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3 Mental Shortcuts That Aren’t Doing Our Money Any Favors

By Sallie Krawcheck

You may be familiar with the gender pay gap — the oft-cited statistic that women earn 82 cents on average for every dollar that white men do. But are you familiar with the gender wealth gap? This stat is cited less often, but I’d argue it’s more meaningful: Women own only 32 cents for every dollar a man has. And, for both of these stats, the numbers are far less for women of color.

The difference between the pay and the wealth gap is driven by a number of factors: for example, we take more career breaks than men do. We suffer from the “pink tax.” We are charged higher interest rates on loans.

It’s also because historically, we haven’t put our money to work making money for us: We haven’t invested as much as men have. For many of us, it’s because investing has felt too unapproachable — we thought it was for rich people, or the jargon has been off-putting.

But, also, our brains haven’t been our friends here, which historically has led us to fail to recognize how much investing could have added to our wealth. Three mental shortcuts that aren’t doing us any favors:

#1: The power of compounding is not intuitively obvious.

We’ve written about this a good deal. In short, compounding works like this: When you invest money, you could earn returns on that investment. If you do, and if you keep those returns invested, you have the opportunity to earn even more returns — not only on your initial amount, but also on the returns you’ve just earned. And if you keep all that invested over time, you’ll have the chance to earn returns on the returns on the returns. So it builds on itself.

The average annual return in the equity (stock) markets since 1928 has been 9.7%. Lots of years were better than that (like last year, when the equity market returned 31.2%), and lots of years worse than that (like 2008, when the market was down 36.6%) — but through those ups and downs, the average was 9.7%.

At that annual average return of 9.7%, the first dollar you invest would take eight years to become $2. But it would only take five years after that to become $3, and then just four more years to become $4, and only three years after that to become $5. This increasing rate of growth is the “mathemagic” of compounding, as the growth of the money snowballs.*

This compounding is the further reason that historically, if you had invested $1,000 in the equity market at the age of 22 and earned that 9.7% annual return, you would have had $53,565 at the age of 65. If you had waited to age 30 and invested that $1,000, it would be $25,541; at 40, it would be $10,120; at 50, it would be $4,010.*

(Side note: compounding can work in reverse too, on things like credit card debt, when you may have to pay interest not just on the cost of your original purchase, but on your borrowing costs as well.)

#2: We see the markets as a roller coaster.

The second mental shortcut that has hurt us is that many of us tend to think that the equity market performance has historically looked something like this:

The Simpsons on a Roller Coaster

Instead, historically, the performance of the equity market from 1928 to 2019 looked like this, with ups and downs certainly but an overall upward trend:

Historical returns of the S&P500

Breathless market commentators have reinforced this roller-coaster misperception, hyping record highs in the equity markets as though they will, like night follows day, inevitably decline and probably crash.

And that, of course, sometimes happens. But historically, there has been a long-run upward trend, with plenty of ups and downs around that upward trend along the way, as the economy has grown and as there have been expectations for continued growth.

#3: We tend to remember bad experiences more than good ones.

The third way our brain has not been our friend is “the negativity effect.” Losses feel more painful than gains feel good. As a result, so many people tend to overestimate the number of years in which the equity markets have gone down, and underestimate the number of good years.

(I want to make an important point here: This is what has happened historically. And just because the equity markets went up in the past — or went up 9.7% a year on average — is absolutely no guarantee that they will do the same in the future. What I can pretty much guarantee is that they won’t go up or down in any smooth way.)

The point of all of this is that a component of closing the gender wealth gap can be investing, allowing the historical power of compounding to do its work: It’s the old “using money to make money,” or “wealth begetting more wealth.”

How powerful has this been? This compounding effect and the upward trend in the equity markets are two reasons why the wealth gaps have been widening, not closing. Despite all of our working, getting those raises, asking for those promotions.

Fun fact: The historic upward movement in the equity markets has been powerful enough that some have estimated that if Donald Trump had taken the money his father gave him and invested in the stock market rather than building his career in real estate (and all that came with it), he would be a good bit wealthier today than he actually is. Don’t @ me; just sharing a fun fact.

All of this is why we have no investing minimum at Ellevest, to make investing more accessible. It’s why we come to work every day. It’s why investing is the ultimate “lean in.”


Sallie Krawcheck Signature


Disclosures

*Calculated by Ellevest, using 1928–2019 historical return data of the S&P 500, assuming dividends were reinvested. Forecasts calculated using Net Present Value. These results are presented for the purpose of demonstrating the effect of compounding. They are hypothetical in nature, do not represent any investment product offered by Ellevest (as Ellevest does not allow clients to invest 100% of their assets into the stock market), and do not include any advisory fees, taxes, or other expenses that a client would pay that would subtract from returns.

© 2020 Ellevest, Inc. All Rights Reserved.

*Calculated by Ellevest, using 1928–2019 historical return data of the S&P 500, assuming dividends were reinvested. Forecasts calculated using Net Present Value. These results are presented for the purpose of demonstrating the effect of compounding. They are hypothetical in nature, do not represent any investment product offered by Ellevest (as Ellevest does not allow clients to invest 100% of their assets into the stock market), and do not include any advisory fees, taxes, or other expenses that a client would pay that would subtract from returns.

All opinions and views expressed by Ellevest are current as of the date of this writing, for informational purposes only, and do not constitute or imply an endorsement of any third party’s products or services.

The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

Investing entails risk, including the possible loss of principal, and there is no assurance that the investment will provide positive performance over any period of time.

Information was obtained from third-party sources, which we believe to be reliable but not guaranteed for accuracy or completeness. The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

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Sallie Krawcheck

Sallie Krawcheck is the Co-Founder & CEO of Ellevest. Her life’s mission is to help women to reach their financial and professional goals.