If you save a little money now, you are still not a millionaire.
If you splurge now, you still didn’t go broke.
But keep doing this over time, and you’ll see some real changes.
Almost half of all New Year’s resolutions are about personal finances.
Only 16% of all New Year’s resolutions succeed,
which means that many promises that we make ourselves
about both finances and other important topics, are broken.
That begs the question
- Why is this so difficult?
Why do people continue making promises to themselves that they cannot keep?
And, perhaps most importantly,
is there a way out of this infinite loop of disappointment?
The answer to these questions lies within our habits.
This is a top 5 takeaway summary of Atomic Habits,
written by James Clear.
And this is The Swedish Investor,
bringing you the best tips and tools for reaching financial freedom,
through stock market investing
… and habits.
Takeaway number 1: The Aggregation of Marginal Gains
You’ve heard the exceptions.
The entrepreneur who hit it big during his first year of business.
The musician who won a contest and became an instant success
The person who guessed a correct string of numbers at the Powerball.
These are stories of explosive wealth accumulation,
and, while they can sometimes be mesmerizing,
they aren’t really that reliable.
Let me ask you this:
Do you know of something that you can and will do
that is likely to improve your finances by 100% in a month?
No? Well, me neither.
Do you know of something that could improve your finances by 1%?
This is MUCH simpler.
It could be as straightforward as getting a credit card with some nice cashback,
moving money from a cash account to an index fund,
figuring out how to monetize your hobby,
or just quitting that subscription service that didn’t add much to your life anyways.
The 100% improvement is the needle in the 1% haystack.
Don’t try to find it.
Instead, just grab the haystack and go look for another one.
In Atomic Habits, James Clear points out that
you need no defining moment to reach success,
whatever success means to you.
Instead, you need many small wins that aggregate over time.
You need a ton of those tiny 1% gains,
which are much easier to spot and act on,
and over time, they’ll accumulate.
If you can improve your finances by just a single percentage point each month,
and you keep on doing that, say, for the next thirty years,
you’ll see some truly remarkable results.
$10,000 would become $359,496.41,
a 3495% improvement!
James Clear refers to this as “the aggregation of marginal gains”.
This is a really similar concept to what we within financial circles call compound interest.
And it works in the other way too.
If you move 1% in the wrong direction for too long,
you end up in a terrible spot.
This makes one thing strikingly obvious:
It doesn’t matter much where you are right now.
What matters is your trajectory.
That’s because your current outcome is always a lagging measure of your habits.
A small change in your habits will drastically affect your life
when you allow it to compound.
The plane that takes off in New York lands in Stockholm instead of Moscow
if the pilot shifts the heading just 2.4 degrees north.
But there is a catch.
Anyone who has ever failed a New Year's resolution
knows all too well that motivation alone won't cut it.
Afterall, then everyone would probably succeed with these things,
but the fact is that we are all very conservative with our energy.
Translation: we are lazy.
We shall soon look at a 4-step model that will make you much more likely to succeed
with any new type of habits,
but first, we shall talk about why most of your old New Year’s resolutions
were doomed right from the get-go.
Takeaway number 2: Systems >> Goals
Conventional wisdom tells us to set smart goals.
That’s S M A R T with capital letters:
specific, measurable, achievable, relevant and time-bound.
If we follow this advice,
your SMART New Year’s resolution might look something like this:
"By the end of this year, I will make sure that my savings account holds $20,000.”
It does sound like a good idea,
but James Clear explains that even smart goals are actually dumb,
especially for achieving long-term success and aggregation of marginal gains.
Here’s why:
- Goals are, per definition, only temporary changes.
$20,000 is quite a bit of money,
but it’s not match for a spendthrift to burn through.
- Goals are not very motivating.
After you’ve reached your goal, you’ve won the game.
As Warren Buffett likes to ask:
“… and then what?”
- Goals restrict your happiness.
In a sense, you are telling yourself that you aren’t satisfied until X happens.
Happiness shouldn’t only be for your future self!
Instead, we want to turn that goal on its head and ask the following:
“What makes it so that I can have $20,000 in my savings account by the end of the year?”
Take note of the process, the system, that will get you there.
If nothing pops up, try to imagine a person who can get there, imaginative or real.
What does this person do on a daily basis?
