People can spend a lifetime saving and be mystified at how little they seem to have accumulated.
“Where did all the money go? It went on taxes and inflation,” according to Paul Overy, former financial advisor and author of Tricks of the Rich: How to Make, Grow and Save Money.
Speaking at the Dublin Investment Summit (@DublinInvest) this week, Overy told of how people can let emotions cloud their judgment about money. “It’s just arithmetic. It’s just numbers … figures don’t lie,” he said. Considering himself a pretty good salesman, Overy added, “I have a 10-year-old daughter and I can’t convince her, 5 and 5 is 11.”
Many money decisions are emotional, he said. He cited the decision faced by someone who had invested in property during the bubble and was now facing a decision. Should he sell? Or should he accept new repayment terms being offered by the bank?
Overy ran the numbers and found that property prices would have to increase by 12.9 percent annually — they are still falling and could stabilize at 70 percent below bubble prices in Ireland — if the bank’s offer were to make sense.
Overy noted that it is emotionally tough for people to take the hit, but it could be worth more in the long run to take the loses now than continue to pay the bank.
Repeating a phrase attributed to Einstein, (originator of the Theory of Evolution!) Overy joked that compound interest is the second most powerful force in the universe. But people fail to take it in to account when making investment decisions.
For example, the Republic’s inflation rate averaged 2.5 percent between 1999 and 2010 — even though 2009 and 2010 were deflationary years. If €1,000 were stuffed in a mattress in 1999, its buying power would be €7,380 in 2011. If money were put in a bank, interest must keep pace with inflation just to maintain the principle’s value. Then taxes are paid on interest. If those push the effective interest rate below inflation, the money’s worth is slowly leaching away.
Overy’s advice: “Never forget to take inflation in to your due diligence.”
The Dublin Investment Summit, however, was more about entrepreneurship and investing than personal finance. Overy recommended that potential investors have an exit strategy. He said he has come across private investors who put money in to fledgling companies without thinking through their plans. No one would walk in to a dark room without knowing the way out, he said. “Why they do it with their money, I don’t know.”
Another problem small investors face is dilution during subsequent funding rounds, Overy said. “Our ego runs away with us. We think we can win every time,” he said. But investing in start ups means more money will be required in further funding rounds. Unless investors can keep ponying up cash, their stakes become progressively more diluted. Overy likened it to a poker game: The big money wins because it can buy everyone out.
A recent post on our attitudes to money by behavioral economist, Pete Lunn, can be found here.
Image of Money sign by lalunablanca on Flickr.