A Dollar Is A Dollar Is A Dollar. Except in Our Minds.
The form of money—salary vs. bonus, income vs. capital—affects the way we treat that money. Sometimes that helps us financially. And sometimes it hurts us.
The form of money—salary vs. bonus, income vs. capital—affects the way we treat that money. Sometimes that helps us financially. And sometimes it hurts us.
Do you care if an assistant at the chemist gives you change in one $10 note or two $5 notes?
Are you more reluctant to spend hard-earned dollars than windfall dollars?
Do you distinguish the “income” dollars paid as dividends on your stock from the “capital” dollars of the value of the stock itself?
Rational investors answer “no” to each of the three questions. After all, money is money, and rational investors can easily distinguish between the substance of money and its form. Hard-earned dollars and capital dollars are no greener than windfall dollars and income dollars.
Normal investors, however, are likely to answer “no” to the first question, but many are sure to answer “yes” to the second and third questions.
All of us are normal investors. For us, the form of money does make a difference. A dollar may be a dollar may be a dollar. But not in our minds.
Sometimes, such normal thinking helps us in our financial lives. But sometimes it hurts us. And understanding the difference between the two—that is, knowing when we’re being smart, even if not rational, and when we’re being neither smart nor rational—can make us better savers, spenders and investors.
Here are some examples of our normal thinking, and when it hurts and helps us:
We regularly divide our paychecks into pots. Sometimes they are tangible pots, such as checking accounts or glass jars. Sometimes they are virtual pots, such as Excel sheets or mental pots in our minds. We mark each pot with a label such as rent, food, entertainment, Christmas gifts or emergency funds, and refrain from dipping into pots other than designated ones.
Of course, none of this is rational. Rent dollars aren’t any greener than entertainment dollars. Rationally, they should all be in one pot labelled “money.”
Yet this practice is smart when it makes budgeting easier and prevents bounced checks and disappointed children on Christmas morning. For example, one couple I read about maintained a joint account and two sets of checking and savings accounts—one for daily expenses, such as groceries, and the other for larger expenses, such as taxes. The wife was responsible for paying daily expenses from one account and the husband was responsible for paying larger expenses from the other. The idea was to make sure they always had enough for both groceries and taxes.
Rational? No. Smart? Yes.
Of course, refraining from dipping into pots other than designated ones requires self-control. Yet this is difficult when we face temptation, such as using money in the emergency pot for entertainment. One smart way to bolster self-control is to place obstacles in the way of pots other than designated ones.
For example, one woman who contacted me put her money in a bank that is an hour’s drive away, and cut the bank’s ATM card.
Similarly, the government places obstacles to dipping into retirement pots by generally imposing a 10% penalty on withdrawals from defined-contribution retirement saving accounts on those younger than 59½.
Again, none of this is rational. A dollar is a dollar is a dollar. But thinking about the form of those dollars can make us financially healthier.
Except not always. Sometimes self-control is too strong rather than too weak, preventing reasonable dips into ample capital pots. That’s especially true for retirees who have plenty of money, but have spent a lifetime cultivating a saving mantra: Never dip into the capital pot. Now at the very time when they should be doing just that to enjoy life, they can’t bring themselves to do it. They continue to spend only the income they derive from their savings, and their lives are more constrained as a result.
Rational? No. Smart? No.
Easy come, easy go.
We regularly distinguish money earned with much effort, such as salary, from windfall money obtained with little or no effort, such as gifts. We tend to place hard-earned money in one mental pot and windfall money in another, and we spend windfall money more easily than we spend hard-earned money.
That distinction also affects our willingness to take risk. In one set of experiments, people were divided into two groups, hard-work earners and windfall receivers. People in the hard-work group received an amount of money for completing work requiring physical effort—peeling 25 potatoes or making nine envelopes within 30 minutes. People in the windfall-receiver group received the same amount of money as a gift, with no work requirement. Subsequently, people in the hard-work group made less-risky and less-impulsive choices than people in the windfall group.
Rationally, of course, it makes no difference whether somebody receives money from a windfall or hard work. It may also not be smart if it leads recipients of windfalls—whether bonuses, bequests or lottery winning—to fritter away these windfalls on meaningless purchases or risky investments. Then again, it could be smart if you’re a person who is not spending as much as you should because of an unwillingness to tap money from a large account. If thinking differently about “extra” money makes you more likely to spend what you can afford, go for it.
Money illusion refers to the failure to distinguish dollars framed as “nominal” from dollars framed as “real”—that is, after inflation. For example, a 2% increase in a nominal annual salary, say from $100,000 to $102,000 is a 1% decrease in the real annual salary when the annual inflation rate is 3%.
