To err is human, to forgive....Don't count on it!!

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
- Warren Buffett

 

The above is attributed to Warren Buffett, the Oracle of Omaha, and one of America’s wealthiest persons.  It points out his contrarian style and his value oriented approach to investing.  It is often pointed out that value investing, as opposed to growth investing, will lead to statistically greater returns[i].   That is not the subject, however, of this tip.  This tip is about human behavior and investors are human.  They make mistakes and they may behave irrationally and human behavior affects investment decisions, just as it affects others spheres of life.  By studying human behavior and identifying common investor mistakes, the field of behavioral finance can contribute to improving returns or reducing investors’ mistakes that emerge from the confluence of finance and psychology.

 

What are some common behaviors that we observe and from which we can learn to behave more rationally?

 

One of the first is overconfidence.  Nothing can lead to regret more quickly than success.  An investment decision that turns out to be great often leads investors to overestimate their knowledge and their abilities.  Such an increase in confidence may cause them to increase the amount of risk they are willing to take with their investments.  Investors need a plan – a well thought out plan.  Then, they need to stick with the plan, while constantly learning and modifying as necessary.

 

A good lesson, that is hard to learn, is to not allow sunk costs to change your decision.  We are disposed to hold onto investment losses, as we do not want to lock in “regret”.  We do not want to regret, so we postpone this feeling and hold investments that have losses (or not taking some gains) in the mistaken belief that the investment will recover (or continue to increase).  (Investors are, unfortunately, more likely to take small gains and let losses increase, as they do not want to regret their bad decisions.  We think less about opportunity costs.)  

 

Closely related is the Ostrich effect, where the investor simply puts her head in the sand.  This is true on many levels.  Investors are reluctant to cut their losses and ignore them until the pain drives them to sell – often just before the market turns around.  (Reminder: Be greedy when others are fearful.)  The same thing can happen when markets have been on a sustained upward run, when valuations are quite high.

 

An easy mistake to make is for investors to consider winnings to be house money and to rationalize their losses, as simply money that wasn’t really theirs.  First, investing is not gambling.  Investing is the implementation of a plan.  “Gamblers” who buy a stock and win will often seek riskier investments with their house money.  At the same time, if they invest and lose, they again tend to buy riskier investments in an effort to recoup their initial losses.  Don’t play this game.  The house always wins.

 

It has been observed that investors are more comfortable investing in companies with whom they are familiar.  Familiarity increases comfort and may come from building investors’ confidence in their knowledge or a sense of control.  Yet, when we only invest in companies in a single geographic region or if we combine employment and investments, we have a diversification problem.  (If you don’t believe me, ask an ex-employee of Enron.)

 

The fancy word for having a selective memory is cognitive dissonance, where our mind remembers successful investment decisions but represses the bad ones.  One must learn from their mistakes, before they go broke learning.

 

When individuals act together, they are known to be herding.  Yes, like the cows coming to the barn to be milked.  If investors lack the discipline to have independent thoughts and to be committed to their plan, their desire to be a part of the parade will often lead them to get in line when the parade is about over.  As such, you buy when the market is high (greed) and sell when it is low (fear).  Of course, herding will magnify individual investors’ biases as we have others – many others – who seem to agree with us.

 

Investors must learn to overcome detrimental behaviors, in order to be committed to financial success.  While human behavior is a part of the market for investments and human behavior helps markets maintain their efficiency, we are all human.  Try to remove emotions from financial decisions and limit your use of trial and error. Become informed, develop a plan, save more money, stay diversified, and make good decisions over a long period of time.  If you do, you will reach your goals.  Count on it!

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[i] One of our past-colleagues has written much about this topic and a short “lay-press” article about the subject is here.  

Buying a new car

The 2012 models of cars are out.  Are you in the market?  It can be scary to buy a new car, especially if it is your first time. There is a lot to think about, so do your research. Decide what car model and options you want, and how much you can spend. If you have already given your purchase some thought, you’ll feel less pressured into making an expensive decision at the showroom and more likely to get a better deal.

 

Consider these suggestions: 

·         Check publications at a library, bookstore or the Internet that describe new car features and prices. You can find information on the dealer’s costs for specific models and options. 

·         Shop around to get the best possible price by comparing models and prices in ads and at dealer showrooms. If you can, go to three different dealers. 

