Financial Acumen

Reading an article (yet another one) about Madoff, I learned something that startled me: people tend to prefer a steady stream of even small gains (okay, thats obvious), and will do so even if the stream is periodically interrupted by a major loss that wipes out the cumulative effect of the gains, and then some. The reverse is also true: people tend to dislike a steady stream of even small losses, even if the stream is periodically interrupted by a major gain that wipes out the cumulative effect of the losses, and then some. You get used to the number of positive or negative events, to the exclusion of the value of those events. I think thats an amazing, mind-boggling piece of information.

Speaking of boggled minds: you occasionally hear of college kids who don't know how a credit card works, or how to balance their checkbook. When I hear these things, I think, smugly, that our daughter knows these things, at least in the abstract. She'll never get surprised by the concepts, never say But I can't be out of money -- I still have checks!!!

Today, my daughter said that she wanted to switch to the other rate plan for her cell phone (we each have a pay as you go plan), because she'd been texting a lot lately, and thought it would be cheaper. So I looked at her balance, and then I sent her this email:

You are on the 10 cents a minute + 1 dollar a day plan, which means you pay one dollar every day you use the phone, and ten cents for every minute or part of a minute. Your current balance is 25.91.

The other plan is 25 cents a minute, no daily charge. If you only made a couple of calls a day, this plan would be cheaper. The breakeven point is about seven minutes of calls a day - more, and your plan is cheaper, less, and this plan is cheaper. Let me know if you want to change.

If you are curious, I figured that breakeven point -- the point where the two plans cost roughly the same -- with this equation -- .10*M+1 = .25*M + 0 . Thats the cost per minute plus the daily charge for each of the plans. Setting them equal says 'at what value of Minutes are the costs the same?' .

First, she thought that the dollar a day plan was just to have the phone. In that case, wanting the other plan made sense. I explained that no, that was just invoked if you actually used the phone that day -- simply having it didn't incur a change. After which, she said "Yeah, I am going to do a lot more texting, so I want to switch." I stared at her, dumbfounded. Finally, after a couple more minutes of conversation, including the phrase If you are going to use more than seven minutes of phone time a day, the plan you are on now is the cheaper of the two, she finally concluded that she didn't want to change.

Maybe we'd beter talk about credit cards and checking accounts?