The Psychology of Money Chapter 12: Surprise!

Between the years 1800 and 2000, roughly 15 billion people were born. Consider how different the world would be if the following 0.00000000004% of those 15 billion had not been born.

1. Adolf Hitler

2. Joseph Stalin

3. Mao Zedong

4. Gavrilo Princip

5. Thomas Edison

6. Bill Gates

7. Martin Luther King

As we read in chapter 6 regarding tail events, there are a very small number of things that have an outsized impact. This is true with financial markets, and as we study the history of investing, we can see key events that had outsized impacts. The Great Depression, World War II, The Great Financial Crisis.

Most investors have at least a general notion of the fact that, historically speaking, financial securities have provided a return greater than inflation, that stocks have returned more than bonds, and that the US markets have generally outperformed global markets. Often this historical tendency is communicated in a forward looking manner, for example with the language “in the long run, stocks outperform bonds”, but it is important to note that this is an attempt to use the past to help us guess at what will happen in the future.

Housel warns: Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.

1. You’ll likely miss the outlier events that move the needle the most

2. History can be a misleading guide to the future of the economy and stock market because it doesn't account for structural changes that are relevant to today's world

To demonstrate point #1, reference the list of people above. 7 people changed the lives of billions, some positively and some negatively. There would be no way to miss out on bad market days without also missing out on good ones.

Regarding point #2, I’ll mention again my traffic example: If there’s a road that nobody takes and cuts your commute in half, as soon as everybody else starts using it, it is no longer a time saver. Financial markets are like roads that many, many people are trying to travel in the most efficient way. Only when we can accurately predict what every individual person is going to do, what consequences their actions will have (whether intended or not), how those consequences affect the next round of decisions, and how decisions add up to structural changes in systems and regulations can we predict what will happen in financial markets. If you find a way to do that, please give me a call 😉

So what are we to do? As we’ve said often, success in our personal finances comes down to how we behave. For this chapter, it’s not what we do but what we don’t do.

• Don’t build a plan that falls apart if new, never-before-seen, surprising things happen, since they often do.

• Don’t think that, because of the last surprising event (the Covid pandemic, for example), we’re now ready for the next surprising event. The next one will be one of the infinite events that we are not ready for, largely because they have not happened—yet!

Let us know

• From your perspective, do surprising events seem to happen more or less frequently now than when you were younger?

• What surprising event has largely affected your financial situation (whether positively or negatively)?

Until next time, happy reading!