The Psychology of Money

A tendency to adjust to current circumstances in a way that makes forecasting your future desires and actions difficult, resulting in the inability to capture long-term compounding rewards that come from current decisions.

Every five-year-old boy wants to drive a tractor when they grow up. Then you grow up and realize that driving a tractor maybe isn’t the best career. So as a teenager you dream of being a lawyer. Then you realize that lawyers work so hard they rarely see their families. So then you become a stay-at-home parent. Then at age 70 you realize you should have saved more money for retirement.

Things change. And it’s hard to make long-term decisions when your view of what you’ll want in the future is so liable to shift.

This gets back to the first rule of compounding: Never interrupt it unnecessarily. But how do you not interrupt a money plan – careers, investments, spending, budgeting, whatever – when your life plans change? It’s hard. Part of the reason people like Grace Groner and Warren Buffett become so successful is because they kept doing the same thing for decades on end, letting compounding run wild. But many of us evolve so much over a lifetime that we don’t want to keep doing the same thing for decades on end. Or anything close to it. So rather than one 80-something-year lifespan, our money has perhaps four distinct 20-year blocks. Compounding doesn’t work as well in that situation.

There is no solution to this. But one thing I’ve learned that may help is coming back to balance and room for error. Too much devotion to one goal, one path, one outcome, is asking for regret when you’re so susceptible to change.