·         Plan to negotiate on price. Dealers sometimes give up some of their profit to make a sale — sometimes as much as 10 to 20 percent. This is usually the difference between the manufacturer’s suggested retail price (MSRP) and the invoice price that the dealer paid to the manufacturer. Make sure you reduce the price you offer by any cash-back offers the dealer has. 

·         You can order a new car if you don’t see what you want on the dealer’s lot. This may take more time, but cars on the lot may have options you don’t want and that can raise the price. Dealers want to sell their current inventory quickly, so you may be able to negotiate a good deal if an in-stock car meets your needs.

 

Learning the terms

 

Negotiations often have a vocabulary of their own. Here are some terms you may hear when you’re talking price. 

·         Invoice price – what the manufacturer charged the dealer. It is often higher than the dealer’s real cost because dealers get rebates, allowances, discounts and incentive awards from the manufacturer. The invoice price usually includes freight (also known as destination and delivery). If you’re buying a car based on the invoice price (e.g., at invoice, $100 below invoice, 2 percent above invoice) and the freight is already included, make sure the dealer doesn’t add it again to the sales contract. 

·         Base price – the cost of the car without added options. This includes standard equipment and factory warranty. The price is printed on the Monroney sticker. 

·         Monroney sticker price – shows the base price, the manufacturer-installed options with the manufacturers suggested retail price, the manufacturer’s transportation charge and the fuel economy (mileage). Federal law requires that this label may only be removed by the buyer of the vehicle. 

·         Dealer sticker price – usually on an extra sticker, is the Monroney sticker price plus the suggested retail price of dealer-installed options. This price is negotiable and may include additional dealer markup (ADM) or additional dealer profit (ADP), dealer preparation and undercoating.

 

Financing

 

If you decide to finance your car, be aware that dealer financing, even if the dealer contacts lenders for you, may not be the best deal you can get. Contact lenders yourself and compare the financing they offer with what the dealer offers.

 

Offers vary, so shop around for the best deal, comparing the annual percentage rate (APR) of interest and the length of the loan. Try not to focus only on the monthly payment. The total amount you will pay depends on the price of the car you negotiate, the APR and the length of the loan.

 

Dealers sometimes offer very low financing rates for specific cars or models, but won’t negotiate on their price. You may have to make a large down payment to qualify. It might be more affordable to pay higher financing charges on a car that is lower in price or to buy a car that requires a smaller down payment. Ask lenders to tell you the total amount you will have to pay before you own the car.

 

Before you sign a contract to buy or finance the car, consider all the terms of the financing and be sure you can afford it. Before you drive off the lot, get a copy of the contract that both you and the dealer have signed and make sure that all blanks are filled in.

 

Some dealers and lenders may ask you to buy credit insurance to pay off your loan if you should die or become disabled. It is rarely worthwhile. Check your existing policies to avoid duplicating benefits. Credit insurance is not required by federal law and it has to be reflected in the APR if they make you buy it. Contact the Missouri attorney general’s office by calling 800-392-8222 to learn about credit insurance requirements and regulations.

 

Trading in your old car

 

Discuss the possibility of a trade-in only after you’ve negotiated the best possible price and financing for your new car and after you’ve researched the value of your old car. Check the library for reference books or magazines that can tell you how much it is worth. This information may help you get a better price from the dealer. It might take longer to sell your car yourself, but you generally get more money for it than if you trade it in.

 

Service contracts

 

Service contracts that you may buy on a new car provide for the repair of certain parts or problems. Manufacturers, dealers or independent companies offer these contracts and they may or may not provide more coverage than the manufacturer’s warranty. Remember that a warranty is included in the price of the car while a service contract costs extra.

 

Before deciding to purchase a service contract, consider these questions:

 

·         What’s the difference between the coverage under the warranty and the coverage under the extra service contract? What repairs are covered?

 

·         Is routine maintenance covered?

 

·         Who pays for the labor and parts?

 

·         Who performs the repairs? Can repairs be made somewhere else?

 

·         How long does the service contract last?

 

·         What are the cancellation and refund policies?

 

The Missouri attorney general’s office has an excellent publication called All About Autos. It is available online at http://ago.mo.gov/publications/allaboutautos.pdf. Call the Missouri attorney general’s consumer protection hot line at 800-392-8222 to request a copy.

