What Chinese New Year Blackjack Taught Me About Money

blackjackOkay, hypothetical scenario.

Imagine you’re on your honeymoon in Las Vegas, chilling in your swanky hotel room while your spouse is taking a shower. While checking out the minibar, you come across a $5 gaming chip in one of the drawers – the previous occupant must have mistakenly left it there.

You take the $5 chip and head downstairs to the roulette tables, where you bet it on your favorite number: 25. To your surprise, the ball lands on 25 and the dealer hands you $175. You decide to let your winnings ride by betting it on 25 again. Once again, the ball lands on 25 and your stash grows to $6,125. Taking this as a good sign, you bet it again and win, netting you $214,375.

You’re on a roll! You’re still in luck in the next round, which gives you $7.5 million dollars, more than what most people will ever earn in a lifetime. You bet it all on 25 again and amazingly, you now have $262 million, which makes you richer than Mitt Romney.

You decide to try your luck one last time. If it works, you’d be worth almost ten BILLION dollars. Sadly, this time the ball plops onto the number “00” with a sickening thud, and you lose all your winnings. You walk back to your hotel room and tell your spouse you were playing roulette downstairs. Your spouse asks how you did.

“Not bad,” you reply, “I only lost $5.”

The Great Chinese New Year Mystery

Sooooo…. What does a botched up roulette game have in common with Chinese New Year?

For most of us here in Singapore, Chinese New Year involves a helluva lot of eating, answering awkward questions about why you’re not married, and… gambling.

This year, I found myself wondering why Chinese New Year was such a popular time for gambling. Most of the time, I scoff at the hordes of people who frequent casinos and throw their hard-earned savings away. But whenever Chinese New Year rolls around, I find myself stumbling to blackjack games like a delirious addict on too much bak kwa.

After pondering over this curious dilemma for a couple of days, I had my conclusion: The culprit was the innocuous little ang bao.

(Side note: For my international friends who don’t know what “ang baos” are, they’re red envelopes filled with cash that your relatives give you during Chinese New Year while you’re still unmarried. #norushhere)

Mentally Accounting for Mental Accounting

Psychologically, receiving an ang bao has exactly the same effect as finding a $5 chip in your Las Vegas hotel room. Namely, they’re both “found” money, which inflicts this interesting psychological effect on you known as mental accounting.

Nope, mental accounting has absolutely nothing to do with your ability to multiply 17 x 32 in your head. Instead, it’s a psychological phenomenon that causes you to treat money differently depending on where it comes from, where it is kept, or how it is spent. So mental accounting posits that you’d treat $100 from an ang bao very differently from $100 you’ve worked hard to earn. Mental accounting causes you to spend $500 in your vacation allowance way more freely than you would for the same $500 in your savings account.

But mental accounting has a dark side too. It causes you to be flippant when you’re dealing with “surprise” or “additional” money, like your bonuses, or your gambling gains. Ever find yourself winning a hand at poker, and then aggressively calling or raising in subsequent rounds? That’s mental accounting at work, and it could easily work against you.

Two Systems to Prevent You From Getting Screwed

The strategy to prevent mental accounting from screwing with you is to set predefined systems, something I practice as much as possible. Go to all gambling games with two predefined rules: 1) a stop-loss and 2) a lock-in percentage.

Most people are familiar with a stop-loss, which is a predefined amount you’d be fine with losing. But few people implement a lock-in percentage, which kicks in once you start winning. For example, if I set a lock-in percentage of 20%, I pocket 20 cents for every dollar I win and don’t touch it for the remainder of the night. These rules have helped me to save hundreds of dollars over the past few years.

But the awesomeness of the lock-in percentage rule goes way beyond Chinese New Year blackjack games – Think about how you can apply it to your bonuses, allowances, inheritances, rewards, rebates, or any sort of “found” money you come across. For example, predefining a rule that states you’ll save 50% of your bonus will help you to save way more effectively than the average cubicle dweller who blows his entire bonus on dumb things to overcompensate for his sad, sad life.

When applied right, predefined rules could potentially save you tens of thousands of dollars throughout your lifetime.

Psychology > Tips

Ask most people how they handle their personal finances, and they’d give you all sorts of tips and tactics like choosing the right credit cards or investing in some obscure growth stock.

However, while we don’t think of it often, it’s interesting how psychology has such a disproportionate influence on our ability to hold on to and grow money. A mastery of a couple of psychological principles could be way more effective than hundreds of money tips and tactics.

So remember this the next time you’re at a roulette table. Don’t say I didn’t do nothin’ for ya. 🙂

Footnote: Definition of mental accounting and casino example taken from “Why Smart People Make Dumb Money Decisions” (aff link) by Gary Belsky and Thomas Gilovich

Image credit: Images_of_Money

The Great Index Unit Trust Hoax

Whenever I check into a hotel, I get really fascinated by just how crazy expensive some of the items in the minibar are.

