The Psychology of Money

Everyone has their own way of seeing the world. What I think is wild might be normal for someone else. Your background can really change how you look at investing and how much risk you’re willing to take. So, don’t judge other people’s investment choices, because they might not see things the same way as you do.

Becoming wealthy and staying wealthy are two distinct games. Achieving wealth can be a stroke of luck or a result of ingenuity. However, maintaining wealth requires discipline, frugality, and long-term planning.

Enough. At a party hosted by a billionaire on Shelter Island, Kurt Vonnegut told his friend Joseph Heller that their host, a hedge fund manager, had made more money in one day than Heller had earned from his hugely successful novel Catch-22 throughout its entire history. Heller’s response?

Yes, but I have something he will never have — enough.

The importance of compounding. There is an old riddle about a lily pad in a pond.

The lily pad doubles in size every day and after 30 days it covers the whole pond. On what day does the lily pad cover half the pond?

Many people would say “day 15” because that’s what our minds think of first. But the answer is actually day 29.

A more interesting question is, how much of the pond would be when the lily pad have covered on day 15? The answer is .0031%. On day 24 it will cover more than 1%. On the day 29 it will cover half of it.

This riddle is tricky because the lily pad’s growth is exponential, not linear. Our minds struggle with exponential models and we understand linear growth better because it is easier to estimate. Exponential growth is hard to envision and our estimates don’t usually work, but this is exactly how compound interest works, thus take it into account when thinking of your investments.

Long tails. In addition to compounding, long tails also play a significant role in the wealth narrative.

In a venture capital portfolio, it is assumed that after distributing funds across multiple investments, most of them will fail. However, returns from a couple of “unicorn” investments will compensate for all the fund returns. Similarly, consider what would have happened if ten of the more than 15 billion people who have lived on Earth during the XIX and XX centuries had not existed. The course of history would have been completely different.

The dynamics of investing are no different, so keep compounding and long tails in mind when thinking about wealth.

Remember to pay yourself first. While it’s easy to fall into the trap of debt and unnecessary spending, doing so means that a large percentage of your hard-earned money goes towards paying off those debts. This can leave you with less income than you deserve, even before you get a chance to enjoy it.

If you take this argument to the extreme, you may not even have enough money to cover your daily expenses, let alone save for the future. So, to stay afloat and ensure that you can grow your savings account, it’s important to prioritize yourself and your financial well-being.

Don’t waste your time pursuing the wrong things. People often desire admiration and respect, believing that they can obtain it by acquiring extravagant possessions, such as jewelry, fancy cars, or huge houses. But owning these things doesn’t necessarily follow admiration and respect. Seeing a Ferrari on the road might make you appreciate the car’s engineering and craftsmanship, but it won’t necessarily make you think the driver has “made it.”

In fact, owning a Ferrari is often the opposite of accumulating wealth. It only means that the person has 500K less in their bank account, or worse, is in debt.

A margin of safety. When it comes to investing, it’s always important to remember to have a margin of safety and room for error. While being a risk-seeker is important, it’s equally important to be cautious and avoid getting knocked out of the game.

This is an idea also present across all Nassim Taleb’s work and The Value Investor, that at the end of the day, the most important thing is to keep playing.

Investing is a long-term game. It’s easy to get caught up in short-term market fluctuations, but it’s important to keep a level head and not panic. Stay the course and stick to your long-term plan.

There is also no such thing as a completely safe investment, and you should always be prepared for the possibility of losing money. However, with proper planning, long-term perspective, and a margin of error, can be a powerful tool for building wealth over time.

You must fail often to reap extraordinary rewards. Personal finance is akin to a venture portfolio. The few investments that succeed typically account for the majority of the returns. This may seem counterintuitive and even intimidating, but diversifying your investments across different baskets can mean that most of them fail, while the few that succeed will more than make up for the losses.

Assets don’t always have a rational price. Even bubbles can be rationalized at any given time, since nobody wants to be stuck with an overvalued asset. Ultimately, the price depends on various factors, such as the type of investor and the time horizon.

What may be a good choice for a day trader may not be the best option for a long-term holder. These two investors don’t know each other and are playing different games, yet on the same board. Therefore, it’s essential to know your goals and evaluate what makes sense for you at any given point in time.

I am a passive investor, optimistic in the worlds ability to generate real economic growth, and I’m confident that over the next thirty years that growth will accrue to my investments.

Stories people tell. The economic landscape in late 2009 was much better than it had been two years prior. In 2007, the economy was thriving, prices were rising, and prospects were promising. However, by 2009, it seemed like everything was going downhill. Stories and narratives often influence market sentiment, even when metrics point in a different direction.

First published on January 12, 2023