that idiot may sound more respectable if he calls himself an economist. :) :) :)

A few months ago, a blogger on the Economist wrote about the history of macroeconomics. It stated that economists spent 30 years debating what the experience of the Great Depression meant and then another 30 seeing if they had arrived at the right answer. 

That it was man made became the economic consensus; the rest was intensely debated by squawking heads. Not surprisingly. According to Edgar Fiedler (an economist of course), "ask 5 economists one question and you will get 5 different answers; 6 if one went to Harvard". 

So the Keynesians focused on fiscal policy as an engine of stabilisation. They held that central banks were relatively helpless because interest rates fell to very low levels. 

Others vociferously protested - Milton Friedman led this pack. He said that interest rates were low because the Fed has pursued a too-tight monetary policy. Friedman argued that the Depression indicated that monetary policy was extremely powerful and the central bank had an important influence over money supply and in the short run this could have a significant impact on the real economy.

Later on Robert Solow had something to say about this: "Everything reminds Milton Friedman of the  money supply. Everything reminds me of sex, but I try to keep it out of my papers." If he is an idiot, he is an honest one!

But the funniest of all is this quote by John Kenneth Galbraith: "Economics is extremely useful as a form of employment for economists." Seriously, I am not one to judge specially since I hold no Ph.D in Economics. But was that not an idiotic statement? Or am I missing some profound meaning? If yes, then maybe I am the one who is an idiot. And on that, I am quite sure I could get a consensus. 

The myth of diamonds & romance

A friend asked me to accompany him shop for an engagement ring for his girlfriend.

We saw some fabulously eye-catching stones – fantastic clarity, great saturation of colour, large size and brilliant cuts. But he consistently ignored the rubies, emeralds or sapphires. He was fixated on a diamond. His reasoning: That is what men give women they love and what women want to feel loved (seriously, how overly clichéd was this?). I reminded him that even Mark Zuckerberg bypassed the diamond and went for a ruby. "But he must have had stock options to compensate," my friend argued.  

Earlier this year, Ashleymadison.comcommissioned a survey across 2,600 ‘actively-cheating husbands’ across the US. The driver behind this survey? To obtain a better  understanding of male infidelity. I doubt there are any more interesting revelations to unearth on this subject, but a few tit-bits from this survey were worth noting.  

• 53% of the cheaters said they would buy diamond jewellery for their mistresses, and only 27% considered doing the same for their wives
• 38% would buy flowers for their mistresses, only 19% would do so for their wives
• While just 8% would buy household items (like toasters, I guess) for their mistresses, 27% would happily gift such stuff to their wives (how practical)

So diamonds might hint at romance, but not at fidelity. 

In an earlier post, I wrote about Paco Underhill's reasons on why men purchase jewellery for women from his book Call of the Mall.

1) Keys to the front door

When men want to make blatant declarations of affection or intention they gift jewellery. These occasions don’t present themselves very often - engagement, marriage. And if the woman is lucky, an anniversary or birthday down the line. This is their way of convincing/ reminding the woman of the extent of their love. After all, you would not blow up thousands if you were not committed right? My friend falls in this category.

2) Keys to the back door

When they need the convenience of a relationship without the commitment that comes with front-door entry. Hence, mistresses, lovers and girlfriends are recipients of jewellery. Their way of convincing the woman it is worth her while to hang around. Ashleymadison’s ‘actively cheating husbands’ would feel right at home here. 

3) Keys out of the doghouse

Their way of saying sorry and want to make amends for bad behavior, specially if the woman at the front door has found out about the woman at the back door. Flowers wither too quickly, perfumes don’t last forever and chocolates will only make you fat. Nothing says “please forgive me for being such a jerk” better than a fine necklace that has caused a sufficient dent to the bank balance.

But then again, this is jewellery at large. Why are diamonds so stereotypically associated and synonymous with romance?

Apparently, the blame is to be squarely laid at the feet of De Beers. Ira Weissman, Founder, Truthaboutdiamonds.com, believesthat the entire tradition of the diamond as a gift given during a marriage proposal is a modern-day invention of Fifth Avenue real-life Mad Men. :)

The De Beers ad campaigns in timeless black and white used the slogan “A diamond is forever” in what has been expressed as one of the best marketing campaigns ever (credit to agency N. W. Ayer). In this particular one,  it tells you how two month’s salary lasts forever. Of course, it does not say that the size of the salary will also determine the size of the diamond and the eventual return on the investment. In another, a man screams "I love this woman" on a public square much to her embarrassment. The ad suggests a better way - give her a diamond ring. On getting that she throws her arms around him and whispers "I love this man, I love him, I love him".

