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[Financial Friday] Investor, Know Thyself: How Your Biases Can Affect Investment Decisions

Over the past few decades, a field has emerged that examines how human psychological factors influence economic and financial decisions. Understanding these biases may help you avoid questionable calls in the heat of the financial moment.

Investor, Know Thyself: How Your Biases Can Affect Investment Decisions

Traditional economic models are based on a simple premise: people make rational financial decisions that are designed to maximize their economic benefits. In reality, however, most humans don’t make decisions based on a sterile analysis of the pros and cons. While most of us do think carefully about financial decisions, it is nearly impossible to completely disconnect from our “gut feelings,” that nagging intuition that seems to have been deeply implanted in the recesses of our brain.

Over the past few decades, another school of thought has emerged that examines how human psychological factors influence economic and financial decisions. This field–known as behavioral economics, or in the investing arena, behavioral finance–has identified several biases that can unnerve even the most stoic investor. Understanding these biases may help you avoid questionable calls in the heat of the financial moment.

Sound familiar?

Following is a brief summary of some common biases influencing even the most experienced investors. Can you relate to any of these?

  1. Anchoring refers to the tendency to become attached to something, even when it may not make sense. Examples include a piece of furniture that has outlived its usefulness, a home or car that one can no longer afford, or a piece of information that is believed to be true, but is in fact, false. In investing, it can refer to the tendency to either hold an investment too long or place too much reliance on a certain piece of data or information.
  2. Loss-aversion bias is the term used to describe the tendency to fear losses more than celebrate equivalent gains. For example, you may experience joy at the thought of finding yourself $5,000 richer, but the thought of losing $5,000 might provoke a far greater fear. Similar to anchoring, loss aversion could cause you to hold onto a losing investment too long, with the fear of turning a paper loss into a real loss.
  3. Endowment bias is also similar to loss-aversion bias and anchoring in that it encourages investors to “endow” a greater value in what they currently own over other possibilities. You may presume the investments in your portfolio are of higher quality than other available alternatives, simply because you own them.
  4. Overconfidence is simply having so much confidence in your own ability to select investments for your portfolio that you might ignore warning signals.
  5. Confirmation bias is the tendency to latch onto, and assign more authority to, opinions that agree with your own. For example, you might give more credence to an analyst report that favors a stock you recently purchased, in spite of several other reports indicating a neutral or negative outlook.
  6. The bandwagon effect, also known as herd behavior, happens when decisions are made simply because “everyone else is doing it.” For an example of this, one might look no further than a fairly recent and much-hyped social media company’s initial public offering (IPO). Many a discouraged investor jumped at that IPO only to sell at a significant loss a few months later. (Some of these investors may have also suffered from overconfidence bias.)
  7. Recency bias refers to the fact that recent events can have a stronger influence on your decisions than other, more distant events. For example, if you were severely burned by the market downturn in 2008, you may have been hesitant about continuing or increasing your investments once the markets settled down. Conversely, if you were encouraged by the stock market’s subsequent bull run, you may have increased the money you put into equities, hoping to take advantage of any further gains. Consider that neither of these perspectives may be entirely rational given that investment decisions should be based on your individual goals, time horizon, and risk tolerance.

A negativity bias indicates the tendency to give more importance to negative news than positive news, which can cause you to be more risk-averse than appropriate for your situation.

An objective view can help

The human brain has evolved over millennia into a complex decision-making tool, allowing us to retrieve past experiences and process information so quickly that we can respond almost instantaneously to perceived threats and opportunities. However, when it comes to your finances, these gut feelings may not be your strongest ally, and in fact may work against you. Before jumping to any conclusions about your finances, consider what biases may be at work beneath your conscious radar. It might also help to consider the opinions of an objective third party who could help identify any biases that may be clouding your judgment.

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[Motivation Monday] 5 Tips to Boost Your Self-Confidence

Simply put, self-confidence is the belief that you can do something well. It’s about trusting your own skills and acting accordingly. Self-confidence is that voice within you that tells you that you’re capable of achieving what you set your mind to.