Rational investors are immune to the money illusion, but many normal investors are not. And that is not to the benefit of the normal investor.
We see the distortions caused by money illusion in the current concern about the low yields of bonds. For example, the average nominal yield on 3-month Treasury bills during the first nine months of 2020 was a meager 0.42%. The real yield is even lower, a negative 0.98%, because the rate of inflation during the period was 1.40%. Indeed, inflation has exceeded Treasury-bill yields in most years since 2002.
Yet there was less concern in 1979 when the nominal yield on 3-month T-bills was 10.07% and the rate of inflation was 12.26%, implying a negative 2.19% real yield. This is because many normal investors are misled by the money illusion, comparing the low 0.42% nominal yield of 2020 to the high 10.07% in 1979, while neglecting to note that the real yield in 2020, while negative, is higher than in 1979.
Moreover, 1979 investors paid higher taxes on a 10.07% yield than 2020 investors pay on 0.42%. Investors tend to overlook this 2020 tax balm.
Framing money in nominal terms is easier than in real terms because it does not require knowledge of inflation rates and how to use them to convert nominal dollars into real ones. Yet such framing is not smart when it misleads us to act as spendthrifts when high inflation pushes nominal interest rates up, and as misers when low inflation presses nominal interest rates down.
Investors holding shares of a company have two ways to derive money from these shares. Say you need $1000. You can receive a $1000 company-paid dividend. Or you can create a $1000 homemade dividend by selling $1000 of shares.
Rational investors would prefer homemade dividends to company-paid dividends because they can time homemade dividends when it is best for them, whereas timing of company-paid dividends is in the hands of the company. Also, taxes on homemade dividends are likely lower than on company-paid dividends. Homemade dividends do involve transaction fees as investors sell shares, but these fees are now pretty close to zero.
Many normal investors, however, prefer company-paid dividends to homemade dividends.
That can be both smart and not so smart.
Normal investors have two distinct mental pots: “income” and “capital.” Company-paid dividends, like wages, belong in the income pot. Shares, like other savings, belong in the capital pot. The self-control rule many people live by is to “spend income but don’t dip into capital.”
Thinking of the money as being in two distinct pots is smart when self-control is too weak to protect savings from excessive spending. A $1,000 company-paid dividend places a definite limit on the amount that can be spent, whereas a $1,000 homemade dividend opens the door to selling and spending, say, $2,000 of shares when a tempting vacation overpowers weak self-control.
Still, dividing money this way can backfire. To understand why, consider that an anticipated pain of regret is another reason for preferring company-paid dividends to homemade dividends. Imagine that you received $1,000 as a company-paid dividend and used it to buy a TV set. Compare it to creating a $1000 homemade dividend by selling shares to buy a TV, only to find that the price of shares zoomed soon after you sold them. The pain of regret is likely greater with homemade dividends because you bear responsibility for selling shares when you did, whereas you don’t bear responsibility for the company paying dividends when it did.
But the pain of selling stock—and then watching the price rise—should not be determining which form of money we “prefer” when we need $1,000. Stock prices do not zoom after we sell shares just because we sold shares. It’s just bad luck.
Avoiding selling stock and waiting for dividends because of the fear of regret may be what a normal investor would do. But it isn’t rational. And it probably isn’t smart.
A bond ladder is composed of bonds of a range of maturities. For example, a $10,000 bond ladder can be built by allocating $1,000 to each of 10 Treasury bonds with maturities ranging from one to 10 years. The alternative is to place the $10,000 into a Treasury bond mutual fund.
In substance, a bond ladder is a “homemade” bond mutual fund with average maturity equal to that of a corresponding bond mutual fund. The value of a bond ladder declines when interest rates increase, as much as the value of a corresponding mutual fund. Therefore, rational investors are, at best, indifferent between the two if their costs are the same (more on that in a minute).
Many normal investors, however, prefer bond ladders because they can manage them in ways that reduce regret.
Imagine that you hold a bond ladder with 10 bonds with maturities ranging from one year to 10 years. You bought each of them at their $1,000 face value. Nine months pass, and you need $1000 to buy a TV set. Meanwhile, however, interest rates increased such that the prices of all 10 bonds are now lower than $1,000. If you sell the one-year bond you’ll receive, say, $995. Adding $5 to the $995 will not squeeze your budget too much, but realizing a $5 loss inflicts the pain of regret. A bond ladder gives you the option to wait three months until the one-year bond matures and receive $1,000, avoiding the pain of regret.
Bond mutual funds do not afford this waiting option. You cannot be assured that you’ll be able to avoid realizing a loss, no matter how long you wait.
