Why don’t most people become wealthy?
What does wealth even mean?
The definition changes depending on who you ask, but in this post, we’ll define wealth as having the ability to live your life without the need for income.
You’re wealthy if you can afford to live the life you want without having to work. Usually, this means you’ve turned your income into wealth by investing it in something that continues to grow or pay you money over time.
The process is pretty simple. Make enough income to save some of it and put it into a vehicle that generates money. This includes things like investing in stocks, buying real estate, and creating or buying a business that makes money without your need to be there.
Over a long period of time, this is achievable by most people. But it requires patience, discipline, and engaging in the right behaviors. None of those factors have much to do with your I.Q. Instead, you must become a master of your own emotions to make the process work. You need a millionaire mindset.
That’s right, the key to building wealth all starts in your head.
Human beings have flaws, biases, and belief systems that get in the way of the diligent process of wealth building. Let’s take a look at some of the most common biases and talk about ways to overcome them.
You can’t embrace a millionaire mindset if you’re (too) afraid to lose
Loss aversion makes you more sensitive to losses than you feel positive about making gains. This makes it difficult to invest because most investments experience periods where their value goes down. Sometimes, those investments go down sharply and quickly.
To become a good investor, you have to learn how to weather the storm and hold onto your investments when they experience losses. This can be tricky. Some stocks go down and never fully recover.
This is why most professional investors suggest buying and holding index funds instead of trying to pick your own. Or investing in something with more predictable returns like real estate. If you decide to build a business, you need to make sure you can handle losing the time and energy you put into it in the short term.
Even if your investments do recover, it may take a long time, even years, to fully recover. Some businesses never take off and you can lose everything. But unless you’re willing to lose sometimes, you’ll never win the wealth-building game.
Here are some strategies you can use to fight loss aversion:
- Never invest money you can’t afford to lose – Always use excess savings to pour into investments
- Understand your risk profile – Higher rewards mean higher risk. You can choose low-risk investments to reduce your potential for losses, but don’t expect to get rich quickly. You can build wealth quicker with riskier bets but fully understand the downsides.
- Understand what losing means – When you have an investment like a stock, you never lose money until you sell it. If your portfolio goes down, avoid ‘panic selling’ and locking in those losses.
- Prepare your mind in advance – Think about how you’d feel if your whole portfolio went down 30 percent right now. Could you handle it? You have to prepare for the ups and downs of investing before they happen.
- Always play a long time – Time tends to reduce risk. Take a look at a chart of the long-term performance of certain investments. Usually, you’ll see a long-term upward trend with temporary downturns along the way.
To the person with a hammer, everything looks like a nail
When you have a millionaire mindset, you do your research and understand your own motivations when it comes to investing. Any of us can be prone to confirmation bias—meaning you tend to stick to your current beliefs, even when new evidence contradicts them. When you make an investment, it’s important to have conviction in it because it helps when you experience those short-term losses I just mentioned.
But you can also hold onto a bad investment because you’re married to the idea of it. Does this sound tricky and counterintuitive? Welcome to the process of building wealth. There are no certainties. Sometimes it makes sense to stick with an investment and sometimes it makes sense to admit when you’re wrong. So how do you know which decision to make?
Whenever you’re making an investment, you should have solid reasons to back the investment. You can have many solid reasons to choose one. Maybe you invest in a business you believe in because it has solid profits and a ‘moat’ against competitors. Or you think it’s in an industry that’s set to explode in the coming years and decades. Perhaps you made an investment in a proven commodity that does well over time.
Your exact reasons and wealth-building plan don’t matter as much as whether or not you stick to it. If you have a plan based on certain factors and those factors change, you might need to re-consider. Let’s say you invest in a project because you believe it will become a profitable and solid business a few years from now. If the company is still underperforming years later, it might make sense to cut your losses.
Overall, you should always be willing to change your mind if the right evidence comes in.
Some ways to push back against confirmation bias are:
- Understand the ‘bear case’ for your investment – If you buy an investment, you’re ‘bullish’ meaning you think it will perform well over time. You should understand why some people are ‘bearish’ and think you’re wrong. You don’t have to believe their argument, but you should understand it.
- Try to pick your own ideas apart – In addition to listening to others, try to come up with your own reasons why your investment won’t work. If you do this and your investment idea stands the test, you’ll know you’re making a rational decision.
- Revisit your plan often – You should take time to check in on your plan once in a while to make sure it still makes sense given the current conditions. Don’t forget about or abandon your plan and simply hope for good results.
