The Psychology of Money | Timeless lessons on wealth, greed, and happiness by Morgan Housel
24 July, 2021 - 21 min read
I. Brief Summary
This book triggered so many emotions at so many levels every time I flipped a chapter. I have been reading Morgan's blog since 2015 and I consider him as one of the best writers in the field of behavioral science and personal finance. Morgan has a writing power like no other—each chapter is built thread by thread, weaving in and out of each other. If I could pass this down to every single kid in the world and especially in America, this is the book I would recommend! My relationship with money and investing is personal and a lot of the lessons I have learned come from those experiences. If you want a life that is fulfilling and leads to freedom, pick this book and read it every year.
The premise of this book is literally the title of this book—the psychology of money. It is not how smart you are with your money, but how you behave with your money. The book is covered with several anecdotes to drive the lessons home.
I work in investment industry so a lot of the lessons shared in the book were nothing new, but the beauty of the lessons lies within Morgan's ability to write and connect ideas. One thing is clear after reading this book—money means many things to many people. What is enough for me might not be enough for someone else and vice-versa. But everyone should strive to live a peaceful life and if the financial affairs are not in order, it might impact your health and personal relationships. Just like money, habits also compound. It is worth investing in good habits and assessing our behavior around personal finance topics.
Finance is one of the greatest shows on Earth. It offers lessons in confidence, risk and happiness. Finance on Wall Street is treated much like physics, but it should be treated more like psychology. Below are the important lessons that Morgan shared in his book, but I highly encourage reading the book because the little stories related to each big idea is much more meaningful than the summary of ideas.
- Everyone has their own unique experiences with how the world works. Risk and reward is quite different for a child in poverty than a child of a wealthy banker. Those who were scarred during the Great Recession of 2008 would not look at the stock market the same as someone who started investing in 2012 (investment returns have been enormous since then). Both of these are unique experiences led by random events, but no one is crazy. It is just we make decisions based on our own unique experiences.
- Luck and risk are siblings. There is effort and then there is risk and luck that an outcome should be attributed to. The latter two are hard to measure and hard to accept. Someone else's failure is usually attributed to bad decisions, while your own failures are usually attributed to risk. Take for example, Facebook turned down Yahoo's offer to acquire Facebook and we credit Mark Zuckerberg for a wise decision. But we criticize Yahoo with passion to reject Microsoft's offer. Luck and risk are indeed siblings! Let's recognize them as well when crediting or criticizing an outcome. There is more to than just efforts and IQ.
- There is no reason to risk what you have and need for what you don’t have and don’t need. Americans often get in trouble for having too many houses by stretching out their debt limits. That is what happened in 2008. The hardest financial skill is getting the goalpost to stop moving. After achieving financial success, money has no utility. With rise in income, expectations rises, but striving for more money has no utility. In that case one step forward pushes the goalpost two steps ahead 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.
- A small starting base can yield to little growth which then fuels for future growth. This can lead to results so extraordinary they seem to defy logic. Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came in his mid-60s. His skill is investing, but his secret is time. We call that compounding.
- There’s only one way to stay wealthy—combination of frugality and paranoia. Getting money is one thing. Keeping it is another. Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risk. Not “growth” or “brains” or “insight.” 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.
- Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. 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. Apple was responsible for almost 7% of the S&P 500 index’s returns in 2018. And it is driven overwhelmingly by the iPhone, which is another tail event amongst the technology products. Tails drive everything.
- Freedom is the highest form of capital return. Control over doing what you want, when you want to, with the people you want to, is what makes people happy. Money's greatest intrinsic value is time. Six months’ emergency expenses means not being terrified of your boss, short commute, taking on a satisfying job with lower salary, and on, and on. Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with. United States is the richest nation in the world, but when we look at time for 99% of the population, it tells you a different story. People lose their time due to jobs and upgrading their lifestyle.
- People don't want expensive car; they want respect and admiration from other people. People think expensive stuff will bring that admiration which it almost never does.
- We should be careful to define the difference between wealthy and rich. Rich means having expensive stuff financed by debt. We rely on outward appearances to gauge financial success. But the truth is that wealth is what you don’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. It’s not hard to spot rich people. They often go out of their way to make themselves known. But wealth is hidden. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.
- Save. Period. Savings can be created by spending less. You can spend less if you desire less. And you will desire less if you care less about what others think of you. Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment. Savings without a spending goal gives you options and flexibility, the ability to wait and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms. What is the return on cash in the bank that gives you the option of changing careers, or retiring early, or freedom from worry? I’d say it’s incalculable. 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. Savings in the bank that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate. Having more control over your time and options is becoming one of the most valuable currencies in the world.
- 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.
- History is mostly the study of surprising events. But it is often used by investors and economists as an unassailable guide to the future. It is not a map of the future. If you view investing as a hard science, history should be a perfect guide to the future but finance is not like studying geology or medicine. 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 most important events in historical data are the big outliers, the record-breaking events. They are what move the needle in the economy and the stock market. The Great Depression. World War II. The dot-com bubble. September 11th. The housing crash of the mid-2000s. That doesn’t mean we should ignore history when thinking about money. The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff.
- The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—“unknowns”—are an ever-present part of life. 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. The best we can do is think about odds. Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong. Leverage—taking on debt to make your money go further—pushes routine risks into something capable of producing ruin.
- An underpinning of psychology is that people are poor forecasters of their future selves. Imagining a goal is easy and fun, but goals evolve and change with age, which makes those goals irrelevant. Keep this in mind when planning for long-term financial goals.
- We’re not good at identifying what the price of success is, which prevents us from being able to pay it. Every job looks easy when you’re not the one doing it because the challenges faced by someone in the arena are often invisible to those in the crowd. 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. Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. 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. It sounds trivial, but 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.