Decades ago, Edward Jay Epstein wrote a legendary piece in The Atlantic on this very subject. Advertising agency N. W. Ayer drew up a well-orchestrated advertising and public-relations campaign to impact the "social attitudes of the public at large and channel American spending toward larger and more expensive diamonds instead of competitive luxuries."

The agency romanticized diamonds by altering the public's picture of the way a man courts -- and wins -- a woman. Since "young men buy over 90% of all engagement rings" it would be crucial to inculcate in them the idea that diamonds were a gift of love: the larger and finer the diamond, the greater the expression of love. Similarly, young women had to be encouraged to view diamonds as an integral part of any romantic courtship.

Movie idols, the paragons of romance for the mass audience, would be given diamonds to use as their symbols of indestructible love. 
The agency offered stories and society photographs to select magazines and newspapers to reinforce the link between diamonds and romance. Stories would stress the size of diamonds that celebrities presented to their loved ones, and photographs would conspicuously show the glittering stone on the hand of a well-known woman. 
Fashion designers would talk on radio programs about the "trend towards diamonds".

The Ayer plan also envisioned using the British royal family. "Since Great Britain has such an important interest in the diamond industry, the royal couple could be of tremendous assistance to this industry by wearing diamonds rather than other jewels." Queen Elizabeth later went on a well-publicized trip to several South African diamond mines, and she accepted a diamond from Oppenheimer.

Lecturers were arranged to visit high schools across the country. "All of these lectures revolve around the diamond engagement ring, and are reaching thousands of girls in their assemblies, classes and informal meetings in our leading educational institutions," the agency explained in a memorandum to De Beers.

And that for me explained the link between romance and diamonds - all the fabrication of smart marketing executives. 

But of course, as an investment, diamonds outshine many rivals. This month itself, the auction of diamonds created waves across the globe. A flawless deep-blue diamond sold for little over SFr 10 million (Sotheby, Geneva). The Archduke Joseph Diamond fetched around SFr 20.35 million (Christie’s, Geneva). 

SFr = Swiss Franc

While this is beyond the reach of virtually all humans on this planet, it has indicated a trend of holding diamonds as an investment. Eric Valdieu, an expert formerly with Christie's  launched an investment fund last year called Divine Jewels. In September, Financial Times reported that IndexIQ, a New York company, is supporting the first diamond-backed exchange-traded fund. The proposal is being reviewed by the Securities and Exchange Commission. Harry Winston, the largest publicly traded diamond company, is also collaborating with a Swiss asset manager on a $250m fund to buy diamonds wholesale to store in a vault, using money from hedge fund investments.
The article went on to state that diamonds have proved to be a low volatile investment and the super rich are giving it serious thought. Prices of polished diamonds have risen 100% since 2004 and show no signs of abating. 
A few months ago Business Today wrote on how Indians are considering diamond purchases though we are apparently way behind the Chinese.

If you are considering an investment in diamonds, there is no fund (as mentioned above) available in India. You will have to purchase the stones, so make sure you buy certified ones. Gold is gold. But each diamond is different and unique and the pricing tends to be opaque. Do your homework before venturing into this territory. 

Dating, investing & the reptilian brain

My friend ventured on a speed date.

Her logic was impeccable.

To optimize her chances of meeting “Mr Right” she needed to go to where the supply exceeded (or at least matched) demand. Where else will she meet at least a dozen compatible (single) men in one room and get the chance to talk to all of them?

At a speed date session, the men and women have a couple of minutes to chat with and impress each other before moving onto the next prospective candidate. The ones that potentially hit it off indicate that they would like to start dating.

According to economist Tim Harford, research on speed dating indicates that both sexes tilt towards educated non-smokers; but men prefer slim bodies and women prefer fat wallets. Those findings must bear some semblance to reality going by my friend’s experience. She took an immediate fancy to a good looking, well-dressed guy with an apparently hot job. Both are educated non-smokers, she is slim and he seemed well to do. They were keen on seeing each other again. 

