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Sticking to a long-term financial strategy doesn’t just require you to understand the mindsets above—it also requires you to know how the information you encounter affects your decisions so that you can make better decisions. In this section, we’ll share Housel’s two lessons that help ensure you pay attention to the right information: Know your personal financial goals, and be careful what stories you believe about money.
In Chapter 16, Housel argues that one way to ensure you pay attention to the right information is to know what financial goals matter to you personally so that you don’t get caught up chasing the goals of other people. ****In other words, ****don’t get caught up in a herd mentality chasing investment opportunities that lots of other people are chasing, just because others are doing it.
Housel explains that when you know your financial goals, you can ignore irrelevant information that might lead you to make poor decisions, such as basing your financial moves on others’ actions, and thus you’re able to make better financial decisions and better protect your financial health.
To demonstrate the risks of paying attention to the wrong information, Housel points to the economic devastation caused by bubbles. A bubble is an economic situation where an asset price becomes significantly higher than the asset’s actual worth. It causes harm, Housel argues, because during a bubble, long-term investors base their financial decisions on information they don’t realize is only relevant to short-term traders.
Housel explains that in a bubble, short-term traders set the price of an asset class: They see an increasing asset price and purchase it, assuming it will continue to increase. Their purchase pushes the price up more, which attracts more short-term traders—until most of the people invested in a particular asset class are short-term traders, which is when the bubble forms. When this happens, the price the short-term traders are willing to pay for an asset becomes the only price at which it’s available.
Housel explains that this price is reasonable for a short-term trader but not reasonable for a long-term investor. A short-term trader who cares only that the asset price rises in a few hours or days can reasonably purchase assets at a much higher price than a long-term investor, who wants any asset she buys to continue increasing for decades.
(Shortform note: So how do you determine what is a reasonable price for an asset? Housel doesn’t recommend a formula, but one way is to follow the 50/30/20 budgeting strategy: Spend 50% of your take-home pay on what you need, 30% on what you want, and 20% on savings and debt. With this strategy, you wouldn’t invest in any assets that cost more than your 20% savings budget for the month.)
Unfortunately, long-term investors often don’t realize that the asset price available in a bubble doesn’t make sense for their own goals. They mistakenly assume that since others are buying at that price, they should also buy at that price. When the bubble inevitably bursts, their long-term plans suffer dramatically.
How the Information Age Impacts Our Investing Decisions
Past bubbles—like the dot-com bubble Housel discusses—mostly occurred before the Internet was widely available: People got limited information from the radio or TV. But we now have constant access to unlimited information: How does this affect our experience of bubbles?~~ ~~
~~> ~~In some ways, the Internet has made bubbles more dangerous for unsuspecting investors. Experts note that bubbles are bigger and faster than they used to be, partly because investing apps make it easy to invest. They add that novice investors are often drawn to the market via social media posts about investing. These posts are often irrelevant to the novice’s goals—so if she doesn’t do extra research, she may risk more than she can afford to lose.
However, the Internet may also have made us less susceptible to bubbles. Experts explain that we’re now better at filtering out irrelevant information—so long-term investors may be better at ignoring what short-term investors are doing. Furthermore, as personalization algorithms dominate news apps and social media, we encounter mostly information we already care about. If you’re not interested in investing to begin with, you may be less likely to encounter information about a developing bubble and thus less likely to fall for one.
To avoid a similar fate, Housel argues, you must be consciously aware of your financial goals so that you can pay attention to the right information. One strategy Housel recommends is to write a mission statement for your finances. Ask yourself: How long are you going to invest your money? What do you think is going to happen over that time? What risks are you willing to take?