Some of the most important concepts in the book:
by Morgan Housel
The Psychology of Money is a book written by Morgan Housel that explores the psychological and emotional aspects of personal finance. It delves into the history and psychology of money, and how our attitudes and behaviors around money can affect our financial well-being. The book covers topics such as the role of luck in financial success, the impact of our emotions on financial decision-making, and the importance of understanding the long-term nature of investing. Overall, the book aims to provide readers with a deeper understanding of the psychological and emotional factors that influence our relationship with money, and offers practical advice for building wealth and achieving financial happiness.
Housel suggests that people’s actions and decisions regarding money are heavily influenced by their personal experiences, upbringing, and societal factors. People’s understanding and approach to money can vary greatly depending on their generation, family background, and economic conditions. Despite understanding the importance of making informed investment decisions based on personal goals and characteristics of investment options, people’s actions are often swayed by their emotions and biases. The author suggests that economic conditions and past experiences can shape an individual’s perceptions of risk and reward, leading to different investment strategies and behaviors. Overall, the author suggests that while people’s actions with money may seem irrational, they are not inherently crazy, but rather a product of their unique experiences and perspectives.
According to the author, in many cases, success or failure is not solely determined by skills or effort, but also by luck and risk. Circumstances and opportunities play a large role in determining one’s potential for success, and every action taken also has unintended consequences. The author uses the example of Bill Gates and his co-founder of Microsoft, Paul Allen, and their friend Kent Evans, to illustrate how luck and risk can greatly influence outcomes.
While all three were smart and had a passion for computers, Gates and Allen were fortunate to attend a school with a computer, which set them on a path towards success with Microsoft, while Evans’ untimely death prevented him from being a part of the company.
Be more objective when evaluating success and failure, by not drawing conclusions from extreme examples, and instead looking at broader patterns across many examples. Housel also advises to remember that things are not always as good or bad as they may seem, and to avoid quick judgments of people, including oneself. He advises to be aware that luck and risk play a role in life, and to keep a sense of perspective when things are going well or badly.
The desire for wealth is often insatiable, with people constantly striving for more and more money. This can lead to individuals taking unnecessary risks and sacrificing what is important to them in pursuit of something that may not be important. The author quotes Warren Buffet, who states that it is foolish to risk something that is important to you for something that is unimportant.
Few pieces of advice to individuals who are constantly striving for more wealth to remember a few things:
One of the most challenging aspects of personal finance is setting and sticking to financial goals. As people achieve more success and acquire more wealth, their aspirations and expectations also tend to increase, leading to a never-ending cycle of chasing more and more. According to Housel when ambition outpaces satisfaction, it becomes dangerous, and it is important to be aware of this tendency.
Another obstacles in achieving financial well-being is the tendency to compare one’s wealth and financial status with others. This habit is a never-ending game, as there will always be someone wealthier and more successful. The author suggests that the only way to win this battle is to not fight it at all, and to accept that one might have enough, even if it is less than those around them.
Another great suggestion is that having enough does not mean living a meager lifestyle, but rather having the ability to recognize the point at which additional wealth or success will not bring any more satisfaction or happiness. Housel claims that “enough” is the point ahead of which one will start to regret their choices, whether it is working too hard for extra money, or making risky investments that are not sustainable.
Next aspect to consider – there are certain things that are never worth risking, no matter the potential gain. These things include reputation, freedom, family and friends, and happiness. The author suggests that understanding what is truly valuable and enough is the key to avoiding risks that could harm these things. The author suggests that there is a simple tool to understanding what is enough, which will be discussed in the next chapter.
Warren Buffett’s success as an investor is not his investment strategy or formula, but rather the power of compounding over time. He started investing at a young age and was able to reap the benefits of compound interest by allowing his investments to grow over time.
Compounding only works when an asset is given enough time to grow, and the key to success is not high returns but decent and consistent returns that can be sustained over a long time. Here is what the author suggests:
Good investing is not necessarily about making good decisions, but rather consistently avoiding mistakes. The key to staying wealthy is a combination of frugality and paranoia. Rather than focusing on making big returns, it’s important to strive for financial stability, as this will ultimately lead to the biggest returns in the long run.
In business and investing, it is possible to be wrong half the time and still make a fortune. Housel explains that in finance, long tails, or the farthest ends of a distribution of outcomes, have a significant influence. A small number of events can account for the majority of outcomes.
