Why Smart People Make Big Money Mistakes — We Fear Being Too Alive.
The book argues in its introduction (Page 26) that people are both too much like mules and too much like sheep. We are overconfident in our own abilities, which makes us close-minded. And yet we also rely too much on the opinions and actions of others in forming our own opinions; we are so open-minded that we are willing to go along with ideas that do not really add up. The authors argue that these two findings are in conflict and that the conflict cannot be reconciled. I think that the conflict can be reconciled.
We behave like sheep because we are disinclined to take personal responsibility for our decisions. Many of us would rather lose money as the result of decisions that we can attribute to an “expert” than stand a good chance of earning money as the result of decisions attributable to ourselves alone. To make a decision is to live. We are afraid to live.
To be alive is fun but to be alive is hard. A big part of the project of becoming a successful saver or a successful investor is developing the confidence to live life to the fullest. Bruce Springstein observed that: “It ain’t no sin to be glad you’re alive.” It ain’t no sin to go against the “experts” and invest in a way that truly makes sense.
We behave like mules for the same reason we behave like sheep. If you have the confidence to make an investing decision because of your personal confidence that it is the right way to go, you will likely have the grace to acknowledge that the decision was wrong if that turns out to be so. Decisions made in reliance on “experts” are hard to reverse because reversing them means acknowledging the flawed basis for the decision — it means acknowledging being a coward.
We run from life and we run from acknowledging that we run from life. Holy existential dilemma, Batman!
Why Smart People Make Big Money Mistakes — We Are Not Computers with Legs.
The idea of science is to explain the world as it exists. Too often the idea behind the junk that parades as science in InvestoWorld is to create imaginary worlds that are easier for the “experts” to understand than the real one that we actually live in. The authors observe on Page 34 that many economists believe that we should view money as fungible and thus are critical of our tendency to set up “mental accounts” of money being used for different purposes and subject to different money management rules. We’re right and the “experts” are wrong, this fine book tells us: “The average person, more self-aware, perhaps, than the average economist, knows that he or she is not as smart or as iron willed as economists maintain.”
Good for us! The experts do indeed go too far with their point. However, that doesn’t mean that they do not have a point worth considering. I don’t think we should apologize for setting up mental accounts. It’s a perfectly reasonable short-cut reasoning method to treat some money (retirement money) as more important than other sorts of money (vacation money). Still, it’s a plus to manage our money more rationally. By developing budgets and becoming more aware of where our money is going, we can more effectively direct it to the purposes to which we would most like to direct it.
We are not computers with legs and we should express the appropriate disdain for “experts” who treat us as such. There are some tasks that computers do exceedingly well, however. It is by combining the things that computers do well with the things that only humans can do well that we can come to be truly expert at the money management task.
Why Smart People Make Big Money Mistakes — Lacking Good Explanations, We Settle for Poor Ones.
Humans have a tendency to grasp for explanations for every puzzle. In a way, that’s a good thing. We are natural problem solvers and problems solved are lives enhanced.
The problem is that we are so driven to explain mysteries that we sometimes accept solutions that do not really make sense. I argue in my book Passion Saving against the common perception that our inability to save can be traced to our lack of willpower. I find this explanation insulting to the middle-class worker.
I was happy to see that the authors of Why Smart People Make Big Money Mistakes offer an alternative explanation of the saving problem on Page 39. The real reason why we find it so hard to save is that we tend to be cost-conscious only when making big spending decisions. We sweat a decision to buy a car or a house or a major appliance. But we tend to spend on small items like groceries and gas and movies mindlessly. These categories don’t seem like a big deal.
The reality, of course, is that it is the small everyday expenses that are the biggest deal of all. We spend only a small amount on each trip to the grocery store. But there are more opportunities to enhance the value proposition obtained from the money we earn by looking carefully at our spending on groceries than there are by looking carefully at spending on cars because we spend on groceries so much more frequently.
My suggestion is that we transform the small spending categories into a big mental deal by adopting saving goals of intense personal concern that we hope to achieve within a few years. What we need to do is to feel as dumb to make a mistake in our spending on groceries as we already do to make a mistake in our spending on cars.
We can stop beating ourselves up. It turns out that willpower doesn’t have much to do with saving.
Why Smart People Make Big Money Mistakes — We’re Rationalizers More Than Thinkers.
There’s a reason why every book in the bookstore isn’t a book on logic. Humans create novels and picture books and biographies and cartoon collections and all sorts of things other than logic books. Why? Because you can’t explain human behavior through the use of logic alone. We promise to love our spouses forever and yet we cheat. We pray for children and yet we let them down when they come. We owe everything to our parents and yet we resent them. We drink. We gamble. We pray. We hope. We overcome. We redeem ourselves and others.
We’re so complicated.
Here’s what Belsky and Gilovich say on Page 52: “The same outcome can often be described either in the vocabulary of gains or in the vocabulary of losses, and such unconscious and inconsistent coding has far-reaching effects.”
You want an example? Please take a look at the “Banned at Motley Fool!” section of the site. A visitor from Mars who thought that humans were a rational bunch might presume that the idea of a safe withdrawal rate study is to identify what withdrawal rates are safe. It seems logical enough, eh?
What we have found instead is that the idea of the Old School safe withdrawal rate studies was to persuade unsuspecting retirees that withdrawal rates that are high risk are safe. The aim of these studies is not to help aspiring retirees. It is to destroy their hopes of achieving safe retirements.
That seems crazy, right? Too crazy to be true, right? That’s because it is too crazy to be true. That’s because the money behavior of humans is too crazy to be true. Any money management model that presumes logic on the part of humans misses the point by a country mile. We have seen on our boards in recent years that there are all sorts of motives pursued by humans recommending financial strategies that have very little to do with money.
