Last week, Ben Carlson from A Wealth of Common Sense published an interesting article about how staying rich is harder than getting rich. He writes:
Research shows over 50% of Americans will find themselves in the top 10% of earners for at least one year of their lives. More than 11% will find themselves in the top 1% of income-earners at some point. And close to 99% of those who make it into the top 1% of earners will find themselves on the outside looking in within a decade.
It's great that so many people get to taste what it's like to earn a lot of money, if only for a little while. What's not so great is that as most people earn more, they spend more. But if you spend all (or most) of what you earn as you're surfing an income bubble, you can find yourself in trouble when that bubble bursts.
Carlson quotes a story about a couple that lived a lavish lifestyle because they were making a lot of money. When the income dried up, they realized they had nothing left. They were broke. Says the husband: “The money was just coming so fast and so easy that my ego led me to believe that, ‘Oh, this is my life forever.'”
I've been thinking about that last line for a week now: “This is my life forever.” This couple fell for a common (but seldom examined) mental trap: the forever fallacy. The forever fallacy is the mistaken belief that you will always have what you have today, that you'll always be who you are today.
The Forever Fallacy
It's easiest to see the forever fallacy at play in extreme cases. Take professional athletes, for instance.
In a 2009 Sports Illustrated article about how and why athletes go broke, Pablo S. Torre wrote that after two years of retirement, “78% of former NFL players have gone bankrupt or are under financial stress.” Within five years of retirement, roughly 60% of former NBA players are in similar positions.
Fundamentally, the problem here is the forever fallacy. Athletes (and popular entertainers) tend to enjoy a few years during which they earn great gobs of money. The challenge is to figure out how to make five years of income last for fifty years. This never occurs to most of them. As the money is rolling in, it feels like the money will always be rolling in. When the income stops, the pain begins.
“[A pro athlete] can't live like a king forever,” says Bart Scott in ESPN's Broke, a documentary about pro athletes and their money problems. “But you can live like a prince forever.”
The forever fallacy doesn't just trap athletes and entertainers and lottery winners. It snares average folks like you and me too.
I'm sure we've all had friends who found themselves flush, whether from a windfall or from a raise at work. They succumb to lifestyle inflation, spending more as they earn more. They buy a bigger house, a new car, a boat. Then, without warning, something awful occurs and they're no longer rolling in dough. It felt like the good times would last forever — but they didn't.
The forever fallacy manifests itself in lots of little ways too.
- When you choose not to keep an emergency fund because you've never needed one in the past, you're succumbing to the forever fallacy.
- When you take out a large mortgage, one that pushes the limits of your earning power, you're giving in to the forever fallacy.
- When you fund your lifestyle through debt, you're living in the forever fallacy.
The forever fallacy doesn't apply only to positive expectations. People also give in to the forever fallacy with negative expectations. They're trapped in a minimum wage job and project that they'll always be working minimum wage. They're in a shitty marriage and let themselves believe that they'll always be trapped in a shitty marriage. And so on.
The key thing to understand is that everything changes. You change. Your circumstances change. The people around you change. Nothing is forever. The challenge then is to balance this concept — everything changes — with living in the present. You must learn to enjoy today while simultaneously preparing for possible tomorrows.
One way to protect yourself from the forever fallacy is to play “what if?” games.
In A Guide to the Good Life by William Irvine, the author advocates a psychological exercise he calls “negative visualization”. Learn to ask yourself, “What's the worst that could happen?”
The Stoics…recommended that we spend time imagining that we have lost the things we value — that our wife has left us, our car was stolen, or we lost our job. Doing this, the Stoics thought, will make us value our wife, our car, and our job more than we otherwise would.
Sounds a little gloomy, right? Irvine says that's not the case. You're not meant to dwell on these things, but to occasionally ponder them as a thought exercise.
In my own life, I used to imagine what it would be like if I lost my job. “I could always go to work at McDonald's,” I thought. “And I grew up in a run-down trailer house. Worst case, I could always live in something like that again.” This line of thinking drove my ex-wife crazy but gave me comfort. I knew that if disaster struck, I'd be fine flipping burgers and living in a trailer park. I've done it before and can do it again.
Nowadays I challenge myself by thinking about what might happen if the stock market crashed or our house burned down. What would I do if I lost everything? Where would I go? How would I earn money?
The Stoics took this exercise even further. Seneca the Younger encouraged followers to live as if each moment were their last. But that's not to say that he wanted people to descend into debauchery. Here's how Irvine explains it:
Living as if each day were our last is simply an extension of the negative visualization technique: As we go about our day, we should periodically pause to reflect on the fact that we will not live forever and therefor that this day could be our last. Such reflection, rather than converting us into hedonists, will make us appreciate how wonderful it is that we are alive and have the opportunity to fill this day with activity. This in turn will make it less likely that we will squander our days.
Negative visualization is useful because it forces you to look beyond the here and now, to imagine other possible realities. It encourages you to consider that the future might not be a linear projection of the present. I think it can also help nudge a person to think about what's truly important in their life.
Too many people squander their days and their dollars. They spend their time and money on things that don't matter, not even a little. When you die, will you be glad you watched every episode of Game of Thrones? Or will you regret not having used that time for something better aligned with your passion and purpose?
In the realm of personal finance, there are plenty of things you can do to be prepared.
- Get out of debt and stay out of debt. As somebody who was deep in debt for almost twenty years, I now see that carrying debt is a classic expression of the forever fallacy. It's blind faith that you'll be able to repay what you owe in the future.
- Maintain an emergency fund to handle unexpected problems such as car accidents and broken bones.
- Start an opportunity fund so that you can take advantage of the unexpected good things that come along, such as a chance to travel with friends or a great deal on a used pickup truck.
- Carry adequate insurance to protect yourself from catastrophic loss like earthquake, heart attack, or giant fire-breathing monsters from the sea.
- Boost your saving rate, the gap between what you earn and what you spend. This has a two-fold effect. A high saving rate helps you set aside more for the future, but it also makes you more resistent to the slings and arrows of outrageous fortune today.
- Build social capital by creating a web of friends, family, and colleagues that you trust and support — and who trust and support you.
The truth is you're never going to beat the forever fallacy and neither am I. Not completely, anyhow. It's simply human nature to extrapolate our present and past into the future. The best we can do is mitigate the trouble caused by this tendency.
Be Like Bond
Recently, I've been reading the original James Bond novels by Ian Fleming. I like the books because the literary Bond is more realistic than the cinematic Bond; he's less of a superhero and more of an everyday person (who happens to be a secret agent). He eats too much, drinks too much, and can be a bit lazy at times.
Where Bond excels, however, is preparation. He's always thinking a move or two ahead of his foes. He tries to anticipate what might go wrong so that he can take steps to prevent trouble. This doesn't mean that he always evades trouble — there'd be no drama if he did — but his dedication to preparation helps him avoid some scrapes while also allowing him to sometimes survive certain death.
Bond does not suffer from the forever fallacy, neither in the short term nor the long. (He often wonders if he's near the end of his career, too old to continue working as a spy.) We'd all have greater success in life if we were more like James Bond, if we took precautions, if we didn't give in to the forever fallacy.
Accept the inevitability of change. Prepare for an uncertain future. Plan the best but be ready for the worst. Don't obsess over what might go wrong, but be aware of potential problems and plan for what you'll do in a worst-case scenario.