The Finance Buff

John Templeton Foundation sponsors a “Big Questions” essay series. It posts a philosophical question and invites answers from scientists, scholars, and public figures. A recent Big Question was

Does the free market corrode moral character?

There were 13 answers. John Bogle, founder of Vanguard, gave his answer. Mr. Bogle concluded,

“Fettered” capitalism has indeed corroded our moral character, by both privatizing the rewards of the market and (in the form of federal bailouts) socializing its risks. Both are betrayals of the free market and its genuine virtues. Our society has a huge stake in demanding higher moral values in a
less fettered market system.

I agree 100% with Bogle’s answer, which he also elaborated in his book The Battle for the Soul of Capitalism. Capitalism has changed from owners’ capitalism into managers’ capitalism. That’s not good.

If you make a change to your portfolio, say you add some more money into a fund, do you check the price the next day and see if your move made money? I do, and it doesn’t make much sense.

If I have some money in a fund, I don’t check the prices every day and see if the value of my fund increased or decreased. I let the money ride with the market. But if I add $2,000 to the fund, even if I already have 10 times more in the same fund, I still prefer to see on the next day that my $2,000 move was a good one. It seems I care about the new money much more than I care about the old money, although money is just money. Money has no memory. It doesn’t know whether it’s old or new.

I don’t think I’m alone. I asked a colleague what he would do if he had 100% of his money in stock funds which lost 40%. He said he would hold because the prices are really low today. I then asked him what he would do if he had nothing in stocks but a bunch of cash in a bank savings account. He said he would buy into the market slowly because the prices may go down some more. So if he had old money in stocks, he’s willing to let it ride, but he’s not willing to do the same for his new money. So what’s so special about new money that makes us  care more about it? When does new money turn into old money, at which point we don’t care as much about it any more?

Behavior economists call this phenomenon endowment effect. Whatever form the money is currently in, people have a preference to keep it in the same form. Therefore if it’s already in stocks, people don’t want to sell, fearing that the price is too low.  If it’s in cash, people don’t want to use all the cash to buy stocks right away fearing that the price is too high. Because stocks are riskier than cash, they appear to be extra careful with their new money while they don’t mind losing their old money. It’s related to loss aversion. People are afraid of making a wrong move so they keep the money where it is, no matter where it happens to be.

How do you overcome this behavioral bias? The first step is recognizing money is just money, whether it’s old or new. Be as cautious with old money as you are with new money. Be as aggressive with new money as you are with old money. Make it mechanical. Decide on the rules ahead of the time. Write them down. When the time comes, just do it.

Do you think we have too many banks in the United States? There were 8,451 FDIC-insured banks as of June 30, 2008. Canada, on the other hand, with 1/10th of the population as the U.S., only has 81 banks, which can be listed on one page. On a per capita basis, we have 10 times as many banks as in Canada.

Of course the benefit of having this many banks is competition, which is usually good for the consumers. When I was in Canada a few years ago, I was astonished how hard it was to find a basic free checking account (or checquing chequing account as they spell it). I just looked on a few Canadian bank web sites. It’s still the same today. Even the most basic account has a monthly fee. You need to maintain a $1,000 minimum balance to waive the monthly fee. Then they also charge you for each transaction after you use up your allowance of 10 or 15 free transactions per month. That kind of metered checking account is almost unheard of in the U.S.

Intense competition also can go the wrong way, as we know by now how banks were stepping over each other offering mortgages to subprime borrowers. They can’t charge you monthly fee, so they gouge you on foreign ATM and overdraft fees. I think we have too many banks in the U.S.

In A Non-Deductible IRA Is Worth It For Me, I mentioned I’m going to establish a self-employed 401(k) plan, also known as a solo 401k plan or an individual 401k plan. This is in part for providing a safe haven in 2009 for the pre-tax money in my IRAs, in preparation for converting the remaining after-tax money in my IRAs to Roth in 2010. It will also allow me to shelter a little bit of money from my self-employment income. Every bit helps, you know?

When I tried to figure out how much I can contribute from my self-employment income to the solo 401k, I found that the information on the Internet assumes that the self-employment income is the person’s only earned income. For example the calculation worksheets provided by Fidelity, Schwab, and Vanguard all make that assumption. They don’t consider the cases like me who work at a day job while earning some self-employment income on the side. Because I participate in the 401k plan at work, the maximum I can contribute to my solo 401k plan changes with what I earn from my day job and what I contribute to the workplace 401k plan. The Social Security tax I pay depends on the sum of my salary as an employee and my self-employment income. The salary deferral contributions I can make from self-employment income also depends on how much I already contribute to my 401k plan at my day job. I would think there are enough consultants, freelancers, moonlighters, and bloggers who are in the same camp as I am, but there is very little resource I could find for people who earn their income from a mix of W-2 salary and self-employment.

You know where this is going to lead to, don’t you? I had to create a spreadsheet for myself and I’m sharing it here in case other people like me find it helpful.

Spreadsheet: Solo 401k For Part-Time Self-Employment

This spreadsheet takes into account employment income, contributions to workplace 401k, and self-employment income. It calculates the maximum salary deferral contribution and the maximum profit sharing contribution I can make to my solo 401k plan. If there is no day job, just set the day job related fields to zero and it will work for people who only have self-employment income as well. There are two tabs: one for an unincorporated business (sole proprietorship), the other for an incorporated business. As usual, use this and everything you find on this blog at your own risk, because I’m not a CPA.

I’m going to use Fidelity for my plan because I already have other accounts with them and their plan is free and flexible. Vanguard is going to offer a plan but it looks like they don’t allow incoming rollovers and there is no brokerage option.