The illusion soon dissipated when they met the next time. Once he began to talk, which was instantly and constantly, he had tremendous difficulty shutting up. No doubt, he loved the sound of his voice. He went on an evangelical monologue about anecdotes from his life and times in various countries. His elevated opinion of himself was “nerve wracking”. The guy turned out to be an insufferable oik. The clincher was when he referred to himself as a global citizen, which according to my friend, made him sound like an ageing hippy. She refused to ask him what he meant by that term (he had resided in 4 countries out of the 190+ counted by the United Nations) and branded him a fiasco of style over substance.

Why am I writing about this? Because of my friend's conclusion. She rationalised that her initial attraction boiled down to a reaction of her lizard brain.

Apparently, there are 3 parts to our brain.

The lizard (reptilian) brain is the most primitive part that is concerned with self preservation and survival (we share this with other reptiles). It is known for snap judgments. Have you ever suddenly just met someone and instantly your “gut feeling” is not to trust him or her? The lizard brain is at work. This reaction is based on appearance and mannerisms and happens on a barely conscious level. It is the part of our brain that works on auto-pilot – keeps your heart beating, controls breathing, pumps adrenalin when needed, etc. It is constantly alert to danger and focused on survival.

The limbic system (mammalian brain) allows us to experience our feelings and emotions.

 

The cerebral cortex is the logical part of our brain and is much bigger than the above two parts combined. It is where our speech, writing, math and thought come from.  It is the part of our brain that is conscious, intentional and rational. You are using it right now as you read this post. It helps you decide whether to have a tequila shot or a Bloody Mary and maneuver your way through traffic jams. 

All three parts of the brain are processing information simultaneously. So, if you have been dumped by your boyfriend, you experience the deep survival fear through the lizard brain, the emotion through the mammalian brain and logic (he was a jerk anyway) through the cerebral cortex.

Now what my friend indicated was that when she found herself attracted to this man, it was her lizard brain that kicked into action since it was looking for self-preservation and survival based on primitive instincts – security (capable of taking care of her & her offspring), resources (money & home) and protection (able bodied). What was unsaid was that the rest of her brain apparently switched off in the first interaction (or was probably figuring out which drink to settle upon) and began to work only on the first date when it told its reptilian counterpart to shut up. 

Frankly, I am of the opinion that she laid a mind-blowing trip on me because she did not want to admit she was a sucker for first impressions. Yet, it was not the first time I heard about our 3-part brain. Very recently, Michael Crowley of TIME magazine claimed that individuals processed the US presidential election debates with their reptilian brain when referring to the Obama-Romney debate. No one remembers the 2008 Obama-McCain debate but many would recall the vice-presidential debate between Joe Biden and Sarah Palin where she got infamous for her multiple winks at the camera. I really could not fathom which part of Palin's brain was working when she behaved so ridiculously, but Crowley was not talking about her brain. He claims that the crowd remembers it because the reptilian brain (audience in this case) watches for moments of conflict, wit and fallibility.

In Self interest has to be your only interest, Peter Guber claims that as much as 95% of our decisions are controlled by our subconscious mind. In particular, the reptilian brain actually manages much of how humans behave. It acts viscerally, responding by fight or flight; is ruled by hunger and fear; and is concerned about survival. The reptilian brain makes decisions in about 2 milliseconds, far faster than the 500 milliseconds that your rationale brain requires. That would probably explain why we react so badly when someone rubs us the wrong way and then regret our impulsive behaviour. 

All this has financial implications. Marketwatch.com talks about former Goldman trader Terry Burnham who explained investing in these terms. In his book "Mean Markets & Lizard Brains", he says that our primitive brain was designed to help our ancestors hunt for food and daily survival stuff. For instance, if they knew that animals frequented a particular place at a particular time of day they would work around it. Or, if certain animals or birds were most active before dawn, they would act accordingly. So the lizard brain is designed to look backward. But investing "by its very nature, requires us to be forward-looking, to anticipate events. Thus, the lizard brain (which is backward looking) causes us to be optimistic at market peaks (after rises) and pessimistic at market bottoms (after falls)." So whether it's optimism or pessimism, greed or fear, Burnham is of the opinion that trading and investment is not done rationally. 

