On Money and Markets
Five things I’ve learned about people and finance this year
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I’ve been thinking about money lately.
After moving to San Francisco, my cost of living spiked significantly. Rent increased, student debt kicked in, and virtually everything became 30% more expensive. I also have an MBA, and feel some weird moral imperative to understand money more deeply than others. The fact that I work in Fintech doesn’t help the cause.
So I’ve been working hard to learn more and more about money. When I want to master something, I tend to spend a lot of time reading about it. Here are five things I’ve taken away from the books I’ve read this year:
Asset bubbles and bank runs are mirrored opposites, and both highlight the same point: crowd psychology makes us do silly, silly things.
We’re very, very good at creating positive and negative feedback loops. If enough people wear the same brand of shoes, you’ll feel implicit pressure to wear them as well.
This is true in asset bubbles: tech stocks in 2001 traded at ridiculous P/E ratios, untethered from their business fundamentals. In 2018, WeWork’s market cap peaked around $42 billion, more valuable than many of the skyscrapers they occupied.
This is true in bank runs: Silicon Valley Bank failed because of liquidity concerns, not solvency concerns. The business fundamentals were fine, but once depositors felt their cash was threatened, all bets were off.
This explains, in part, why the stock market appears inefficient from time to time.
Business school professors love the Efficient Market Hypothesis. People react to all public information quickly and efficiently. And whenever there’s a lag, smart people recognize good arbitrage opportunities. Mispriced stocks are quickly short-sold or purchased, bringing their price to something more appropriate. Hence, markets are efficient.
That said, things change when crowds do silly things. Crowds are powerful, carry a ton of momentum, and are often wildly irrational. When a crowd pushes stocks up or down, there’s nothing efficient about it. It’s happened before and will happen again.
None of this matters if you buy and hold.
Warren Buffet has said many times over: the ideal timeline to hold a stock is forever. Earnings grow, dividends grow, the value of the security increases. Every time you sell, you miss out on all future growth and earnings.
What this means: frequent buying-and-selling leaves money on the table. Every time you sell a stock, you lose its future growth, something which compounds in your favor. The best strategy is to buy it and let it rot.
If you do sell stocks, you’re probably selling the wrong ones.
There’s a tired trope in the stock market: buy low and sell high. It’s how you make money.
But for reasons we just unpacked: the last thing you should do to a high-performing stock is sell it. Corporate profits tend to grow, dividends tend to grow, and P/E ratios improve as a result. Each of these means that high-performing stock will become more valuable in the future. Selling leaves money on the table.
And for stocks performing poorly: we tend to hold low performers, even if there’s no hope that they pick back up in the future. We can’t stand the thought of taking a loss. But taking a loss means a tax break with less income to report, hence improving net financial position. Hence, hold the winners and sell the losers.
We make bad decisions, like the one above, because of the many biases we carry around.
You’re probably more sensitive to losses than you realize
You’re probably overconfident
You probably value the things you have a little too highly (compared to similar things others have)
You probably give sunk costs too much thought
You probably ignore base rates
You probably anchor yourself to irrelevant pieces of information
You probably don’t need another example, you get it.
This is all well and good, but this is more information about money than anyone really needs. All that really matters are the basics:
Save an emergency fund, 6+ months if you can manage it
Pay off all credit card debt
Take your employer’s 401k match
Invest the rest in index funds
Go have some fun
It is kind of like Act 1 Scene 7 of Macbeth:
Lady Macbeth (otherwise known as Lady FOMO) sitting there asking, "Art thou afeard to be the same in thine own act and valor as thou art in desire?" like not following every impulse makes you lesser.
At some point you have to say and believe "I dare do all that may become a man; Who dares do more is none"
A human cannot see the future, a human cannot divine fate, those who dare to pretend they are more than human distance themselves from others in a way that also distances them from enjoying human experience.