Managing Impulses to Build Wealth
Growing up as an immigrant, investing and portfolio management was not a part of my upbringing. A college degree and a lifetime of work were supposed to be sufficient to build a nest-egg to retire on. In high school, I took a finance class where I learned such concepts as compound interest and buying low/selling high, however, even then, the access to the stock market was largely through brokerage firms that carried fees per trade.
With the advent of Robinhood and the elimination of transaction fees from other retail brokers, putting money in the market is a thumb swipe away. Through this accessibility, an entire generation of day-traders was created. While amateur investors chase the dream of turning thousands into millions, the average investor is more likely to lose their money than beat the market. Meanwhile, their debt climbs ever higher.
The culture of instant gratification is the biggest lie that we swallow up. It forces people to look at the now and to delay thinking about tomorrow as they fiddle with shiny new toys. Yet, as the future becomes the present and the novelty of our decisions wears off, the consequences demand payment.
“It is human nature to want it and want it now; it is also a sign of immaturity. Being willing to delay pleasure for a greater result is a sign of maturity.” — Dave Ramsey
Stop thinking short-term with your money
The risk of losses from short-term investment strategies far outweighs the potential for significant gain. Short-term investors face greater market volatility, especially with all-in strategies on “hot stocks”. Furthermore, a lack of diversification means that the loss is maximized if the price of the stock plummets. Even if marginal gains are realized, short-term gains are taxed at the personal income tax rate versus the more favorable capital gains tax rate for investments held over one year.
Websites like Stocktwits and Reddit add further incentive to chase the win with entire communities pumping up various stock picks. Instead of relying on company fundamentals, inexperienced investors are taking the community’s sentiment to heart and risking their savings on over-pumped stocks and then watch their money take a dive when these “pumpers” decide to take their profits and run.
“The success rate for day traders is estimated to be around only 10%, so … 90% are losing money.” — Neale Godfrey, Forbes
Warren Buffet is the father of value investing. The idea is that you invest money into companies that appear undervalued and then keep your money invested long-term. As the market fluctuates between peaks and dips, your investment will grow over time. For those individuals that do not have the savvy to read the market, there are vehicles such as ETFs that will diversify your investment for you.
The long-term growth of money is not exciting. There is no sudden explosion of gains. It is a process that takes time. However, by lowering risk through diversification and long term outlook, the average person can take advantage of dividends, capital gains tax treatment, and compound interest. Stop treating your finances like a casino and focus on building wealth.
A life sentence of debt
America is a consumer society. Most adults will have some form of debt through credit card spending, auto loans, mortgages, or student loans. The idea of “minimum payment” lulls many people into complacency, allowing the debt interest to accumulate and earn the lender additional money.
One of the problems is that debt is not thought of in the same vein as income. Debt is a negative income. It is a monthly commitment that subtracts from your earnings just as surely as income taxes. Instead of viewing it as paying down a credit card, you should view it as adding additional monthly income.
The mistake that a lot of people make is that they compare the interest rate of their loans with the potential rate of return on investments in the stock market. The stock market rarely guarantees a particular rate of return. Stocks can dip, companies can go out of business, and your hard-earned funds can be cut in half. Meanwhile, like clockwork, your loans will continue accumulating interest.
When paying off a loan, you are guaranteed a rate of return that no other financial vehicle can promise. You are freeing up monthly funds, allowing you to invest in your future without worrying about your debt offsetting your earnings. If this is such a wonderful thing, why aren’t more people choosing to pay down debt?
The answer is that this process takes years, if not decades to accomplish. During this period of time, a person has to budget and avoid accumulating more debt. This does not feel good. You want to take that vacation. You want to buy a new car. These impulses promise instant enjoyment as long as you close your eyes to the gaping hole in your finances.
“Live like no else today, so you can live like no else tomorrow.”
― Dave Ramsey
Risk management is a way of life
Risk management goes hand-in-hand with investment. A person investing in the stock market at 20 years sold can recuperate from a loss much better than a person approaching retirement. This is because a 20-year-old has a longer opportunity to correct financial missteps and to absorb losses.
Any decision that affects your financial well-being should be passed through a risk management filter. Never risk money that you cannot afford to lose. This philosophy is not exclusive to the stock market. Decisions relating to your career should receive similar consideration.
When I reached five years in my profession, I got a bit restless in my field. Personal injury law, like many other areas of practice, becomes repetitive after a while. To escape the daily grind, I considered transitioning to another area of law or even leaving the legal field altogether. Those decisions had to be weighed against the potential loss of salary, bonuses, and benefits.
A fresh start would certainly feel exhilarating. However, that feeling passes. When the novelty of your choice wears off, you must consider the reality of your decision. Better yet, consider the potential outcome before you take that leap. The idea of pursuing one’s dreams is a romantic notion. Romantic notions don’t pay your electric bill.
This isn’t to say that every person is a slave to their circumstances. It is important to move forward and make an effort to build your happiness. However, you must look at your circumstances and decide how much risk you are willing to take in your decisions. Do you owe rent? Do you have kids? Are you willing to accept a pay cut? Are you willing to lose that rainy day fund? Only by considering the risks and benefits, together, can you make an informed decision that will mitigate undesirable outcomes.