Making Money Decisions

Do you every wonder about your ability to make good decisions about money? Do you think you need to know something special to be better than average? Before you got that seminar, buy that book, or sign up for that MBA program, you should take some time to look at how you make money decisions. Success in investing, or choosing the best mortgage, or picking a sensible credit card all starts with using your mind to figure out your options and to make decisions.

The Making Money Decisions posts will take you through a few basics of decision making and take some of the stress out of making decisions about your money.

The ability to make good decisions is as skill that can be improved through practice and the use of the proper techniques. None of these techniques are based on any sophisticated mathematical or psychological concepts. If anything, the basic techniques of decision making are about figuring out what information you need for a decision, making a clear decision, and checking up on the results afterward. It is about finding the proper balance between intuition and analysis and recognizing that you can develop all the decision making skills that you need to become a better investor.

Next Lesson: Taking the time to think about your money problem

Money Market: For People that Always Looking for Something More

It is common that people always look on ways for their money to grow more in speed and value.

While expecting their money to grow in speed and value, people always consider and weigh between risk and yield. Naturally, higher risk yields higher result. On the contrary, lower risk yield lower result.

The battle of risk and yield always present in one’s mind, and often attributed to one’s personality traits - for example, in outdoor activity, do you like bungee jumping or strolling in the park? Your answer will be one of the indicators of your risk tolerance toward investing your money.

How much do people want more?

As people always look for something more, the quantity of ‘more’ in people’s mind is widely different, depending on the personality traits, investment outlook and personal finance budgeting and planning.

There are investment instruments that allow you to choose the investment type that best suited to your situation.

Investment in stocks, mutual funds, money market, certificate of deposits, etc. along with the macroeconomic trends will determine how much you will get out of your investment.

Money market

I would like to focus on one of the most common investment option, but not many people aware the benefit of - money market.

According to Wikipedia - In finance, the money market is the global financial market for short-term borrowing and lending. It provides short-term liquid funding for the global financial system.

Normally, investing in money market by opening a money market account yield more return than the conservative saving account.

According to M&T Bank eMoney Market website, the Annual Percentage Yield (APY) of money market is 3.25 per cent, compared to the 2.25 of national savings average.

Just like other forms of investing, you can open an online money market account, such as M&T Bank eMoney Market Account.

Money market might have the right compromise between risk and yield for some person. I personally recommend money market account (and do not recommend savings account) as part of diversification in your personal finance budgeting and planning to achieve your financial goal.

Investing: Can you take the pain?

On a day at the stock market like today we almost all feel the pain. As I write this the Dow Jones Industrial Average (the Dow) is down 130 points for the day and off 450 points in the last 4 trading days. So when the value of your mutual fund or stocks are moving strongly to the down side what are you tempted to do? Sell to stop the hemorraging or buy more because of the value. Some psychological studies can tell us which way we probably lean.

Studies done in the 1970’s have shown we feel twice pain or distress for the financial loss than we feel happiness for a gain. Let us see if I can engender some pain and gain in you. Imagine you have a mutual fund account with a value of $100,000. You get your quarterly statement and the account value has fallen to $90,000, how do you feel? A little (maybe more than a little) pain there, heh? Now you open the statement and see a $10,000 gain to $110,000. Feels pretty good, but definitely not a strong as losing that $10 grand! Leave it to psychologists to figure a way to measure phychological pain and pleasure, but the double the pain makes sense to me.

So how does this affect us as investors? From the question in the first paragraph, I think when our investments start falling in value, we are strongly tempted to sell to just stop the pain. It gives us a good idea why so many investors are so good at buying high and selling low. I know personally when a stock I have invested in goes down I start to mistrust my judgement and search the news for clues I might have missed that this was a bad investment. Doing this research will, hopefully, help me hang on to good investments when the overall market does not think much of them.

One last point we need to remember so we do not let the pain of less lead us to the poor house. A recent article submitted to Seeking Alpha did a pain vs. gain calculation. First, the average return of small cap stocks over the last 60 years is 16.3% per year and the average return for large cap stocks is 12.76%. The author used monthly returns to record a positive point for each percentage of positive months and 2 negative points for each percent negative return in negative months. The more volatile small cap stocks racked up a score of minus 788 (-788) points even as an investment would have grown to 13 times the original investment (using rule of 72). The steader large cap still gave us minus 482 (-482) pain points in spite of a 10 fold gain.

