“Every investment is valued by taking a number from today and multiplying it by a story about tomorrow.” Morgan Housel-The Psychology of Money
The stories about what you expect the future to look like create a framework for how you make financial decisions. What things do you think will remain the same in the future? What are the things you believe will change?
I have heard hundreds of different stories from clients over the years about how they think the future will unfold. Mostly, stories are a way to smooth out the range of possibilities that surround your decisions.
What you believe will happen in the future is heavily influenced by your recent experiences, the groupthink spewed out by the financial media and your overall comprehension of economics.
WHY UNDERSTANDING ECONOMICS MATTERS
Are your stories about the future economic fairytales? Here’s a quick test. Think about your investment decisions in the past. Did all of these decisions work out just like you planned? If not, do your stories about the future acknowledge this uncertainty, or do they portray the future with only positive outcomes?
The better you understand basic economics, the better your financial choices will be. Professor Per Bylund in his excellent little primer How to Think About the Economy defines economics as “the concept of human action as purposeful behavior.” When you make an investment decision, you want something good to happen. You are trying to achieve something.
All of the stories that support your investment decisions rely on some form of economic reasoning. From simple to complex, financial choices boil down to what these economic exchanges mean to you and the others participating in the transactions.
Perhaps you have decided it’s time to sell an investment because you’re sanguine about the future. The buyer of the investment you are selling is making the opposite decision because she thinks the future is bright. This exchange happens because your story about the future differs substantially from hers. Each of you is trying to take purposeful action that will produce a future gain. You receive something that you value, (money), while the buyer obtains something she values, (the investment).
HOW YOUR STORIES REFLECT YOUR OUTLOOK
Your stories about the future usually contain either an optimistic or pessimistic theme. Economic and financial market history reflects that things get better for most people most of the time. However, pessimism is much more common. Somehow, pessimistic narratives appear to be smarter and more practical, even if they rub against the grain of history.
Optimism doesn’t mean you believe everything will work out every time. It’s just an acknowledgment that over time the odds are in your favor, even if the path contains many obstacles and setbacks.
By analogy, think about traffic signals with their green (optimistic), yellow (caution), and red (danger) lights. If your destination involves traveling on streets with traffic lights, you understand that sometimes you will come upon red lights. In your financial life, there will be times when you experience mostly green lights and other times when you encounter red signals. Markets mostly go up, but over time include both up and down periods.
Your stories can be powerful fuel for your financial future. Your stories can also be a major obstacle to accomplishing your goals. Be careful with the stories you carry around in your head. Just because you want the story to be true, doesn’t mean it’s actually true. Markets adapt and innovations occur. Make sure your stories about the future reflect these truths. Start there. Ready for a real conversation?
Related: Are Your Investments Fashionable?