One time when I was on vacation, I felt a little hungry so I lumbered over to the minibar and pulled out a pack of cashew nuts – just the regular kind you’d find at any convenience store. Just to be safe, I checked the prices before I tore the pack open, and involuntarily yelled: “NINE DOLLARS FOR A PACK OF TWELVE NUTS?! ARE YOU OUT OF YOUR FRICKIN’ MIND???”

It’s absolutely crazy how people are perfectly willing to pay several times the price for the EXACT SAME PRODUCT – a product that they could have gotten much cheaper elsewhere. We see this everywhere: a Nike sneaker vs a non-branded one, Tropicana orange juice vs a house brand, and beer that costs $12 in a restaurant and $2.50 in the supermarket.

A pack of nuts from the minibar might do a little damage to your wallet, but it’s nothing compared to the damage a unit trust (also known as a mutual fund for my American friends) could do to your long-term wealth.

Costs Matter

I’m not even going to discuss actively managed unit trusts with their high management costs. Nobody takes those seriously anymore – There’s more than enough research that shows that as a whole, actively managed unit trusts are a terrible choice compared to index funds.  Check out here and here.

Today, I’ll just uncover a pricing anomaly I like to call The Great Index Unit Trust Hoax, which involves 2 unit trusts being sold to Singaporean investors. Both charge exorbitant amounts to essentially help you invest in portfolios that you could have easily put together yourself… at a fraction of the cost.

To Infinity… and Beyond!

Exhibit A is the Infinity US 500 Stock Index Fund, which is supposed to help you track the return of the S&P 500. To accomplish this, it hits you with a whopping 0.98% expense ratio.  Now 0.98% may not sound like too much of a big deal, but try compounding that over 30 years and you’re talking about a difference of tens of thousands of dollars of extra cash that’s coming out of your pocket.

But hold on – there’s another, cheaper way for you to track the return of the S&P 500 on your own. You could buy an ETF from Vanguard, which gives you the EXACT SAME RETURN, while charging a mere 0.05% expense ratio. This makes the Infinity unit trust almost 20 TIMES MORE EXPENSIVE than the Vanguard ETF. Yeah, I know.

Home Sweet Home… For 4x The Price

Okay, I hear you say, so maybe that’s a problem unique to the USA.

Oh wait, it’s not.

Presenting Exhibit B, the patriotically-named unit trust MyHome Fund run by Singaporean asset management company Nikko AM. It invests in 1) an ETF tracking the Straits Times Index and 2) the ABF Singapore Bond Index Fund ETF. They’ll charge you a ridiculous expense ratio of 1.2% for all their hard work.

But wait! Did you know that you could totally log onto your online brokerage and invest in 2 ETFs which track the EXACT SAME THING for a fraction of the cost? Namely:

1. SPDR Straits Times Index ETF (SGX Ticker: ES3) – Expense ratio: 0.30%

2. ABF Singapore Bond Index Fund ETF (SGX Ticker: A35) – Management fee + trustee fee: 0.20% (I couldn’t find an exact figure for the total expense ratio on their website – those sneaky bastards – but it shouldn’t  be too far away from the sum of these 2 fees).

Total weighted expense ratio: 0.28%

Ta-daahh! You’ve constructed the exact same product, at a quarter of the cost. And that’s not taking into account sales charges, redemption charges, front-end charges, admin charges, and hire-an-attractive-banker-to-convince-you-to-part-with-your-money charges.

Do Yourself a Favor

My point here is to always, always, read the fine print. The finance industry loves to play down details like these because it means higher commissions for them – commissions that come right out of your pocket.

If you plan on investing passively, do yourself a favor and skip out on the unit trusts. You’re way better off buying the equivalent ETFs instead. Of course, there are a few disadvantages in buying ETFs (eg brokerage commissions, currency exposure, inability to invest in small amounts), but they can be easily circumvented (eg investing regularly using no-minimum commission brokers,  or in the case of the STI ETF, setting aside an amount every month until you can afford one lot). None of the disadvantages of ETFs justifies the tens of thousands of dollars you’re giving up in expenses if you invest in unit trusts.

It would be totally awesome if a reputable fund provider like Vanguard would set up an index fund in Singapore (are you reading this, John Bogle?), which would eliminate all the disadvantages in the para above, and yet charge a reasonable expense ratio that doesn’t require us to give up our first-born child.

In the meantime, stay smart and read the fine print. Save your money for those overpriced cashew nuts from the minibar. At least they’re tasty.