- Understand which game you are playing. An idea exists in finance that seems innocent but has done incalculable damage. It’s the notion that assets have one rational price in a world where investors have different goals and time horizons. 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. You can say a lot about these investors. You can call them speculators. You can call them irresponsible. 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. Identifying which game you are playing is critical.
- Pessimism holds a special place in our hearts than its sibling optimism. Kahneman says the asymmetric aversion to loss is an evolutionary shield. 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. Pessimism sounds smarter. It’s intellectually captivating, and it’s paid more attention than optimism, which is often viewed as being oblivious to risk. 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. The simple idea that most people wake up in the morning trying to make things a little better and more productive than wake up looking to cause trouble is the foundation of optimism. It’s not complicated. It’s not guaranteed, either. It’s just the most reasonable bet for most people, most of the time. Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention. When you realize how much progress humans can make during a lifetime in everything from economic growth to medical breakthroughs to stock market gains to social equality, you would think optimism would gain more attention than pessimism.
- We are storytellers and we control the narrative based on what we want to hear. 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. Or take Bernie Madoff. In hindsight his Ponzi scheme should have been obvious. He told a good story, and people wanted to believe it. The bigger the gap between what you want to be true and what you need to be true to have an acceptable outcome, the more you are protecting yourself from falling victim to an appealing financial fiction. But the biggest risk is that you want something to be true so badly that the range of your forecast isn’t even in the same ballpark as reality.
American culture stretches itself thin by consuming more than what it needs. How did we get here? What gave rise to consumerism? Morgan does a great job by taking us back to WWII. A must read chapter.
- “A genius is the man who can do the average thing when everyone else around him is losing his mind.” — Napoleon
- “The world is full of obvious things which nobody by any chance ever observes.” — Sherlock Holmes
- 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.
- Most of the reason why, I believe, is that we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance).
- 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.
- “Our findings suggest that individual investors’ willingness to bear risk depends on personal history.”
- When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.
- 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.
- But more important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures.
- “Yes, but I have something he will never have … enough.” — Joseph Heller
- 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 business and investing, and many will only stop reaching for more when they break and are forced to.
- If I had to summarize money success in a single word it would be “survival.”
- Capitalism is hard. But part of the reason this happens is because getting money and keeping money are two different skills.
- Compounding only works if you can give an asset years and years to grow. It’s like planting oak trees: A year of growth will never show much progress, 10 years can make a meaningful difference, and 50 years can create something absolutely extraordinary.
- way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.” — Nassim Taleb
- 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.
- “I’ve been banging away at this thing for 30 years. I think the simple math is, some projects work and some don’t. There’s no reason to belabor either one. Just get on to the next.” — Brad Pitt
- Stock goes to zero, have a nice day.
- There are 100 billion planets in our galaxy and only one, as far as we know, with intelligent life. The fact that you are reading this book is the result of the longest tail you can imagine.
- It was my dream to have one of these cars of my own, because (I thought) they sent such a strong signal to others that you made it. You’re smart. You’re rich. You have taste. You’re important. Look at me. When you see someone driving a nice car, you rarely think, “Wow, the guy driving that car is cool.” Instead, you think, “Wow, if I had that car people would think I’m cool.” Subconscious or not, this is how people think.
- When material appearance took precedence over everything but oxygen.
- People are good at learning by imitation. But the hidden nature of wealth makes it hard to imitate others and learn from their ways.
- 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.
- People with enduring personal finance success—not necessarily those with high incomes—tend to have a propensity to not give a damn what others think about them.
- You’re not a spreadsheet. You’re a person. A screwed up, emotional person.
- History is the study of change, ironically used as a map of the future.
- This is not a failure of analysis. It’s a failure of imagination.
- The correct lesson to learn from surprises is that the world is surprising.
- The most important economic events of the future—things that will move the needle the most—are things that history gives us little to no guide about.
- 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.
- The Intelligent Investor is one of the greatest investing books of all time. But I don’t know a single investor who has done well implementing Graham’s published formulas. The book is full of wisdom—perhaps more than any other investment book ever published. But as a how-to guide, it’s questionable at best.
- Historians are not prophets.
- The most important part of every plan is planning on your plan not going according to the plan.
- A good rule of thumb for a lot of things in life is that everything that can break will eventually break.
- 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.
- ... the hardest-working guy I knew. These people have a lot to teach because they have an unfiltered understanding of every inch of the road to success.
- Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key.
- 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.
- “Every job looks easy when you’re not the one doing it.” — Jeff Immelt
- Pessimism just sounds smarter and more plausible than optimism.
- 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.
- In 2007, we told a story about the stability of housing prices, the prudence of bankers, and the ability of financial markets to accurately price risk. In 2009 we stopped believing that story. In 2009 we inflicted narrative damage on ourselves, and it was vicious. It’s one of the most potent economic forces that exists.
- The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.
- Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
- Incentives are a powerful motivator, and we should always remember how they influence our own financial goals and outlooks. It can’t be overstated: there is no greater force in finance than room for error, and the higher the stakes, the wider it should be.
- Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is out of your control. And that can be hard to accept.
- Risk is what's left over when you think you've thought of everything. — Carl Richards
- Investing has a social component that’s often ignored when viewed through a strictly financial lens.
- The reason surprises occur is not because our models are wrong or our intelligence is low. It’s because the odds that Adolf Hitler’s parents argued on the evening nine months before he was born were the same as them conceiving a child.
- The world is never that nice. There’s a price tag, a bill that must be paid. This is the price of market returns. The fee. It is the cost of admission.