PLJ Income - Believe you can and you're halfway there

Let’s face it… if you don’t believe in yourself, does it really matter if anyone else does?

That self-trust is what enables you to think, plan, and act towards success – whatever that looks like to you.

Being a self-confident person has been proven to be a hugely positive impact in one’s life. Self-confidence can boost your career and, as a consequence, your income; it can also have a favorable effect on your personal relationships, and it helps to maintain a healthy body and mind.

Although it isn’t hard to figure out the correlations between self-confidence and success in life, let’s explore this connection a bit more.

When you truly believe you’re capable of facing tough challenges, you’ll set more ambitious goals and do your best to succeed.

This helps to find (or create) career opportunities that favor your specific skill set. When it comes to finances, self-confidence allows you to disregard money-related myths, and enable you to know your own worth.

“Knowing your worth” is not only financial – it also applies to relationships. If you see yourself as someone who is deserving of meaningful, respectful relationships… that’s what you’ll look for and attract.

The link between self-confidence and health is easy to see as well. Confident people take good care of themselves. In fact, several signs of anxiety and depression are known to be consequences of low self-esteem and confidence.

To top it all off, self-confidence is what allows you to be yourself. It helps you to draw a healthy line between what others think and your own actions and beliefs about yourself.

You have the ability to live the life you want, so get a nice dose of self-confidence and do it!

After reading all this, self-confidence might seem like some sort of magical power, but it’s not (that’s actually the best part, right?).

Here are 5 tips to boost your self-confidence:

1. Get to know yourself.

Every type of self-improvement starts with knowing yourself a bit more. Maybe you already know that you need to increase your self-confidence; maybe you’re not sure.

If that’s the case, try this:

Take a few minutes to think about your life. Make sure there’s no distractions around and that you do this on a regular day when you are not feeling particularly stressed.

Are you happy? Which area of your life do you feel the most confident in? Which area might you be lacking confidence in? When would you say you’re at your most confident? What makes you feel insecure?

Don’t be afraid to have a deep conversation with yourself. It’ll give you a lot of clarity.

2. Get inspired.

The whole point of assessing yourself and admitting that you could use more self-confidence in certain areas of your life is to use it as motivation. Getting inspired can be the kick-start you need to boost your confidence.

Try this:

Think about at least 3 people you admire and regard as confident. Once you’ve got them in your mind, describe their personality with as many details as possible. Chances are some personality traits will overlap.

For example, those 3 people may have different careers or come from different backgrounds, or you may not personally know them. However, they all seem to be sociable, financially independent, witty, or go-getters.

What are the words that overlap in your list?

Once you determine how you perceive self-confident people, you’ll have a compass to follow. Since “self-confidence” is a broad concept, you’ll be better off by tackling some of its components, instead of aspiring to be super-confident all the time in all aspects of life.

3. Get rid of procrastination.

Procrastination makes us stay in our comfort zone. Forget about that. Sure, it’s a hard habit to let go of, but if you start little by little, you’ll soon start to feel your confidence levels rising.

Try this:

Conquer procrastination by doing small and simple tasks each day. Start with baby steps so you don’t get discouraged. Plan a budget for your next vacation now. Write down your grocery list now. Write a quick e-mail to a friend and set up a coffee date now. These examples may appear trivial, but your mind will get the message: you can handle things.

The trickiest part about getting rid of procrastination is to start. So just start without giving it a second thought.

4. Set a goal and get working.

It always helps to empower yourself. Now that you’ve looked for inspiration in other people, it’s time to look within you. What are your accomplishments? What are you really good at? If you don’t like to “toot your own horn,” think about what others have told you that you’re great at.

It’s important that you know your strengths because it’ll give you the confidence to get working on new goals.

Try this:

You can read and study about self-confidence all you want; but ultimately, what really matters is that you start moving. That’s why all our tips include some kind of action. Your next step is to set a goal.