And – just as importantly
- what does this person NOT do?
This person probably doesn’t wait until the end of the month to see if there’s some
money left over to put towards investment,
but rather, that’s the first thing he does
when he gets his paycheck.
He probably doesn’t watch too many reality series, but instead,
he consumes information that makes him wiser
and that benefits him in the long run.
Moreover, he doesn’t invest aimlessly,
picking up the stocks of the latest fad that his colleagues at work recommend
or that he heard about on Reddit.
Instead, he invests with a purpose and a strategy.
Do you think that a person with these habits
- with this system - can accumulate $20,000?
Of course, and he doesn’t even have to set it as a goal.
He will reach it anyways, because he already knows how to play.
According to Super Bowl winner Bill Walsh:
“The score takes care of itself.”
The purpose of a goal is to win the game,
but the purpose of a system is that you continue playing the game.
To get as many reps as possible.
Ultimately, it’s reps in a properly constructed system that is driving success anyways.
So now I think it’s time to learn how to keep playing.
Takeaway number 3: The 4-Step Model of Habits
If you’ve ever wondered why you cannot stick to the habits
that will transform you into the person you want to become,
the answer lies in one of these four:
Cue, craving, response, reward.
Biologically, we are wired so that when we are put in a certain context (cue),
we want to feel something (craving),
which gets us to act (response),
and finally, getting what we craved for (reward).
For each rep, for each successful cycle in this loop,
your habits become more and more internalized and easier to perform.
The link between cue and reward becomes more obvious,
which can be both an advantage and a disadvantage,
depending on the value that you attach to a certain action.
Before getting into the loop, you need to take inventory.
Create a “Habits Scorecard” where you write down what you do in a day
with a + (positive), = (neutral) or – (negative) next to each habit,
depending on if the habit is turning you into the person you want to be or not.
Now, you are ready to go.
The most powerful cues that exist are time and place.
You want to make cues that lead to positive habits obvious
and those that lead to negative behaviour invisible.
For example, maybe you've noticed on your Habits Scorecard that if you're at the bar
with a certain group of friends right after receiving your paycheck,
you tend to … show off a bit.
You want to be “the king of the bar”
as the Swedish musician Magnus Uggla sings.
Well, then you need to change things up.
If you change the time or the place,
you may have changed the cue so much
that you will no longer indulge in this financially destructive behaviour.
For positive habits, make it obvious,
and there’s a powerful method for this which James Clear calls habit stacking.
It looks something like this:
“After [CURRENT HABIT] I will [NEW HABIT]”.
Oftentimes this has both time and place built into it, thanks to your current habit.
With that cup of coffee that you make yourself at home in the morning,
you can learn about personal finance and investing by watching an episode of The Swedish Investor.
Too self-serving? Well, read the damn Economist then.
The next step is craving,
and you crave what is attractive to you, and avoid what is unattractive.
Therefore, you need to make positive habits attractive and negative habits unattractive.
This can be done through as little as reframing your mindset about a few things.
For instance, when you see someone with an expensive car
(which is not a good idea for your wallet right now),
instead of thinking
“wow, this person must be so successful, because otherwise, he couldn’t have afforded that car”
you can think
“wow, this person is probably pretty squeezed right now because he spent that much on a car.”
Such a mindset makes splurging less attractive.
It could also mean that you pair some short-term reward
with habits that otherwise just pay off in the long run.
Warren Buffett has mastered this by making reading annual reports of stock market companies more attractive.
While reading, he gets to have an unlimited amount of Coke.
Alright, I made this up, but the man does drink a ton of Coke,
and he does read a ton of annual reports.
Thirdly, we have the response.
You want the response to be easy for good habits and difficult for bad ones.
James Clear gives a ton of great examples on how to do this in his book,
and I think that the most powerful one that we can talk about in conjunction with financial habits is the lock-out.
If you have a tendency to come home with more than you expected every time you visit the mall,
then start bringing just enough cash for the purchase you planned, but no more.
You can do similar things to lock-in good behaviours, but there’s another powerful technique too.
This is to downscale every new habit into a lesser version of itself.
Staying up until midnight working on your side-business before waking up at 6 AM for work
becomes doing something for your side-business for 5 minutes after finishing dinner.
