Why We Go Wrong
Why We Go Wrong
John Lim | January 16, 2021
I’VE LONG BEEN flummoxed by the difficulty people have managing money. It all seems so intuitive: Save, invest, repeat. Buy more when the market falls and a lot more when it crashes. Rebalance by adding more to losing asset classes—which today means buying value and international stocks.
Now, don’t get me wrong: I’m no financial genius. I’ve made my share of blunders. But I also know that being a do-it-yourself investor has saved me boatloads of money. When I’ve encouraged colleagues to do the same—imploring them that “it’s really not that hard”—I’ve received only steely stares and blank looks.
It’s slowly dawned on me that the financial demons people wrestle with are real and of Herculean proportions. Finance is a minefield that few navigate without getting maimed. It’s replete with mirages—what you see is often not what you get. Our instincts hurt us more often than they protect us. Actions that are sensible in every other realm of life lead us astray in finance.
What follows is an exploration of eight key concepts that many—and perhaps most—investors struggle with. The biggest paradox of all: While managing money may appear simple, it’s anything but.
1. Compound interest is the key to wealth. We’re woefully ill-equipped to wrap our heads around the wonder that is compound interest. Warren Buffett described his eureka moment at age 10. “That’s where the money is,” he told himself, referring to the power of compound interest.
The miracle of compound interest is a collision of two intangible concepts—exponential growth and a long time horizon. It’s well known that people struggle when making decisions that have consequences well into the future. Economists refer to such myopia as “present bias,” a universal human tendency to favor the present over the future.
The abysmally low U.S. savings rate exemplifies this mindset. But it also reflects a failure to grasp the immense power of exponential growth over long stretches of time. In brief, we each need our own eureka moment.
Consider the story of the Lenape Indians. In 1626, they sold the island of Manhattan to Peter Minuit for a mere $24. That was the greatest swindle in U.S. history, right? If you compound $24 at 7% a year—which is the average after-inflation return of the stock market—what would it be worth today? Almost $10 trillion. Let that sink in.
2. Laziness is a virtue. Life teaches, and common sense affirms, that hard work pays off. Sloth was so disdained in medieval times that it was labeled one of the seven deadly sins. Yet lazy investing leads to superior, not inferior, results.
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Fidelity Viewpoints
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Recently, for instance, I've been re-reading Brett Wilder's The Quiet Millionaire [my review]. It's different than most personal finance books. It's targeted at those who are farther along their financial journeys rather than at those just starting out. Still, there are bits and pieces in The Quiet Millionaire that are applicable to everyone.
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I love scotch; she hates it.
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We've been happily together for 16 years, which makes me wonder: Does love make the financial side of marriage work, or is it the other way around?
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