Key Money Lessons From Morgan Housel’s The Psychology of Money

Investing is a lot more than choosing the right investments. Your returns are also determined by how you handle your emotions, ego, and biases. In the book, The Psychology of Money – Timeless Lessons on Wealth, Greed, and Happiness, author Morgan Housel takes a look at the emotions behind our investment decision. Housel is a well-known financial author. He is a former writer for the Wall Street Journal and is currently a contributor to The Motley Fool.


The Psychology of Money –  Book Summary

Our personal experience creates our reality

Our personal experience with money guides how we think. But our personal experience is a small part of what happened in the world. If we had lived through the great depression, we may view the world differently compared to someone in Australia. a country that has not seen a recession in 30 years.

The challenge for most investors is that no amount of reading or open-mindedness can simulate the power and fear of uncertainty. Most investors believe that they can easily hold stocks through the next recession. But when their stocks are down 50%, they struggle with fear and uncertainty. We are all newbies – there is a lot we have not seen.

Role of luck and risk

Most of us attribute our financial outcomes to the quality of decision-making. But luck plays a big part too. Investors like Warren Buffet may be beneficiaries of luck and those who lost their fortune may have been victims of risk.

Housel tells the story of Bill Gates. He was lucky enough to go to a school that had a computer. He was good friends with Kent Evan, who was in some ways smarter than Bill Gates but unfortunately died in a mountaineering accident before graduating high school. He could have been one of the founders of Microsoft if not for fate.

Never Enough

As we acquire more money and assets, we want to make more. We move the goalposts and try to keep up with the Joneses.  Social pressure is real. Rajat Gupta (ex McKinsey CEO) and Bernie Maddoff too much risk that destroyed their reputations because they just couldn’t be satisfied with what they had.

Compounding is powerful

Warren Buffet is worth $84.5 billion but he made 96% of that money after his 50th birthday. Buffett started investing when he was 10. Buffett was an exceptional investor but it was time that did the heavy lifting for him and made him a billionaire. If he had gone about like a normal person and didn’t start investing until his 20s, even with his extraordinary returns he won’t be a billionaire.

Making Money vs Keeping Money

Making money and keeping money take two different skill sets. To make money, you must be willing to take risks. But to keep the money you earned, you must be frugal and paranoid. You need a survival mindset to keep the money you earned. Plan to be financially unbreakable and let compound interest do the magic.

Understanding long tails

Not every one of our financial decision is going to be good. In fact, a majority of our decisions may be bad and we may still come out ahead. That’s because long tails – the farthest distribution of outcomes have a big influence on your financial outcomes. What we do as investors day to day may not matter but what decides our investment returns is what we do during a small number of days (eg. during market crashes, recession, etc.)

Controlling your own time is the best reward

The wealthiest person is not the one that has the most money but it is the one who can get up and choose to do whatever he wants. Having control over our life gives us more satisfaction than having material things. Big salaries, houses, and boats can’t match the emotional high you get when you can set your own schedule.

Ferraris are not worth it

Showing off wealth by buying an expensive car is not worth it. Most folks driving these expensive vehicles are looking for respect and admiration, which are best acquired by showing humility, kindness, and empathy.

Wealth is what you don’t see

We love to spend money on things that make us look attractive. But real wealth is income that is not spent. Wealth is the nice car or house that we don’t buy. The hidden nature of wealth makes it hard to imitate those who are wealthy.

Save money – It’s the one thing you have complete control over

How much wealth we have is not determined by our income or investment. Our wealth is primarily determined by your savings rate and we have complete control over how much we save. The more we limit our expenses, the more we can save. Once your basic needs are met, maybe you need a bit more (comfortable basics). Beyond that, any spending is just a reflection of our egos.

Our savings give us flexibility and control over time. With a high savings rate, we can take a lower-paying job or wait to make the right investments.

Being reasonably rational is enough

We humans don’t need to make optimal decisions all the time. A complicated spreadsheet may help us arrive at the perfect solution but we won’t be able to sustain that decision for long (eg. investments, habits, etc.). Aim for reasonable decisions and we can stick with those for the long run.

History is a misleading guide

History is the study of surprising events. Yet we use history as a guide to the future. When it comes to investing, future economic events that are likely to move your portfolio the most are things that history will not guide you. History is an imperfect guide because it doesn’t consider the structural changes and innovations that have happened since events of the past.

Allow room for error

Benjamin Graham called it the margin of safety. It’s allowing room for error in case your decisions are wrong.  The extra margin allows you to stick around long enough for the odds to turn in your favor. Avoid single points of failure. If you are relying on one thing, remember that it will eventually break. A good example is relying on a single paycheck for short-term needs with no savings.

We change a lot

Long-term planning is difficult because our goals change more often than we think. We are very poor at forecasting what our future selves will need. We are good at realizing how much we have changed in the past but still underestimate how much we are likely to change in the future. As an example, young people pay a lot of money to remove tattoos that they got as teenagers (and paid a lot of money for it).

Everything has a price

If we want to be a good investor, the price we pay is volatility, fear, doubt, uncertainty, and regret. Only by paying this price, will we get good returns. Everything in life has a price and they are not always in dollars. Find out what the price is for what you want, and be willing to pay that price.

What game are you playing?

Everyone is playing a different game in the market. A day trader is playing a different game from someone who primarily invests in index funds.  People have different goals and time horizons. Don’t be persuaded by the actions of others. Stay true to your goals. If you are investing on a 30-year time horizon, short blips such as recessions or poor earnings don’t matter as much.

Pessisimism is seductive

Pessimistic arguments sound smarter and make intellectual sense. Pessimists tend to extrapolate the present without assuming that markets adapt. So optimism is the best way because the world does get better for most people over time.

Stories are powerful

The more we want something to be true, the more we are willing to believe a story. We all have an incomplete understanding of the world. But we form a narrative to fill the gaps. Stories give us an illusion of control.

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