SUNK COST EFFECT

Personal Finance – “the process of planning your spending, financing, and investing so as to optimize your financial situation.” Doesn’t sound so hard does it? Much of personal finance is rational and quantifiable. Why then do so many struggle with their finances? Obviously there are a lot of potential explanations. I want to focus on one common problem – the sunk-cost effect.

The sunk cost effect is the tendency to persist in an endeavor once an investment of effort, time, or money has been made. This is problematic because it often leads to emotional rather than rational decision-making. We know [rationally] that “sunk costs” (past investments that are now irrecoverable) are irrelevant to decision making. Sunk costs are the same regardless of the course of action that we choose next. If we are to evaluate alternatives based solely on their merits, we should ignore sunk costs. We’d be better off making the decision by weighing future gains and losses. Yet, the more we invest in something (financially, emotionally, etc.) the harder it becomes for us to give up on that investment. Much research has been done in this area with interesting results. For example, one study arranged to have similar tickets for a theater performance sold at different prices; people with more expensive tickets were less likely to miss the performance. A study of NBA [basketball] players found that the higher a player was selected in the draft, the more playing time he gets [and longer career], even after adjusting for differences in performance.

Why is it so difficult to free oneself from sunk cost reasoning? We feel obligated to keep investing because, otherwise, the sunk cost will have been ‘wasted.’ We would then need to admit that we made a mistake.

Techniques for countering sunk cost bias:
1. Seek opinions from people who were uninvolved in the original choice.
2. Be alert to sunk cost bias in the decisions and recommendations made by others. “We’ve invested so much already” …
3. Don’t be afraid to admit when you are wrong.
4. Sometimes even smart choices (taking into account what was known at the time the decision was made) can have bad outcomes. Cutting your losses doesn’t necessarily mean that you were foolish to make the original choice.

A guy who knows a thing or two about money (Warren Buffet) said it well: “When you find yourself in a hole, the best thing you can do is stop digging.” So if you’re hanging on to a bad relationship or a bad financial investment, consider if your decision-making is rational or emotional … You can read more about the sunk-cost effect in the July, 2007 edition of ‘Smart Money’ magazine in the ‘7 Money Mistakes to Avoid’ (Throwing good money after bad) section.

OPEN COURSEWARE

Nearly two years ago at a financial counseling conference, I learned about a newly established consortium of Universities around the world that had collaborated to provide free, open access to educational materials. It sounded like an interesting idea at the time; I hadn’t heard anything about it since until this past week when I was reading the most recent edition of Kiplinger’s Magazine. The article – “Audit a course for free at Online U” shares a little more about this consortium that is a literal ‘who’s who’ of Universities – Johns Hopkins, Notre Dame, Tufts, Michigan State, Harvard Law, and MIT (the pioneer of this ‘open courseware’ movement) who will have at least some teaching materials from all 1,800 of their undergraduate and graduate courses this fall. While access to the materials is free, you won’t get credit toward a degree or have the ability to interact with other students or a professor.

I was able to find a couple of the courses that were personal finance-related. One is offered through UC-Irvine and appears to offer some valuable information related to ‘Fundamentals of Financial Planning;' Utah State also shares information about their undergraduate Family Finance class. The general content available from each course will vary dramatically – some have little more than a syllabus/ reading list. Others provide full PowerPoint slides for lectures, audio podcasts, video webcasts, exams … the whole nine yards. The link below to the list of consortium members will allow you to visit Universities that provide resources associated with a myriad of course topics.

The current consortium consists of more than 100 institutions of higher education. Additional information is available at http://www.ocwconsortium.org/about/index.shtml.

Sampling of other free online Personal Finance courses:
- Consumer Debit Resource – ‘Checkbook Basics’
- FDIC – ‘Money Smart’
- Florida State – ‘Fundamentals of Financial Planning’
- Freddie Mac – ‘Credit Smart’
- IRS – ‘Understanding Taxes’
- Money 4 Living
- Money SKILL
- NEFE – ‘High School Financial Planning Program’
- Rhode Island Center for Personal Financial Education – ‘Credit 101’
- Rutgers – ‘Investing for your Future’
- Smart Money – ‘Investing 101’
- Spend 2 Success
- Visa – ‘Practical Money Skills for Life’

This list should not be considered exhaustive by any means nor expected to represent an endorsement of any curriculum or program. The resources are merely informational. If you are aware of other good resources, please share them with me.

YOUR CREDIT -- YOUR RIGHTS

Numerous agencies (lenders, insurers, employers, landlords, etc.) view your credit when making decisions about you – how familiar are you with your credit and your rights? The Fair Credit Reporting Act (FCRA) and the Fair and Accurate Credit Transactions Act (FACTA) are legislation designed to protect you and your credit.

FAIR CREDIT REPORTING ACT.
This act is designed to promote accuracy, fairness, and privacy of information in the files of every consumer’s credit report.

