I have an idea that guides almost all my thinking about investing: It is easier and more common to be stupid than smart with your money.
With this idea comes a truth: If you want to get better with money, you should spend more time studying people who have failed than those who have succeeded. That's where you can find quick, meaningful lessons applicable to your own life. You will make so much more progress learning to avoid failures than you will trying to copy successes.
The good news is that there is no shortage of failures to learn from. The same number of people filed personal bankruptcy in 2010 as earned bachelor's degrees (1.6 million). Half of Americans can't come up with $2,000 for an emergency in 30 days. The average investor underperforms the market by more than half.
Here's what I've learned from failures about the easiest ways to ruin your financial life.
1. Risk what you to need in order to gain what you don't need
Warren Buffett was once ridiculed by a group of billionaire hedge fund managers who bet the farm and went bankrupt.
"To make money they didn't have and didn't need, they risked what they did have and did need," he said. "And that's foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense."
But a lot of people do this. Nobel Prize-winning psychologist Daniel Kahneman once went to his financial advisor and said he didn't want to be richer. He had enough money and didn't need to risk what he had -- and needed -- in an attempt to accumulate more, which he didn't need. She said, "I can't work with you," according to Kahneman. So he left.
This goes both ways. More money has been lost trying to predict and avoid market crashes than has been lost by enduring them. Young investors can ruin their financial lives by risking what they need – the market's long-term returns – in an attempt to gain what they don't need: a stable portfolio.
2. Anchor expectations to the most successful people you know
The best explanation I've heard for why we had a consumer debt bubble is this: A sliver of legitimately rich people inflated the aspirations of everyone else, whose stagnant incomes meant they had to use debt to keep up with the Joneses. "Trickle-down economics may be a chimera," Joseph Stiglitz wrote, "but trickle-down behaviorism is very real."
The quality of your life depends on your ability to avoid this trap.
Step One is realizing that the correlation between money and happiness is probably a fraction of what you think it is. Step Two is realizing that wealth is the money you've saved, which people don't see, not the stuff you've bought, which they do. Step Three is realizing that working like a dog to earn more money can be miserable. "My only measure of success is how much time you have to kill," Nassim Taleb says.
3. Have a life expectancy measured in decades and an attention span measured in minutes
In 1940, a 50-year old had a life expectancy of 21.9 years, and the average stock was held for about seven years. By 2010, a 50-year old had a life expectancy of 29.6 years, and the average stock was held for less than a week.
In his book Wait: The Art and Science of Delay, Frank Partnoy writes:
Given the fast pace of modern life, most of us tend to react too quickly. We don't, or can't, take enough time to think about the increasingly complex timing challenges we face. Technology surrounds us, speeding us up. We feel its crush every day, both at work and at home. Yet the best time managers are comfortable pausing for as long as necessary before they act, even in the face of the most pressing decisions. Some seem to slow down time. For good decision-makers, time is more flexible than a metronome or atomic clock.
Asked why people make irrational decisions, Kahneman once said, "Because the long term is not where life is lived." It's lived in the short run. And since most people are preoccupied with the short run, that's where there's the most competition. Since it's so competitive, it's really hard to get ahead.
4. Pay close attention to everything
According to investor Jim O'Shaughnessy, Fidelity Investments once ran a study to see which types of Fidelity investors performed best.
"The accounts of people who forgot they had an account at Fidelity." O'Shaughnessy said.
These people weren't checking their accounts, fiddling, buying, selling, rotating, adjusting, or tweaking. They just let their money grow in blissful ignorance. And they did phenomenally.
In contrast, several studies have shown that those who trade the most perform, by far, the worst.
Blissful ignorance is one of the most powerful weapons in investing. Investing is all about controlling your emotions. The more you pay attention to every detail around you – what the economy's doing, what markets are doing, what others are saying, what others are doing – the more you can make up stories in your head to believe whatever you want, and the less control you have over your emotions.
Work a lot, spend a little, save the difference, invest it wisely, leave it alone. It's not that hard. We just make it harder than it needs to be. Paying too much attention to the details of markets is a chief culprit.
For more on this topic:
- 50 unfortunate truths
- If you only know 5 things about investing, make it these
- Peculiar traits of rich people
Check back every Tuesday and Friday for Morgan Housel's columns.