Asymmetrical Information - Megan McArdle

11.26.12

Ask the Blogger

Everything you always wanted to know about personal finance but were afraid to ask

Dear Blogger:

A lot of my current savings is in the form of options I've received from my employer. But there is no current market for the underlying asset since the employer is a start-up. How much should I be risk adjusting the value? I'm pretty bullish on the company and it is a somewhat mature start-up that has shown profit so I'm optimistic. But then I could be wrong.

I don't have the option to diversify by selling the options so diversifying means additional savings. I know what I want to be saving in total and I can put a value on the options. What I don't know is the minimum percentage of my savings that needs to be something other than the options.  

Optionally Yours  

Dear OY:  

You are not going to like my advice.  What's more, I'm willing to bet that you will not follow my advice, because it's no fun.  My advice being that for savings purposes, you should pretend those options don't exist.  

Everyone who is not actually sitting on millions and millions worth of financial assets needs three forms of savings:  emergency funds, sinking funds, and retirement funds funds.  Emergency funds are the 6 months to 1 year worth of cash that you save to cover eventualities such as an illness, a job loss, or an adverse ruling from the IRS about the tax status of your pole dancing revenue.  Sinking funds are what you use to save for specific needs: repairs, new cars, home improvements, and so forth.  Stock options in an unproven startup--no matter how bullish you are!--are no good for these purposes, because when your boiler explodes, you need a replacement now, not whenever the company finally turns cash-flow positive.  

Options might, of course, fund a cushy retirement.  But you can't count on it.  You will definitely need to retire, and now is the best time to save for it, when you have many years for compounding to work its magic.  So save fifteen to twenty percent of your income today, and then if your options do strike, use a bit of the money to buy yourself something really amazing.  If they really strike, you can even ease up on retirement saving later.  But you shouldn't do that until those options are money in the bank.  Right now, they're just a risky bet on the future--and you can't afford to bet your retirement, too.  


Dear Blogger:

This is the probable and predictable question that everyone asks and most economists seem to offer different and variable explanations on the current condition of the real estate market.   I'm on the cusp of buying a home for the first time and hence pondering (if not fiercely ruminating) on the future of the housing market in the United States.  Interest rates are low and have been low for some time.  Unemployment is still high and wages are falling.   Do you believe we will see a real (define that however you wish) housing recovery in the next decade, and if so, what do you believe the catalyst (or catalysts) for the recovery will be?  If not, what would be your advice to prospective buyers?

Home Owner Managing Expectations  

Dear HOME:  

Predictions are hard, especially about the future, and so I am reluctant to say that I know where housing is going.  I'm pretty sure it's not going to roar back to new heights, or fall another 40%, but a modest recovery, or a decade of stagnation, both seem perfectly plausible to me.  The important thing is not to think about this too much, because if there's one thing the housing bubble taught us (or should have), it's that housing is not a good investment class.  If you're counting on your house to fund consumption, college, and a comfortable retirement, you've got way too many eggs in one basket.  We wasted a decade, and an enormous amount of money, on the delusion that your house could do the savings for you while you spent your income on other stuff--worse, that consuming things like granite countertops, jacuzzi tubs, and home saunas was in fact a form of savings.  This was madness, and it should not factor too much into the decision to buy a home.  

Of course it's perfectly reasonable to try to make sure that you don't overpay and end up underwater.  But that's a decision about an individual house, not a question about the broad market.  

There are loads of great reasons to buy rather than rent: it stabilizes your housing cost, ensures that you cannot be kicked out as long as you pay the mortgage, and allows you to customize your home to suit your own tastes and standards.  If you've found a house that you love, and can afford, and where you think you can be happy, then don't obsess about whether it's going to go up.  If it does, bonus!  Go on a great cruise when you sell the place.  And if it goes down a bit, or just kind of sits there, stubbornly refusing to appreciate--well then, you will be prepared with your other savings.  Meanwhile, you'll have enjoyed living there.  Houses make lousy investments, but they make really great homes.  


Dear Blogger: 

I'm a successful twenty-something who has done a fine job of saving, budgeting and keeping tabs on my financial personal health. 

I have no debt, a fully funded 401k, an emergency savings fund, a house fund, a retirement plan, automatic transfers into savings accounts and a fair amount of investments. 

I only buy what I can afford, track my spending in Excel (Mint.com is not specific enough!), and treat credit card points and airline mile maximization like a game to be won. 

I'm also newly married to someone who is not as organized as I am. He is financially successful and his only debt is school loans but the thought of a household budget spreadsheet gives him hives. His idea of financial planning is to someday "make so much money that it doesn't matter."

We plan to keep separate checking accounts for personal purchases but just opened a join checking account for household purchases and savings account for the big stuff (kids, house, exotic animals). 

What else should we do? How can we jointly managed our finances without driving one another crazy?  

A Real Fiscal Conservative  

Dear Fiscal Conservative  

Money is one of the most maddening quandaries of marriage, especially in this era of two earner couples.  The various ways of deciding who earns what, who gets to spend what, and how it's all tracked, are enough to occupy columns and columns, not to mention many late night arguments about whether we need a bigger emergency fund, or a trip to see endangered tortoises in the Galapogos before they all go extinct.  

Let me attempt to save you some trouble: your spouse is not going to track stuff in a spreadsheet like you do.  He's just not.  You can have all these lengthy discussions about it, but even if he decided that it was, like, the best idea ever, he will forget.  The world is divided into two kinds of people: the ones who make long lists of things like all the kinds of people in the world, and the ones who don't.  Never in the history of the universe has one kind been transformed into the other.  

