Book Review: The Psychology Of Money By Morgan Housel
Recently Morgan Housel’s book, The Psychology of Money, was recommended on my list of podcasts and YouTube videos.
Why? I don’t know.
Maybe “Google” was trying to tell me something? 🙂
Anyway, after listening to his interview about his latest book, I had to order one for myself.
I love his statement in the Introduction:
Housel stated, “The premise of this book is that doing well with money has 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.“
Morgan Housel is a former financial columnist for the Wall Street Journal. He’s now a partner at Collaborative Fund which is an early-stage venture capital firm.
In The Psychology of Money, he shows us how our minds can work both for and against us when it comes to our relationship with money.
He claims that expertise in finance requires an understanding of human psychology, and not money per se.
Consumers and investors behave with flawed attitudes such as overconfidence and impatience which can have negative effects on your own personal finances.
He teaches how developing reasonable financial goals, not over-reliant on historical financial performance, can make us financially successful in the long run.
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18 Wealth Lessons From “The Psychology of Money”
The Psychology of Money discusses the strange ways people think about:
It’s broken down into 18 wealth lessons….
#1 No One’s Crazy
Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works.
People should make investment decisions based on their goals and investment options available to them at the time.
But that’s NOT what people do!
Studies show that people’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation – especially experiences early in their adult life.
Because my grandmother grew up in the Great Depression, her willingness to take risks with her investments were next to zero. She never wanted to lose money again. And it didn’t matter to her if she had to leave it in a savings account for the rest of her life.
Investors willingness to bear risk depends on personal history. It has nothing to do with intelligence, education or sophistication. Just the dumb luck of when and where you were born.
#2 Luck & Risk
Nothing is as good or bad as it seems.
My grandmother used to tell me, “Son, make good decisions.”
Speaking of decisions, it’s easy to convince yourself that any of the financial outcomes you get are determined by these decisions.
But this isn’t always the case as you can:
- make BAD decisions that lead to GOOD financial outcomes
- make GOOD decisions that lead to POOR financial outcomes
As with anything we’re trying to accomplish, you have to account for the role of risk and luck. Because they’re both so similar, you can’t believe in one without equally respecting the other.
Housel teaches us to be careful when assuming that 100% of outcomes can be attributed to effort and decisions.
He states we shouldn’t focus so much on specific individuals but more on broad patterns instead. Because those people at the top may have been the benefactors of luck while those at the bottom may have been the victims of risk.
#3 Never Enough
Big idea: Rich people do crazy things.
Housel suggests most that read his book will, at some point, earn a salary or have a sum of money to cover every reasonable thing they need and a lot of what they want.
And if you’re one of them, remember this:
a. The hardest financial skill is getting the goalpost to stop moving.
This is one of the most important. If expectations rise with results there’s no logic in striving for more because you’ll feel the same after putting in extra effort. This gets dangerous when the taste of having more money or power 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.
b. Social comparison is the problem here.
The point is that the ceiling of social comparison is so high that virtually no one will ever hit it. Which means it’s a battle that can never be won, or that the only way to win is to not fight to begin with—to accept that you might have enough, even if it’s less than those around you.
c. “Enough” is not too little.
The only way to know how much food you can eat is to eat until you’re sick. Few try this because vomiting hurts more than any meal is good. For some reason the same logic doesn’t translate to investing, and many will only stop reaching for more when they break and are forced to.
This can be as innocent as burning out at work or a risky investment allocation you can’t maintain.
The inability to deny a potential dollar will eventually catch up to you.
d. There are many things never worth risking, no matter the potential gain
- Reputation is invaluable.
- Freedom and independence are invaluable.
- Family and friends are invaluable.
- Being loved by those who you want to love you is invaluable.
- Happiness is invaluable.
And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.
#4 Confounding Compounding
As of this writing, Warren Buffett’s net worth is $109.5 billion. Of that, $84.5 billion was accumulated after his 65th birthday.