 

To file a complaint

 

You can call the Missouri attorney general’s consumer protection hotline number (800-392-8222) to report problems with Missouri car dealers.  The Federal Trade Commission (FTC) also works for the consumer at the federal level to prevent fraud, deceit and unfair business practices in the marketplace, and it provides information to help consumers spot, stop and avoid them. To file an FTC complaint or to get free information on consumer issues, visit http://ftc.gov/ or call toll-free, 877-FTC-HELP (877- 382-4357); TTY: 866-653-4261.

 

Brenda Procter, M.S.

Associate State Extension Specialist & Instructor

Personal Financial Planning Department

College of Human Environmental Sciences

University of Missouri-Columbia

 

Adapted from Buying A New Car, (Federal Trade Commission, April 2006), http://www.ftc.gov/bcp/edu/pubs/consumer/autos/aut11.shtm (accessed November 10, 2008).

 

Coupons R Cool

Recently, I read an article in our local newspaper about a resident of our community who was appearing on the television show named “Extreme Couponing”.  Being one who thought X-sports were restricted to activities like jumping out of a helicopter to ski a pristine mountain or free climbing in Yosemite, I read the article and discovered that couponing, while not nearly as dangerous, is growing in popularity.   Not only is couponing growing in popularity but the nouveau actress mentioned above runs a website on couponing (http://www.thecoupongirlz.com ) and teaches classes to help people learn more about how to coupon. 

 

Many of us can recall our mothers clipping coupons to take to the store, as well as to mail to us when we were younger.  Couponing hit its peak in 1999, with over 4.6 billion coupons being redeemed, and reached its nadir in 2008, when it reduced to 2.6 billion.  Since then, as we have been battling the recession, coupon growth has increased with the largest ever reported increase in redemptions occurring between 2008 and 2009.  Not surprisingly, internet redemption growth has led the way with growth of 263% between the two years.  It is estimated, however, that 83% of the coupons are used by only 22% of households.  While the “crazed coupon clippers” are interested in a good deal, the heaviest users, representing 18% of households and using 65% of the coupons, actually have been found to make 70% more trips to the stores and to spend 80% more, than non-users.  Hence, these results indicate that many people don’t actually spend less.  They actually buy more and spend more time engaged in the activity of shopping.

 

Many would think that low income households would be the largest category of coupon users.  They are not.  Affluent households are more likely to subscribe and read the newspaper and their greater levels of education help them understand the value of money and the relatively attractiveness of deals.  Thirty-eight percent of “super-heavy” users and 41% of “enthusiasts” households come from American families with incomes greater than $70,000.  It is also interesting that greater coupon use is associated with greater age, larger families, being female, and living in the suburbs.  (Much of the above was from: http://blog.nielsen.com/nielsenwire/consumer/the-coupon-comeback/ .)

 

If you want to enter the coupon-class, here are some tips on coupon use that were gleaned from the internet.  (Most of these were from http://www.couponing101.com/2009/01/a-beginners-guide-to-couponing.html .)

 

Find your coupons in the newspaper, on the internet, or in the stores.  You may Google “coupons” on the internet and find excellent coupons for national stores and brands. 

 

Organize your coupons in files or envelopes that work for you.  Perhaps, organize them by shopping experience – food, clothing, toys, restaurants, or whatever system works for you.  Perhaps, you just want to stick to coupons for one item, say food, as a place to begin.

 

You need to be aware of stores’ coupon policies.  Do not attempt to violate them.  Many stores will double the face value of the coupon, with a maximum savings of $1.00, but most will only let you double a maximum of, say, four coupons.  Some stores will allow you to “stack” coupons, where you use both a manufacturer and store coupon for the same item.  Many stores limit the number of coupons per customer, per manufacturer, per day.  Also, to be responsible, read the coupon before you try to use it.

 

If you really like this process, begin to monitor the prices by keeping a record of prices for commonly purchased items that frequently have coupons.  Then, use the coupons when the item is selling for a reduced price, to maximize your savings.  Don’t spend a lot of time going to many stores to save a few dollars, as the costs in time and transportation could negate any savings.  A good thing to consider is to use your coupons with price matching policies.  Say, for example, your local grocer has a good price on canned vegetables but you are going to Wal-Mart with your coupons.  Take the grocer’s advertisement with you, Wal-Mart will match their sale price and you can still use your coupon.

