Financial Success Luck or Skill?
As a financial advisor, I am often surprised by how much money some of my clients who don’t earn much have built up, and how little capital some clients with huge incomes have managed to amass. How is it possible that a client who has been a teacher for all of his working life can have 10 times more capital accumulated than a client of the same age with a professional finance qualification and an income four times higher than the teacher?
After analysing many cases of people with no financial background and limited income, building much more capital than people educated in finance with large incomes, it is clear that financial success (the building up of capital) is a lot more about how people behave than it is about knowledge of the right and wrong investments. It is actually quite simple, no matter how much you earn if you spend more than you earn, you cannot build up capital. Disciplined monthly saving along with the incredible power of compound interest is normally what separates the financially successful (those that can comfortably retire) from the failures. It must be remembered that we are talking about a normal investor who earns a monthly salary, can’t sell his business for a fortune, or rely on inheritances or family Trusts (or the lottery) to make their financial plans succeed. It has often been stated that those who understand compound interest, “earn it”, and those who don’t, “pay it”. So we see that financial success is more often than not a matter of behaviour rather than skill or hard work.
One of the problems in our society is how we measure success. We measure success by what we can see. We can see the flashy car, the designer clothes, the overseas holidays on Facebook and Instagram, the fancy restaurants and the beautiful houses. We can’t see the bank balances, credit card debt, the overdraft facilities and the lack of “real” assets.
Whilst our normal psychological reaction when confronted with a dangerous situation is either “fight” or “flight”, when working with financial psychology our primary responses are “fear” and “greed”. “Fear” and “greed” override our rational thought processes and cause the average investor to buy when prices are too high (i.e. they have done very well in the past) and sell when prices are low (i.e. they have done badly in the past).
Linked to this fear and greed, and almost as important, is the fact that especially as South Africans we love bad news. The person who focuses on the pessimistic side of life is seen as an intellectual realist whilst the person who focuses on the positive side of the news is often seen as an idealist who has been smoking something illegal. This over emphasis on bad news is one of the major causes of poor financial decision made by individuals. The easiest way to override this fear and greed is to have a plan and to stick to it. Sometimes portfolios will do well and sometimes they will do badly, but by allowing long term compounding to work its magic, your chances of building capital are much higher than chopping and changing your investments based on the most recent flow of news (fake or real).
So how does the average man in the street build wealth?
- Spend less than you earn
- Don’t get caught up in the signs of wealth (cars, holidays, clothes etc.)
- Have a plan and stick to it by ignoring the noise
- Let compound interest work its magic over many years. I heard a recent stat that Warren Buffett created 98% of his current wealth after the age of 50.