Lessons from: The Psychology of Money

Name: The Psychology of Money

Author(s): Housel, Morgan

Synopsis

Again, a very popular book, similar to the one I wrote about last week, The Psychology of Money is basically a collection of frameworks that should help a person to stay financially strong through their life. Don't let the title deceive you though - This is not a financial book, it has more to do with the "psychology" part than with the "money" part - And therefore, anyone can read it even if they are finance novices. The big idea of the book is that how well we do financially in our lives has lesser to do with our education or formal training and more with how we behave with our money. The book is careful to point out that luck plays a major role in one's financial life and it would be remiss to not factor in this variable. Morgan Housel has a very engaging style of writing and each chapter flows to the next very well - so it’s a good read. Be sure to go through the "Notable quotes" section, they are golden. Financial advice that feels like a story so its remembered well, not a lot of those around. Worth a quick read.

Core ideas

1. Our financial decisions are based on the very limited information we have about the world, and even limited understanding how the world works and on top of that our experiences that have an outsized impact on how we evaluate a situation. This unique mental model is what we use to make decisions - Which are right in the moment we make them. So don't think people are crazy with their money.
2. Do not ignore luck: A lot of the financial success or ruin that you see in life has a big component of luck involved that the people making the decisions had no way to impact of even fathom at the moment. So, don't be overly fulsome in praising those who "made it" or dismissing those who did not.
3. It's not all luck though: While individual, isolated instances can be impacted by especially good or bad luck - it is unlikely that over a period of time luck will continuously be good or bad. So, focus less on specific instances and more on broad patterns. If someone made a million dollars overnight, that can be because of a lottery and does not give you any information about their ability to grow that one million into two. But if someone made the same million over 10 years, slowly and intelligently growing the pie, then that is a good indicator that they can grow it further. Use the same logic with your own financial plan - it should not be arranged in such a way that it derives its strength from a few key instances, such as a risky bet on a penny stock paying off. Instead it should be one that consistency grows your wealth and it not impacted by one off cases of bad luck.
4. Understand that you can have enough: Modern society and media convince us into thinking that it's never enough and more is always better. But more can get bad and the hunger for what we do not have (and probably do not even need) can make us lose what we do have and do need. The apex of social comparison is always rising - when I was in school I used to compare myself with my school fellows, when I moved to a good college then I started comparing with college fellow and then we I moved to an ivy-league business school the comparison shifted again - it never ends, it will never end. When it comes to money, you can genuinely have enough (and it's not a super high number either by popular studies). Take a breather once you get there. Focus on the things that really matter: health, relationships, freedom, purpose.
5. You don't need tremendous force for tremendous results: Similar to the lessons from Atomic Habits, focus on taking small steps in the right direction consistently and then let compounding do its magic. "… 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."
6. Only one way to STAY wealthy: Be frugal, be paranoid, keep room for error, plan on the plan not going according to plan, understand your streak of good luck is going to run out. Get into the habit of saving. Do not go all in, do not take bets that have the potential of wiping you out. It is more important to survive long enough to see another day than to aim to make-or-break returns. Hold steady, stick around.
7. Long tails drive outsized returns: So, it's possible that most of your ventures can fail but the very few that do succeed deliver such returns that they eclipse all the losses and then some. So, don't be afraid of taking risk because that is how you find long tails. Just be careful of ruinous risk, you want to stay in the game long enough to find those long tails.
8. Freedom is having control: The reason you want money is because it can allow you have control on your time. Sure, it’s a give and take - you spend time to get money, and then spend money to get time. But the goal should be to generate money faster than time you spend, and generate enough so that you can do what you want where you want when you want with whom you want for as long as you want. Note this is not a call to arms for sky-is-the-limit hoarding of wealth, because, yes, theoretically the previous sentence can be twisted into something like "I want to play golf on my private island by the time I am fifty with the president of the United States", in which case you'll likely be working all the time to get there. Instead, it is an invitation for some honest self-reflection on what you want to do with your life - And then figuring out the money you need to enable that freedom for you.
9. No one is impressed by what you have as much as you are: Kindness, humility, empathy - these are the things people respect. Big houses, fast cars, fancy gadgets - these are things people envy. They don't look at the thing and go "Wow, the person who has this must be really cool", instead they think "Wow, if I had this thing I would look really cool". Keep that in mind while buying expensive stuff. I, personally, try to buy my stuff for the functionality and not social signalling.
10. Wealth is what you do not see: When you see someone living in a large house, it does not mean they are wealthy, instead it means they are poorer by the large amount of money they spent to get that house. Instead wealth is income NOT spent. "The world is filled with people who look modest but are actually wealthy and people who look rich who live at the razor’s edge of insolvency. Keep this in mind when quickly judging others’ success and setting your own goals.".
11. Saving = Ego - Income: Focus on saving because that is more in your control than growing your income each time. Focus on saving because it gives you more control on your time, it gives you the ability to tide over the bad times in wait for the good ones. A way to automatically save is to learn to be happy in the simpler pleasures of life that do not cost a lot of money - raise your savings by raising your humility.
12. The past is a weak guide to the future: Outlier, long tail events that impact the most can rarely be predicted. Plus, our world is changing faster and in newer ways than the entire human race has ever seen, ever. So, the further back in history you look, the more general your takeaways should be.
13. Never go all-in: No financial investment (bet) is worth risking wiping yourself out for. There will always be risks that will surprise you, and you cannot plan for the unknown unknowns. Do not keep single points of failure, anything in life that can go wrong eventually will. Diversify. In fact, this margin of safety a.k.a. room for error is perhaps the most important thing according to the author whose premise that over the long run it is possible to make good, great returns from opportunities that will inevitably arise but only if you have the wherewithal to stay in the game that long, and for that you need margin of safety.
14. People are playing different games: So be careful who you take advice from, whose actions you emulate. The goal of a day trader is very different from the goal of a retiree. People have different hopes, fears and dreams. They see the world differently, so they act differently. The problems begin when you start following them without due diligence on their unique circumstances and goals. As the author says: "… 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.". So, define the game you want to play, and play that and that alone.
15. Be careful about the pessimism going around: It's easier to create, more attractive and easy to notice. Growth takes compound effort over the years but setbacks are a result of a single point of failure that brings down the house - but that does not mean things are all bad, or that past effort was for nought or that we won't have a chance to make things better in the future. Yet we fall quick prey to pessimism and end up doing stupid things. Avoid that, do your due diligence but know that things are rarely as bad (or as good) as they seem.