He notes that anything that is huge, profitable, famous, or influential is the result of a tail event, which is a rare occurrence. He suggests that because most of our attention goes to things that are huge, profitable, famous, or influential, it is easy to underestimate how rare and powerful tail events are.
The author argues that controlling one’s time is the greatest benefit that money can provide. According to him, the ultimate form of wealth is the ability to wake up every morning and have the freedom to do whatever one desires. The author references Campbell’s 1981 book, “The Sense of Wellbeing in America,” in which Campbell sought to understand what makes people happy.
He found that people are generally happier than many psychologists had assumed and the most powerful common denominator of happiness was having a strong sense of controlling one’s life. Housel believes that the greatest intrinsic value of money is its ability to give people control over their time.
People often think that owning flashy cars or big homes will signal to others that they are rich, smart and important. But, in reality, people don’t usually think the owner of these possessions is cool. They use the owner’s wealth as a benchmark for their own desire to be liked and admired.
The author advises that if one seeks money for admiration and respect, then they should be careful, because humility, kindness and empathy will bring more respect than material possessions.
Housel states that using money to display one’s wealth is a quick way to lose money. He advises that the only way to become wealthy is to not spend the money that one has. He further emphasize that this is not only the only way to accumulate wealth but also the very definition of wealth.
No matter how much income or investment returns one has, it is impossible to become wealthy without saving. He notes that it is possible to build wealth without a high income. The main obstacle that prevents most people from saving is their ego, which leads them to spend money to show off to others. Housel’s proposes that in order to stop this behavior, one needs to care less about what others think. He also suggests that it is not necessary to have a specific goal in mind to save, it is beneficial to save for the sake of saving as it provides a hidden return.
In this chapter the author talks against striving for complete rationality when making financial decisions, instead suggesting to aim for reasonableness. He argues that this approach is more realistic and easier to maintain in the long term, which is more important in managing money. Additionally, the author reminds that one is not a spreadsheet, but a person, and this approach allows for being mindful of human nature.
If you want to make God laugh, tell him about your plans!
In chapter 12, Housel warns against the trap of relying too heavily on historical data as a prediction of future conditions, which is a common mistake among investors. He calls it the “historians as prophets” fallacy. The approach is explained as flawed because the world is constantly changing and innovation is constantly happening, so past performance is not necessarily indicative of future results.
The focus in chapter 13, is the importance of considering the possibility that things may not go according to plan when making financial plans. He advises considering a margin of safety, which can be achieved by saving money with no specific goal in mind, but rather for unexpected events that may happen in the future. This way, you are prepared for things that you can’t predict. The idea is to save for nothing, and have a margin of error for the odds that things may not be in your favor.
The main lesson of this chapter is that long-term financial planning is difficult because people’s goals and desires change over time. The author notes that people tend to underestimate how much their personalities, desires, and goals will change in the future, and suggests that aiming for moderate savings, free time, commute, and family time is more likely to lead to success and avoid regret than extreme ends of the spectrum.
He also mentions the concept of “sunk costs,” which refers to the tendency to anchor decisions to past efforts that cannot be refunded, and warns that this can be detrimental in a world where people change over time.
The key takeaway in this chapter is that the true cost of success in investing is not always visible upfront.
It’s important to understand that the ups and downs of the market are not a punishment for making a mistake, but a natural part of the process. By viewing market volatility as a cost rather than a penalty, you will have the mindset to stay invested long enough for it to work in your favor. This mindset shift can help you to better navigate the unpredictable nature of investing.
It is important to be aware that not everyone’s financial goals and priorities are the same as yours. People may have different reasons for spending money on certain things, and it’s important not to compare yourself to others and base your financial decisions on their actions.
Another important aspect to remember is that your own time horizon and goals, and not be swayed by the actions and behaviors of those who may be playing a different game than you. It is crucial for you to identify what game you are playing and make decisions that align with your own goals and priorities.
Pessimism can be seductive as it reduces expectations and narrows the gap between outcomes, but it’s important to remember that growth takes time and not to dismiss new ideas too quickly.
Housel states that stories are more powerful than statistics when it comes to shaping our beliefs and decisions. This is because stories are more relatable and easy to understand, while statistics can be complex and difficult to interpret.
Furthermore, stories tend to be more emotionally charged, which makes them more memorable and influential. This is why it’s important to be aware of the stories we’re telling ourselves and how they shape our financial decisions.