None of it makes a difference to rational investors, because they know that a “paper loss” is no different from a “realized loss.” Sure, delaying realized losses may keep regret at bay, but it has no financial benefits. Indeed, rational investors prefer to realize losses, whether in a ladder or mutual fund, because realized losses become tax deductions, yielding them extra money. And waiting three months (or however long) to get the money you need means you won’t be enjoying whatever you need to use that money for.
What’s more, rational investors would ask themselves: Why build a Rube Goldberg bond ladder, when low-cost index bond mutual funds are simpler and likely cheaper, don’t require homemade construction, and don’t have the extra trouble of monitoring and replacing bonds that reach maturity with new bonds?
In other words, it is normal to try to avoid the pain of regret, but such avoidance can be costly.
Normal? Yes. Smart? No.
Consumers are going to gravitate toward applications powered by the buzzy new technology, analyst Michael Wolf predicts
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As geopolitical tensions rise, Taiwan is shifting its economy to rely more on the U.S. and other countries but at a cost
TAIPEI—For years, Beijing hoped to win control of Taiwan by convincing its people their economic futures were inextricably tied to China.
Instead, more Taiwanese businesses are pivoting to the U.S. and other markets, reducing the island democracy’s dependence on China and angering Beijing as it sees its economic leverage over Taiwan ebb.
In one sign of the shift, the U.S. replaced mainland China as the top buyer of Taiwanese agricultural products for the first time last year.
Electronics firms such as chip maker Taiwan Semiconductor Manufacturing Co. are also selling more goods to American and other non-Chinese buyers, thanks in part to Washington’s chip restrictions and Apple’s bets on Taiwanese chips.
Overall, Taiwanese exports to the U.S. in the first 10 months of 2023 were more than 80% higher than in the same period of 2018, Taiwanese government data shows. Taiwanese exports to the mainland were 1% lower—a major change from a decade or so ago when China’s and Taiwan’s economies were rapidly integrating.
Taiwan’s outbound investment has also shifted. After flowing mostly to mainland China in the early 2000s, it has now moved decisively toward other destinations, including Southeast Asia, India and the U.S.
Taiwanese electronics giant Foxconn, which assembles iPhones in mainland China, is expanding in India and Vietnam after Apple began pushing its suppliers to diversify.
Chinese state media recently reported that China had opened tax and land-use probes into Foxconn. Though Taiwanese officials and analysts interpreted the probes as a sign that China wants Foxconn founder Terry Gou to drop plans to run in Taiwan’s presidential election in January, some have said Beijing may also be trying to pressure Foxconn into resisting decoupling with China.
“Any attempt to ‘talk down’ the mainland’s economy or to seek ‘decoupling’ is driven by ulterior motives and will be futile,” said a spokeswoman for Beijing’s Taiwan Affairs Office in September. “The mainland is always the best choice for Taiwanese compatriots and businesses.”
Fully decoupling from mainland China’s economy likely isn’t possible, and would be disastrous for Taiwan, not to mention China, even if it were.
Foxconn and other major Taiwanese companies depend heavily on China for parts, testing and buyers. Some 25% of Taiwan’s electronic-parts imports still come from the mainland.
If China’s weakened economy returns to strong growth, it could shift the calculus back in favor of the mainland, where the Communist Party claims Taiwan despite never having ruled it. About 21% of Taiwan’s total goods trade this year has been with mainland China, versus 14% for the U.S., though the U.S. share has risen from 11% in 2018.
“My hunch is that the large manufacturing sectors will try to stay in the Chinese market, even with harsh conditions,” said Alexander Huang, director of the international affairs department of the opposition Kuomintang Party, whose supporters include business people with mainland ties. “If you talk to those business owners, they say, ‘Nah, no way will I give it to my competitors.’”
Even so, many forces are pushing Taiwan to rewire its economic relationship with China.
Trump-era tariffs and Biden administration export controls have raised the cost of sourcing from China, and in some cases prohibited it. U.S. firms are pushing their Taiwanese suppliers to diversify sourcing, and rising wages in China have made it less attractive than before.
Long-running shifts in Taiwanese sentiment toward China—and China’s own efforts to punish the island using its economic leverage—are also factors. China has banned Taiwanese agricultural products such as pineapple and, in 2022, grouper fish, and restricted outbound tourism to Taiwan.
Those restrictions to some degree have backfired, pushing Taiwanese businesses to look elsewhere.
Chang Chia-sheng, who runs a fish farming operation in Taiwan, said his main export target a decade ago was mainland China. But as geopolitical tensions climbed, he looked elsewhere. Sales to Americans have jumped fivefold since 2018, he said. “In the U.S., things just seem to work out more easily,” Chang said.