Don’t Save For Retirement

It is close to midnight on December 29, 1972, and Eastern Air Lines Flight 401 is making its final approach to Miami International Airport. 163 passengers are onboard, most hoping to enjoy their new year in sunny Miami.

As it approaches the airport, the landing wheels are lowered and locked into position. At this point, the captain notices something amiss: the green light linked to the landing wheels has failed to light up. This could mean one of two things: Either the wheels have failed to lock into position, or the light is faulty. The pilots report the situation to Air Traffic Control, who orders the plane to circle back and try their descent again.

At this point, the pilot and co-pilot fixate on the light. They take it out of its fitting, blow on it to remove dust, and try to jam it back. Their conversation goes back and forth as they try to figure out what the fault is. They become so fixated on the light, that they fail to notice the 300-pound gorilla in their midst.

The gorilla, in this case, is the fact that their autopilot is disengaged and that they are rapidly losing altitude. They don’t notice that they are dropping rapidly because it is a moonless night and they can’t see the horizon. The altitude warning alarm rings through the cockpit and the altitude meter is dropping crazily, though neither pilot notices. They are too fixated on the light. Only when the aircraft is 7 seconds to impact, do the pilots realize that something is very wrong. They take evasive action, but it’s too late. The plane crashes, killing 101 people.

Crash investigators later found that the wheels had indeed locked into place – it was the light that was faulty. “The crash occurred due to the failure of a $12 piece of kit,” one journalist pointed out. However, the true cause of the crash was deeper than that – it was the pilots’ fixation on one particular problem, which blinded them from the true danger they were in.*

*story taken from Bounce by Matthew Syed

What other gorillas are you failing to see in your life?

Like the pilots who were overfocused on the green landing gear light, most people are fixated on one goal when it comes to personal finance: retirement. They believe that in order to retire, they need to hoard as much cash as possible, starting now. But they fail to realize the huge gorilla charging towards their bank accounts: inflation.

Two posts ago, I wrote about how inflation would slowly but surely destroy the buying power of your savings. If you’re young, letting your cash sit in your bank account (or in your fixed deposits / CPF / mattress) is like putting it in a nest of termites: it’ll eventually get eaten up.

So here’s my advice when it comes to inflation: Don’t save for retirement.

Say what?

Hear me out for a second. If you’re young and wild and free, there are other, more important things you should be focusing your attention on. Instead of saving up for “retirement” and getting a lot less bang for your buck, there are three more useful things you should be directing your money towards:

1.Save for assets

The best way to tackle the inflation gorilla is to put your money into assets that will grow faster than inflation: Stocks and real estate. Stocks are the most accessible because they don’t require a huge cash outlay, they’re easy to understand, and if you live in Singapore, they’re tax-free. Woot woot! Real estate is pretty nifty too, if you can afford the huge downpayment (or if you can’t afford the huge downpayment, you can also look into REITs – more on that later).

The biggest bonus of all is that if you plough your cash into assets that exceed inflation, you will, in fact, be prepping yourself for retirement.

2. Save for life chapters

Here, I’m talking about big, life chapters that you were planning on spending on regardless of what happens. I’m talking about your wedding, your first house, and your daughter’s upcoming college fees. If any of these are going to be happening within the next 10 years, then you should be saving up for them. Don’t act as if you didn’t know they were coming: If you know you’ll be getting married in 3 years, you should be saving up for your hypothetical $30,000 banquet and $15,000 ring… now.

A caveat: I’m not talking about cars, or vacations, or that new washing machine, that you “know” you’re going to spend on anyway. I’m talking about the big, necessary, life chapters here, people.

3. Save for emergencies

Sh*t happens. You’ll need cash to deal with it. If something bad happens, (like losing your job) the last thing you want is to be dipping into your investments to pay for your meals. If you don’t have an emergency fund of 3 months of income parked in an easily accessible bank account, then you should totally start saving up for one now.

In short…

Don’t bother saving for retirement – inflation will render your efforts futile. Other than cash set aside for emergencies and stuff you’re going to spend on within the next 10 years, everything else should be directed towards assets – Assets that keep pace with inflation. If an insurance agent / banker tries to sell you a fancy schmancy 50-year savings plan, run as fast as you can.

Don’t get too fixated on the wrong things. Just because personal finance “experts” tell you that you should be saving for retirement, doesn’t mean that you should be blindly stuffing cash into a bank account. Keep an eye out for the inflation gorilla in your midst, and take action to deal with it.

PS: the topic for this post came from a friend who replied to my previous post on spending money. To everyone reading this, keep the comments coming! They totally give me the inspiration for future blog posts.

As a young person, what do you think about the 3 ways you should be putting your money towards, instead of saving for retirement? Leave a comment, or drop me an email at cheerfulegg@gmail.com. Hope to hear from you soon 🙂