Originally published by Cuffelinks
Half the calendar year has already gone, and all those New Year’s resolutions to lose weight and get finances in order may have gone with it. Now the statements like “I’ve got no willpower” or “this happens every year” come out.
Take heart as the sad truth is that the human body is not wired for long-term planning. Our ancestors were hunters and gatherers who lived by the rule of fight or flight. Their dominant thoughts were purely about survival.
Fast pay off preferred
As a result, we instinctively prefer an action with a fast pay off, than one with a long-term result. The scientific name for it is hyperbolic discounting, which causes people to make choices that can lead to short term pleasure, but long-term disaster.
Credit card usage is an obvious example. Who cares about paying interest at 20% on their credit card balance, living beyond their means, or getting into financial strife when they can simply swipe their credit card and get a retail fix on the spot?
Research from Johns Hopkins University reveals that only 10% of coronary bypass patients make the necessary changes to their lifestyle to prevent further attacks. The remaining 90% still opt for the short-term pleasures of unhealthy food and no exercise.
To make it more difficult, long-term progress by its nature is slow and erratic, and is often discouraging. Imagine you got excited about investing $500 a month into a managed fund that matched theAll Ordinaries Index. If the market had a great year and produced 12% compound you would have $6,341 at year’s end. The profit would be just $341. However, if the market had a bad year and went backwards by 5%, your portfolio would be worth $5,864. The difference is minimal.
The power of compound interest
This is the point where most people give up and move onto to something else with the lure of a quick high return. However, if you continued investing that $500 a month for 35 years, and the investment averaged 9% per annum, the portfolio would grow to $1.4 million.
It works the same when you are paying off a mortgage. If you owed $300,000 on your home at 5.5% with monthly repayments of $1,703, the term would be 30 years and total interest payable would be $314,000.
Suppose you learned about the effect of compound interest and decided to slash your home loan to 20 years by raising your payments to $2,064 a month, which would save over $119,000 in interest. It is a most exciting prospect, but after five long years at the higher payments, you would still owe $253,000, and may well be starting to feel the result is not worth the effort. But hang in there for another 20 years and it would be paid off. In contrast, if you leave the payments at $1,703 you would still owe $157,000 after 20 years.
Focus on understanding the process and the outcome will look after itself. This is a fundamental success principle, which is applicable in every aspect of your life. Success comes slowly, and you will almost certainly get discouraged and probably give up if you keep thinking about the outcome. It is like planting a seedling and then digging it up every year to see if it is growing.
The secret is to get excited about the process, in the certain knowledge that the right process, if followed through, will almost always lead to the outcome you are looking for.