Once you realise that your lizard brain is not the best reference point for making monetary decisions, you will tend not to act based on initial reactions. So you won't go and sell all your funds just because the market has collapsed. Neither will you pump most of your money in a sector fund just because that sector is on a roll. You will learn to judge present circumstances objectively which will help you act consciously and rationally. Once you systematically restrain your instinct, you are on your way to becoming a smart investor. 

Keep your "gut instinct" for dealing with bosses and strangers. Whip your cerebral cortex into action where your money is concerned. It's the only part of the brain that will help you get wealthy. 

Mistresses, single women & the economy

Jin Yanshi knows how to get noticed.

Very recently, this Chinese economist came out with a theory implying that a women's marital status is key to a vigorous economy. According to his theory in China Times and Business Insider, the more the number of single women, the better it is for the economy. 

His hypothesis is cloaked with 3 assumptions: 

1) Women love money (as if men do not!)

2) Women love to spend money (and men are misers, is it?)

3) Women are born consumption animals (and men are not?)

Based on those assumptions, he pontificates on why consumption is such a distinctive element of the female psyche. “Women express their desire in competition" (who knew?). "This competition therefore promotes a city’s consumption.”

His theory: The more the "divorced" and "leftover" women (the latter being a term to describe singles over 28), the greater the chance of an economy's prosperity.

His reason: Their jostling with other females for attention and competing with one another only feeds their innate consumption desire. This, in turn, does wonders for domestic consumption. 

If China follows his theory, the decision makers don't have to worry about an alternative to their faltering export model which is hitting growth. They just need to ensure that their women marry late and encourage divorce. 

I was curious to see what he had to say about "leftover" men, if there is such a term. 

According to him, men who have NO spending power will NOT be able to find wives (he obviously is no romantic) and so will NOT contribute to the city's economy. 
His remedy: Kick them out of town (he failed to cite the destination). 

Yanshi surprisingly excluded ernai; a literal translation is second wife but it actually indicates a mistress. Mistresses are neither divorcees nor "leftovers" but are very much part of China's social landscape. According to a report in Yahoo Finance, Chinese men buying gifts for their ernai may be among the best customers for luxury goods. And the young ladies' designer wardrobes play host to labels like Jimmy Choo, Cartier, Versace, Prada, Chanel, Yves Saint Laurent and Louis Vuitton. For instance, a 42-year old property developer called Jian in the southern metropolis of Shenzhen claimed that his 20-something mistress set him back by $6,100/month. He referred to her as being an "expensive hobby like golf". Jian is not my sleight of hand or figment of my imagination. He actually was interviewed by The New York Times. 

So if infidelity is such a big contribution to China’s consumption story, am surprised that this set of women was ignored when concocting such a theory.

More worrisome now, for retailers, is whether this trend is dropping. During the credit crunch in 2009, CNN reported on how a businessman could not afford to keep his 4 mistresses, so he employed the services of a local modelling agency to stage a private talent show and judge the women on their looks, their singing ability and how much alcohol they could hold. The winner would stay his mistress. 
Moneyweek recently reported that nearly half of the 1,000 richest people in China saw their wealth shrink in the past year. While China's boom spurred a market for mistresses, the weakening economic growth is affecting that equation. According to a research note by HSBC, the practice of wealthy men acquiring mistresses is on the wane. Coupled with the fact that there is less official tolerance of wealthy government officials flaunting their "bling", the $12 billion luxury market is being hit. 

Even though the country's growth engine is spluttering and luxury sales are being hit, China's consumption boom is not fading into insignificance. Yahoo cites various reports to prove this point. A World Bank Report envisages per capita income rising to $16,000 by 2030 (from $5,000 now). The report also predicts that domestic consumption will shoot up to 2/3rd of economic activity. A McKinsey report reckons that China's mainstream consumer class will comprise 400 million people with household incomes between $16,000 and $34,000 by 2020. Boston Consulting Group says China will be the world's No. 2 consumer market by 2015. 

The Wall Street Journal says that China has a lot of tools to drive wealth and encourage investments. China is encouraging domestic demand and household spending in a bid to drive GDP growth and speed up economic restructuring. Encouraging growth in domestic consumption to find quality drivers for the economy was one of the key targets of China’s 12^th 5-year-plan. The country is looking at potential reforms to boost investment and consumption in the areas of pension, healthcare, education, agricultural and land ownership, and continuing urbanization. 
Looks like the government is not taking Jin Yanshi too seriously.