Watch irrational spending; others do
“I went shopping and saved $57.49!” Does the refrain sound familiar? Whether it’s a coffee maker, boxed CD set, or shoes marked down to $22.50 from $79.99, it’s easy to rationalize a purchase when the mind makes a sprightly leap from “spending” to “saving” mode. But no matter how fab that new footwear is, there’s $22.50 less in your wallet when you head for the store’s exit.
Economists across the nation have studied the mind-wallet connection. They’ve found that we’re not only irrational about money issues, we’re predictably irrational. Everything from the way an expenditure is calculated to what currency we use to make a purchase or how much we want to avoid a financial loss can cause us to disassociate with the actual dollars-and-cents decision and start treating our dough like it’s Monopoly money.
Public television stations, for example, have long relied on getting higher pledges by calculating the per-day amount of a donation (and the free mug, umbrella or canvas bag). After all, 41 cents a day is pocket change compared to $150 a year. Same amount, different context. It works like a charm.
Our irrational behavior also depends on how we pay for expenses. Casinos use chips because the perceived losses seem less daunting to gamblers. Those colored discs just don’t seem like real money. Similarly, people spend more when shopping overseas because they don’t rationally equate those pretty little foreign coins with American currency.
The damage to our bottom line plays out fairly predictably in the stock market, too, where investors make decisions based more on emotional attachments than rational analysis (“I just LOVE my Home Depot stock!”). Investors often hold on to poorly performing stocks because they don’t want to acknowledge a loss. On the other hand, many play it too safe because of an exaggerated perception of the stock market’s risk, putting too much money in bonds and too little into stocks.
When you strip out the intricacies of personal finances, you’re left with one simple fail-safe directive that will increase your net worth: Spend less money than you make and invest the difference.
Ask the Fool
Q: What’s book value? — R.G., Springfield, Mo.
A: It’s an accounting concept, reflecting a company’s value according to its balance sheet and equal to shareholders’ equity, or the difference between assets and liabilities.
Book value once approximated a company’s intrinsic value, as most assets, such as factories and land, were capital-intensive and appeared on the balance sheet. But as America’s economy becomes less industrial and more service-oriented, book value has become less relevant for investors. Consider Microsoft. Its recently reported book value is about $47 billion, far from its market value north of $275 billion. Much of Microsoft’s value stems from assets that don’t register significantly on the balance sheet: intellectual property, employees, a strong brand and market share.
As another example, imagine a firm that owns a lot of land and many buildings. Over the years, the value of buildings on the balance sheet is depreciated, eventually to zero. But these assets are rarely worthless and can even appreciate in value over time. Such a company might actually be worth a lot more than its book value.
With many companies, you’d do well to largely ignore book value.
Q: When I see that a stock is up or down some amount, from where or what is it up or down? — B.P., Portland, Maine
A: When you hear that shares of Porcine Aviation (ticker: PGFLY) are down 2 1/2, that means they’re off $2.50 from where the stock ended at the previous close of trading. So if PGFLY closed at $55 per share yesterday and it’s trading around $52.50 right now, it’s down 2 1/2.
My dumbest investment
I bought shares of Saatchi and Saatchi in the late ‘80s on a flier and compounded my mistake. My broker recommended it because a pension fund manager who was “usually right” was buying it. I bought some at $14 5/8 per share and kept buying as it fell. I ended up with 1,000 shares that cost me $5,456. The company ran into trouble and divided in two. I ended up owning a few shares of each firm, worth a fraction of what they cost me. Lesson learned: Do your own thinking and research. — A.H., Seattle
The Fool Responds: Not all brokers serve their customers well — sometimes they’re just eager for you to buy or sell something, to generate some commission fees. (We can help you find good advisers and brokerages at www.fool.com/fa/finadvice.htm and www.broker.fool.com. Visit www.sec.gov/answers/openaccount.htm for more info.) Even smart investors who are “usually right” make mistakes. It’s also risky to “average down,” buying more of a falling stock. Make sure you understand the situation well. Some such stocks recover nicely, but many others keep falling.