Friday, February 3, 2023

Why We All Lack Financial Acumen (Emotional Thinking)

Image result for man struggling with bills
Why is it we all fail at managing our own finances?

I received some mail from two readers on different subjects which neatly dovetail with one another. The first reader questions to why people with a good education are often incapable of managing their own finances. People making six-figure salaries with advanced degrees are living paycheck-to-paycheck and can't seem to balance their own budgets.  They run their credit cards past their limits and bounce checks.  And I know this because I used to do that while making a six figure salary.  It was idiotic - and quite common.

And the funny thing is, oftentimes people like this can make very rational decisions at work, particularly when dealing with other people's finances.  If you were spending the company's money, you may be more astute about the bottom line, as you ain't spending your own money.  But of course, there are exceptions to this rule.  Some folks are spendthrifts at work, or with other people's money entrusted to them.

These exceptions do point out why we lose our financial acumen.  I related before a story about my friend at Detroit Gear and Axle who was assigned to build an office for a foreman.  To save money on plastering and painting, he decided to use an inexpensive paneling from a home improvement store.  But upper management was appalled when he finished the project, as a foreman was not at the manager level qualified to have paneling in his office.  So they spent hundreds of dollars having union painters paint over the paneling, which drove the project over budget.  They wasted money to follow some silly in-house rule based on emotional criteria.

It may be right there is what the problem is.  We get caught up in things like status and emotion when it comes to money.  In our personal lives, we want to have a fancy car and a fancy house and we're willing to go into debt in order to have these things.  We do it for status or perceived status.  We want to show off to our friends that we have nice things and can afford nice things.  Or we think we can afford them anyway.

And of course, we fail to realize that the owning nice things takes little more than signing one's life away in debt. There's no real talent in buying a fancy new car. It's not like you actually went out there and made the car with your own hands. You just went and paid somebody.  And yet, people show off a new car like it was something they built!

Another reader writes about the demise of Sears, after going to a store closing sale.  Again, the example of Sears illustrates that even when it comes to business and industry, managers can make really boneheaded decisions.  Like so many others, I keep wondering what was going through Eddie Lampert's mind in the last decade with regard to Sears. I keep thinking that maybe there's some secret plan he's going to pull out of his pocket at the end where he ends up owning all the real estate in making out like a bandit while screwing all the creditors, shareholders, and pensioners.

But it's beginning to look a lot more and more like he's just a really bad manager and screwed up big time with his operation of Sears. He ran the company into the ground and wasted the shareholders money, the bondholders money, and his own money in the process. And a lot of people, from employees to pensioners, are going to get hurt in this deal.

And again, emotion and status factor into this. He considered himself the boy wonder of hedge fund financing. And he claimed to have a secret plan to turn around Sears using something called "Shop-your-way!" which seems like a desperate last-ditch attempt to salvage the company. A last-ditch attempt that was clearly doomed to fail.

But people often believe what they want to believe, rather than harsh realities. Again emotion trumps logic. People on the Titanic felt the ship could not be sinking even as it was taking on water. And watching Sears go under was like watching the Titanic sink over a period of a decade.

The reader noticed that at the close-out sale there were not very many bargains to be had. Some of the appliances up for sale are the same price as appliances at other retail outlets. Again, emotion raises its ugly head. Store Liquidators are professionals that go from location to location to liquidate various retail outlets. Usually, they start off offering everything at list price at least for the first week or so. Then the next week they lower prices by 10%, and the week after that 20%, and so on until everything is gone.  Oftentimes the liquidators will bring their own merchandise to sell as well.

This creates a conundrum for the consumer. If you wait 2 or 3 weeks for prices to go down, somebody else may purchase the item before you get a chance to. So do you pay more and get a mediocre bargain or wait and hope to snag a real bargain?  It is a fascinating formula that relies more on emotions (FOMO) than on mathematics.

The problem is, you are bidding against people who think that anything at a store closing sale is bargain, without checking prices. They let their emotions get the best of them. So they buy stuff that is being liquidated that really isn't that much of a bargain. If you decide to wait until something is 30 or 40% off, chances are one of these idiots already bought it at the higher price, before you.

Again, emotion is trumping logic. And perhaps that's one reason why I stay away from these liquidation sales. Usually I find there are no real screaming bargains there, in fact usually it's just a lot of broken down crap.

Not only that, they usually don't have what I want. You go to a liquidation sale and you buy things because you think they are perceived bargain. "At a price is like this you can't afford not to buy!" So you buy stuff that you don't really need because you think it's a bargain, even though you have no use for it. It is shopping at its worst.  And yes, I have done this, more than once.

At first, I thought these were all disparate things, but the more I thought about it I realize they're all part parcel of the same. We all tend to use emotions when making financial decisions. And often this clouds are judgment. And it matters not whether the decision is to buy a new SUV, or build a new wing on the factory, or two leverage your company heavily in debt, or to buy a dented stove at a store closing sale.

We let emotions get the better of us, to our own detriment.