Human Nature has been on my mind lately because I’m in the middle of an Audible book, The Laws of Human Nature, by Robert Greene. I can’t enthusiastically recommend it—it is an unusual book and unusually long (over 28 hours), and the paperback is 624 pages. It is, nonetheless, an interesting take on the laws of human nature that, whether we know it or not, shape most of our actions.
My main objection to Mr. Greene’s book is his overly pessimistic interpretation of the motivations or interpretations of human behavior. I believe he writes through the lens of someone who does not believe noble causes, intentions, or good deeds ever exist altruistically. I don’t think Mr. Greene could accept a simple “good morning” without attributing the salutation to a devious, power-hungry human’s attempt to lower your defenses so as to rule over you. His book can sometimes be very dark—Machiavelli would be proud. But, thanks to my father’s influence, I had to finish the thing since I had paid “good money” for the book.
But this is a financial newsletter, not a book review. So, let me move on to how human nature affects our financial planning and investing. In short, it has been the ruin of many a good plan. Actions that kept our species safe and alive on the Serengeti don’t help with the personal financial balance sheet.
Human Nature has molded our thoughts through the natural selection of over 12,000 generations. We have evolved into deep-thinking and rational animals that intensely dislike uncertainty and love comfort, i.e., air conditioning. As a group, humans do not like events that are out of our control. That rustling in the bushes at night drives us crazy. Well, you know what else drives us crazy? A falling portfolio value.
Natural selection explains the rustling bushes example—but the falling portfolio value—not so much. Where else in our economic brain do we not perceive value in lower prices? That new truck you’ve had your eye on just dropped in price- there is too much inventory at the dealer—excellent, high-five, I’m buying it. The grocery store offers a buy one, get one free sale on a seldom needed product—clear the shelves.
Oh, but look, that excellent company that represents 5% of our IRA portfolio just dropped in price because Japan raised its intrabank interest rates? Well, I guess the sky is falling; I’m selling! Remember—lower prices mean better value in almost everything, including equities. Side note: Bank of Japan’s interest rate changes are irrelevant to anything we do here.
This behavior is understandable while still being irrational. It’s Human Nature, or better understood by me, instinctual. As humans, we rue our losses much more than we value our wins. If our prehistoric tribe allowed uncertainty and risk into the camp, it could spell disaster. But if we nabbed our antelope that week, that was a win, but it was to be expected.
In their Noble Prize-winning thesis, Prospect Theory (1979), a couple of Psychologists (Kahneman and Tversky) asserted that contrary to modern economic theory, which posits that humans will act in their own best interests, when it comes to avoiding losses, we are about twice as upset at losing as we are happy about winning. Preventing a loss is emotional rather than rational thinking.
We could go on and on about other ways we sabotage our financial futures; the examples are endless. Just imagine the consequences of our need for immediate gratification on long-term success. This newsletter, thankfully, is not endless, so we can’t list them all. (No wonder Mr. Greene’s book is 627 pages.)
The overall effect of our instinctual behavior as investors is not good. Not good at all. And the thing is, we have known about this flaw for a long time. This is nothing new—it is just one of the Laws of Human Nature—did I mention I’m reading a book by that title?
Anyway, I could show endless graphs, charts, and spreadsheets, showing every market downturn in the last 100 years and how things would have been so much better if only people had simply done nothing. I know, it’s easy to invest retroactively—and if we could, we would. But we can’t. Though we can acknowledge our instincts and use them when, for example, we feel an intuition regarding a threat to our safety, we can also use our rational brain when saving and investing for our future.
Practically, how do we do this—make use of our rational brain? Well, we need a system, and a plan. My system—for my accounts is easy; I never sell. I only buy. First, we only buy with money we don’t need in the next few years. Then, we like to invest in companies, ETFs, and mutual funds, in which we understand their product (mostly), strategy, and management, and then once we buy it, we never sell. I prefer that they pay dividends—and when I can, I reinvest those. (Remember compounding—”never interrupt it unnecessarily,” Charlie Munger.) When rebalancing, we buy whatever is falling behind, knowing they will have their day in the sun.
I aim to supplement my retirement income with the portfolio dividends and distributions. The higher the portfolio value, the less money is a concern. (Though, in the back of my mind, I know that someday I’ll do something irrational that might cause me to sell an asset—think, buying a boat.) If I need to sell something to clear up cash, I’ll be kicking and screaming all the way to the terminal.
Here are some things to calm your mind about your plan to achieve your goal of financial independence.
- The plan is effortless. We reap the portfolio dividends and the distributions with absolutely no physical effort. We’re not working for a paycheck unless we want to.
- The plan has always worked so far. If you care about history—check out the growth in the DJIA or S&P500 over the last 20 years. It’s awe-inspiring. (By the way, my 20th anniversary of financial advising is nine months away—coincidence? ..)
- Market gyrations happen all the time—they are upsetting, sometimes jaw-droppingly brutal, and the catalysts are widely varied. These events cause panic selling, and you know what? Panic sellers constantly enrich someone else—we want to be that someone else!
- Lastly, we don’t know how long we’ll live—but if we never sell—without lifting a finger, we’ve created multigenerational wealth and financial assistance for our family.
That’s my plan, and if I invest your money, I have a good idea of your plan, too. When there’s a system, where there’s a plan—we don’t have to listen to those irrational, prehistoric mumblings in our head about how this time it’s different because, rationally thinking, historically accurate, it is never different.
Thanks for reading—I do appreciate it. MK