Nor, this side of the grave, is he going to reach a point where he doesn't need to plan his money.  The bankruptcy courts are currently sadly full of extremely affluent people who weren't watching where all those dollars went.

There are two possible compromises here.  You can thoroughly separate your money, with a fund for joint expenses, or some kind of elaborate bill-trading scheme, but I don't recommend it; there's just too much potential for strain on your marriage, particularly if one of you earns more.

Instead, I recommend combining your money except for modest personal accounts.  Everyone should have some money that is just theirs to spend, but it should be drawn out of a common pool.  How do you do this when your partner hates record keeping, you ask? By first setting up a budget that includes both of you, second, automating as many payments as possible, and third, reviewing stuff once a month.  There are two ways to do this: the Dave Ramsey way, where you dole out actual cash into envelopes (successfully practiced by my grandparents for 60 years), or the Mint way, where you ask him to put almost everything on the debit card, and let Mint track what he's spending.  Then at the end of the month, you sit down and go over where the money went, and whether that was where it was supposed to go.  This shouldn't take more than an hour a month, and it will give you the peace of mind of control over your money, without giving him hives trying to fill out a spreadsheet.   There will be, as you no doubt anticipate, some slippage in his spending.  Write it off to goodwill, and save your ammunition for really insurmountable problems, like what temperature to keep the thermostat.


Dear Blogger:  

Does it make sense to relocate to a higher cost of living area for more employment opportunities? Or are we getting to a point where telecommunications will make physical location less and less important, particularly for high tech jobs like programming?  Could I be locking myself into a high cost of living area, only to find out in a couple years I could have had the same opportunities staying put.

Maxed out in the Midwest  

Dear Max:

As someone who frequently works from home, I can tell you that the telecommunications revolution in workspaces is real.  I'm not saying that I'm writing this in my bathrobe right now while lying on my couch and munching on Thanksgiving leftovers, but hey, it could be true, and you'd never know, right?  

But I can also tell you that the telecommunications revolution has limits.  We live in Washington DC in part because we love our 19th century rowhouse, the conveniently located bikeshare stations, and 100% humidity every August, but also because for my husband and I--both public policy journalists--it would be very hard to do our job from anywhere else.  Sure, we'd still get all the CBO reports, the BLS data, and the Brookings webcasts.  But we would lose the tacit intelligence that you pick up from being around a lot of other people who spend their lives studying policy.  When I moved here from New York, I began to notice that people in New York wrote stupid things about policy because they didn't understand very basic stuff about how agencies and the legislative process work . . . and shortly thereafter, I realized that I was missing more and more stuff that was going on in financial markets.  I had access to the same data, but not the same discussions, the things that are dropped in casual chitchat.  That stuff matters.  It's why startups and companies in the same industry cluster near each other, and why salesmen still do face-to-face meetings rather than a phone call.

It's also a lot easier to find another job if you have flesh-and-blood friends in the industry.  It's hard to strike up the same personal connection over email, which means that if layoffs hit your firm, you will have a more difficult job search than the guy who's been drinking with colleagues and customers.  So if you think the opportunities are much better elsewhere, you should probably move.  And hey, you might even find that you like the bikeshare stations.  


Dear Blogger:

I've been watching my IRA dwindle all year. I'm pretty young (Mid to late 20's), so this isn't a huge issue, but I do devote 5% (which is matched) from my paycheck to the account. It currently has slightly less money than the total contributions over history, including my contributions and my employers matching contributions. I can choose from several funds, and I currently have a mix between government bonds and the fund that targets a retirement about 30 years from now. I have recently found out that I can take a loan from my account, which will be paid back at at around 1.5% interest, will be paid back in as little as a year, and payments will be made from my paycheck in addition to the automatic contributions. I'm wondering if it is as much of a no-brainer as I think to take the loan and pay off my credit cards and  what's left of my student loans, which all have a higher rate than 1.5%. I'm sure I'm missing something, because this sounds like a no-brainer. What do you think?  

Iffy Retirement Account  

Dear IRA:  

It sounds to me like you're talking not about an IRA, but about a 401(k) or 403(b) account, an employer-based retirement account.    First piece of advice: make sure you know what kind of account you have.  Second piece of advice: stop paying attention to how much is in it.  It will just make you anxious, and there's really no need, because retirement is, at this point, forty years in the future.  That's almost twice as many years as you've been alive, so relax.  Check the statements once a year and otherwise let it go. If the stocks in your account are losing value, that means that your current contributions are buying them at cheaper prices.  Dollar cost averaging means that as long as stocks eventually give you an okay return, you don't need to worry about the short term.

Now onto the third, and most important piece of advice: don't take the loan.  Taking the loan means cashing out those money-losing investments and locking in your losses.  It also has a hidden risk that most people seem unaware of: if you lose your job, you get sixty days to pay the money back, or the IRS slaps you with taxes and a 10% early withdrawal penalty.  When you have just lost your job is, obviously, the worst possible time to have to come up with a hunk of cash to pay back your 401(k) loan.  Even if this is a low risk (and when I was in my twenties I got unexpectedly canned twice because unbeknownst to me, my employer was in serious financial trouble), it's not really a risk worth taking.  

If you can pay off the 401(k) loan in under a year, you can pay off the credit card debt in the same amount of time with a little extra sacrifice.  Buckle down, throw everything you can at it, and as a bonus, after all that effort, I can almost guarantee that you will never be tempted into credit card debt again.  

Ask the Blogger runs every Monday afternoon.  Email your questions to mcmeganmoney@gmail.com