 

Finally, I want to offer a couple of words of caution.  While coupon use can save you money, it can take a lot of time and effort to maximize the savings.  You may have better things to do.  Also, beware of buying “stuff” you don’t want or need, simply because you can purchase it at a reduced price.  If you don’t want something, you don’t want it - at any price.  If you do buy too large of a quantity of an item for you to use in a timely manner, give it away.  Unfortunately, shelters and food pantries are getting more business than they can adequately serve.  Share your financial success, to enable others to simply be.

 

Student Loans Part II

Last week we covered important information about student loans – some statistics, what types of loans there are, and some steps to take before going into default. If you didn’t read that article you can read it here: http://www.mufinancialtip.blogspot.com/. This week we will discuss default rates and some steps you can take to prevent student loan problems.

STUDENT LOAN DEFAULT RATES

If you do enter default, you should still try to utilize one of the methods discussed last week, including forbearance and getting a more flexible repayment plan. If you are in default here are some actions the federal government can take:

• Deny new student loans
• Report the delinquency on your credit report
• Intercept tax refunds
• Garnish your wages without a court order
• Hire aggressive collectors
• Charge high collection fees – as much as 25% of the total loan balance
• Professional license revocation

In addition, there is no statute of limitations on federal student loans, which means they can attempt to collect on your loans indefinitely.

Earlier in September the U.S. Department of Education released the official FY 2009 national student loan default rate^[i] – which is now at 8.8%, up from 7.0% in FY 2008.

Here is a graph of the national student loan default rates for the past 25 years^[ii]:

As you can see from the chart the default rate is substantially lower than it was in the late 80’s and early 90’s, before some reforms in government lending. Unfortunately, after many years of declining default rates, the trend is again going up.

Here is a chart comparing Missouri, and specifically the University of Missouri (Columbia campus only) with the national rates, for the past 3 years^[iii]:

	2009	2008	2007
National rates	8.8%	7.0%	6.7%
State of Missouri	7.6%	5.8%	6.0%
University of Missouri	2.9%	2.3%	2.4%

 

PREVENTING STUDENT LOAN PROBLEMS

There are steps I recommend you take while in school to try to minimize your student loans, which will help you have a lower payment after graduation:

• Don’t use student loans to finance an unaffordable lifestyle – live like a student now so you won’t have to continue to live like one after school.
• Don’t just accept the full amount of loans offered to you if you don’t need it. Review your budget and take the minimum amount you can.
• Don’t use student loans to purchase all the newest electronic gadgets. I know, the iPads and latest iPhones and everything else with an “i” in front of it are really cool, but do you really need all of them while you are a student? If you haven’t had to distinguish between needs and wants before college, there is no better time to do so than now.
• Consider working part-time. Some people won’t agree with me on this, but I think it is OK for students to work part-time while going to school to help pay for housing, food and other living expenses. Students who work part-time gain valuable time management skills as well as resume building experience. School needs to come first, though – if your grades are suffering you need to re-evaluate how many hours you are working.
• While I haven’t talked about private student loans much in these articles, private loans are always going to be more expensive than Direct loans. Maximize your Direct loans before taking out any private loans.
• Keep your grades up and apply for every scholarship you qualify (or might qualify) for.

 

 

Ryan H. Law, M.S., AFC

 

Personal Financial Planning Department

Office for Financial Success Director

University of Missouri Center on Economic Education Director

 

239E Stanley Hall

University of Missouri

Columbia, MO 65211

 

573.882.9211 (office)

573.884.8389 (fax)

 

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[i] http://www.ed.gov/news/press-releases/default-rates-rise-federal-student-loans

[ii] http://www2.ed.gov/offices/OSFAP/defaultmanagement/defaultrates.html

[iii] You can find State-by-State default rates for the past 3 years here:
2007: http://www2.ed.gov/offices/OSFAP/defaultmanagement/2007staterates.pdf
2008: http://www2.ed.gov/offices/OSFAP/defaultmanagement/2008staterates.pdf
2009: http://www2.ed.gov/offices/OSFAP/defaultmanagement/2009staterates.pdf
and rates for each educational institution here:
http://www2.ed.gov/offices/OSFAP/defaultmanagement/cdr.html