4. A tendency to adjust to current circumstances in a way that makes forecasting your future desires and actions difficult, resulting in the inability to capture long-term compounding rewards that come from current decisions.
The paradox of wealth is that people tend to want it to signal to others that they should be liked and admired. But in reality those other people bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth solely as a benchmark for their own desire to be liked and admired.
It’s recognizing that people generally aspire to be respected by others, and humility, graciousness, intelligence, and empathy tend to generate more respect than fast cars.
The problem is that everyone needs a clear explanation of how the world works to keep their sanity. It’s hard to be optimistic if you wake up in the morning and say, “I don’t know why most people think the way they do,” because people like the feeling of predictability and clean narratives. So they use the lessons of their own life experiences to create models of how they think the world should work – particularly for things like luck, risk, effort, and values. And that’s a problem. When everyone has experienced a fraction of what’s out there but uses those experiences to explain everything they expect to happen, a lot of people eventually become disappointed, confused, or dumbfounded at others’ decisions.
6. Historians are Prophets fallacy: Not seeing the irony that history is the study of surprises and changes while using it as a guide to the future. An overreliance on past data as a signal to future conditions in a field where innovation and change is the lifeblood of progress.
The late statistician Hans Rosling put it differently: “I am not an optimist. I am a very serious possibilist.”
You can laugh. But the truth is, yes, people need to be told that. When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire. This is especially true for young people. A key use of wealth is using it to control your time and providing you with options. Financial assets on a balance sheet offer that. But they come at the direct expense of showing people how much wealth you have with material stuff.
The idea is that you have to take risk to get ahead, but no risk that could wipe you out is ever worth taking. The odds are in your favor when playing Russian Roulette. But the downside is never worth the potential upside.
My own money is barbelled. I take risks with one portion and am a terrified turtle with the other. This is not inconsistent, but the psychology of money would lead you to believe that it is. I just want to ensure I can remain standing long enough for my risks to pay off. Again, you have to survive to succeed.
A key point here is that few things in money are as valuable as options. The ability to do what you want, when you want, with who you want, and why you want, has infinite ROI.
2. Cost avoidance syndrome: A failure to identify the true costs of a situation, with too much emphasis on financial costs while ignoring the emotional price that must be paid to win a reward. Say you want a new car. It costs $30,000. You have a few options: 1) Pay $30,000 for it. 2) Buy a used one for less than $30,000. 3) Or steal it. In this case, 99% of people avoid the third option, because the consequences of stealing a car outweigh the upside. This is obvious. But say you want to earn a 10% annual return over the next 50 years. Does this reward come free? Of course not. Why would the world give you something amazing for free? Like the car, there’s a price that has to be paid. The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it. Many people in this case choose the third option. Like a car thief – though well-meaning and law-abiding – they form tricks and strategies to get the return without paying the price. Trades. Rotations. Hedges. Arbitrages. Leverage.
1. Earned success and deserved failure fallacy: A tendency to underestimate the role of luck and risk, and a failure to recognize that luck and risk are different sides of the same coin.
You see a lot of information in the world. You can’t process all of it. So you have to filter. You only filter in the information that meshes with the way you think the world should work. Since everyone wants to explain what they see and how the world works with clean narratives, inconsistencies between what we think should happen and what actually happens are buried.
Jiddu Krishnamurti spent years giving spiritual talks. He became more candid as he got older. In one famous talk, he asked the audience if they’d like to know his secret. He whispered, “You see, I don’t mind what happens.”
5. Anchored-to-your-own-history bias: Your personal experiences make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.
A team of economists once crunched the data on a century’s worth of people’s investing habits and concluded: “Current [investment] beliefs depend on the realizations experienced in the past.” Keep that quote in mind when debating people’s investing views. Or when you’re confused about their desire to hoard or blow money, their fear or greed in certain situations, or whenever else you can’t understand why people do what they do with money. Things will make more sense.
Harry Markowitz won the Nobel Prize in economics for creating formulas that tell you exactly how much of your portfolio should be in stocks vs. bonds depending on your ideal level of risk. A few years ago the Wall Street Journal asked him how, given his work, he invests his own money. He replied: I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.
What you don’t realize is that the traders moving the marginal price are playing a totally different game than you are. And if you start taking cues from people playing a different game than you are, you are bound to be fooled and eventually become lost, since different games have different rules and different goals.
11. The social utility of money coming at the direct expense of growing money; wealth is what you don’t see. I used to park cars at a hotel. This was in the mid-2000s in Los Angeles, when real estate money flowed. I assumed that a customer driving a Ferrari was rich. Many were. But as I got to know some of these people, I realized they weren’t that successful. At least not nearly what I assumed. Many were mediocre successes who spent most of their money on a car. If you see someone driving a $200,000 car, the only data point you have about their wealth is that they have $200,000 less than they did before they bought the car. Or they’re leasing the car, which truly offers no indication of wealth.
Wealth, in fact, is what you don’t see. It’s the cars not purchased. The diamonds not bought. The renovations postponed, the clothes forgone and the first-class upgrade declined. It’s assets in the bank that haven’t yet been converted into the stuff you see. But that’s not how we think about wealth, because you can’t contextualize what you can’t see. Singer Rihanna nearly went broke after overspending and sued her financial advisor. The advisor responded: “Was it really necessary to tell her that if you spend money on things, you will end up with the things and not the money?”
4. A tendency to adjust to current circumstances in a way that makes forecasting your future desires and actions difficult, resulting in the inability to capture long-term compounding rewards that come from current decisions.