Personal Finance for Engineers (Stanford Computer Forum, Apr 2017)

1. Adam Nash @adamnash Personal Finance for Engineers April 6, 2017 Stanford Computer Forum

2. ©2011-2017 Adam Nash ▪ I am not a financial planner ▪ This presentation is not financial advice ▪ You would be extremely foolish to make investment decisions based on the content of this presentation or discussion ▪ The opinions in this deck are intended to provoke discussion & further education 2 Caveats & Preface

3. ©2011-2017 Adam Nash ▪ Poorly covered in traditional education, even top tier universities ▪ Not technically difficult, but the signal:noise ratio is terrible ▪ Massive impact on your life – Money is one of the top 3 reasons   for marital problems 3 Why Personal Finance?

5. (show of hands) BEHAVIORAL FINANCE BASICS: How many of you think you are rational with your money?

6. ANCHORING MENTAL ACCOUNTING CONFIRMATION & HINDSIGHT BIAS GAMBLER'S FALLACY OVERCONFIDENCEHERD BEHAVIOR OVERREACTION &  AVAILABILITY BIAS LOSS AVERSION (PROSPECT THEORY) YOU ARE NOT RATIONAL

7. ©2011-2017 Adam Nash Anchoring ▪ People estimate answers to new / novel problems with a bias towards reference points ▪ Example: 1974 Study ▪ Most common examples: – Price you bought a stock at – High point for a stock 7

9. ©2011-2017 Adam Nash Confirmation &   Hindsight Bias ▪ We selectively seek information that supports pre-existing theories, and ignore / dispute information that disproves them ▪ We overestimate our ability to predict the future based on the “obviousness” of the past (example: real estate) 9

10. ©2011-2017 Adam Nash Gambler's Fallacy ▪ We see patterns in independent, random chains of events ▪ We believe that, based on series of previous events, an outcome is more likely than odds actually suggest ▪ Coin flip example ▪ It's because with human behavior, there are no “independent” events 10

11. ©2011-2017 Adam Nash Herd Behavior ▪ We have a tendency to mimic the actions of the larger group ▪ Crowd psychology is a major contributor to bubbles (believed) ▪ Easier to be “wrong with everyone” than “right and alone” ▪ No one gets fired for buying IBM? 11

13. ©2011-2017 Adam Nash Overreaction &   Availability Bias ▪ Overreact to recent events ▪ Overweight recent trends ▪ Studies demonstrate that checking stock prices daily leads to more trading and worse results on average ▪ Worse in high tech, because we are immersed in “game changers” 13

14. You have a 100% chance of gaining $500.B You have $1,000 and you must  pick one of the following choices: You have a 50% chance of gaining $1,000, and a 50% chance of gaining $0.A OR

15. You have a 100% chance of losing $500.B Now, you have $2,000 and you must pick one of the following choices: You have a 50% chance of losing $1,000, and a 50% chance of losing $0.A OR

16. ©2011-2017 Adam Nash Loss Aversion   (aka Prospect Theory) ▪ We hate losses more than we love winning ▪ Average loss aversion is 3:1 (!) ▪ Affects views on wide range of situations, including taxes, holding on to losing stocks, “sunk cost” mistakes 16

17. IT'S OK TO NOT BE RATIONAL

18. ©2011-2017 Adam Nash ▪ The key is that humans are predictably irrational ▪ Know your own flaws, and you can set up systems to account for them ▪ Self-awareness is key  (yes, my Mom is a psychologist...) 18 It's OK to Not Be Rational

19. ©2011-2017 Adam Nash Liquidity is Undervalued ▪ Strictly defined: it's the quanti- fication of how much money you can get, and how fast ▪ Liquidity is the power to take advantage of great investment opportunities ▪ Liquidity is also, in the end, the only thing that matters when you need to pay for something 19

20. ©2011-2017 Adam Nash ▪ In almost all cases, liquidity is inversely correlated with returns ▪ Examples: – Cash = very liquid – Private equity = very illiquid ▪ Common mistake: Safety! = Liquidity 20 Liquidity & Returns