We all have – at the very least – some amount of self-confidence. In many ways, it’s what keeps us going through the hard times. So pick something that you know you are capable of doing but is still challenging. Once you’ve got your goal picked out, think about how you can apply what you’re already good at to achieve it.

5. Get comfortable with your emotions.

We all feel fear, frustration, envy, and other negative emotions. It’s completely natural. However, part of boosting your self-confidence is to keep negative self-talk and bad attitudes to a minimum. Watch how you talk to yourself and how you react to people who disagree with you. Opt for kindness, and more often than not, that’s what you’ll receive from others.

Try this:

Each time you’re feeling blue or angry, take a deep breath and remind yourself that it’s okay to feel that way; give yourself some time and do everything you can to move on from that moment.

There’s absolutely no need to repress your emotions. Let yourself feel everything, but don’t let it ruin your day. Trust yourself and remember:

“Believe you can and you’re halfway there.”
-Theodore Roosevelt.

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[Financial Friday] When 401(k) Plans Go Bad–Avoiding Disqualification

As a small-business owner, you probably either have, or have considered adopting, a 401(k) plan. 401(k) plans have assumed their starry status in the retirement universe because of the favorable tax benefits they provide to both employers and employees.

when-401k-plans-go-bad-avoiding-disqualification

Most importantly, employers get an immediate tax deduction for contributions they make to their plans, and employees benefit from pre-tax contributions and tax-deferred, or in some cases tax-free, accumulation of investment earnings. But these tax benefits come at a cost. Employers must follow strict and often complicated laws in the Internal Revenue Code, and regulations promulgated by the government agencies charged with interpreting those laws–primarily the Internal Revenue Service and the Department of Labor.

Tax effects of plan disqualification

Plans that comply with the tax rules are said to be “qualified” and therefore entitled to their favorable tax status. But plans that run afoul of the rules (for example, by improperly excluding participants, missing contributions, or failing discrimination tests) can become “disqualified.” The potential consequences of disqualification are severe:

  • Employees are taxed on their pretax contributions in the year those contributions are made to the plan, rather than the year the contributions are paid from the plan.
  • In general, employees are taxed on employer contributions, and plan investment earnings, in the year they vest, rather than the year benefits are paid; in certain cases, highly paid employees are taxed on the entire value of their accounts (to the extent not already taxed).
  • Employers take deductions for plan contributions in the year their employees vest in that contribution, rather than the year the employer made the contributions to the plan.
    The plan trust must pay taxes on its earnings.
  • Distributions from the plan are ineligible for special tax treatment and cannot be rolled over tax free to IRAs or other qualified employer plans.

Even worse, a plan may be disqualified retroactively if the plan defect occurred in a prior year. This means that employers and employees would likely need to file amended returns to reflect the tax effects of disqualification for those prior years. Penalties for underreporting income in those prior years could also be imposed. And while the IRS generally can’t go back more than three years (six years if there was a substantial underreporting of income) to collect taxes for any earlier year, the IRS might require correction of those closed years if an employer seeks to requalify its plan.

IRS to the rescue

Luckily, the IRS has adopted several programs that may help you avoid the potentially disastrous consequences of disqualification.

The Self-Correction Program, or SCP, is generally the program of choice if you’re eligible. This program allows you to self-correct many plan errors–and preserve the tax-favored status of your plan–without contacting the IRS or paying a fee, and there are no application or reporting requirements. “Correction” generally means that the plan and participants must be placed in the same position they would have been if the failure had not occurred. The program is available for any errors that occur when you don’t follow the written terms of your plan. You can correct insignificant errors at any time. And you can even self-correct significant operational errors if you act promptly. (“Egregious” errors can’t be corrected using SCP.)