Setting aside 40% of your income towards investments each month becomes setting aside $100.
The point is to show up, to get in reps, and make it more likely to show up by not committing
to too much already from the start..
Most people would rather dream about running a marathon
than actually tying their running shoes.
But you need to have confidence in the snowball that you are creating by starting out small.
Finally, there’s the reward, and positive habits should have satisfactory rewards
while negative habits should have unsatisfactory ones.
A surprisingly satisfactory tool to use is the streak.
It also works in the opposite direction;
I truly hate breaking my streaks.
The keyword here is visuals.
Put up an almanac on your fridge and make a clear green checkmark
on every day that you, for instance, did not end up with your hand in the cookie jar,
ie. taking money out of your investment account for personal consumption.
If you did, make a big red cross.
But do not miss twice.
If you can get these four right,
you are MUCH more likely to stick with the habits you wish to have and avoid those you do not want.
And there’s something that might be even more powerful that you can do …
Takeaway number 4: Rooting Your Habits in the Deepest Layers
There are three layers of change: Outcomes, processes, and identity.
We’ve concluded that processes, or systems, are more powerful than outcomes, or goals,
but the most powerful habits have their roots in the deepest of the layers; identity.
Here’s an example.
“I’m trying to quit smoking.”
“I’m not a smoker.”
Which one do you think is more powerful?
Another one:
“I want to save $20,000.”
“I am an investor.”
It’s one thing to say that you want this,
and a whole other story to say that you are the person who is this.
People hate contradicting themselves to such a degree that sometimes
they can become completely blind even to facts,
just to stick with a certain identity or belief that they’ve built up over the years.
Therefore, you want to choose your identity and beliefs carefully.
Habits and identity are a two-way street.
Imagine that you have jars of multiple characteristics inside of yourself,
some of them even contradicting.
Every time you choose a certain action,
you are casting a vote for one of these characteristics.
This makes some future actions more likely and other actions less likely.
Therefore, we cannot talk about these things in a vacuum.
Habits and identity live in a constantly reciprocal relationship.
Suppose you wish to strengthen your identity in a certain area.
In that case, one of the most powerful things you can do
is to join a community where many people share the beliefs you are aiming for.
Takeaway number 5: 80% Exploit, 20% Explore
Machiavelli said that:
“Men desire novelty to such an extent that those who are doing well
wish for a change as much as those who are doing badly.”
Habits have a certain weakness.
They lock you in on a given path.
If you are not satisfied with where you are right now,
chances are that you need to push a little bit to change things up.
Meanwhile, if you are content with where you are,
you needn’t change much – repeat what works!
However, as Machiavelli says,
even people on an obviously successful path will eventually reach an obstacle – boredom.
Boredom is the enemy of habits that move you in the right direction.
Sooner or later, these habits will lose their shine,
just like that shirt you used to love,
now hanging in the back of your wardrobe.
It’s still a nice shirt but …
you need novelty.
James Clear suggests that there must be a balance here.
If you are going where you want to
exploit, or repeat what works,
80% of the time
but do not forget to explore for the remaining 20%.
This is a great way of stopping yourself from fiddling with the 80%!
For an investor it could look something like this.
Maybe you’ve been a successful index investor for a while,
but you’re getting bored from just automatically transferring
a certain portion of your salary into the same old index funds every month.
Then take 20% of your capital and try some individual stock picking.
This doesn’t just combat boredom.
It’s also a chance for improvement.
Take Google.
Incredibly successful company,
with many successful products.
No matter, employees at Google are encouraged to take one day a week
(20%)
to explore and seek out,
just … what they find interesting.
By doing this, the company has invented many new great products, such as AdWords and Gmail,
and I think a similar approach can help you and me to become more explorative too.
- Stack a ton of 1% improvements on top of each other,
and you’ll see remarkable results over time
- The score takes care of itself when you have a proper system in place
- If you are having trouble sticking to a certain habit or a system of habits,
the answer lies somewhere in the cue, craving, response, and reward loop
- Making behaviours a part of your identity
is to root them in the deepest of layers
- Repeat what works 80% of the time and renew yourself the remaining 20%
Next up, you may want to check out this video.
The 3rd takeaway contains 12 financial ideas
that you probably want to create habits around.
Cheers guys!