21. ©2011-2017 Adam Nash ▪ Standard recommendation is that you have 3-6 months of living expenses in cash / cash- equivalents ▪ That number increases if you are in highly volatile industry / career ▪ Worth considering length of time for potential job search 21 Practical Outcome: Emergency Funds

22. ©2011-2017 Adam Nash ▪ The ultimate secret to personal finance is quite simple: – Spend less than you make  (on an ongoing basis) ▪ Very easy to measure, but few people do. Annual budget is a great idea. ▪ Don't forget to model in annual expenses & “personal spending” 22 Cash Flow Matters

23. ©2011-2017 Adam Nash ▪ What's the right number? – There is no question - the more you save, the more secure you are.   Income comes & goes, but expenses / lifestyle are sticky! ▪ A lot of models assume working 40 years, and producing savings to generate 80% of working income. – These models don't actually match anyone's real world experience. – There are a lot of models out there, and rules of thumb, but it's   important to run the numbers yourself. 23 Savings Targets

24. ©2011-2017 Adam Nash ▪ Not convinced that Albert Einstein said it was the greatest force in the universe. ▪ It's the key to almost all long term financial planning. ▪ Exponentials are bad in algorithmic cost, good in savings returns. 24 The Magic of Compounding

25. ©2011-2017 Adam Nash ▪ Rule of 72 ▪ In Sheets, for each year, just use   =POWER(1+rate, year) ▪ 4% over 20 years is 2.19x ▪ 8% over 20 years is 4.66x ▪ Careful: it works on debt just as well as savings... in reverse! 25 Simple Model

26. ©2011-2017 Adam Nash The Benefits of   An Early Start ▪ Compounding really takes off over long time periods ▪ In most retirement planning models, money saved between ages 25 - 35 produces more money than all savings between 35 – 65! 26 Years Return at 8% 10 2.16x 20 4.66x 30 10.06x 40 21.72x 50 46.9x

27. ©2011-2017 Adam Nash ▪ Bankruptcy is literally when you can't pay your debts. You can't go bankrupt if you don't have debt ▪ You will never find an investment that pays 8% guaranteed, let alone 20%+ ▪ You will find *tons* of credit offers out there that will charge you that ▪ “Bad” debt is toxic, your best return is to pay it off. But emergency fund takes precedence 27 The Dangers of Debt

28. ©2011-2017 Adam Nash ▪ No one wants to be average, but with investing, average is actually well above average. ▪ You will beat most mutual funds, and a large majority of your peers with simple, low-cost index funds. ▪ Asset allocation explains ~90% of the variance between fund performance 28 Good Investing is Boring

29. ©2011-2017 Adam Nash ▪ Different types of assets (cash, bonds, stocks, etc) have different volatility & return characteristics ▪ Combinations can lower volatility significantly, with moderate impact to returns ▪ Complication: historical performance does not predict future performance 29 Basic Asset Allocation

30. ©2011-2017 Adam Nash ▪ 2 hours of work per year ▪ Pick an asset allocation that is appropriate for your emotional character & time frame & goals ▪ For each asset class, pick cheap index fund to represent ▪ Rebalance every 1-2 years ▪ http://blog.adamnash.com/2010/12/31/personal- finance-how-to-rebalance-your-portfolio/ 30 Simple Operating Model

31. ©2011-2017 Adam Nash ▪ WSJ Guide to Understanding Money & Investing ▪ The Millionaire Next Door ▪ A Random Walk Down Wall Street ▪ The Essays of Warren Buffett ▪ Common Stocks & Uncommon Profits ▪ The Intelligent Investor ▪ Devil Take the Hindmost ▪ When Genius Failed ▪ Against the Gods: The Remarkable Story of Risk ▪ http://blog.adamnash.com/2007/02/14/ personal-finance-education-series-2- recommended-books/ 31 Recommended Books

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