This is the version of my talk, Personal Finance for Engineers, that I gave at Stanford University on November 2, 2015 for the CS 198 Section Leader program.

1. wealthfront.com
Adam Nash
CEO, Wealthfront @adamnash
Personal Finance for
CS 198

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Caveats & Preface
▪ 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

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Why Personal Finance?
▪ 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

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Fast Five Finance Basics
1. Behavioral Finance
Basics
2. Liquidity is Undervalued
3. Cash Flow Matters
4. The Magic of
Compounding
5. Good Investing is Boring
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5. (show of hands)
BEHAVIORAL FINANCE BASICS:
How many of you think you are
rational with your money?

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

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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
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Mental Accounting
▪ Money is fungible, but people put
it in separate “mental accounts”
▪ Lost movie tickets example
▪ “Found Money” problem
▪ Vacation fund & credit card debt
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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)
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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
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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?
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Overconfidence
▪ In one study, 74% of investment
managers believe they deliver above
average returns
▪ Positively correlated with High IQ...
▪ Learn humility early
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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”
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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

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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

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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
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17. IT'S OK TO NOT BE RATIONAL

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It's OK to Not Be Rational
▪ 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...)

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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
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Liquidity & Returns
▪ In almost all cases,
liquidity is inversely
correlated with returns
▪ Examples:
– Cash = very liquid
– Private equity = very illiquid
▪ Common mistake: Safety!
= Liquidity

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Practical Outcome: Emergency
Funds
▪ 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

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Cash Flow Matters
▪ 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”

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Savings Targets
▪ 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.

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The Magic of Compounding
▪ 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.

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Simple Model
▪ 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!

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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!
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Years Return at 8%
10 2.16x
20 4.66x
30 10.06x
40 21.72x
50 46.9x

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The Dangers of Debt
▪ 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

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Good Investing is Boring
▪ 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

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Basic Asset Allocation
▪ 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

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Simple Operating Model
▪ 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/

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Recommended Books
▪ 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/

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Disclosure
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or offer, or recommendation, to buy or sell any security. Financial
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circumstances. Past performance is no guarantee of future
results, and any hypothetical returns, expected returns, or
probability projections may not reflect actual future performance.
Investors should review Wealthfront’s website for additional
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