The Psychology of Money: Timeless lessons on wealth, greed, and happiness
✒️ Author: Morgan Housel |. 📖 Published: 2020 | 🗓 Read: September 23, 2020 | 📄 Pages: 300
Summary
Doing well with money isn’t necessarily about what you know. It’s about how you behave. And behavior is hard to teach, even to really smart people. Money—investing, personal finance, and business decisions—is typically taught as a math-based field, where data and formulas tell us exactly what to do. But in the real world people don’t make financial decisions on a spreadsheet. They make them at the dinner table, or in a meeting room, where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together.
Why You Should Read It
Morgan Housel shares 19 short stories exploring the strange ways people think about money and teaches you how to make a better sense of money. This book fundamentally changed how I viewed money and taught me the foundation about how to grow wealth.
Notable Highlights
Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.
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Money is everywhere, it affects all of us, and confuses most of us. Everyone thinks about it a little differently. It offers lessons on things that apply to many areas of life, like risk, confidence, and happiness. Few topics offer a more powerful magnifying glass that helps explain why people behave the way they do than money. It is one of the greatest shows on Earth.
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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. To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperiling their future.
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I love Voltaire’s observation that “History never repeats itself; man always does.” It applies so well to how we behave with money.
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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.
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The challenge for us is that no amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.
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I can read about what it was like to lose everything during the Great Depression. But I don’t have the emotional scars of those who actually experienced it. And the person who lived through it can’t fathom why someone like me could come across as complacent about things like owning stocks. We see the world through a different lens.
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Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.
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The economists wrote: “Our findings suggest that individual investors’ willingness to bear risk depends on personal history.”
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But every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences.
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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.
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We all do crazy stuff with money, because we’re all relatively new to this game and what looks crazy to you might make sense to me. But no one is crazy—we all make decisions based on our own unique experiences that seem to make sense to us in a given moment.
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“Nothing is as good or as bad as it seems.”
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Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort.
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Countless fortunes (and failures) owe their outcome to leverage.
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The difficulty in identifying what is luck, what is skill, and what is risk is one of the biggest problems we face when trying to learn about the best way to manage money.
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Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.
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Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging of entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.
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Therefore, focus less on specific individuals and case studies and more on broad patterns.
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Studying a specific person can be dangerous because we tend to study extreme examples—the billionaires, the CEOs, or the massive failures that dominate the news—and extreme examples are often the least applicable to other situations, given their complexity. The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was influenced by extreme ends of luck or risk.
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The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.
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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.
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At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.” Enough. I was stunned by the simple eloquence of that word—stunned for two reasons: first, because I have been given so much in my own life and, second, because Joseph Heller couldn’t have been more accurate. For a critical element of our society, including many of the wealthiest and most powerful among us, there seems to be no limit today on what enough entails.
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There is no reason to risk what you have and need for what you don’t have and don’t need.
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The hardest financial skill is getting the goalpost to stop moving.
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Modern capitalism is a pro at two things: generating wealth and generating envy. Perhaps they go hand in hand; wanting to surpass your peers can be the fuel of hard work. But life isn’t any fun without a sense of enough. Happiness, as it’s said, is just results minus expectations.
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The point is 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.
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The idea of having “enough” might look like conservatism, leaving opportunity and potential on the table. I don’t think that’s right. “Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret.
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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. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.
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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. It can be so logic-defying that you underestimate what’s possible, where growth comes from, and what it can lead to.
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Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works.
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Put that all together: From 1950 to 1990 we gained 296 megabytes. From 1990 through today we gained 100 million megabytes. If you were a technology optimist in the 1950s you may have predicted that practical storage would become 1,000 times larger. Maybe 10,000 times larger, if you were swinging for the fences. Few would have said “30 million times larger within my lifetime.” But that’s what happened.
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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.
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Getting money requires taking risks, being optimistic, and putting yourself out there. But 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.
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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.
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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.
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Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.
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Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
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A plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality.
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Room for error—often called margin of safety—is one of the most underappreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes.
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A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
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Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And in fact you know it will be filled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is filled with landmines, and always will be. Those two things are not mutually exclusive.
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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.
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Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. And 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.
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Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.
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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. Tails drive everything.
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These are not delusions or failures of responsibility. They are a smart acknowledgement of how tails drive success. For every Amazon Prime or Orange is The New Black you know, with certainty, that you’ll have some duds. Part of why this isn’t intuitive is because in most fields we only see the finished product, not the losses incurred that led to the tail-success product.
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When we pay special attention to a role model’s successes we overlook that their gains came from a small percent of their actions. That makes our own failures, losses, and setbacks feel like we’re doing something wrong. But it’s possible we are wrong, or just sort of right, just as often as the masters are. They may have been more right when they were right, but they could have been wrong just as often as you.
