As those that have been reading our blog over the years know, I often take my writing in a direction that relates back to the behavioral side of finance. This post will not stray from that focus. Working in wealth management and financial services over the past two decades has taught me that doing well with money is very often more about one’s behavior than it is about one’s intellect, income or natural ability.
I just recently finished reading a book entitled The Psychology of Money written by Morgan Housel. Mr. Housel does a fantastic job of illustrating just how much behavior plays a role in creating and managing wealth. The following paragraphs will be a summary of some of the main themes I took away from reading Housel’s book. The various points I gleaned have provided me with greater peace of mind and more meaning around how I view money and what it can do for me and my loved ones. After reading the following, I hope you also are able to look at money through a slightly different lens; one with a richer perspective and a deeper meaning.
Financial advice is a complex profession and the interactions between advisors and clients are also complex
Often, people who don’t know you very well (the Uber driver, your distant Aunt Sally, or your plumber) will tell you what to do with your money. Unfortunately, someone who doesn’t know you also likely does not know what you are looking to accomplish with your money. Everybody has different experiences which lead to different ways of thinking and different ways of looking at the world. These differences mean that individuals typically want different things from their money at different times for different reasons.
It is precisely because of all of these differences why we, at Wolf Group Capital Advisors, spend so much time up front getting to know our clients and their goals, fears and aspirations before making recommendations. We often spend significant time getting to know our clients through a series of meetings and our robust financial planning process before we delve into any specific advice. This allows us to take a tailored approach with each relationship and account for the many client preferences that we encounter.
For example, some people take great comfort in accumulating and ultimately dying with large sums of money. Others want to lead a life of giving back to their communities, their friends and family and their favorite charitable causes. Other individuals want to travel and have as many varied experiences as possible. There is a nearly infinite combination of goals that people can have. Not only are goals often distinctive but every person prioritizes each goal slightly differently.
Therefore, each client we serve has a different combination that makes them happiest and leads to their most fulfilling life. It is our job, as financial advisors, to help define whatever that precise combination is for the client and then help them achieve those specific objectives. As Housel aptly writes in his book, “there are universal truths in money…yet people come to different conclusions about what is right for them and how they want to apply those truths to their own finances.”
The stock market may not look rational to you; keep in mind that not everyone has the same motivations and goals.
We have a tendency to call every market participant an “investor.” That is not necessarily true as there are speculators, day traders, short-term investors, long-term investors, etc., all playing an active role in the market at the same time. This tendency leads us to believe that many irrational participants are involved. That is not the case. Those making moves deemed irrational by long-term investors may be acting quite reasonably based on their unique motivations and desires.
I used to often say that “different opinions are what make markets.” And while that remains true, deeper reflection reveals that it is not only different opinions and disagreements that make markets but different motivations and goals and types of investors as well.
What works for you?
As fiduciary advisors, we are compensated for providing our clients with unbiased, optimal financial advice. However, we always leave room for what I like to call “the sleep factor.” Employing the strategy that works best for you and allows you to keep the magic of compounding going, is the key. Housel straightforwardly describes it as “doing what works for you.” An example from the book will best describe the point I am trying to make:
We own our house without a mortgage which is the worst financial decision we’ve ever made but one of the best money decisions we’ve ever made. Our goal isn’t to be coldly rational, just to be psychologically reasonable.
The independent feeling we get from owning our house outright far exceeds the known financial gain we would get from leveraging our assets with a cheap mortgage. Eliminating the monthly payment feels better than maximizing the long-term value of our assets. On paper it is defenseless but, it works for us, we like it; that’s what matters. Good decisions aren’t always rational. Sometimes you have to choose between being happy and being right.
As you can gather from reading the above, borrowing at cheap interest rates is a sound financial decision as the individual who employs that strategy is able to earn the spread between the rate of return on their investments minus the cost of borrowing. Over the past dozen years, with historically low interest rates and historically high market returns, it has been a wildly successful strategy. That said, it does not mean it is the right strategy for every single person. Many individuals are not comfortable having a large mortgage and would lose sleep at night. If markets corrected or fell into bear market territory, the anxiety of having a mortgage but lower asset values might make them sell all of their equity investments at a loss and feel the need to immediately pay off their remaining mortgage. The comfort of not having a large mortgage would seem more appropriate for this type of person.
There is the rational move from a financial perspective and there is the reasonable move from a comfort, household and personal perspective. Sometimes those two are the same; sometimes an individual or family unit has to choose something that is not optimal under classic financial theory based on their comfort level and risk tolerance. This does not make it irrational; it simply makes it a reasonable approach based on one’s preferences.
Other words of wisdom from The Psychology of Money
- Less ego = more wealth. Money saved is the gap between your ego and your income.
- Wealth is what you cannot see. You essentially have to give up immediate gratification today for the ability to have what you want tomorrow.
- Time is the most powerful force in investing. As Charlie Munger said, “the biggest part of compounding is to never interrupt it unnecessarily.”
- Use money to gain control over your time. Not having control over your time is a powerful and universal drag on happiness.
- The ability to do what you want when you want with who you want for as long as you want is the highest dividend that exists in finance.
- Everyone’s life is a continuous chain of surprises. You don’t need a reason to save. Just save.
- Most financial costs don’t have visible price tags. Uncertainty, doubt and regret are common costs in the finance world. Stock market volatility is another. They are often worth paying.
- Always give yourself a margin of safety. A margin of safety is also known as your room for error. This will keep you in the game and prevent you from selling at an inopportune time.
- All lifestyles exist on a spectrum. What is reasonable to one person can feel like royalty or poverty to another.
- Keeping your expectations in check and living below your means are the keys to independence. Independence at any income level is driven by your savings rate. Once you pass a certain income level, your savings rate is a function of keeping your lifestyle expectations from running away.
As less than perfect humans, we often get caught up in what doesn’t matter as much and lose track of what matters the most. We sometimes take unnecessary risks with money we need, to accumulate money we don’t need. We forget that financial wealth is “what you cannot see” and can fall victim to “keeping up with the Joneses” when that rarely brings us any sort of long-lasting benefit, be that happiness or contentment.
While obtaining strong market returns will always be important, an extra 0.5% of return often pales in comparison to managing our behaviors in a way that allows us to maximize our savings and enables us to always stay invested in a diversified portfolio that achieves good returns over a long period of time. Maximizing our savings gives us higher financial flexibility and greater independence of our time. The ability to do what you want with your time is hugely important.
As fiduciary advisors, we must always act with our clients’ best interests in mind. When we define best interests, we take into account many qualitative aspects that help one live a meaningful life. We always want to make sure our clients are working toward their goals and toward achieving what they want from life. Many advisors make the mistake of thinking every client wants to die rich. At Wolf Group Capital Advisors, we want all of our clients to live richly. We know that “living richly” can be defined in countless ways. It is with that customized perspective that we advise all of our clients and empower them to live their most fulfilling life.
By Charles Verruggio, Chief Investment Officer