An important distinction I like to make about personal finance is that it is simple but not easy.
An important way to look at the world is to distinguish things that are ‘simple’ versus ‘complex’ and ‘easy’ versus ‘difficult.’
Consider the distinction between running a marathon and flying an airplane.
Running a marathon is simple, but not easy. Ask anyone who’s tried it! The challenge of the marathon is not just the two (in extreme cases) to six hours on race day, it’s the weeks of preparation leading up to the moment. Any healthy person can prepare for a marathon in four to six months, provided (1) she decides it’s important and (2) does the daily training required. On race day, there are multiple possible outcomes ranging from a PR (personal record) to a trip to the hospital.
Flying an airplane is complex, but not difficult. It requires training, practice, mastery of multiple disciplines, and constantly re-learning all of these things. When the flight takes place, there is only one acceptable outcome: the plane lands safely at its chosen destination and everyone walks away. This cannot be difficult, because it happens about 100,000 times per day, every day of the year, around the world.
Some things look easy, but are actually quite difficult. Consider the case of the free throw (foul shot) in basketball. The target is stationary, there is no defense. All the baskets are exactly the same height off the floor and the exact same distance from the free throw line. Why does a professional basketball player, who is paid millions of dollars to do nothing else, ever miss a free throw?
Even more strangely, why do about 1 of every 4 free throws miss? So far in the NBA this season, 24.4% of free throws attempted are missed. Over the past 50 (!!) years, this is almost always exactly the case. Not only do they miss regularly, it appears they are not learning how to improve.
Or, perhaps, 75% is the upper limit of human competence at this function.
But back to personal finance. To repeat my initial thesis, it is simple but not easy.
Spend less than you bring in. Invest the difference. Prosper. Lather, rinse, repeat. Much like the NBA players above, what seems automatic is in fact elusive.
Research from Dalbar studies the relative performance of individual investors versus the performance of investments. The results are bloody.
Individual investors consistently fail to match the performance of index funds with their own investments, even after allowing for modest operational costs. This is usually the fault of performance-chasing: buying an investment product that has recently out-performed the market or its peers. Then, the same investment fails to out-perform going forward. The disappointed investor sells, and repeats the process.
It’s called “Buy high, sell low.” Simple, right?
On being rich
An important distinction I like to make about personal finance is that it is simple...