Good investing is not necessarily about making good decisions.
It’s about consistently not screwing up.
Applying the survival mindset to the real world comes down to appreciating three things.
- More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.
No one wants to hold cash during a bull market. They want to own assets that go up a lot. You look and feel conservative holding cash during a bull market, because you become acutely aware of how much return you’re giving up by not owning the good stuff. Say cash earns 1% and stocks return 10% a year. That 9% gap will gnaw at you every day.
But if that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year—it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.
Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.
- Planning is important, but most important part of every plan is to plan on the plan not going according to plan.
What’s the saying? Financial and investment planning are critical, because they let you know whether your current actions are within the realm of reasonable. But few plans of any kind survive their first encounter with the real world. If you’re projecting your income, savings rate, and market returns over the next 20 years, think about all the big stuff that’s happened in the last 20 years that no one could have foreseen: September 11th, a housing boom and bust that caused nearly 10 million Americans to lose their jobs, a record-breaking stock-market rally that ensued, and a coronavirus that shakes the world as I write this.
A plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality.
A good plan doesn’t pretend this weren’t true; it embraces it and emphasizes room for error. The more you need specific elements of a plan to be true, the more fragile your financial life becomes. If there’s enough room for error in your savings rate that you can say, “it’d be great if the market return 8% a year over the next 30 years, but if it only does 4% a year I’ll still be OK,” the more valuable your plan becomes.
Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right. Room for error—often called margin of safety—is one of the most underappreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes.
It’s different from being conservative. Conservative is avoiding a certain level of risk. Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher margin of safety, the smaller your edge needs to be to have a favorable outcome.
- A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And in fact you know it will be filled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is filled with landmines, and always will be. Those two things are not mutually exclusive.
The idea that something can gain over the long run while being a basket case in the short run is not intuitive, but it’s how a lot of things work in life. By age 20 the average person can lose roughly half the synaptic connections they had in their brain at age two, as inefficient and redundant neural pathways are cleared out. But the average 20-year –old is much smarter than the average two-year-old. Destruction in the face of progress is not only possible, but an efficient way to get rid of excess.
Imagine if you were a parent and could see inside your child’s brain. Every morning you notice fewer synaptic connections in your kid’s head. You would panic! You would say, “This can’t be right, there’s loss and destruction here. We need an intervention. We need to see a doctor!” But you don’t. What you are witnessing is the normal path of progress.
This Article is taken from The Psychology of Money
Written by Arshad. A