Think about that for a minute. It’s hard for us to wrap our minds around the reality that compounding interest can lead to logic-defying results.
Yes, he’s a skillful investor, but his secret is time. That’s how compounding works. It’s a powerful thing!
Remember this. Good investing isn’t necessarily about earning the highest returns, because those tend to be one-off hits that can’t be repeated.
It’s about earning fairly good returns that you can stick with and which CAN be repeated for the longest period of time. And that’s when compounding starts to run wild.
#5 Getting Wealthy vs Staying Wealthy
Good investing is not necessarily about making good decisions. It’s about consistently not screwing up.
Sounds like he wants us to play more defense than offense.
Here’s Housel’s thoughts about getting wealthy vs staying wealthy:
“If I had to summarize money success in a single word it would be ‘survival.’”
“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.”
“The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest difference. This should be the cornerstone of your strategy, whether it’s in investing or your career or a business you own. There are two reasons why a survival mentality is so key with money. One is the obvious: few gains are so great that they’re worth wiping yourself out over. The other is the counterintuitive math of compounding. Compounding only works if you can give an asset years and years to grow.”
Housel states that we must apply a survival mindset to the real world which comes down to appreciating three things:
1. More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.
2. Planning is important, but the most important part of every plan is to plan on the plan not going according to plan. A plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality.
3. A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
The bottom line is the ability to stick around for a long time, without wiping out or being forced to give up, makes the biggest difference when it comes to making money. Compounding only works if you can give an asset years to grow.Join the Passive Investors Circle
#6 Tails, You Win
You can be wrong half the time and still make a fortune.
Napoleon’s definition of a military genius was, “The man who can do the average thing when all those around him are going crazy.”
It’s the same with investing.
Most financial advice is about today. What should you do right now, and what stocks look like good buys today?
But most of the time today is NOT that important. Over the course of your lifetime as an investor the decisions that you make today or tomorrow or next week will not matter nearly as much as what you do during the small number of days – likely 1% of the time or less – when everyone else around you is going crazy.
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 (think social media).
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.
Controlling your time is the HIGHEST dividend money pays.
The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”
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.
More than your salary. More than the size of your house. More than the prestige of your job. Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
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.
Speaking to time, here’s my thoughts about The Time Value of Money.
#8 Man in the Car Paradox
“No one is impressed with your possessions as much as you are.”
There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.
It’s a subtle recognition that people generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine. If respect and admiration are your goal, be careful how you seek it.
Humility, kindness, and empathy will bring you more respect than horsepower ever will.
#9 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.
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.
The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth.
We should be careful to define the difference between wealthy and rich. It is more than semantics. Not knowing the difference is a source of countless poor money decisions.
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.”
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.
#10 Save Money
Building wealth has little to do with your income or investment returns, and lots to do with your savings rate.
Investment returns can make you rich. But whether an investing strategy will work, and how long it will work for, and whether markets will cooperate, is always in doubt. Results are shrouded in uncertainty.
Personal savings and frugality—finance’s conservation and efficiency—are parts of the money equation that are more in your control and have a 100% chance of being as effective in the future as they are today.
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.
Makes sense to me….
More importantly, the value of wealth is relative to what you need.
Learning to be happy with less money creates a gap between what you have and what you want—similar to the gap you get from growing your paycheck, but easier and more in your control.
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.
Spending beyond a pretty low level of materialism is mostly a reflection of ego approaching income, a way to spend money to show people that you have (or had) money.
Think of it like this, and one of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.
When you define savings as the gap between your ego and your income you realize why many people with decent incomes save so little.
#11 Reasonable > Rational
Housel claims that we’re not a spreadsheet. We’re a screwed up, emotional person.
With it comes something that often goes overlooked:
Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.
What’s often overlooked in finance is that something can be technically true but contextually nonsense.
