Personal Finance for Engineers (Coinbase, 2017)

Personal Finance for

Adam Nash @adamnash

©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


▪ 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?


Fast Five Finance Basics

1. Behavioral Finance Basics

2. Liquidity is Undervalued3. Cash Flow Matters4. The Magic of

Compounding5. Good Investing is Boring

4

(show of hands)

BEHAVIORAL FINANCE BASICS: How many of you think you are

rational with your money?

©2014 Wealthfront, Inc.

ANCHORING MENTAL ACCOUNTING CONFIRMATION & HINDSIGHT BIAS

GAMBLER'S FALLACY

OVERCONFIDENCEHERD BEHAVIOR OVERREACTION &AVAILABILITY BIAS

LOSS AVERSION (PROSPECT THEORY)

YOUARENOTRATIONAL


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


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

8


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


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


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


Overconfidence

▪ In one study, 74% of investment managers believe they deliver above average returns

▪ Positively correlated with High IQ...▪ Learn humility early

12


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


You have a 100% chance of gaining $500.B

You have $1,000 and you mustpick one of the following choices:

You have a 50% chance of gaining $1,000, and a 50% chance of gaining $0. A

OR


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


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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IT'SOKTONOTBERATIONAL


▪ 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


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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▪ 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


▪ 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


▪ 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


▪ 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


▪ 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


▪ 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


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


▪ 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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The Dangers of Debt


▪ 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


▪ 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


▪ 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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Simple Operating Model

http://blog.adamnash.com/2010/12/31/personal-finance-how-to-rebalance-your-portfolio/






▪ 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

http://blog.adamnash.com/2007/02/14/personal-finance-education-series-2-recommended-books/



Economy & Finance

Personal Finance for Engineers (Coinbase, 2017)