The Psychology of Money
Having more money will make you happier. Therefore having more money will give you more control over your time. If an individual wants to gain the amount of wealth that grants him/her to do what they want, when they want, and with whom they wish to, one must think differently about money and develop solid investing psychology. To build or master strong investing psychology, one needs to understand the three concepts of money, which most people fail to understand. These concepts may seem simple enough, but many intelligent investors fail to follow these concepts.
#1 Concept: Compounding
If I give you 2 dollars at the start of the month and double it every single day since the first day, how much money would you have at the end of the month? The power of compounding is not limited to doubling or tripling your initial investment. By compounding two dollars at 100% for 31 days, you would receive $4,294,967,296 on the 31st of that month. You can become a billionaire in a month. But if you delay the pattern of compounding by a week and start the same process at the start of the second week, you would receive $33,554,432, which is barely a portion of what you invested in the beginning. So by waiting just a week, you would bring home 99% less money. If this seems complex, Don't Worry. The human mind does not quickly grasp the power of compounding.
Warren Buffet is regarded as one of the greatest investors of all time. His net worth today is approximately 83 billion dollars, but did you know more than 80% of his 83 billion net worth was generated after his 65th birthday. Since the age of 11, Warren Buffet has received an annual average return of 22%, twice as good as the average stock market return. The primary reason behind Buffett's wealth is maximizing his time in the market to leverage the power of compounding. The first key to achieving financial independence is investing now with whatever small or significant contribution you can afford and keeping that money invested so that compounding can work its magic over time.
If you are ever tempted to take on risk and chase a significant return at any given point in time of the year, if you are wrong and lose 50% of your money in one year, you will then need to achieve a 100% return the following year to break even. When you watch your investment portfolio, for example, let's take the stock market portfolio fall by 40% in a market downturn, fear could most likely consume you and make you believe that you are going o lose all your money, so you better sell and wait for the market to recover. In such cases, it is imperative to develop the mental fortitude to weather short-term downturns to benefit from long-term uptrends and leverage the tremendous power of compounding. And this leads us to the second concept of money.
#2 Concept: Volatility
Volatility refers to the daily ups & downs in the market. Stocks are financial assets with high Volatility because the stock portfolio could swing in either way by a few percent on any given day. People who cannot handle the emotional ups & downs of the stock market or other volatile market (cryptocurrency) generally invest in low volatility assets such as bonds and investment contracts to achieve a steady return. If history has shown anything, no common volatility asset will outperform a stock market over an extended period. Volatility is the emotional price you need to pay if you as an investor want good returns. If you invest in something like an Index fund that constantly keeps adding growing and upcoming companies to replace the companies that are fading away, you can have a confident outlook over the long term trajectory of that index which is up and to the right regardless of how much Volatility that index experiences at any given point in time. If you own an index like the S&P 500, view the Volatility and the occasional dip as a fee for being in the market and getting the opportunity to receive high annual returns over an extended period.
One needs to view Volatility as a Fee, not a fine - Morgan Housel
#3 Concept: Tail investments
Jeff Bezos ex.CEO of Amazon made hundreds of small bets at amazon. One of those bets was Amazon Web Services (AWS), which started as a small side project and now brings in over 60% of amazon's operating revenue. This is known as a tail investment, a single investment that massively outperforms all other assets and makes up for several bad investments. Since it is impossible to know which investment will make huge returns and which will not, it is wise to spread out your bets. Instead of going all-in on one investment, make at least 8-10 equal investments in different companies, currencies, commodities, assets, etc. you could double in the next five to ten years.
You can be wrong half the time and still make a fortune - Morgal Housel
When it comes to money, it is vital to strengthen your investment psychology and remind yourself to use the magic of compounding, embrace volatility and make many diversified investments. To reap the benefit of money, make time your most significant competitive advantage.
References:
I got my references from the book "The Psychology of Money" by Morgan Housel. It is a great book that I read recently, and I highly recommend it to young investors and people who want to learn more about money and make sense of life's most important topics.
