What is Investing?
Investing, in the context of protecting and building wealth, involves more than commonly thought.
Investing is the foundational principle to protect and build wealth. In fact, it is virtually impossible to build wealth without investing. It can be done otherwise of course, though you can’t count on winning the lottery and ill-gotten gains will land you in jail. That leaves investing as the only viable option.
So what is investing then? Oxford Languages provides a good starting point. 1
As expected from a dictionary, that is a good definition of how the word is commonly understood. However, while accurate in the context of enabling clear communication, this definition is incomplete in the context of protecting and building wealth. In that context, investing is more than just the definition above. Investing is also about delayed gratification and the balance between comfort and growth. 2
Investing is about delayed gratification because building wealth requires consuming less today, delaying gratification, for the potential to consume more in the future. This is straightforward. Spend all your money, save none and you will not build wealth. Spend some, save some and you will.
The same dynamic holds in less straightforward situations as well. Attending college means forgoing income today, and often borrowing money to do so, for the potential to earn greater income in the future. Starting a business requires the immediate sacrifice of time and money, both your own and often that of others as well, in hopes of building something worth more in the future. Expanding or hiring requires a business to use funds, in some cases borrowed, that could have been used otherwise, based on the expectation for higher earnings in the future.
The same dynamic even holds beyond purely financial situations. Working extra hours, rather than watching Netflix and chilling on the couch, requires giving up certain immediate pleasure for the potential of higher earnings and career advancement in the future. Helping out family, friends or in the community means not spending that time on instant satisfaction but rather on the potential for stronger relationships in the future. Even exercise shares this dynamic. No one wants to exercise. It is a hard and unpleasant activity. Regardless, many willingly do so based on the potential for better health and longevity into the future.
Delayed gratification presents obvious benefits for building wealth, not to mention increased health and happiness as well. So why then is delayed gratification so difficult? The challenge, I believe, is that we are physiologically and psychologically ill-suited for it. Anyone who has ever overindulged understands this at least at some level.
The human species dates back anywhere between 200,000-360,000 years and millions of years further before then if you include ancestor species. Almost the entirety of this time was spent in an environment of tremendous scarcity. Whatever you hunted or gathered, you ate. There was no ability, much less any desire, to delay gratification.
Only within the last 10,000 or so years, coincident with the advent of farming, did humans gain any real ability to delay gratification, planting some seeds or breeding some animals that could have been eaten today in hopes of a greater bounty of food in the future.
And only within the last 250 or so years, beginning with the Industrial Revolution, has humanity gradually transitioned from an environment of scarcity to an environment of abundance. Humans are mere novices when it comes to delaying gratification and not well conditioned for it. No wonder it can be so difficult.
After delaying gratification, investing is about finding the right balance between comfort and growth. Again, this is straightforward. Only invest in the safest assets and you will certainly be comfortable, though you will certainly not build wealth. Only invest in the riskiest assets and you may or may not build wealth, but you will certainly be uncomfortable. To grow, you must voluntarily accept the appropriate amount of discomfort.
Each delayed gratification example above also has a comfort versus growth dynamic. Whether attending college, starting a business or expanding or hiring, each is a voluntary embrace of discomfort, and often debt as well, for a chance at growth. Without this embrace, there can be no growth.
As with delayed gratification, the comfort versus growth dynamic extends beyond the purely financial. With each such example above, immediate comfort is balanced with the desire for personal growth.In psychology, there is a concept known as the zone of proximal development, within which growth is promoted by accepting a tolerable level of discomfort. 3 Similarly, embracing discomfort via exercise promotes physiological growth within the body as it adapts to new stressors. Discomfort even promotes interpersonal growth. By showing vulnerability, relationships can grow stronger.
The comfort and growth dynamic presents two related challenges to building wealth. The first is financial in nature, finding the right balance between comfort and growth. The second is psychological in nature, overcoming cognitive biases against discomfort.
In financial markets, while greater discomfort is often a necessary condition for greater growth, a favorable outcome is not assured. The only surety is uncomfortable price fluctuations and the potential for greater growth or loss. However, discomfort must be embraced to have any chance at growth. The first challenge then is to find the right balance. This exercise is probabilistic in nature, seeking to maximize the chances of an acceptable outcome while simultaneously minimizing the chances of failure. The answer is unique for everyone, but never static or certain.
As discomfort results from overcoming the first challenge, the second arises. Humans are disproportionately sensitive to discomfort. This results from a well-documented and universal cognitive bias called loss aversion, or a tendency to feel greater pain from a loss than pleasure felt from an equivalent gain. 4
Loss aversion is thought to have deep evolutionary roots. Survival was challenging for much of early human existence, with many dangers. Individuals disproportionately sensitive to threats would have been more likely to survive. Inevitably, this tendency would have grown increasingly pronounced and become universally shared over time. The challenge to building wealth then is to resist this deeply ingrained tendency and accept the necessary discomfort to allow for growth.
So what is investing then? Investing, in the context of building wealth, is about delaying gratification and finding the appropriate balance between comfort and growth. These two actions are easily understood and widely applicable across many aspects of life, though neither are natural motions for the body and mind. Despite these challenges, investing is the only viable option for building wealth. I hope that, after reading this, you now have a better understanding of what is required to build wealth and a better chance of overcoming the obstacles to doing so.
Thoughts? I would love to hear them. Email me at firstname.lastname@example.org.
Written By Keith R. Schicker, CFA
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There are actually several definitions, depending on the use of the word. I included only the definition most relevant within the context of our discussion.↩
In finance, the comfort / growth dynamic is called risk / reward, but the former characterization allows for a wider application while remaining largely accurate to the latter. ↩
More precisely, this is a concept from educational psychology. The zone of proximal development exists on a spectrum between what the child can do unaided and what the child cannot do, representing what the child can do only with assistance. As children gradually learn to accomplish these tasks independently, the unaided zone grows and the zone of proximal development expands to include previously unachievable tasks. ↩
Loss aversion is one of a long list of cognitive biases detailed by psychologists Daniel Kahneman and Amos Tversky. Tversky died in 1996 and Kahneman received the Nobel Memorial Prize in Economic Sciences in 2002 for their work. ↩