One of the key differences between socioeconomic classes is how we view money. For example, psychologists have long noted that wealthier people prefer to spend on experiences (e.g., holidays, concerts, sports), rather than material items. In the field of finance, it’s long been known that the wealthy also perceive the notion of risk differently – that’s why someone with the wrong mindset, such as a lottery winner who isn’t financially literate – tends to lose the money even if they have it. For both Financial Advisors and their clients, it’s important to identify productive ways of viewing money:
Poorer people are sometimes taught to pride themselves on poverty and struggle; and to view the pursuit as wealth as something selfish or decadent. Talking about growing money, investing, side-businesses, etc. may be seen as materialistic and unhealthy.
In reality though, financially successful people are seldom driven by simple greed. Instead, their interest in money comes from a place of compassion, or responsibility.
They understand that people who can’t make enough money to look after themselves become a liability to their loved ones.
The motivation to make money isn’t to buy bigger condos, nicer clothes, or the latest gadgets (although those are side-benefits). Rather, the motivation comes from questions such as:
● When my parents grow older, how can I afford to look after them if I don’t even have enough for myself?
● If I lose my job or can’t work, will my family have to bear the costs?
● Who pays for the luxuries I enjoy in life, and how much does it burden them?
It’s helpful to reframe our perspective on money matters, and see topics such as investment or wealth accumulation as an act of care. If we insist on associating wealth with negative notions like greed, decadence, or shallowness, it discourages the pursuit
of financial literacy.
If you need to educate yourself or a client on financial matters, this is a more beneficial perspective. Focusing on “what cool things we can buy” tends to provide only short-lived motivation, and can result in unhealthy spending habits.
When it comes to risk appetite, financially successful people are on a bell curve. Studies show that the wealthy take higher risks when it comes to small amounts, but lower risks as the amount grows.
A multi-millionaire may, for instance, be willing to stake $10,000 on starting a new business venture. But this same individual could become extremely conservative with a $5 million portfolio, and allocate only to defensive, low-risk assets.
The behaviour of poorer people, on the other hand, seems to be the opposite. Someone with only $50 to their name, for example, is more likely to be stingy about risking even $5 or $10 (not surprising, as it’s a big portion of what little they have). However, they’re more likely to make an all-or-nothing gamble, such as betting all $50 on 4D tickets for a “big win”. When it comes to larger amounts, poorer people tend to take bigger risks than wealthier people.
One reason why this benefits the wealthy is that, consciously or otherwise, they tend to get outsized rewards for the risks they take.
For example: the wealthy may put 95 per cent of their assets in low-risk, low-return assets; like a simple savings plan. However, the remaining five per cent go into highly risky and volatile ventures, like a side-business, or exotic alternatives like wine and fine art.
If the volatile alternatives outperform (higher risks bring higher rewards), the wealthy then obtain outsized returns for their small, five-per cent risk. If the alternatives are all disasters, well, the most they lose is five per cent.
Anchoring refers to the way a prior number / price affects your sense of cost, or even the way you negotiate.
This subtle effect can be seen in the way we spend. You probably know some people who will refuse to pay $5.50 for their economy rice, because it’s widely established that $4.50 is the “right” price. They may even be willing to walk to another coffee shop, just over that $1.
But what happens if they’re buying a $1,099 iPad? Chances are, those same people won’t bother walking to another store just because it sells the same iPad for $1,098.
And yet, the price difference between the iPad and the economy rice is the same: $1 is still $1, regardless of the item being bought. The only difference is the anchoring effect: when we start off with larger sums, we tend to lose our objective sense of cost.
Financially successful people can sometimes seem “stingy”, because they care about sums like a few hundred dollars, even when buying something like a car or house.
However, they have the right perspective: a difference of $500 may not seem much in context of an $80,000 car: but if you see it as 111 meals (of $4.50 economy rice), you’ll have a better sense of value.
A common habit of gamblers is to “double down”, or put more money in the game, when they won the last round. This is to capitalise on a “winning streak”.
This is also how Ponzi schemes trick people into bad investments: they pay out good returns the first time around, thus causing you to increase your investment the second or third time around (e.g., if you got $1,000 out of $500 this time around, you might get $10,000 if you put in $5,000!)
Financially sensible people take controlled risks, and resist this impulse. A simple example is intelligent portfolio balancing:
Say you have a $50,000 portfolio, which is meant to consist of 80 per cent equities ($40,000).
After a year, the value of the equities grows to $47,000, while the portfolio grows to about $51,000. This means equities are now around 92 per cent of the portfolio, and have likely outperformed other assets.
A gambling move would be to pour everything into equities, since it’s “the best earner”. However, the financially prudent would actually sell off equities, until the total value of equities in the portfolio is just $40,800; this would maintain the strategic allocation of 80 per cent.
It is counterintuitive to most people to do this. Financial Advisors, for example, are often confronted by incredulous clients, who ask why they’d sell something that’s doing well.
The more financially literate know the answer: it’s to avoid “doubling down” on an asset just because it performed well that year, and to maintain a balanced approach.
Some people see debt as a burden to be avoided at any cost; others see it as an easy way to get what they want. Neither attitude is truly prudent.
When we avoid debt by any means possible, we also lose out on the possibility of leveraging. For example, consider someone who refuses to buy a home in Singapore and wants to rent forever. By doing this, they certainly avoid debt – they don’t need to
borrow from the bank or HDB.
However, when they reach their retirement age, they will have no tangible housing assets. Lacking their own home, they are at the mercy of landlords till the end of their days (or have to rely on their family). Options such as downgrading to a smaller home,
Lease Buyback Schemes, reverse mortgages, etc., are not possible; and they would have lost out on the appreciating value of property.
The same could be said of those who refuse to take education loans, and try to go through life without higher qualifications. While it’s certainly possible, long stretches of lower income (possibly throughout their entire career) leave them more impoverished than if they’d use a loan.
The flipside is a more obvious problem: people who rack up credit card debt and personal loans, and leave it to snowball. This traps them in a cycle of debt repayments, possibly till the end of their lives.
Financially successful people straddle the line: they know when to take on “good” debt (e.g By taking an education loan, a subsequently higher income would pay for the tuition fees many times over), but they also know not to use high-interest loans on
non-essentials.
Most Singaporeans understand not to be frivolous; but it’s common for many, especially the older generation, to be afraid of any form of debt or leveraging. This mindset has to change; it’s better if, like their financially successful counterparts, they learn to see debt as a tool – analogous to a screwdriver or hammer. It must be treated with respect and caution, but it’s illogical to avoid using them altogether.
At Exodus Capital, we aim to cultivate growth mindsets, and a view of financial tools that’s rooted in empowerment rather than restriction. It’s more helpful to show people how to reach their financial goals, rather than tell them to “just budget and don’t buy anything”. We also help finance industry professionals to convey the right message, to best help their clients. Reach out to us and find out more today.
