A genius who loses control of their emotions can be a financial disaster. The opposite is also true. Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence.
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Author and Partner at Collaborative Fund Morgan Housel shares 19 short stories exploring the strange ways people think about money; the book’s major theme is that we can better understand money through psychology and history than finance. In 2018, Morgan wrote a report outlining 20 of the most important flaws, biases, and causes of bad behavior towards money titled The Psychology of Money; the report went viral; the book is an expanded version of the report.
In investing you must identify the price of success—volatility and loss amid the long backdrop of growth—and be willing to pay it.
The Book’s premise is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people. A genius who loses control of their emotions can be a financial disaster. The opposite is also true. Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence.
“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” – Bill Gates
Here are my favourite take-aways from reading,The Psychology of Money by Morgan Housel:
Health and Money
“Two topics impact everyone, whether you are interested in them or not: health and money.“
The health care industry is a triumph of modern science, with rising life expectancy across the world. Scientific discoveries have replaced doctors’ old ideas about how the human body works, and virtually everyone is healthier because of it.
Money is everywhere, it affects all of us, and confuses most of us. Everyone thinks about it a little differently. It offers lessons on things that apply to many areas of life, like risk, confidence, and happiness. Few topics offer a more powerful magnifying glass that helps explain why people behave the way they do than money. It is one of the greatest shows on Earth.
“To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism. To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperiling their future.”
People do some crazy things with money. But no one is crazy
People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons.
“Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.”
“Our findings suggest that individual investors’ willingness to bear risk depends on personal history. Not intelligence, or education, or sophistication. Just the dumb luck of when and where you were born.” – The Economist
Mindets
Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works.
Take a simple example: lottery tickets. Americans spend more on them than movies, video games, music, sporting events, and books combined.
The lowest-income households in the U.S. on average spend $412 a year on lotto tickets, four times the amount of those in the highest income groups. Forty percent of Americans cannot come up with $400 in an emergency. Which is to say: Those buying $400 in lottery tickets are by and large the same people who say they couldn’t come up with $400 in an emergency. They are blowing their safety nets on something with a one-in-millions chance of hitting it big.
Nothing is a good or as bad as it seems
“Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort.“
If you give luck and risk their proper respect, you realize that when judging people’s financial success—both your own and others’—it’s never as good or as bad as it seems.
Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation. Just as with luck, the story gets too hard, too messy, too complex if we try to pick apart how much of an outcome was a conscious decision versus a risk.
“The line between bold and reckless can be thin. When we don’t give risk and luck their proper billing it’s often invisible.”
When things are going extremely well, realize it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly.
But the same is true in the other direction.
Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk. The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.
Never Enough
“Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret.“
John Bogle, the Vanguard founder who passed away in 2019, once told a story about money that highlights something we don’t think about enough:
At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.
There is no reason to risk what you have and need for what you don’t have and don’t need.
The hardest financial skill is getting the goalpost to stop moving.
But it’s one of the most important. If expectations rise with results there is no logic in striving for more because you’ll feel the same after putting in extra effort. It gets dangerous when the taste of having more—more money, more power, more prestige—increases ambition faster than satisfaction. In that case one step forward pushes the goalpost two steps ahead. You feel as if you’re falling behind, and the only way to catch up is to take greater and greater amounts of risk.
Modern capitalism is a pro at two things: generating wealth and generating envy.
Confounding Compounding
$81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday.
The danger here is that when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider compounding potential.
There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called Shut Up And Wait. It’s just one page with a long-term chart of economic growth.
The practical takeaway is that the counterintuitiveness of compounding may be responsible for the majority of disappointing trades, bad strategies, and successful investing attempts.
You can’t blame people for devoting all their effort—effort in what they learn and what they do—to trying to earn the highest investment returns. It intuitively seems like the best way to get rich.
But good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.
Getting Wealthy vs Staying Wealth
Good Investing is not necessarily about making good decisions. It’s about consistently not screwing up.
Getting money requires taking risks, being optimistic, and putting yourself out there.
