The Psychology of money by Morgan Housel – Book review

Why I picked up the book:

About the book:

In the book, Morgan Housel argues that finance is not a hard science. You cannot just learn all the principles of economics and finance to achieve money success. It depends more on our emotions, biases and cognitive abilities.

What I liked: 

It is not what you expect from a finance book. It offers a very fresh and relatable perspective to personal finance.

What I didn’t like: 

I thought hard about this. But I couldn’t find anything negative to say about this book. Even the narration of the audiobook is very good.

The premise of the book: 

To convince you that financial success depends more on your emotions and ego than your knowledge.

Who should read this book: 

Anyone who wants to achieve financial success

Short summary:

 

 

 

Lesson 1: Luck and risk play a huge role in success and failure

Attributing all to hard work or laziness is a very simplistic way to view the world. By recognizing its complexities it’ll allow you to to find humility when things are going right and forgiveness/compassion when they go wrong.

Lesson 2: Modern capitalism is pro at two things: generating wealth and generating envy. 

Knowing what is enough is important to know where to stop. Don’t risk money you own for a money you don’t own

Lesson 3: Financial success = Money you make – Money you lose. 

You should optimize for both sides of the equation. Making money and keeping money require two different skills. The first requires taking risks, being optimistic and putting yourself out there and the latter requires humility, 

Lesson 4: Use money and wealth to buy flexibility and control over your life. 

It will benefit you way more than accumulating luxury goods.

Lesson 5: You may think you want expensive things but most of the time you don’t.

What you really want is respect and admiration from other people.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.

Lesson 6: 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”

“When people say they want to be a millionaire, what they really want is to spend a million dollar”

Lesson 7: Save just for saving’s sake. 

That’s the first step to building wealth

Lesson 8: You’re not a spreadsheet. 

You’re a person. A screwed up, emotional person. 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.

Detailed notes

 

 

 

No One’s Crazy

“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.”

We all think there’s a unique way to deal with money by following a set of hard principles and rules. The reality is money is a very complex subject that depends on individual experiences. What may make sense to me may not make sense to you. RIsk tolerance, work/money reward … all differ from person to person. This explains the generational gap when it comes to money. The historical events that each generation has gone through, wars, inflation, political instability, market crashes, … has a significant influence on their money habits.

“Everyone has their own unique experience with how the world works. And what you’ve experienced is more compelling than what you learn second-hand. So all of us—you, me, everyone—go through life anchored to a set of views about how money works that vary wildly from person to person. What seems crazy to you might make sense to me.”

“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. So equally smart people can disagree about how and why recessions happen, how you should invest your money, what you should prioritize, how much risk you should take, and so on.”

“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.”

“Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.”

Luck & Risk

The dominating narrative is that hard work leads to success and all successes are a result of hard work. The luck factor is often ignored either intentionally or intentionally. 

Morgan gives the example of Bill Gates and how he ended up being in the only high school with a computer. That element of luck is a huge factor in the existence of Microsoft. He also brought up his other friend Kent who worked with Gates on Microsoft in their highschool days. Kent died in a mountaineering accident before graduating highschool and never had the chance to witness what Microsoft has turned out to be. Kent experienced luck’s close sibling, risk.

• • The world is too complex to be able to predict outcomes at 100%. 

• • Luck and risk are doppelgangers

• • Not all success is due to hard work and not all failures are due to laziness

• • Focus less on specific individuals and case studies and more on broad patterns. The stories of successful or failed CEOs and billionaires are extreme examples that are less applicable to most people. The outcome is very influenced by luck and risk. 

• • The trick in dealing with financial risk is arranging your financial life in a way that a failure won’t wipe you out.
    
    

Never enough

• • Morgan gives examples of many millionaires who went to prison for fraud because they wanted more money. To make money they didn’t have and didn’t need, they risked money they did have and did need. 

• • The hardest financial skill is getting the goalpost to stop moving

• • Modern capitalism is pro at two things: generating wealth and generating envy.

• • The quest towards more is driven by social comparison. The only way to win the battle of keeping up with the wealth of those around you is to not play it. 

• • Knowing what enough is, is hard for some people because no one wants to leave opportunities on the table.

• • Some things are not worth risking no matter the gain. When the potential gain increases the risk of harming these things you need to stop.
    
    

Confounding Compounding:

• • If something compounds—if a little growth serves as the fuel for future growth—a small starting base can lead to results so extraordinary they seem to defy logic.

• • “Warren Buffet is the richest investor of all time but he’s not the greatest – at least not when measured by average annual returns”

• • The secret to Warren’s success is time. He started young and kept it consistent.
    
    

Getting Wealthy vs. Staying Wealthy

• • “Good investing is not necessarily about making good decisions. It’s about consistently not screwing up”

• • Money success depends on two factors: getting money and keeping money which require two different skills.