- A rational investor makes decisions based on numeric facts.
- A reasonable investor makes them in a conference room surrounded by co-workers you want to think highly of you, with a spouse you don’t want to let down, or judged against the silly but realistic competitors that are your brother-in-law, neighbor, and own personal doubts.
Investing has a social component that’s often ignored when viewed through a strictly financial lens.
In the book, he uses the example of someone having a fever. He asks, “If fevers are beneficial, why do we fight them so universally?”
The main reasons are that fevers hurt and people don’t want to hurt. That’s it.
We all know that fevers can have marginal benefits in fighting infection, but they hurt. And what do people go to the doctor for? To stop hurting, right?
It may be rational to want a fever if you have an infection. But it’s NOT reasonable.
That philosophy – aiming to be reasonable instead of rational is one more people should consider when making decisions with their money.
The correct lesson to learn from surprises is that the world is surprising.
Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next.
History is the study of change, ironically used as a map of the future.
But two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next:
- You’ll likely miss the outlier events that can really move the needle.
- History can be a misleading guide to the future of the stock market and economy because it doesn’t account for structural changes that are relevant to today’s world.
Yes, it’s smart to have a deep appreciation for economic and investing history.
But history is NOT, in any way, a map of the future.
#13 Room for Error
Margin of safety—you can also call it room for error—is the only effective way to safely navigate a world that is governed by odds, not certainties. And almost everything related to money exists in that kind of world
We should use room for error when estimating our future returns.
For his own investments, Housel assumes the future returns he’ll earn in his lifetime will be ⅓ lower than the historic average.
So, he saves more than he would if he assumed the future will resemble the past. It’s his margin of safety.
He claims that the biggest single point of failure with money is the sole reliance on a paycheck to fund short-term spending needs, who NO SAVINGS to create a gap between what you think your expenses are and what they might be in the future.
Remember, you don’t need a specific reason to save.
The most important part of every plan is planning on your plan not going according to plan.
#14 You’ll Change
Long-term planning is harder than it seems because people’s goals and desires change over time.
We’re such poor forecasters of our future selves that’s there’s a term for this phenomenon: The End of History Illusion.
This is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.
Long-term financial planning is essential. But things change – both the world around you, and your own goals and desires.
Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life stresses that grow with competitive pursuits is something entirely different.
When you’re making long-term decisions remember to avoid the extreme ends of financial planning and accept the reality of changing your mind.
#15 Nothing’s Free
Everything has a price, but not all prices appear on labels.
The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due, it doesn’t feel like a fee for getting something good. It feels like a fee for doing something wrong.
Housel states, “Thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.”
Most things are harder in practice than they are in theory. Sometimes this is because we’re overconfident. More often it’s because we’re not good at identifying what the price of success is, which prevents us from being able to pay it.
“Define the cost of success and be ready to pay for it. Because nothing worthwhile is free.”
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#16 You & Me
Avoid taking financial cues from people playing at a different game than you are.
An iron rule of finance is that money chases returns to the greatest extent that it can.
Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.
A takeaway here is that few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are.
The main thing I can recommend is going out of your way to identify what game you’re playing and ignore the rest.
#17 The Seduction of Pessimism
Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you and more plausible than optimism.
In finance, pessimism is paid more attention than optimism, and is, therefore, more persuasive.
Housel claims that, “It’s easier to create a narrative around pessimism because the story pieces tend to be fresher and more recent. Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together. True financial optimism is to expect things to be bad and be surprised when they’re not.”
#18 When You’ll Believe Anything
Stories are, by far, the most powerful force in the economy.
The more you want something to be true, the more likely you are going to believe a story that overestimates the odds of it being true.
After World War I ended, for instance, few thought there would ever be another world war.
Housel states there are many things in life that we think are true because we desperately want them to be true.
He calls these things “appealing fictions,” and they have a big impact on how we think about money—particularly investments and the economy.Join the Passive Investors Circle