That, he noted, was how much just one beer could cost me in attorney’s fees for getting myself into trouble. Not to mention the price of a lost scholarship or job offer or something else. He wanted to teach me a lesson before something potentially bad happened, something that would have the chance to compound negatively.
The pageantry of this lesson has stuck with me over the years. Through my own experiences, I’ve learned that decisions have consequences that can and will compound, both positively and negatively. This is true both personally and financially.
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Recently, I was meeting with someone who said, “I really appreciate you giving me that book The Psychology of Money. There are so many good lessons in there. I even just sold my car!”
First, it is a great book with countless great and practical ideas. My copy has notes, highlighting and scribble littered throughout. Second, I said back to him, “What do you mean you sold your car?! I hope you didn’t do that because of me!”
There’s a chapter in the book where the author explains that no one cares what kind of car you drive. People may admire your car for one reason or another, but that’s much different than someone admiring you for driving that particular car. They don’t!
If someone pulls up in a shiny red Ferrari, the spectator is likely staring and imagining themselves driving that beautiful machine with flawless paint and their own hair blowing in the wind. They’re not gazing at the driver thinking how wonderful he or she is.
The takeaway for my reader was that he no longer needed the flashy BMW in the driveway. It meant nothing to him. He swapped that for a Prius.
This is someone who is in wealth accumulation mode. He and his family are focused on making the right decisions to set themselves up for future, long-term success. They want their assets to be helping generate wealth, not deplete it.
This was not a matter of someone who couldn’t afford to pay for the BMW; he could, but at what cost? After selling the BMW and paying cash for the Prius, he walked away with about $30,000 cash. He felt free, and his happiness actually improved.
We talked about how that money could be used. Maybe it helps towards the purchase of their next business, or maybe it’s invested according to their overall strategy and long-term goals like early retirement and funding education. Either way, that $30,000 will compound over time to put them in a better financial situation.
Note: this is not to say that Ferraris are bad or that you should sell your car.
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Conversely, financial decision-making can compound negatively, like in the instance where an investor abandons their strategy, plan and goals in the wake of fear and uncertainty. Deciding to make wholesale changes to one’s portfolio after downturns in the market can be incredibly costly.
Let’s say an investor with $3 million has experienced a 20% decline in their portfolio due to normal market conditions. They’ve lost $600,000 on paper and their account is now worth $2.4 million. Moving to cash or making dramatic shifts in the portfolio at the wrong time could mean missing out on a market rebound, essentially locking in that $600,000 loss.
So while the portfolio may have come back to the $3 million mark had it been left alone, the emotional investor has just lost out on that rebound that can never be had back. That money is gone, and it’s a tremendous negative consequence because it’s not just the $600,000 today that stings. It’s also what that $600,000 could have become over the rest of the investor’s time horizon, perhaps 10, 20, 30 years or more. That could literally be millions of future dollars lost because of poor decision-making and the negative consequences that ultimately come with it.
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Whether it’s the $10,000 beer, the Prius, or the fear, decisions have consequences. With the right frame of mind and clarity on what is truly important to you, those consequences can compound in an unbelievably positive way.
