Updated: Jan 22, 2021
A realistic approach to building wealth
‘Investing is not the study of finance; Investing is the study of how people behave with money.’ - Morgan Housel
The mythical art of building wealth is often touted as a complex algorithm understood by few, entirely out of grasp for the majority of us, poverty-stricken ne’er do wells.
The truth is, from a more comprehensible, median wealth perspective, wealth building is a far more mundane task. The mythical algorithm we all crave… ‘save more than you spend and invest the rest’. Devastatingly boring, I know, but bear with me.
Firstly, there are a few misconceptions we will need to clear up. We all tend to have preconceived notions on what wealth is and what wealth should look like.
Morgan Housel explains this best in ‘The Psychology of Money’
“We tend to judge wealth by what we see. We can’t see people’s bank accounts, so we rely on outward appearances to gauge financial success. Cars. Homes. Vacations. Instagram photos”.
Financially speaking however, wealth is what you don’t see. It’s the cars not purchased. The diamonds not bought, and the holidays forgone. Financial wealth is technically the assets in the bank that haven’t yet been converted into the stuff you see.
But that’s not how we think about wealth, because you can’t contextualize what you can’t see.
When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire.
Accumulating wealth is definitely far less glamorous and instantaneously gratifying than spending all the money you have, no arguments here and highlighting much of this may seem obvious, but it is vital that you make the distinction between the two before we delve any deeper.
Wealth provides the financial freedom to make choices and provides you with options, but these options typically come at the direct expense of flaunting your cash (at least over the shorter term) so choose wisely.
So, where do we go wrong?
Only when we have shed our misconceptions and fully understand the type of ‘wealth’ we want to achieve can we start to take a more rational approach towards accumulating it.
Keeping up with the Jones’
Many of us convince ourselves that the wealthy have accumulated such opulence from family fortunes or got lucky on some superstar unicorn stock investment that made them millions. Of course, these are the ones we focus on, the outliers, the 1% of the 1%. Textbook human behavioural fallacy to overweight the relevance of the extremes. However, the reality is, the vast majority of those we would deem to be financially wealthy have achieved this by patiently and consistently following a well-worn investment path.
Stop obsessing over what has been
We all obsess over the fabled ’20 bagger’ and understandably so, who doesn’t want to sit back and watch their original $5,000 investment turn in to $1,000,000. We are bombarded with endless headlines along the lines of
‘this is how much you would have made if you invested in ‘x’ when it went public’
all the while, brazenly assuming we would have sat through the interim volatility. An easy assumption when you know the positive outcome. We all marvel at the heroic rise of Amazon to the upper echelons of the mega cap world as we sit on the sidelines mumbling something about a friend of a friend who knew a guy who told you to invest in it 25 years ago, all the while blindingly ignoring the fact that Amazon lost 93% following the tech crash in 1999 because, well, that takes the gloss off the story. Amazon isn’t alone in this, virtually every company’s success is littered with periods of incomprehensible volatility that the vast majority of us mere mortals wouldn’t have had the stomach to stick out, but we convince ourselves otherwise because to dream is more fun, right?
In short, a far more worthwhile approach is to stop dreaming, put practical steps in place to build wealth today, stop thinking about what could have been, and start focusing on what can be. Sure, there are opportunities you have missed, but the probability is, you are likely to lose more money waiting for a stock to pullback than you will from buying at the top.
As the Chinese proverb goes,
“The best time to plant a tree was 20 years ago. The second-best time is now”.
You are likely looking back now, thinking of the opportunities missed in the market over the last few months and what could have been. Stop dwelling on the past, put steps in place so that history doesn’t repeat itself because if you don’t, an older, more wrinkled you will be cursing the present you for your inaction.
So, where do I start?
Of course, it is not as easy as just throwing your money into the stock market and coming back in 20 years to collect your winnings, if it was, I’d be out of a job. The point I am trying to make with all this is, good investing isn’t about who appears wealthiest or searching for the highest one-off return; it’s about earning solid returns that you can stick with for an extended period of time.
In order to build a portfolio that you are willing to hold through the inevitable pits and troughs of various investment cycles; you will need to have an investment plan that suits you.
Clarity around your investment plan
Your plan, your needs, not anyone else’s. The more understanding you have around your own investment needs and goals, the higher the probability of you sticking with it through short term fluctuations as you will be able to focus on your underlying longer-term goal as opposed to the current volatility.
Risk tolerance: To create an appropriate investment plan, you will need to firstly ascertain your own risk tolerance. (the level of risk you are willing to take). Overestimating this will have you jumping ship at the least opportune time, and underestimating this will likely leave you disappointed with your portfolio returns over time. Everyone is different so take some time to realistically analyse what range of losses you can comfortably be exposed to both physically and mentally. It is crucial that you don’t overlook the latter, just because you can physically survive a significant decline in your portfolio doesn’t guarantee that the mental anguish from watching your assets decline won’t spur you into unnecessary action, ultimately deviating from your original plan.
Time Horizon: Figuring out your own time horizon is vital. The academics of the world will tell you that starting your investment portfolio when you are about five years old and only touching it moments before your death is the most optimal way to build portfolio wealth. Of course, theoretically, through the magic of compounding, they are correct, but this approach isn’t exactly practical. It doesn’t lend itself very well to our ever-changing goals and needs. College, starting a family, buying a house, changing career, retirement, all these are financial milestones that will invariably adjust your financial situation, so be aware of your long-term financial plan but be mindful that these goals may need to be adjusted somewhat as your priorities change along the way.
Creating a diversified investment plan that is conducive to you personally will ultimately put you in the position to achieve a much more attainable and probable wealth target. Given the choice, I know I would choose financial freedom in reality over unprecedented riches in my dreams, so for now, focus on the prior instead of wasting all your time daydreaming about the latter.
Just my two cents