Book Review: How to Think About Money by Jonathan Clement
Clement seeks to simplify how we approach money. Money is confusing to many people, but at a basic level, building wealth is not complicated. “We save as much as we reasonably can, take on debt cautiously, limit our exposure to major financial risks, and try not to be too clever about our investing.” He gives five basic steps to make our money a source of satisfaction rather than an area of stress.
The first step is to spend our money carefully. Often, the things we think we want fail to bring lasting happiness. Being aware of this and focusing our spending on things that truly improve our lives can be powerful. We adapt quickly. This is good when we have major life setbacks, but it can be an obstacle when trying to spend money to get the life we want. A new big-ticket item is exciting at first, but quickly becomes part of our base level of happiness – or worse. It can become an added burden. Studies show that experiences produce more happiness than things. Experiences with others are even better. They create shared memories. Spending on other people brings more life satisfaction than personal consumption. Small, frequent purchases drive more happiness than large infrequent ones. Delaying purchases brings more happiness because we get to enjoy the anticipation. Lifestyle is relative. We naturally compare ourselves to those around us, which can drain our joy. We should be careful about the trap of stretching to be in a higher social circle, only to feel disappointed when we fail to keep up with our new peers. Clement warns against the long commute, which studies have found to be a large drain on happiness.
The second step is to bet on a long life. Clement suggests getting on track financially as soon as we can, saving up some money. When we are young, we are less likely to truly know what we want to do with our lives. Getting some savings established that can grow throughout our lifetime gives us flexibility later to change careers or to pursue other passions once we figure those out. For younger workers everything is new and exciting. As we get more experienced and cynical, it gets more difficult to work hard in job we find unfulfilling. Take advantage of those early years to build up nest egg. Over time, our focus should shift to what we find most fulfilling. We should try to find what puts us in the state of “flow”. Clement also suggests we invest for the long run, which means a commitment to stocks. As markets fluctuate, we will have opportunities to buy at attractive prices, and we will suffer through transitory declines in value. Over the course of our lifetimes, we should enjoy a nice return if we stick to the plan. Finally, we should be more concerned about living a very long time than about dying early. This mindset favors delaying Social Security as long as possible, and maybe even buying fixed annuities (for longevity insurance, not as an accumulation tool.)
The third step is to avoid the common money mistakes. Clement lists twenty-two common errors people make. Some examples are thinking there is safety in numbers (if everyone else is doing this, it must be ok), believing stories over statistics, rationalizing irrational decisions, thinking short-term, being over-confident and seeing patterns where none exist. These mistakes in thinking lead to mistakes in actions, which can be devastating. Even small mistakes made repeatedly can have big consequences. Success comes from doing the little things well, over and over. Clement suggests keeping our fixed spending low to make it easier to save, and then automating savings. When the money is out of our checking account, we are less likely to spend it. Not only will avoiding the big purchases (that would not have brought us as much happiness as we expected) help us to save more, but a lower cost of living will require a smaller stockpile for retirement.
The fourth step is to think big. Rather than compartmentalizing our lives, think of them holistically. This will eliminate some of the irrational decisions we make. Rather than insuring some risks and ignoring bigger ones, consider what our biggest vulnerabilities are. Rather than thinking of our assets and liabilities as completely separate, think of them in the context of each other. It may not make sense to carry a mortgage and hold lower-yielding bonds in our portfolio. It certainly doesn’t make sense to have interest-bearing debt and carry a large cash balance at roughly zero interest. Most importantly, people spend money on things that are unnecessary without taking care of the inevitable – retirement. Retirement is unique in that it can’t be paid for with our paycheck. It is also our biggest expense, and it is not necessarily discretionary. We should think of our lifetime earnings potential as our greatest asset, at least when we are young. As we age, the value of that asset diminishes by virtue of some of it being used up. Prudence demands replacing that with savings so that when we no longer are able or want to work, we can still take care of our needs. This does not mean we have to give in to the idea that we will do nothing. Clement notes, “Retirement should be redefined so that it is viewed not as a chance to relax after four grueling decades, but rather as an opportunity to take on new challenges, without worry about whether those challenges come with a paycheck.” As we get closer to financial independence, we can less afford for the value of our savings to swing wildly. If our goal is to replace a steady paycheck, bonds are the most comparable investment, as they pay a steady, predictable cash flow. Our portfolio should shift to bonds. We should also look to eliminate our debts – certainly any that carry a higher rate than the bonds we can buy.
The fifth step is to win by not losing. There are two ways to lose – the slow bleed and the quick death. Slow losses include investment expenses and taxes, little unnecessary costs, and not shopping around for big items, like a mortgage. Losing quickly comes from not insuring major risks like death or disability of the primary breadwinner, failing to diversify our investments, taking on too much risk at the height of a bull market and then panicking and selling at the bottom. Protecting ourselves simply requires insuring risks that could be devastating, paying attention to our investment costs, diversifying broadly, matching our portfolio construction with our individual needs, and sticking with a predetermined plan.
The book concludes with a brief recap – twelve admonitions. The last sums it up well: “The goal isn’t to get rich. Rather, the goal is to have enough money to lead the life we want. We shouldn’t put that at risk by incurring excessive investment costs, straying too far from a global indexing strategy and failing to buy insurance against major financial risks.” Following the advice of this book is simple, but it is not easy. It is worthwhile, however, and should lead to freedom, satisfaction and meaningfulness.