If you’re not eligible for SCP (or if you’d like the comfort of IRS approval of your corrections), the next step is the Voluntary Correction Program (VCP). This program is available only if your plan is not being audited. You must submit an application to the IRS describing the plan failure(s), describe how you intend to correct those failures, and detail the administrative changes you intend to adopt to avoid those failures occurring in the future. You must also pay a compliance fee, ranging from a few hundred dollars to $25,000, depending on the nature of the failure and the number of plan participants. If your application is approved, the IRS will generally agree not to disqualify your plan because of the disclosed failures if you complete the approved corrections within 150 days.

If you don’t use SCP or VCP to voluntarily correct plan errors, and the IRS discovers the failures itself (for example, during a plan audit), you may still be able to preserve your plan’s tax benefits by using the Audit Closing Agreement Program (Audit CAP). Under this program, you must correct the plan failures, enter into a “Closing Agreement” with the IRS, and pay a penalty equal to a negotiated percentage of the additional taxes that would have been payable had the plan been disqualified.

The qualified plan rules are complicated. Working with a retirement plan professional can help you avoid mistakes that could lead to the ultimate penalty of disqualification.

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[Motivation Monday] You Don’t Have to Give Up Now

 

PLJ Income - You have to fight through some bad days to earn the best days of your life

What happens when motivation is nowhere to be found? Most of the time, what happens is that people give up, often without even realizing it. It’s not an easy decision to make, and they don’t typically go, “That’s it. I give up on my dream.”

What does happen is this: they slowly stop taking steps to achieve what they want. They procrastinate and make excuses. They stay in the dreaded comfort zone and blame someone or something else for it.

But what if they didn’t give up?

There are going to be difficulties in your life. When it comes to pursuing your dreams, obstacles are going to happen as well, and you have to evaluate whether your battle is worth fighting for. Put everything into perspective and consider if you’re the one who’s actually standing in your own way.

Ultimately, you’re responsible for your life. So why not travel on the path that you really want to?

There’s no reason why should give up your dreams. After all, dreams let us know what we really desire. That’s why we should pay attention to them, rather than dismissing them so easily. If you’re like most people, you have at least one dream that has always seemed appealing. Some say;

  • “I could’ve been a singer” or
  • “I’ve always wanted to help others but never figured out how” or
  • “I just love painting! But one can’t afford a living just by creating art”

… you get the picture, right?

It’s easy to limit ourselves for a number of complicated (and human) reasons. As a consequence, we often feel trapped and overpowered by everyday tasks.

If you’re about to give up on your dream (whatever it is)… consider asking yourself these questions instead.

– How important is your dream?
To you, that is. Make sure that you’re on the right track by asking yourself this question. You’ll immediately feel the answer. As you think about your dream, you’ll either start feeling stressed and fearful, or eager and a bit excited.

If the road towards your dream didn’t have any complications whatsoever, would you run to it? Or would you still have some hesitations?

– Is it really yours?
Why do you want to achieve this? Sometimes, we want to make others happy so badly that we try to fulfill their expectations instead of ours. That may be one of the reasons we feel like giving up. So, is your dream really yours?

Imagine the best-case scenario in which you achieve your dream: would you feel truly happy? If the answer’s yes, then you’re going after something that really resonates with your heart and soul.

– What’s the worst that could happen?
We all think about how awful it would be to give our best shot at something only to fail. The thought of fear and rejection can be paralyzing. You could stop all these negative feelings by facing them head on.

Think about the worst thing it could happen and compare it to the best thing that could happen. More likely than not, you’ll have a lot more to gain if you give it a go.

– What means do I need to make it happen?
It’s great to dream, but at some point we have to land the plane. In order to fully commit and live the life you want, maybe you’ll need financial help, legal assistance, emotional coaching… whatever it is make an investment in yourself and you won’t regret it.

PLJ Income - No matter how you feel, get up, dress up, show up, and never give up

Once you know your dreams and goals are worth fighting for, proceed to create an action plan. Thinking and reflecting upon your desires will only be effective if you take action. You have to work for it.