FCRA PROVISIONS:

• You must be told if information in your file has been used against you (denial of employment, credit, insurance, etc.)
• You have a right to know what is in your file.
• You are entitled to a free report at any time if: You are unemployed and plan to seek employment within 60 days; you are currently on welfare; you are a fraud victim or you are denied credit, employment, insurance, etc. based on report info.
• All consumers are entitled to one free report (per credit reporting agency) every 12 months upon request - http://annualcreditreport.com/
• You have the right to ask for a credit score (a numerical summary of your creditworthiness). You will have to pay for the score, but you now have access to it.
• You have a right to dispute inaccurate information.
• Inaccurate or unverifiable information must be corrected or deleted.
• Outdated information may not be reported (FCRA specifies duration). 2 years for inquiries; 7 years for 'most' negative information; 10 years for judgment liens and most bankruptcies; 10 years [or more] for 'positive' information.
• Access to your file is limited - may be used for consideration of applications such as employment, insurance, credit and landlords.
• Forces identification of individuals inspecting your file.
• Consent is required for reports provided to employers or reports containing medical information. An estimated 70% of employers examine credit reports prior to hiring.
• You have a right to file a lawsuit against collector if FCRA has been violated.
• You may limit 'pre-approved' offers for credit and insurance. You may opt-out by calling toll free (1-888-5-OPTOUT). Additional information is available at: http://financialsuccess.missouri.edu/tipoftheweek/optoutcc.pdf and http://financialsuccess.missouri.edu/tipoftheweek/optout.pdf.

Maintaining the accuracy of your credit report is YOUR responsibility. To read the entire FCRA, go to http://www.ftc.gov/os/statutes/fcra.htm.


FAIR AND ACCURATE CREDIT TRANSACTIONS ACT.
Signed into law by Pres. Bush in December of 2003, the Fact Act [as it’s often called] was designed to ensure that all citizens are treated fairly when applying for credit. Specifically, the bill was designed to significantly increase consumer protections against the growing problem of identity theft. FACTA also extends the current provisions (mentioned above) of the Fair Credit Reporting Act.

Some of the major provisions of FACTA:

• Provide consumers with a free credit report every year.
• Give consumers the right to see their credit scores (for a fee).
• Provide consumers with the ability to opt-out of information sharing between affiliated companies for marketing purposes.
• Ensure that consumers are notified if merchants are going to report negative information to the credit bureaus about them.
• Allow consumers to place "fraud alerts" in their credit reports to prevent identity thieves from opening accounts in their names (includes special provisions to active duty military).
• Allow consumers to block information from being given to a credit bureau and from being reported by a credit bureau if such information results from identity theft.
• Restrict access to consumers' sensitive health information.
• Provide consumers with one-call-for-all protection by requiring credit bureaus to share consumer calls on identity theft, including requested fraud alert blocking.
• Require creditors to take certain precautions before extending credit to consumers who have placed "fraud alerts" in their files.
• Stop merchants from printing more than the last five digits of a payment card on an electronic receipt.

Consumer credit is a vital thing for many – the ability to have protections in place to help consumers protect the credit they work so hard to build and develop is critical.

NEW LOAN RATES + NEW HAMPSHIRE

The past few years have been very attention-grabbing at this time of year; with students and grads awaiting word of where student loan rates would go on July 1st. Things this year are much less eventful for three reasons:

1. Last year’s law change prohibits students now from consolidating until graduation.

2. The new legislation changed the nature of Federal [Stafford and PLUS] loans borrowed after 7/1/06. Loans borrowed after that date are a fixed 6.8% for Stafford (7.9% or 8.5% for PLUS). You should have already ‘locked’ the rates on all of your variable rate federal loans during the low rate environment of the past three years, making this rate change moot - hopefully that is the case.

3. Lastly, the rate change is very minimal. Rates will go up on July 1st to 6.62% from it’s current 6.54% level (that is in-school/in-grace rate; rates are .6% higher for out of grace); variable rates on PLUS loans will go from 7.94% to 8.02%. Not a very dramatic move considering the nearly 2% jump each of the past two years … Loans affected by the new rate are those taken out between 7/1/98 and 6/30/06 that have not been consolidated.

The Department of Education’s press release on the new variable interest rate is available at: http://ifap.ed.gov/eannouncements/0530FFELDLInterestRate.html.


New Hampshire.
Several consolidation programs have been mentioned in the past because of their borrower benefits: Educational Loan Company, The Loanster, and North Carolina are often discussed because of their deep interest rate benefits (preferable for those using extended repayment options). Key Bank and FinanSure provide the most competitive principal balance credits (beneficial to those planning to pay loans off promptly). Now entering the arena ... New Hampshire. A state program that no longer has residency requirements. They are the first program in the country to offer substantial rate reduction benefits immediately (rather than the typical reductions after 3-4 years of on-time payments).

The New Hampshire program offers the following:
- ½% rate reduction for setting up auto pay
- 1% rate reduction when repayment starts
- $250 principal balance reduction after 12 on-time payments

It is unlikely this program will be able to save more time and interest payments for those with large student loan debts opting for extended repayments; it will likely best serve those looking at repaying their student loans off in 10 years or less … another good option available nonetheless. Also, NH has a small required loan minimum (only $5,000); many programs require $20K+ … You can learn more about New Hampshire’s program at: http://www.nhheaf.org/ln_cons.asp ... information about all of the consolidation programs is available at the OFS website (http://financialsuccess.missouri.edu).