In the world of personal finance and investing, many believe that it’s all about math. Still, while mathematics plays a powerful role, in Morgan Housel’s recent book, The Psychology of Money, Housel argues that finding financial success is more a lesson in psychology than in mathematics.
Housel believes that it is better for investors to be quite reasonable than frankly rational because, in the end, behavior and emotions end up causing much of an investor’s success or downfall.
To demonstrate his point of view, Housel tells the story of Julius Wagner-Jauregg, a 19th-century psychiatrist who won the Nobel Prize in Medicine for his work in treating neurosyphilis.
Wagner-Jauregg specialized in patients with severe neurosyphilis, who had a survival rate of about 3 out of 10 at the time. Through his work, he began to recognize a startling result: patients with high fever due to a separate disease seemed to have a better chance of survival. So he started testing his theory. Wagner-Jauregg began injecting patients with mild strains of typhoid, malaria, and smallpox to induce fever and fight syphilis.
As you can imagine, this was an incredibly dangerous trial and many of the patients treated died. However, after much trial and error, his intuition was confirmed.
Wagner-Jauregg had set his sights on a mild version of malaria that he could easily treat after a few days of high fever. He later reported that “6 out of 10 patients with syphilis treated with ‘malaria therapy’ recovered, compared with 3 out of 10 patients left alone.”
Housel writes about the impact this advance had at a time when fevers were feared and misunderstood. He says: “… Wagner-Jauregg faced something. Fever is not a casual ailment. It plays an important role on the road to recovery of the body. We now have better scientific evidence on the usefulness of fever in fighting infection. Increasing body temperature has been shown to decrease the replication rate of some viruses by a factor of 200 “.
But, laments Housel, this is where science ends and reality takes over. Even today, fevers are mostly seen as a bad thing and are usually treated as quickly as possible to get rid of them.
If we know that fevers are an essential piece in the fight against disease, why are we so quick to treat them?
Housel says it’s simple: “Fever hurts. And people don’t want to get hurt.”
“The goal of a doctor is not just to cure diseases. It is to cure diseases within the limits of what is reasonable and tolerable for the patient … It may be rational to want fever if you have an infection. But it is not reasonable.” keep on.
This same logic applies to your money: it doesn’t matter if you’ve found the mathematically optimal investment strategy; if it doesn’t allow you to sleep at night, don’t cling to it.
Housel writes, “What is often overlooked in finance is that something can be technically true but contextually meaningless.”
Despite being a totally rational and mathematically optimal strategy, no investor will be able to withstand volatility.
He goes on to say, “Researchers argued that when using their strategy ‘the expected retirement wealth is 90% higher compared to life-cycle funds.”
“It’s also 100% less reasonable.” House removals.
For those who want to come up with a reasonable financial plan that resolves to sleep well at night, here are some keys to keep in mind.
Humans are connected to prevent losses and some are stronger than others.
Part of a successful financial plan comes down to understanding your risk tolerance. Risk tolerance is your ability to withstand the ups and downs of a market while still sleeping well at night. Markets are rising and falling, and as an investor, you need to be mentally prepared to deal with this volatility.
The benefits of a financial buffer often outweigh the drag of inefficiency.
From a mathematical point of view, cash and bonds are usually not the most efficient use of capital at this time. That said, they are less volatile than stocks and allow investors to create some stability in their financial plan. During lean years or in a low market, they can be as valuable as oxygen. Investing in 100% stocks may be the most rational strategy, but it is not always the most reasonable.
Invest in things you love.
Among investment professionals, there is a common opinion that you should be detached from your investments: you will be willing to cut ties and jump if something goes wrong. On the other hand, keep this in mind: if you invest in things you love, you’re more likely to keep it through the tough years rather than sell yourself at the first signs of trouble. This allows you to maintain the total investment and capture the returns that can follow.
TrueNorth Wealth is here to help.
If you are interested in developing a reasonable financial plan that matches your unique goals, we are here to help.
At TrueNorth Wealth, one of Salt Lake City’s leading wealth management companies, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by combining our clients with a professional dedicated to CFP® with the support of an amazing team. We understand that it can be a challenge to maintain a long-term investment mindset, which is why we help our clients create an investment strategy that matches their risk tolerance and specific goals.
For our TrueNorth team, this is so much more than money. It’s about caring for families across Utah and helping them achieve freedom and flexibility in their lives. For more information or to schedule a free consultation, visit our website at TrueNorth Wealth or call (801) 316-1875.