Compound interest is merely one example of an exponential function. Human beings have great trouble thinking in exponential terms. It is far easier to think in linear terms and, because this is our natural instinct, most people vastly underestimate the power of investing over a long lifetime. Compounding takes a long period of time to work its magic and we live in a society that prizes instant gratification above all else.
Part of getting older is gaining insight into the reality that living a good life has far more to do with factors such as health and family that simply cannot be purchased with money. However, money is definitely a prerequisite for living a secure life. Since poverty almost always guarantees misery and since anyone in the middle class or higher can easily attain financial independence over a lifetime, there is no excuse to persist in irresponsible spending. Your future self will thank your present self for being prudent and sensible.
Tag: finance
“Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same.”
Dean Williams:
One of the most consuming uses of our time, in fact, has been accumulating information to help us make forecasts of all those things we think we have to predict. Where’s the evidenced that it works? I’ve been looking for it. Really. Here are my conclusions: Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same. And when it comes to forecasting—as opposed to doing something—a lot of expertise is no better than a little expertise. And may even be worse. The consolation prize is pretty consoling, actually. It’s that you can be a successful investor without being a perpetual forecaster.
We have security analysts. We get research reports from brokers. We get forecasts about the economy, interest rates, the stock market. We process that information and act on the basis of it. For all of that to make any sense, we all have to believe we can generate information which is unknown to the market as a whole.
There is an approach which is simpler and probably stands a better chance of working. Spend your time measuring value instead of generating information. Don’t forecast. Buy what is cheap today. Let other people deal with the odds against predicting the future.
“Trying Too Hard”, Financial Analysts Federation Seminar 1981 [PDF]
Beznalichnye
David E. Hoffmann, writing in The Oligarchs: Wealth And Power In The New Russia:
The Soviet system also had another kind of funds, known as non-cash, or ‘beznalichnye’. This was not banknotes or coins, but a kind of virtual money that was widely distributed as government subsidies to factories. The ‘beznalichnye’, or ‘noncash’, existed only as an accounting unit. A factory would be transferred subsidies in beznalichnye, which it would record on its books and might use to pay another enterprise—but it was not something you could put in your wallet.
The key dilemma for a factory manager was that the system was rigid: mixing the two kinds of money was prohibited. The factory manager was not allowed to take the beznalichnye and turn it into real cash. Both kinds of money were controlled by Gosbank, the official state bank, and by the central planners.
However, factory managers almost always needed more cash than they could get out of the system. The supply of cash was tight, but the supply of beznalichnye was very plentiful — maybe because there was not much use for it. The result was an imbalance in the value of the two kinds of money. Cash was much more valuable and sought after. By some estimates, a cash ruble was worth ten times a noncash ruble.
This imbalance was an invitation to huge profits. Someone who figured out how to turn the beznalichnye into cash would make a fortune. The planners’ greatest nightmare was that someone would do this and pump the relatively worthless state subsidies into real cash rubles.
Guess who figured it out.