It is believed that people who are in extreme poverty cannot make rational decisions. Sometimes these irrational decisions may lead them to much worse situations. Nowadays, many success books state that it’s the poverty mindset that makes you poorer. They encourage readers to think like a rich man. By doing so, readers can get rid of poverty and be successful.
According to them, there are differences between a rich mindset and a poverty mindset on investment.
Do you believe it?
In fact, this is the biggest misunderstanding about poverty mindset.
In most cases, a poverty mindset helps poor people make most rational decisions. Poor people can’t afford go to work by taxi (spend money to buy time), take loans (dare to be in debt), invest in stocks and bonds (take risks). All these will only make them poorer.
In essence, rich mindset is the same with poverty mindset. They are both the most reasonable choices of resource distribution based on the judgement of existing resources and expectations.
So, there’s no way to get rid of poverty?
Of course NOT.
The world is not black or white. It has a grey zone. We have a third choice between a rich mindset and a poverty mindset, which is critical thinking.
The rich mindset presupposes we are very rich while the poverty mindset presupposes we in extreme poverty. However, that’s not true. Most of us are in the middle. Therefore, critical thinking can be used to analyze the 5 choices in the chart.
I’d like to introduce you the concept of Opportunity Cost, which means the benefit that is missed or given up when an investor, individual or business chooses one alternative over another.
For example, a programmer, let’s call him Jack, has an hourly wage of $100. Jack has an opportunity cost of $100 per hour. Spending money or spending time? It depends on the price Jack’s going to pay.
If Jack wants a cup of coffee now, during the busy hour, it takes him half an hour; or he can have it delivered to his office, paying $10 for the delivery fee. In that case, since the delivery fee is cheaper than his opportunity cost, Jack should choose to spend money to save his time.
Like I mentioned in the other article, fluid intelligence reaches the peak at 20s. (How to earn your money back after Black Friday?) The better learning capacity you have, the more potential benefits and opportunity cost you will get.
The time you’ve saved is not only the immediate benefits, but also your future benefits. For example, Jack can pay for a two-hour house cleaning service to study CFA. If he passes the CFA test, maybe his company will give him a higher salary.
Whether one dares to be in debt, determined by two factors, risk tolerance and risk preference. In general, rich people have higher risk tolerance than the poor. They dare more to be in debt. However, it is not always reasonable to be in debt. It depends on three things: cost of funds, yield and liquidity. If the investment yield is more than cost of funds, you can have debts.
For example, Jack is a millionaire and wants to buy a house. He can choose to pay all cash or take a loan. I’d say, it’s better for Jack to take a loan. Because Jack can invest with his money and have more gains than the loan interests.
From this perspective, it’s irrational for poor people to take a loan. First, they have higher cost of funds. Most financial institutions are unwilling to lend extremely poor people money, because they don’t have enough securities. Only usury will do. Second, they lack various investment channels. Their earning yield is lower. Last, poor people must consider their capital liquidity. In another word, can they afford their living costs after the monthly payment.
It’s not always true that rich people are risk takers and poor people are risk averters. You must consider the risk-return trade-off. Simply speaking, you can’t have high benefits with low risks. That requires you to choose the best buy.
Some investors I know, would choose the highest-yielding assets (under the same risks). Here’s the question: how can you choose the best one? Learning is the only way. Risks are relative. If you know more, your will be more confident, and risks will be relatively small.
When you invest, you should consider the cost-performance ratio. It is the same with the cost. Last time I chatted with a friend, she told me that her mother bought two pounds of apples, because these apples were cheap. However, they tasted badly.
Did her mother make a bad decision? It depends on how she defines the cost-performance ratio.
Cost-performance ratio is an equation used to balance the cost of an item against its effectiveness. It’s subjective to value the effectiveness of an item. If her mother believes that taste of the apple is not the most important thing, instead, the nutrition attaches great importance, then her choice is reasonable.
In nature, this is the choice of resource distribution in the dimension of time. I’d like to mention a concept called Time Value of Money.
For most people, we prefer the present rather than the uncertain future, which is to say, we believe that $100 of this year is more valuable than $100 of the next year. Of course, some of us may choose to give up the $100 for now-if he can earn more in the future. Why rich people have long-term visions? Because the $100 they save now may repay them with $120 via all kinds of investments.
That’s why some people argue that if you choose to spend rather than invest, you are like killing a goose with golden egg.
Wait, what if this goose lays a second golden egg 10 years later and you are starving to death right now? Would you still choose to wait? Just eat the goose!
So, the more rational decision is to learn more, right now, if you want to have long-term visions.
Have you heard of a book called Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty by Abhijit V. Banerjee and Esther Duflo, who are the winners of Nobel Memorial Prize in Economic Sciences in 2019.
This book mentions an interesting phenomenon. People of extreme poverty will give birth to a lot of children, and they don’t care about the affordability of raising children. Because they see having kids as having lotteries. What if they are lucky enough to have a promising kid who can help them get rid of poverty?
Sometimes we should jump out of our comfort zone and take a good look at this world. Try to experience more and learn more. It’s never too late to learn.