Imagine you’re throwing a party. Would you expect it to be the party of the year by imagining it? No! You would call and invite your friends, plan some fun things to do, maybe prepare a special menu… and you’d definitely get up, dress up, and show up. It’s your party!

Honor your heart’s true desires. You’re here to live and maximize your full potential. We all fear rejection and failure, but that shouldn’t stop us from trying out new things and living fully. Dreams mean we have desires, and having desires means that we’re alive.

Go for it.

You don’t have to give up.
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[Financial Friday] Cost of Living: Where You Live Can Affect How Rich You Feel

Do you find yourself treading water financially even with a relatively healthy household income? Even with your new higher-paying job and your spouse’s promotion, do you still find it difficult to get ahead, despite carefully counting your pennies? Does your friend or relative halfway across the country have a better quality of life on less income? If so, the cost of living might be to blame.

Cost of living

The cost of living refers to the cost of various items necessary in everyday life. It includes things like housing, transportation, food, utilities, healthcare, and taxes.

Single or family of six?

Singles, couples, and families typically have many of the same expenses–for example, everyone needs shelter, food, and clothing–but families with children typically pay more in each category and have the added expenses of child care and college. The Economic Policy Institute (epi.org) has a family budget calculator that lets you enter your household size (up to two adults and four children) along with your Zip code to see how much you would need to earn to have an “adequate but modest” standard of living in that geographic area.

What areas have the highest cost of living? It’s no secret that the East and West Coasts have some of the highest costs. According to the Council for Community and Economic Research, the 10 most expensive U.S. urban areas to live in Q3 2015 were:

Rank Location
1 New York, New York
2 Honolulu, Hawaii
3 San Francisco, California
4 Brooklyn, New York
5 Orange County, California
6 Oakland, California
7 Metro Washington D.C./Virginia
8 San Diego, California
9 Hilo, Hawaii
10 Stamford, Connecticut

Factors that influence the cost of living

Let’s look in more detail at some of the common factors that make up the cost of living.

Housing. When an area is described as having “a high cost of living,” it usually means housing costs. Looking to relocate to Silicon Valley from the Midwest? You better hope for a big raise; the mortgage you’re paying now on your modest three-bedroom home might get you a walk-in closet in this technology hub, where prices last spring climbed to a record-high $905,000 in Santa Clara County, $1,194,500 in San Mateo County, and $690,000 in Alameda County. (Source: San Jose Mercury News, Silicon Valley Home Prices Hit Record Highs, Again, May 21, 2015)

Related to housing affordability is student loan debt. Student debt–both for young adults and those in their 30s, 40s, and 50s who either took out their own loans, or co-signed or borrowed on behalf of their children–is increasingly affecting housing choices and living situations. For some borrowers, monthly student loan payments can approximate a second mortgage.

Transportation. Do you have access to reliable public transportation or do you need a car? Younger adults often favor public transportation and supplement with ride-sharing services like Uber, Lyft, and Zipcar. But for others, a car (or two or three), along with the cost of gas and maintenance, is a necessity. How far is your work commute? Do you drive 100 miles round trip each day or do you telecommute? Having to buy a new (or used) car every few years can significantly impact your bottom line.

Utilities. The cost of utilities can vary by location, weather, usage, and infrastructure. For example, residents of colder climates might find it more expensive to heat their homes in the winter than residents of warmer climates do cooling their homes in the summer.

Taxes. Your tax bite will vary by state. Seven states have no income tax–Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In addition, property taxes and sales taxes can vary significantly by state and even by county, and states have different rules for taxing Social Security and pension income.

Miscellaneous. If you have children, other things that can affect your bottom line are the costs of child care, extracurricular activities, and tuition at your flagship state university.

To move or not to move

Remember The Clash song “Should I Stay or Should I Go?” Well, there’s no question your money will go further in some places than in others. If you’re thinking of moving to a new location, cost-of-living information can make your decision more grounded in financial reality.

There are several online cost-of-living calculators that let you compare your current location to a new location. The U.S. State Department has compiled a list of resources on its website at state.gov.

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