Time for some therapy. “Hello, I’m DividendLife and I have irrational financial behaviors.” It’s true! I sometimes make less than optimum financial choices and I know it. Yet I’m somehow okay with that. Here are three irrational things that I know I do and why I choose to accept them.
How am I irrational? Let me count the ways…
Finance is largely math. It’s uncaring, logical and precise. You’d think therefore, that all financial decisions would be simple logical choices. Is option #1 cheaper than option #2? Yet emotion and over-thinking plays a big role in the “personal” part of personal finance.
Now, I don’t think I’m that bad overall. But here are three things that I see in myself.
1. I pay more taxes than I need to
My Income Fund investments are held entirely in Taxable accounts which means I pay 15% taxes on all dividend income and more on my bond income (28%). Plus, I invest with income that has already been taxed at an average 20% rate.
What I should do
There are several ways I could reduce the amount of taxes I pay.
1) Max out my 401k contributions.
2) Use my tax-advantaged accounts more efficiently
Last year I contributed $10,060 to my 401k and my employer added another $10,140. I could have made an additional contribution of $7,860 but didn’t.
I’ll cover the tax-advantaged accounts in a bit more detail below as it’s not just about the taxes.
Why I choose not to
I first started on a path to Financial Independence because I had money sitting in an online savings account. Admittedly, that’s a nice problem to have, but I wanted it to do something. The limited amount of interest that it earned was taxed at my marginal rate of 28%.
I could have continued to save the money I’ve subsequently invested in that savings account instead, but as a result, I’d be a lot less wealthy. When considering income from my Income Fund, I automatically compare it to that interest and tax rate. Most income from my Income Fund is taxed at 15%, the rest is taxed at the same rate as interest from a savings account.
And lastly, I know it’s a bit of a contentious topic, but similar to No More Waffles, I don’t mind paying taxes. Maybe it’s because I chose to become an American citizen last year that I don’t mind paying a bit more.
Yet at the same time, I’m glad that I’ll never be one of those people arguing that the rich should pay their fair share of taxes while taking advantage of every single tax rule they can to avoid taxes.
2. I keep my investment portfolios separate.
Now, I do have tax-advantaged accounts (a 401K, Traditional IRA and Roth IRA). I just don’t count them for my FI journey, and I keep my “Retirement Account” entirely separate from my “Income Fund”, both mentally and physically in different accounts.
My intent is to become financially independent before I can even need to touch any money in this account. My Retirement Account isn’t even part of my Wet Worth, so I rarely write about it; after all it’s a boring three-fund portfolio.
My sin here is mental accounting which I do all the time. I manage my Retirement Account as one big portfolio split across three accounts. Likewise, my Income Fund is split over two brokerages. But I don’t consider them as one giant account.
What I should do
- Allocate investments more tax-efficiently.
- With a larger combined portfolio, I should be reach Financial Independence even earlier.
Traditional financial advice recommends treating all of your investments as one giant portfolio, and matching the investment asset class (stocks, bonds) with the account type to minimize taxes and fees.
Combining my Retirement Account and Income Fund into one would double the size of the overall portfolio. So, I’d be a whole lot closer to Financial Independence.
Why I choose not to
Time. You can’t access money in your tax-advantaged retirement accounts until you’re 59.5 years old (Roth IRAs allow contributions to be withdrawn at any time). But I want to try to be financially independent before then, so I don’t want to rely on my Retirement Account funds.
Simplicity. I don’t have to worry about contributions limits, early-withdrawal penalties, required minimum withdrawals. At least not yet, until I get to be 65. I can continue to throw as much money into my taxable accounts as I can until I chose otherwise.
Since my Income Fund is a standalone portfolio and completely liquid (give or take a few days), it’s very simple for me to see how much “spendable” money it’s generating, even if I’m re-investing that money.
And tax-efficiency? As a mentioned above, I don’t mind paying it. Perversely, it’s almost like a personal challenge – can I reach Financial Independence despite the Government? I like to be independent after all.
3. I’m loyal to the companies I buy shares of
I prefer to buy products from companies that I hold individual shares of. This means, for example, that I’m inclined to shop at Walmart instead of Meijer or Target, just because I own a tiny fraction of Walmart.
This is irrational because the products I buy will have no impact on the company’s overall performance. And, even if it did, because I own Total Stock Market funds in my retirement account, I’m only hurting other companies that I also ‘own’.
And of course, if I buy something that’s more expensive at a company I ‘own’ instead of the same thing cheaper elsewhere, well that’s just irrational too.
What I should do
- Stocks should be bought solely on the company’s fundamental business strengths, management and growth prospects.
- Similarly, products should be bought based on their value and quality, not simply their brand name.
Just because I like a product doesn’t mean the rest of the market does, or will continue to like it. Hey, I liked HD DVD over Blu-Ray, and we all know how that worked out. Yet only five years later, I’ll never buy a movie on video disc again, instead I’ll stream it. Technology and consumers are fickle.
Why I choose not to
I think I’m a very loyal person. Maybe because it’s because I’m not comfortable with change. But if I feel that I own a company then I should also want to use its products because they’re a little bit ‘mine’. And in holding individual shares, I feel more connected to a company than from owning the same number of shares in an index fund.
So, I irrationally feel that I’m getting a ‘discount’ on my monthly telephone bill because AT&T are paying me dividends. And I wouldn’t feel the same if that discount to my AT&T bill came from Verizon.
I’m not entirely blind to this of course, I haven’t switched to AT&T for internet because their broadband speed in my area is pretty dire. It’s just that I sometimes find myself explaining away a little price premium because, well, “that’s my company”.
That’s three irrational financial behaviors that I know I have. There are probably some more I don’t know about because they’re so ingrained in my habits I don’t even notice. At least, not yet. But I’m watching out for them every day. Fortunately, I’m sticking only to Financial behaviors, otherwise I’d probably never finish this article.
Knowing your idiosyncrasies is the first step to recovery and deciding if they’re worth worrying about. To learn more about behavioral finance, please take a look at my review of The Little Book of Behavioral Investing which gives a great introduction to the topic.
Do you have any irrational financial behavior? What am I saying? Of course, you do! Come on, you can tell me…