The right way to think about money is to focus on opportunity costs. That’s how Duke University behavioral economist Dan Ariely opened an interview late last year (https://www.cfainstitute.org/learning/products/multimedia/Pages/128000.aspx). That means that we should think clearly about all the possible alternatives we are giving up as a result of spending money on something.
Of course that is hard to do — or as Ariely says, “not humanly possible.” For each latte or pair of running shoes or automobile we are about to buy, there are far too many alternative uses of money for our brains to handle. We’re not capable of managing that much information. So the result is mistakes, mistakes, mistakes . . .
The list of the wrong ways to think about money is long. We drive to save $10 on a $30 item but not for a $200 item – even though it’s $10 out of our pocket either way. We buy a king-size bedspread that’s far too big for our queen-size bed because there’s a better sale on the king-size product. We end up with something inconvenient and that we don’t need (that’s actually something a behavioral economist — someone who studies irrationality professionally — admitted to doing in Richard Thaler’s book Misbehaving). We anchor ourselves to the prices we’ve experienced in the past even when they’re irrelevant today.
On top of that, we have a time horizon problem: We can think short-term but are bad at thinking long-term. We are good at focusing on short-term results because we have been hard-wired since cave days to survive by responding to immediate threats and needs. But we haven’t evolved to fully grasping consequences many months or years or decades out. The future is too distant and abstract.
If it were easy to think long-term, we would trade off instant gratification for greater future benefit all the time. We wouldn’t overeat. We wouldn’t overspend. We wouldn’t intend to start a diet next week. We would start now. We wouldn’t go for decent earnings results this quarter. We would aim for killer results and market domination in a decade. But as Ariely has said in another talk: “In the future we are wonderful people – but we don’t live in the future, we live in the present.”
Yet being able to think long-term is one way to win at a lot of things.
Jeff Bezos, the founder of Amazon, famously wrote about long-term thinking in his 1997 shareholder letter. In an interview in Wired, Bezos said: “If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”
And that’s the thing about investment too. The field thins out at longer time horizons. Heck, most investors aren’t even looking at a three-year horizon, let alone seven. For most it’s quarter to quarter or calendar year. But if you are one of those few who can think long-term, you will find that a wider, more interesting investment opportunity set that isn’t available to short-term thinkers opens up for you. You will end up playing a different game from everyone else — and it’s a great source of natural advantage to not be playing the game the rest of the investment industry is.