Good comes to those who wait
A crucial component for developing a millionaire mindset? Waiting. The desire for instant gratification, or hyperbolic discounting, is one of the biggest downfalls that keep people from building wealth. This bias doesn’t just impact your net worth, it affects your ability to achieve anything meaningful.
Take someone like Warren Buffet. For all his genius, his most useful trait is patience. It’s hard to spend five to six decades waiting for your money to grow, but it takes time to let the magic of compounding kick in. Most people could become millionaires if they stashed money away into safe investments for a long period of time. But, most people don’t.
The average retirement savings in America is only $172,000 for those age 60 and above. Often, people don’t realize how much time and money they squandered until it’s too late. Instead of saving money to invest, they spend it on things that make them happy now. When people start making more money, they tend to upgrade their lifestyle because they want to enjoy the money now.
You don’t want to live like Scrooge, but you also need to make decisions now that will help you build wealth in the long run.
How to resist immediate gratification:
- Spend consciously – It’s okay to spend your money on things you enjoy. To do it the smart way, plan what you want to spend in advance. Finance expert Ramit Sethi calls this “conscious spending.”
- Automate your saving and investing – Automation removes “decision fatigue.” Creating a set-it-and-forget-it strategy allows your automated plan to delay gratification for you.
- Wrap your head around compounding – Try actually looking up how much money you’d make in the long run if you executed your investing plan. You’d be surprised at just how large the numbers can grow. When you truly embrace that you will get rich in the long run, it’s easier to delay gratification in the short term.
People with a millionaire mindset are confident, not cocky
Greed can ruin you when it comes to building wealth. We get greedy because of over-optimism bias. Logically, we know taking on too much risk can create downfalls, but we always think we’ll be the ones to win. There’s a saying in Wall Street “Bulls make money, bears make money. Pigs get slaughtered.”
Greed causes you to make rash decisions because you want to make money fast. This ties in with the point about delayed gratification. Get rich quick schemes usually fail. It’s much easier to get rich slowly
It’s tempting to make risky bets when it seems like everyone is making money. But most ‘bubbles’ will pop eventually, leaving someone “holding the bag.”
Greed can also cause you to pile on even more risk than simply choosing risky investments. Take for example the man who took out a $20,000 loan to buy Gamestop stock when the price was soaring. He bought right before the stock cratered, leaving him with a loss on his investments and an additional debt he still owed.
Some tips you can use to fight greed and build a millionaire mindset:
- What goes up must come down – Consider how you’ll feel if you chase a hot investment only to see it crash and burn
- Be an investor, not a speculator – An investor has a plan and seeks to gain a modest return. Speculators treat investments like gamblers treat bets
- Monitor your emotions – Often feeling euphoric can be a sign it’s time to sell an investment or avoid jumping into one due to fear of missing out
- Stop moving the goalposts – How rich do you need to be, really? Do you need to be rich right now? Learning how to quit while you’re ahead is an underrated yet highly profitable skill
- Study history – If you study the history of investing, you’ll see countless stories of people who got greedy and got burned. Just like most gamblers, the stories of greedy investors almost always end badly.
When it rains, it pours
Charlie Munger, Warren Buffet’s business partner, once gave a talk discussing 25 psychological biases that cause you to make misjudgments. The talk includes many of the items mentioned in this post.
At the end of the talk, he talked about the most deadly bias. The lollapalooza effect.
This happens when you experience many different biases at once and the overwhelm causes you to make terrible decisions. We can tie the points we mentioned earlier into a story that could create this effect.
Say you start investing and you have strong convictions about it. The investment goes up, which causes you to get greedy and pile in more money than you said you would. Confirmation bias kicks in. The higher it goes, the more convinced you are. Then, it experiences a sharp decline and you sell the investment.
Now, you’re down on your money and the losses hurt badly. Loss aversion kicks in and the loss of the money hurts so bad that you’ll do anything to make it back. So, you choose a new investment in the hopes to make your money back quickly. You can’t delay your gratification and wait long enough to make up for your losses, so you start making riskier moves instead of just doing nothing.
By the end of it all, you go through an emotional rollercoaster that eventually causes you to give up altogether. You sell everything and tell yourself you’ll never invest again. A decade passes. The original idea you invested in pays off huge, but you didn’t get to reap the rewards because you exited the game.
How do you avoid this effect? You combine all the strategies we talked about and, with consistent discipline, you build a millionaire mindset. Above all else, you just wait. The hardest skill to learn for adopting this mindset and building wealth is the ability to do nothing—to be patient and give your wealth-building strategies time to actually work. There is no magical formula that will teach you patience.
You’ll have to go through periods where you struggle and make bad decisions based on your biases. But if you can find a way to recover and stay in the game, on a long enough time scale, you will become wealthy.