The U.S. and Taiwan reached an agreement in May on a number of trade and investment measures to deepen ties, though the deal stopped short of reducing tariffs.
In the June quarter of 2023, 63% of revenue at TSMC, which makes most of the world’s most cutting-edge logic chips, came from the U.S., up from 54% in the same period in 2018, according to S&P Global data. Just 12% of TSMC’s revenue now comes from Chinese buyers, down from 22% in the second quarter of 2018.
Taiwan’s government is also encouraging closer economic links with Southeast Asia, South Asia, Australia and New Zealand. Its “New Southbound Policy,” rolled out in 2016, has been the subject of fierce debate in Taiwan, with the Kuomintang Party saying steps to boost relations—like handing out scholarships—aren’t worth the cost.
Exports to “New Southbound” partners have risen, however, to $66 billion in the first nine months of 2023, about 50% higher than the same period in 2016.
“Frankly speaking, we’re responding reactively” to the need for more diverse trading partners, Taiwan’s Economic Minister Wang Mei-hua said. “Taiwan needs to manage the risks on its own, but we also need our allies to join us more in mitigating these risks.”
Together, the U.S. and the six largest Southeast Asian economies accounted for 36% of Taiwanese exports in the third quarter of 2023, according to data from CEIC, surpassing the percentage sent to mainland China and Hong Kong on a quarterly basis for the first time since 2002.
In September, Taiwan sent less than 21% of its exports to the mainland, the lowest percentage since the global financial crisis.
Taiwanese foreign investment into mainland China, steady at around $10 billion a year for most of the early 2010s, plummeted in late 2018 and has since been running at about half that level, according to Taiwanese government data. In 2023 so far, just 13% of Taiwan’s investment went to mainland China; 25% went to other Asian locations, and nearly half went to the U.S.
A survey of Taiwanese businesses conducted last year on behalf of the Center for Strategic and International Studies, a Washington think tank, found that nearly 60% had moved or were considering moving some production or sourcing out of China—a significantly higher rate than European or American firms.
Jay Yen, chief executive of Yen and Brothers, a Taiwanese frozen-food processing company, said his firm received a government subsidy of around $75,000 to market his products to American consumers. China now only accounts for about 3% of its revenue, he said.
That said, “if you really have to consider the risks of a war between the U.S. and China and its potential impact on Taiwan, you might want to place your bets on a third country—neither China nor the U.S.,” Yen added.
After China began to open up its economy in the late 1970s, Taiwanese businesses were among the first investors.
By the 2000s, China seemed to be succeeding in its strategy of integrating the two economies, with more than 28% of Taiwan’s exports going to the mainland in 2010, from less than 4% a decade earlier.
Direct flights between the two sides were normalised for the first time in decades. Mainland tourists were allowed to visit Taiwan on their own.
By 2014, the tide was turning as more Taiwanese grew worried about over dependence on China. Student demonstrators protested against a trade pact, later abandoned, that would have deepened ties with China. President Tsai Ing-wen, who took office in 2016, has pushed to diversify Taiwan’s economy.
China has responded by moving trade issues more into the spotlight.
In April, it opened an investigation into Taiwanese trade restrictions that it says limit exports of more than 2,400 items from the mainland to the island in violation of World Trade Organization rules. In October, China’s Ministry of Commerce announced the probe would be extended until Jan. 12—the day before Taiwan’s coming election.
Taiwan’s government has called the probe politically motivated.
Chinese officials have implied that Beijing could suspend preferential tariff rates for some Taiwanese goods in China under a 2010 deal signed when Kuomintang’s Ma Ying-jeou was president. Beijing has also reacted angrily to Taiwan’s recent trade agreement with the U.S.
For Taiwanese companies, building and operating new factories in places other than China isn’t cheap or easy. Protests have at times disrupted operations at Indian plants operated by Foxconn and Wistron, another Apple supplier. In September, a fire halted production at a Taiwanese facility in Tamil Nadu.
Still, some Taiwanese businesspeople have clearly soured on China.
“The electronics industry has already become a Chinese empire, not a Taiwanese one,” says Leo Chiu, who worked in mainland China in quality control for an electronics manufacturer for 14 years before concluding he couldn’t move up further there and returning to Taiwan in 2019. Many of his old colleagues have left, he said.
“If Xi Jinping steps down, there’s still a chance it could change,” says Chiu. “But I think it’s very hard.”
Consumers are going to gravitate toward applications powered by the buzzy new technology, analyst Michael Wolf predicts
Chris Dixon, a partner who led the charge, says he has a ‘very long-term horizon’