Bottom line: If you want to be a stock market investor, you must figure out a way to handle the negative emotions of negative returns. Markets go up and down, but the research shows it is much harder for us to live with the down part.

Investment perspective redux

“We’re putting all our spare cash into the stock market right now,” my coworker M said to me not long ago. “I figure that it’s cheap to buy right now, and prices are bound to go up.”

“We had twelve thousand dollars in the stock market,” my friend J said to me not long ago. “Then when everything came down it was ten. Now it’s back up to eleven. But we’re sure not doing anything with stocks until it gets back up to twelve at least. We can’t afford it.”

There are differences between M and J, of course–one is that M is in a household with two good incomes and J is in a household with (temporarily) one fair one–but they also have different perspectives on investing. Following up on Tim’s post, different people can look at the same world situation–a depressed stock market in which prices which had been rising have fallen and are slowly climbing again–and have radically different reactions.

As Tim said, the price you pay or how you feel about an investment doesn’t affect its outcome–but it does affect yours. Buying stocks cheaply now may well be a good move; but even if J had the money, she probably wouldn’t do it because she’s risk-averse and has just suffered a loss, which increases her risk aversion. M, on the other hand, is relatively risk-loving. If both of them were given the same opportunity–for example, the chance to buy stock in a company being touted as the next Google–chances are that they would react differently, even if they have the same information about the market and the absolute risk, based on their investment styles and their previous experiences.

It’s worth considering whether your previous experiences are coloring your thinking when it comes to investing. Maybe you lost money recently in your portfolio. (Chances are you did; most people have.) That doesn’t mean you’re going to lose money if you make another investment. It doesn’t mean you’ll make it, either, of course. It all depends on the market and world events; but not, as Tim said, on your action or your personal history.

Your investment decisions can have global effects

If you could choose only one, would you choose to (a) save a thousand people in a foreign country from dying in an earthquake, (b) save a hundred people in your home town (but that you don’t know) from dying in a plane crash, or (c) save your best friend from dying in a car accident?

Most people will answer (c), and will choose (b) over (a). (Up the ante by changing “your best friend” to “your child” and all but the most Vulcan-like among us will answer c.) You could call it egoism–the view that humans always act based on rational self-interest–or emotionally-motivated behavior or just plain selfishness; but given the choice, people almost always choose to do what benefits them, even at the detriment of other people, especially if those other people are distant strangers.

This is healthy human behavior; we value what we have and what we know, and we act to protect what we value. Rationally, however, if we assume that human life in general is valuable, we know that (a) is the most logical choice. Most of us don’t worry too much about this, since saving one’s best friend from death is pretty big, and after all, it’s just a hypothetical dilemma.

Now let’s talk about the food crisis. Chances are you’ve heard that food prices are rising and seen it for yourself. There are a number of factors causing the higher prices: increased demand, low reserves, the weak dollar, the high price of oil…and speculators. This Washington Times article describes how investors are putting money into futures markets for corn, wheat, and rice (among other things), which actually drives prices higher.

Speculators have always played a prominent role in commodities markets, but in the past year, they have literally overwhelmed them, causing a dramatic increase in trading volume, volatility and prices and disrupting many of the normal relationships between producers and end-users.

…As with the credit bubble before it, the explosion in commodities prices has its origins in a global savings glut and massive trade imbalances…The difference this time, however, is that even before it bursts, this bubble is causing economic discomfort for households and businesses around the world, and misery for hundreds of millions of hungry people who suddenly cannot afford a bowl of rice or scrap of meat.

Generally speaking, your financial decisions affect you, your family, and maybe a corporation’s profit margin or a stock broker’s bonus. But this is a new twist in financial decision making, where deciding to make some money could mean making a family just like yours–even if it’s on the other side of the world–go hungry.

If you could choose only one, would you choose to (a) feed a hundred starving people in India, (b) feed ten hungry people in your home town, or (c) make a little extra money off the stock market?

Choosing to invest in the stock market, even in the commodities market, won’t directly bring you to that choice, of course. But it’s true that thanks to our truly global economy, your financial decisions can now truly affect people in foreign countries. What would you choose?