What possible motive could an investing “expert” have for reporting a high-risk withdrawal rate as a safe withdrawal rate? How about wanting to be popular with the people he advises? And what possible motive could investors have for wanting to be provided with false safe withdrawal rate claims? How about the universal human desire to get something for nothing, to believe that it is possible to see the sorts of returns provided by stocks in the late 1990s and to not have those returns paid for by those who invest heavily in stocks in the years that follow?
How you ask a question determines the answer you obtain to it. If we were all Mister Spocks, all safe withdrawal rate studies would report the number accurately. I think it would be safe to conclude after six years of The Great Safe Withdrawal Rate Debate that we are not all Mister Spocks.
Why Smart People Make Big Money Mistakes — We View Our Lives as Stories, Not as Balance Sheets.
Someone who made $50,000 last year and is making $60,000 this year is happy. Someone who made $70,000 last year and is making $60,000 this year is grumpy. It’s not so that $60,000 is $60,000 is $60,000. We view our lives as stories, not balance sheets. Going from $50,000 to $60,000 is Moving On Up to the Deluxe Apartment in the Sky. Going from $70,000 to $60,000 is one step away from being forced to move into Ralph’s and Alice’s apartment.
Here’s Belsky and Gilovich on Page 75: “People stay in unsatisfying careers because of the time and money they invested in school, not because they enjoy the work or expect to in the future; we finish a bad book because we’ve already gotten so far, not because we’re anxious to see how the characters live; we sit through a boring movie because we bought the ticket, not because it’s a good flick.”
Live your life by different sorts of stories. Keep three books at your bedside table and view them as being in competition with each other for your attention; get excited about the freeing up of an opportunity to read Book #2 that comes into place if Book #1 happily fails to make the grade. Identify things that you learned in school that help you in the career that really does turn you on; your years in accounting are the edge that is going to help you make it in the restaurant business, no?
Are you kidding yourself to go with the sorts of strategies I recommend here? You are. You’re kidding yourself in some way in any event; all humans kid themselves all the time. The trick is to gain some self-knowledge about how you kid yourself, to gain some power to control it, and to shape your self-kidding behavior in positive directions.
Here’s a secret: A sense of humor is essential to long-term success in your money life. Woody Allan captured the hearts of women he had no business asking to dance. Adopt a different take on things and you can attain financial freedom years sooner than you now think possible.
Why Smart People Make Big Money Mistakes — Human Inertia Is the Strongest Force on Planet Earth.
It’s hard to get people to do stuff. It’s hard to get them to visit a web site. It’s hard to get them to post to a discussion board. It’s hard to get them to buy a book. It’s hard to get them to change an investing strategy. I know whereof I speak re this one.
Belsky and Gilovich note on Page 96 that “whatever value you place on, say, a stereo at a store will likely be increased once it sits in your den for a few weeks.” Just as hard as it is to get you to buy, it’s that hard also to get you to return something you bought after you broke down and bought it.
What if we made it a habit to do things that are not habits? What if you made it a regular practice to read about political ideas you don’t agree with or to buy things with money-back guarantees with a strong intent to return them if they do not provide a good value proposition or to change some aspect of your daily routine each Wednesday? Human inertia is a powerful force. But it can be used for all sorts of purposes. It’s possible to become habitually unpredictable.
Why Smart People Make Big Money Money Mistakes — Even Our Attempts at Humility Cause Us to Become Overly Proud.
The book speaks favorably of both Index Investing (Page 208) and Value Investing (Page 195). Some see this as a contradiction. I do not. Investing in an index does not mean that you do not seek value in your investments; it just means that you like to assure value the easy way, through diversification. Those who feel that because they favor indexing they must stop thinking about the prices of stocks are the ones living a contradiction. Indexers talk all the time about how they avoid paying transaction fees. Transaction fees are generally tiny compared to the costs of ignoring prices.
The common theme is humility. Smart indexers acknowledge that there are benefits to picking individual stocks, but are humble enough to acknowledge that they lack either the time or skills needed to pick stocks effectively and thus settle for the “good enough” investing approach. Smart investors also acknowledge that prices cannot be ignored and are sure to adjust their stock allocations to reflect the change in the risk profile of stocks that takes place with significant valuation changes.
Picking stocks is smart if you really are one of those who can do it. If not, it only looks smart. Indexing really is smart for those able to acknowledge that it does not need to be superior to every other investing approach to qualify as a fine strategy and that valuations matter even for indexers. For conventional indexers, it only looks smart. Humans are too often drawn to looking smart over actually being smart (which is often the simpler and yet harder course — because it is the more humble course).
Why Smart People Make Big Money Mistakes — Smart Can Hurt As Well as Help.
List your three best decisions. Were those three decisions the product of intelligence? Or something else?
The book argues on Page 206 that: “Too much illusory information can be destructive,” noting studies that show that investors who tune out financial news do better than those who do not. How can having more information hurt? It can paralyze you, it can cause you to doubt things in which you need to have confidence, it can cause you to lose perspective.
Some people think that we should make decisions about dating and about raising children and about deciding where to live in more rational ways — that we should read more books on these topics and write out more lists of pros and cons of various options. I see it the other way. I think we need to become better able to rely on intuition when making decisions about saving and investing and career growth. We all “know” things that we do not know we know.
It is when we seek to rely only on what we know in a strictly intellectual sense that we create our biggest mess-ups. Smart people make big money mistakes because they are not as smart as they have come to think they are. There’s more than one way in which to be smart. We need to make use of all the forms of smartness when making decisions about how to make the most of our money, which are really decisions about how to make the most of our lives.