The only way to know how much food you can eat is to eat until you’re sick. But for some reason the same logic doesn’t translate to business and investing, and many will only stop reaching for more when they break and are forced to. This can be as innocent as burning out at work or a risky investment allocation you can’t maintain. Whatever it is, the inability to deny a potential dollar will eventually catch up to you.
- Reputation is invaluable.
- Freedom and independence are invaluable.
- Family and friends are invaluable.
- Being loved by those who you want to love you is invaluable.
- Happiness is invaluable.
Your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough. There is no reason to risk what you have and need for what you don’t have and don’t need.
Warren Buffett is a phenomenal investor. But you’ll miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him.
Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time.
Consider a little thought experiment.
Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. No one comes close to this record. As we just saw, Buffett has compounded at roughly 22% annually, a third as much.
Simons’ net worth, as I write, is $21 billion. He is—and I know how ridiculous this sounds given the numbers we’re dealing with—75% less rich than Buffett.
Why the difference, if Simons is such a better investor? Because Simons did not find his investment stride until he was 50 years old. He’s had less than half as many years to compound as Buffett. If James Simons had earned his 66% annual returns for the 70-year span Buffett has built his wealth he would be worth—please hold your breath—sixty-three quintillion nine hundred quadrillion seven hundred eighty-one trillion seven hundred eighty billion seven hundred forty-eight million one hundred sixty thousand dollars.
Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild. The opposite of this—earning huge returns that can’t be held onto—leads to some tragic stories.
Tails, You Win
When you accept that tails drive everything in business, investing, and finance you realize that it’s normal for lots of things to go wrong, break, fail, and fall. Peter Lynch is one of the best investors of our time. “If you’re terrific in this business, you’re right six times out of 10,” he once said.
- If you’re a good stock picker you’ll be right maybe half the time.
- If you’re a good business leader maybe half of your product and strategy ideas will work.
- If you’re a good investor most years will be just OK, and plenty will be bad.
- If you’re a good worker you’ll find the right company in the right field after several attempts and trials.
And that’s if you’re good. No one makes good decisions all the time. The most impressive people are packed full of horrendous ideas that are often acted upon.
Take Amazon. It’s not intuitive to think a failed product launch at a major company would be normal and fine. Intuitively, you’d think the CEO should apologize to shareholders. But CEO Jeff Bezos said shortly after the disastrous launch of the company’s Fire Phone:
If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip.
It’s OK for Amazon to lose a lot of money on the Fire Phone because it will be offset by something like Amazon Web Services that earns tens of billions of dollars. Tails to the rescue.
Netflix CEO Reed Hastings once announced his company was canceling several big-budget productions. He responded:
Our hit ratio is way too high right now. I’m always pushing the content team. We have to take more risk. You have to try more crazy things, because we should have a higher cancel rate overall.
These are not delusions or failures of responsibility. They are a smart acknowledgement of how tails drive success. For every Amazon Prime or Orange is The New Black you know, with certainty, that you’ll have some duds.
Man in the Car Paradox
When you see someone driving a nice car, you rarely think, “Wow, the guy driving that car is cool.” Instead, you think, “Wow, if I had that car people would think I’m cool.” Subconscious or not, this is how people think.
There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.
The point here is not to abandon the pursuit of wealth. Or even fancy cars. But if respect and admiration are your goal, be careful how you seek it. Humility, kindness, and empathy will bring you more respect than horsepower ever will.
No Such Thing As One Size Fits All
Clarence Hughes went to the dentist in 1931. His mouth was radiating pain. His dentist put him under crude anesthesia to ease the pain. When Clarence awoke hours later he had 16 fewer teeth and his tonsils removed.
And then everything went wrong. Clarence died a week later from his surgery’s complications. His wife sued the dentist, but not because the surgery went awry. Every surgery risked death in 1931. Clarence, she said, never consented to the procedures in the first place, and wouldn’t if he were asked. The case wove through courts, but went nowhere. Consent between doctor and patient wasn’t black and white in 1931.
This wasn’t ego or malice. It was simply a belief in two points:
- Every patient wants to be cured.
- There is a universal and right way to cure them.
Not requiring patient consent in treatment plans makes sense if you believe in those two points. But that’s not how medicine works.
In the last 50 years medical schools subtly shifted teaching away from treating disease and toward treating patients. That meant laying out the options of treatment plans, and then letting the patient decide the best path forward. This trend was partly driven by the truth that medicine is a complex profession and the interactions between physicians and patients are also complex.
You know what profession is the same? Financial advice. No expert can tell you what to do with your money, because they don’t know you. They don’t know what you want. They don’t know when you want it. They don’t know why you want it.
Recommendations for Better Financial Decisions
Doctors and financial advisors are far from useless, obviously. They have knowledge. They know the odds. There are universal truths in money, even if people come to different conclusions about how they want to apply those truths to their own finances. With that caveat in place, let’s look at a few short recommendations that can help you make better decisions with your money.
- Go out of your way to find humility when things are going right and forgiveness & compassion when they go wrong. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control.
- Less ego, more wealth. Wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today.
- Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions.
- Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune, because a small minority of things account for the majority of outcomes. No matter what you’re doing with your money you should be comfortable with a lot of stuff not working. That’s just how the world is. It is fine to have a large chunk of poor investments and a few outstanding ones. That’s usually the best-case scenario.
- Use money to gain control over your time. That’s because not having control of your time is such 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 to, pays the highest dividend that exists in finance.
- Be nicer and less flashy. No one is impressed with your possessions as much as you are. You might think you want a fancy car or a nice watch. But what you probably want is respect and admiration. And you’re more likely to gain those things through kindness and humility than horsepower and chrome.
- Save. Just save. You don’t need a specific reason to save. It’s great to save for a car, or a down payment, or a medical emergency. But saving for things that are impossible to predict or define is one of the best reasons to save. Everyone’s life is a continuous chain of surprises. Savings that aren’t earmarked for anything in particular is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.
- Define the cost of success and be ready to pay it. Nothing worthwhile comes for free. Remember that most financial costs don’t have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid).
- Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge, but if it keeps you in the game it can pay for itself many times over.
- Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the more you may regret them as you evolve.
- You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time. Know the game you’re playing, and make sure your actions are not being influenced by the rules of others.