But keeping money requires the opposite of taking risk. It requires humility, and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
“Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.” – Nassim Taleb
Margin of safety
Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.
A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.
Tails, You win
You can be wrong half the time and still make a fortune.
Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. And most of our attention goes to things that are huge, profitable, famous, or influential. When most of what we pay attention to is the result of a tail, it’s easy to underestimate how rare and powerful they are.
Freedom
Controlling your time is the highest dividend money pays.
People want to become wealthier to make them happier. Happiness is a complicated subject because everyone’s different. But if there’s a common denominator in happiness—a universal fuel of joy—it’s that people want to control their lives.
The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.
Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time. To obtain, bit by bit, a level of independence and autonomy that comes from unspent assets that give you greater control over what you can do and when you can do it.
Reactance
“Doing something you love on a schedule you can’t control can feel the same as doing something you hate.”
There is a name for this feeling. Psychologists call it reactance. Jonah Berger, a marketing professor at the University of Pennsylvania, summed it up well:
“People like to feel like they’re in control—in the drivers’ seat. When we try to get them to do something, they feel disempowered. Rather than feeling like they made the choice, they feel like we made it for them. So they say no or do something else, even when they might have originally been happy to go along.”
“When you accept how true that statement is, you realize that aligning money towards a life that lets you do what you want, when you want, with who you want, where you want, for as long as you want, has incredible return.”
Wealth is what you don’t see
Spending money to show people how much money you have is the fastest way to have less money.
We tend to judge wealth by what we see, because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Instagram photos.
Modern capitalism makes helping people fake it until they make it a cherished industry.
But the truth is that wealth is what you don’t see.
Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.
That’s not how we think about wealth, because you can’t contextualize what you can’t see.
“There is no faster way to feel rich than to spend lots of money on really nice things. But the way to be rich is to spend money you have, and to not spend money you don’t have. It’s really that simple.” – Investor Bill Mann
Wealth vs Riches
Rich is a current income. Someone driving a $100,000 car is almost certainly rich, because even if they purchased the car with debt you need a certain level of income to afford the monthly payment. Same with those who live in big homes. It’s not hard to spot rich people. They often go out of their way to make themselves known.
But wealth is hidden. It’s income not spent. Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.
Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.” Wealth is turning down that treat meal and actually burning net calories. It’s hard, and requires self-control. But it creates a gap between what you could do and what you choose to do that accrues to you over time.
Save Money
“Past a certain level of income people fall into three groups: Those who save, those who don’t think they can save, and those who don’t think they need to save.”
Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.
More importantly, the value of wealth is relative to what you need.
A high savings rate means having lower expenses than you otherwise could, and having lower expenses means your savings go farther than they would if you spent more.
History
It is smart to have a deep appreciation for economic and investing history. History helps us calibrate our expectations, study where people tend to go wrong, and offers a rough guide of what tends to work. But it is not, in any way, a map of the future.
Continuous Change
The most important driver of anything tied to money is the stories people tell themselves and the preferences they have for goods and services. Those things don’t tend to sit still. They change with culture and generation. They’re always changing and always will.
The mental trick we play on ourselves here is an over-admiration of people who have been there, done that, when it comes to money. Experiencing specific events does not necessarily qualify you to know what will happen next. In fact it rarely does, because experience leads to overconfidence more than forecasting ability.
The most important part of every plan is planning on your plan not going according to plan.
Avoid Single Point of Failure
A good rule of thumb for a lot of things in life is that everything that can break will eventually break. So if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe. That’s a single point of failure.
“The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.”
Sunk Cost
Sunk costs—anchoring decisions to past efforts that can’t be refunded—are a devil in a world where people change over time. They make our future selves prisoners to our past, different, selves. It’s the equivalent of a stranger making major life decisions for you.
Embracing the idea that financial goals made when you were a different person should be abandoned without mercy versus put on life support and dragged on can be a good strategy to minimize future regret.
The quicker it’s done, the sooner you can get back to compounding.
Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.
All the best in your quest to get better. Don’t Settle: Live with Passion.
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