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“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.” You can be wrong half the time and still make a fortune.
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The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”
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Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.
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Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
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Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time. To obtain, bit by bit, a level of independence and autonomy that comes from unspent assets that give you greater control over what you can do and when you can do it.
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But doing something you love on a schedule you can’t control can feel the same as doing something you hate.
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If your job is to build cars, there is little you can do when you’re not on the assembly line. You detach from work and leave your tools in the factory. But if your job is to create a marketing campaign—a thought-based and decision job—your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you’re making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning. You might be on the clock for fewer hours than you would in 1950. But it feels like you’re working 24/7.
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No one—not a single person out of a thousand—said that to be happy you should try to work as hard as you can to make money to buy the things you want. No one—not a single person—said it’s important to be at least as wealthy as the people around you, and if you have more than they do it’s real success. No one—not a single person—said you should choose your work based on your desired future earning power.
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What they did value were things like quality friendships, being part of something bigger than themselves, and spending quality, unstructured time with their children. “Your kids don’t want your money (or what your money buys) anywhere near as much as they want you. Specifically, they want you with them,” Pillemer writes.
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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.
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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.”
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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.
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Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.
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But 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.
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Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.” Wealth is turning down that treat meal and actually burning net calories. It’s hard, and requires self-control. But it creates a gap between what you could do and what you choose to do that accrues to you over time.
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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.
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The world grew its “energy wealth” not by increasing the energy it had, but by decreasing the energy it needed.
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More importantly, the value of wealth is relative to what you need. Past a certain level of income, what you need is just what sits below your ego.
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When you define savings as the gap between your ego and your income you realize why many people with decent incomes save so little. It’s a daily struggle against instincts to extend your peacock feathers to their outermost limits and keep up with others doing the same.
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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. And you don’t need a specific reason to save.
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Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.
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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.
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That flexibility and control over your time is an unseen return on wealth.
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Intelligence is not a reliable advantage in a world that’s become as connected as ours has. But flexibility is. In a world where intelligence is hyper-competitive and many previous technical skills have become automated, competitive advantages tilt toward nuanced and soft skills—like communication, empathy, and, perhaps most of all, flexibility.
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Why does this happen? If fevers are beneficial, why do we fight them so universally? I don’t think it’s complicated: Fevers hurt. And people don’t want to hurt. That’s it. A doctor’s goal is not just to cure disease. It’s to cure disease within the confines of what’s reasonable and tolerable to the patient. Fevers can have marginal benefits in fighting infection, but they hurt. And I go to the doctor to stop hurting. I don’t care about double-blind studies when I’m shivering under a blanket. If you have a pill that can make a fever stop, give it to me now. It may be rational to want a fever if you have an infection. But it’s not reasonable.
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One is that “minimizing future regret” is hard to rationalize on paper but easy to justify in real life.
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Let me suggest that you love your investments.
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There are few financial variables more correlated to performance than commitment to a strategy during its lean years—both the amount of performance and the odds of capturing it over a given period of time. 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.
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If you view it as the thing providing the endurance necessary to put the quantifiable odds of success in your favor, you realize it should be the most important part of any financial strategy.
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Few things stay the same for very long, which means we can’t treat historians as prophets.
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The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound. How, for example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans, but that’s what happens in a world driven by a few outlier tail events.
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Realizing the future might not look anything like the past is a special kind of skill that is not generally looked highly upon by the financial forecasting community.
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Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make that mistake again.’ But, in fact, what you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising.
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The correct lesson to learn from surprises is that the world is surprising.
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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. They will be unprecedented events. Their unprecedented nature means we won’t be prepared for them, which is part of what makes them so impactful. This is true for both scary events like recessions and wars, and great events like innovation.
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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.
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An interesting quirk of investing history is that the further back you look, the more likely you are to be examining a world that no longer applies to today.
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History is littered with good ideas taken too far, which are indistinguishable from bad ideas. The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—“unknowns”—are an ever-present part of life. The only way to deal with them is by increasing the gap between what you think will happen and what can happen while still leaving you capable of fighting another day.
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“The purpose of the margin of safety is to render the forecast unnecessary.” 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.
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The grey area—pursuing things where a range of potential outcomes are acceptable—is the smart way to proceed.
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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.
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An underpinning of psychology is that people are poor forecasters of their future selves. Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life stresses that grow with competitive pursuits is something entirely different.
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“All of us,” he said, “are walking around with an illusion—an illusion that history, our personal history, has just come to an end, that we have just recently become the people that we were always meant to be and will be for the rest of our lives.” We tend to never learn this lesson. Gilbert’s research shows people from age 18 to 68 underestimate how much they will change in the future.
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