We shared a
Daily Read article this week from the
Psychology of Money, an article that blew me completely away with its truths that I spent the entire week reflecting on its lessons. Here are a few that stood out for me, starting with this interesting perspective on investing.
Investing is not the study of finance. It’s the study of how people behave with money. And behavior is hard to teach, even to really smart people. You can’t sum up behavior with formulas to memorize or spreadsheet models to follow. Behavior is inborn, varies by person, is hard to measure, changes over time, and people are prone to deny its existence, especially when describing themselves.
I started appreciating the true value of compounding a few years ago when I was reflecting on how much time and money I had wasted looking for quick returns on some investment or idea that looked awesome on paper. After years of failure, it became apparent that patience, consistency and compounding with low-risk investments would have gotten me much better returns (and much less psychological trauma).
Underappreciating the power of compounding, driven by the tendency to intuitively think about exponential growth in linear terms.
The punchline of compounding is never that it’s just big. It’s always – no matter how many times you study it – so big that you can barely wrap your head around it.
I have heard many people say the first time they saw a compound interest table – or one of those stories about how much more you’d have for retirement if you began saving in your 20s vs. your 30s – changed their life. But it probably didn’t. What it likely did was surprise them, because the results intuitively didn’t seem right. Linear thinking is so much more intuitive than exponential thinking.
The sobering realization about compounding money is that it works better when you start early, or immediately. And the earlier you start, the better. Like we’ve seen in the example I shared above, the difference between a compounded savings plan started in your twenties vs. in one your thirties can be mind boggling, and the older you get the harder it becomes. Which means there is no better time to start a compounded savings plan than today.
And remember, once you start on a savings or investment plan, especially a compounded one, do whatever it takes to never, ever interrupt it until it’s reach the target goal.
A tendency toward action in a field where the first rule of compounding is to never interrupt it unnecessarily.
When volatility is guaranteed and normal, but is often treated as something that needs to be fixed, people take actions that ultimately just interrupts the execution of a good plan. “Don’t do anything,” are the most powerful words in finance. But they are both hard for individuals to accept and hard for professionals to charge a fee for. So, we fiddle. Far too much.