Notable quotes

• The premise of this book 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.
• One, financial outcomes are driven by luck, independent of intelligence and effort.
• … financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.
• 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.
• You are one person in a game with seven billion other people and infinite moving parts. The accidental impact of actions outside of your control can be more consequential than the ones you consciously take.
• 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.
• There is no reason to risk what you have and need for what you don’t have and don’t need.
• Modern capitalism is a pro at two things : generating wealth and generating envy.
• 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.
• 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.
• … there’s only one way to stay wealthy : some combination of frugality and paranoia.
• 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.
• Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
• A barbelled personality — optimistic about the future, but paranoid about what will prevent you from getting to the future — is vital.
• Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control. A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.
• But if there’s a common denominator in happiness — a universal fuel of joy — it’s that people want to control their lives.
• Money’s greatest intrinsic value — and this can’t be overstated — is its ability to give you control over your time.
• Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.
• You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does — especially from the people you want to respect and admire you.
• 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.
• When you don’t have control over your time, you’re forced to accept whatever bad luck is thrown your way. But if you have flexibility you have the time to wait for no - brainer opportunities to fall in your lap. This is a hidden return on your savings.
• My own theory is that, in the real world, people do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night.
• 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.
• ... 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.
• Go out of your way to find humility when things are going right and forgiveness / compassion when they go wrong.
• Less ego, more wealth.
• Manage your money in a way that helps you sleep at night.
• If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon.
• Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune,
• Use money to gain control over your time,
• Be nicer and less flashy.
• Save. Just save. You don’t need a specific reason to save.
• Worship room for error.
• You should like risk because it pays off over time.
• There is no universal truth. There’s only what works for you and your family, checking the boxes you want checked in a way that leaves you comfortable and sleeping well at night.
• That stuck with me. Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals.
• Independence, at any income level, is driven by your savings rate. And past a certain level of income your savings rate is driven by your ability to keep your lifestyle expectations from running away.
• If there’s a part of our household financial plan I’m proud of it’s that we got the goalpost of lifestyle desires to stop moving at a young age. Our savings rate is fairly high, but we rarely feel like we’re repressively frugal because our aspirations for more stuff haven’t moved much.
• Comfortably living below what you can afford, without much desire for more, removes a tremendous amount of social pressure that many people in the modern first world subject themselves to.
• Good decisions aren’t always rational. At some point you have to choose between being happy or being “ right. ”
• I’m saving for a world where curveballs are more common than we expect. Not being forced to sell stocks to cover an expense also means we’re increasing the odds of letting the stocks we own compound for the longest period of time.
• One of my deeply held investing beliefs is that there is little correlation between investment effort and investment results. The reason is because the world is driven by tails — a few variables account for the majority of returns. No matter how hard you try at investing you won’t do well if you miss the two or three things that move the needle in your strategy.
• My investing strategy doesn’t rely on picking the right sector, or timing the next recession. It relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades. I spend virtually all of my investing effort thinking about those three things — especially the first two, which I can control.

In closing

This is the kind of advice that I imagine a father giving to his kids; "Sit down kids, you're old enough, let me tell you something about money and how it works in this world we live in". I think had I been taught these earlier I might have been a little more financially independent than I am today. Not that I am much worse off because my upbringing somehow embedded in me these concepts even if my dad did not sit me down to explain them to me. At the same time I can totally imagine someone who will need to be told these things.

Definitely recommend this book as a just read for those just starting out on their career, first jobbers or even those who do not want to go down the beaten path - having a healthy relationship with money is something that all of us can benefit from. I got formally educated in business but was never taught these fundamental concepts, it's no surprise though since this book melds psychology, money and certain timeless indelible features of human existence which might not make it to mainstream MBA education. But these ARE good, timeless lessons about the modern world and should be placed in the latticework of our minds. The book does not really need a second read if you have understood and imbibed the concepts.