• • “Getting money requires taking risks, being optimistic and putting yourself out there.”

• • “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.”

• • If I had to summarize money success in a single word it would be “survival.”

• • Survival mindset comes down to 3 things:
    • • Being financially unbreakable. Because you’ll be able to stick long enough to make compounding make wonders.
    • • Planning for the plan not going according to plan. Always reason from a margin of error perspective.
    • • Being optimistic about the future but paranoid about what will prevent you from getting to the future
        
        

         

Tails, you win:

This principle reminded me in a way of the Pareto principle. There are few things that actually have a huge impact on your financial success even if you end up screwing a lot of things up.

• • “It’s not whether you’re right or wrong that’s important,” George Soros once said, “but how much money you make when you’re right and how much you lose when you’re wrong.”

• • “A lot of things in business and investing work this way. Long tails—the farthest ends of a distribution of outcomes—have tremendous influence in finance, where a small number of events can account for the majority of outcomes.”

• • “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.”

• • “When you accept that tails drive everything in business, investing, and finance you realize that it’s normal for lots of things to go wrong, break, fail, and fall.”
    
    

Freedom

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. 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.”

• • When you use money to buy bigger and better stuff, you lose control over your time.

• • “Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.”
    
    

Man in the Car Paradox

• • You may think you want expensive things but most of the time you don’t. What you really want is respect and admiration from other people.

• • “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.”
    
    

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”

• • Wealth is what you don’t see

• • “When people say they want to be a millionaire, what they really want is to spend a million dollar”

• • “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.”
    
    

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.

• • The first idea—simple, but easy to overlook—is that building wealth has little to do with your income or investment returns, and lots to do with your savings rate.

• • 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.

• • “Having more control over your time and options is becoming one of the most valuable currencies in the world.”

• • Saving does not require a goal of purchasing something specific. You can save just for saving’s sake. And indeed you should. Everyone should.
    
    

Reasonable > Rational

• • A lot view finance as a hard science. It is not. It is influenced a lot by human behavior

• • You’re not a spreadsheet. You’re a person. A screwed up, emotional person.

• • 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.

• • Academic finance is devoted to finding the mathematically optimal investment strategies. 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 historical odds of making money in U.S. markets are 50/50 over one-day periods, 68% in one-year periods, 88% in 10-year periods, and (so far) 100% in 20-year periods. Anything that keeps you in the game has a quantifiable advantage.
    
    

Surprise

• • “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.”

• • “But investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing, which can make even smart people nervous, greedy and paranoid.”

• • 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.

• • Two things happen when we rely too heavily on investment history to predict the future:

1- We miss out on big events that move the needle the most. “0.00000000004% of people were responsible for perhaps the majority of the world’s direction over the last century. The same goes for projects, innovations, and events.”

2- History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world. (Rise of venture capitalists – 411 retirement …)

Room for Error 

• • When planning for your future investments, always reason with a margin of error. The future is full of unknowns and cannot be predictable. This allows you to avoid single points of failure.

• • “The most important part of every plan is planning for your plan not going according to plan”

• • Margin of safety—you can also call it room for error or redundancy—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.

• • But people underestimate the need for room for error in almost everything they do that involves money. Stock analysts give their clients price targets, not price ranges. Economic forecasters predict things with precise figures; rarely broad probabilities. The pundit who speaks in unshakable certainties will gain a larger following than the one who says “We can’t know for sure,” and speaks in probabilities.⁴²

• • But room for error is underappreciated and misunderstood. It’s often viewed as a conservative hedge, used by those who don’t want to take much risk or aren’t confident in their views. But when used appropriately, it’s quite the opposite.

• • There are a few specific places for investors to think about room for error. One is volatility. Can you survive your assets declining by 30%? On a spreadsheet, maybe yes—in terms of actually paying your bills and staying cash-flow positive. But what about mentally? It is easy to underestimate what a 30% decline does to your psyche … Another is saving for retirement. What if long-term history is a good estimate of the long-term future, but your target retirement date ends up falling in the middle of a brutal bear market, like 2009? What if a future bear market scares you out of stocks and you end up missing a future bull market, so the returns you actually earn are less than the market average? What if you need to cash out your retirement accounts in your 30s to pay for a medical mishap?

• • 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.

• • 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.
    
    

You’ll Change

• • “Long-term planning is harder than it seems because people’s goals and desires change over time.”

• • We should avoid the extreme ends of financial planning. Assuming you’ll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you’ll one day find yourself at a point of regret. The fuel of the End of History Illusion is that people adapt to most circumstances, so the benefits of an extreme plan—the simplicity of having hardly anything, or the thrill of having almost everything—wear off. But the downsides of those extremes—not being able to afford retirement, or looking back at a life spent devoted to chasing dollars—become enduring regrets. Regrets are especially painful when you abandon a previous plan and feel like you have to run in the other direction twice as fast to make up for lost time.

• • Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.

• • We should also come to accept the reality of changing our minds. Some of the most miserable workers I’ve met are people who stay loyal to a career only because it’s the field they picked when deciding on a college major at age 18. When you accept the End of History Illusion, you realize that the odds of picking a job when you’re not old enough to drink that you will still enjoy when you’re old enough to qualify for Social Security are low.

• • 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.
    
    

Nothing’s Free

• • Everything has a price but not all prices appear on a label

• • Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.

• • The question is: Why do so many people who are willing to pay the price of cars, houses, food, and vacations try so hard to avoid paying the price of good investment returns? The answer is simple: 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 fine for doing something wrong.

• • “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.”

• • The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty—not just putting up with it, but realizing that it’s an admission fee worth paying.
    
    

You & Me

• • “Beware taking financial cues from people playing a different game than you are.”

• • “Smart, informed, and reasonable people can disagree in finance, because people have vastly different goals and desires. There is no single right answer; just the answer that works for you.“

• • When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.

• • Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.

• • The formation of bubbles isn’t so much about people irrationally participating in long-term investing. They’re about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself. What do you expect people to do when momentum creates a big short-term return potential? Sit and watch patiently? Never. That’s not how the world works. Profits will always be chased.

• • 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 behaviours 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.
    
    

     

The Seduction of Pessimism

• • “Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.”

• • “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.”

• • Optimism is the best bet for most people because the world tends to get better for most people most of the time.

• • Real optimists don’t believe that everything will be great. That’s complacency. Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.

• • If a smart person tells me they have a stock pick that’s going to rise 10-fold in the next year, I will immediately write them off as full of nonsense. If someone who’s full of nonsense tells me that a stock I own is about to collapse because it’s an accounting fraud, I will clear my calendar and listen to their every word.

• • money is ubiquitous, so something bad happening tends to affect everyone and captures everyone’s attention.

• • There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. In a connected system where one person’s decisions can affect everyone else, it’s understandable why financial risks gain a spotlight and capture attention in a way few other topics can.

• • pessimists often extrapolate present trends without accounting for how markets adapt.

• • There is an iron law in economics: extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways.

• • A third is that progress happens too slowly to notice, but setbacks happen too quickly to ignore.

• • There are lots of overnight tragedies. There are rarely overnight miracles.

• • 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.
    
    

When You’ll Believe Anything

• • stories are, by far, the most powerful force in the economy. They are the fuel that can let the tangible parts of the economy work, or the brake that holds our capabilities back.

• • there are so many financial opinions that once you pick a strategy or side, you become invested in them both financially and mentally. If you want a certain stock to rise 10-fold, that’s your tribe. If you think a certain economic policy will spark hyperinflation, that’s your side.

• • Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

• • Most people, when confronted with something they don’t understand, do not realize they don’t understand it because they’re able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world, however limited those experiences are. We all want the complicated world we live in to make sense. So we tell ourselves stories to fill in the gaps of what are effectively blind spots.

• • Satisfying that need is a great way to put it. Wanting to believe we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated and solved. The illusion of control is more persuasive than the reality of uncertainty. So we cling to stories about outcomes being in our control.
    
    
    
    

SUMMARY:

• • Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong. Because it’s never as good or as bad as it looks. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control. You’ll also have a better chance of finding the right role models. 

• • Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today. 

• • Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions. 

• • If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve.

• • Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune, because a small minority of things account for the majority of outcomes. No matter what you’re doing with your money you should be comfortable with a lot of stuff not working. That’s just how the world is. So you should always measure how you’ve done by looking at your full portfolio, rather than individual investments. It is fine to have a large chunk of poor investments and a few outstanding ones. That’s usually the best-case scenario. Judging how you’ve done by focusing on individual investments makes winners look more brilliant than they were, and losers appear more regrettable than they should. 

• • Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance. 

• • Be nicer and less flashy. No one is impressed with your possessions as much as you are. You might think you want a fancy car or a nice watch. But what you probablywant is respect and admiration. And you’re more likely to gain those things through kindness and humility than horsepower and chrome. 

• • Save. Just save. You don’t need a specific reason to save. It’s great to save for a car, or a downpayment, or a medical emergency. But saving for things that are impossible to predict or define is one of the best reasons to save. Everyone’s life is a continuous chain of surprises. Savings that aren’t earmarked for anything in particular is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment. 

• • Define the cost of success and be ready to pay it. Because nothing worthwhile is free. And remember that most financial costs don’t have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid). 

• • Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge, but if it keeps you in the game it can pay for itself many times over.

• • Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the more you may regret them as you evolve.

• • You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time.

• • Define the game you’re playing, and make sure your actions are not being influenced by people playing a different game.

• • Respect the mess. Smart, informed, and reasonable people can disagree in finance, because people have vastly different goals and desires. There is no single right answer; just the answer that works for you.