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Timeless Lessons on the Psychology of Money

Morgan Housel released the bestseller, The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness in 2020 and it has already sold several million copies. The book is a recommended read and shares twenty short lessons about money. There are some great tips here that will help you think differently about money and become a better investor.

1. No One’s Crazy

Husband, wife and son meeting with a realtor inside a home.

How and when we were raised has a large bearing on how we think about money. If you grew up when stocks performed well you tend to favor investing in the stock market. If your parents owned real estate you tend to believe that is a great strategy. Unless it didn’t work out for them, in which case you are likely to be anti-real estate investments.

We all make crazy decisions about money but no one is crazy. We just make decisions based on our unique circumstances and beliefs that don’t look sane to others with their own unique perspective.

2. Luck & Risk

NYU Professor Scott Galloway notes, “nothing is as good or as bad as it seems.” Much of what we all attribute to a smart decision or great strategy is really just due to luck and chance. On the other hand, you may have agreed with the decisions of people who later result in terrible outcomes.

Be careful both who you praise and emulate and also who you look down upon. Focus less on individual people and decisions and instead on broad patterns of success and failure.

3. Never Enough

Housel shares several stories of investors who became very wealthy but then became overconfident, got caught up in the game of making money, and later lost everything. The lesson is to identify your goal – your investment number – and not change it to “keep up with the Joneses.” If you are patient and get to your number you may want to slow down and become more conservative. Also realize that many things are never worth the risk, no matter the potential gain.

4. Confounding Compounding

Most of us underestimate how powerful the compound effect is. Here are a few of my favorite examples:

A girl folding a piece of paper.

How many times do you think you can fold a piece of paper in half? If you had a really big piece, guess how thick your piece of paper would end up if you folded it in half just 42 times? Answer: your paper would be thick enough that it would stretch to the moon! About 60 additional folds would get you outside of our entire universe!

Warren Buffet is known for his wise investment decisions, but Housel suggests he should be known more for his investing longevity. As of 2019, Buffet had a net worth of $84.5 Billion. Of that total, over $84.2 Billion was accumulated after his 50th birthday. His real secret is starting to invest at age ten and still investing at age 92!

Housel notes that good investing is more about earning “pretty good” returns for a long period of time.

5. Getting Wealthy vs. Staying Wealthy

Housel notes that there are a million ways to get wealthy, but good investing is mostly about consistently not screwing up. You must combine a measure of frugality and paranoia to survive and allow compounding enough time to make a difference.

Be optimistic about the future but avoid taking risks that have the potential to wipe you out.

6. Tails, You Win

Psychology of money.

The Russell 3000 index of companies has combined returns of 73X from 1980 to 2020. That is a spectacular return. Yet 40% of the companies in the index have effectively failed. Only 7% of the companies in the index performed well, but that performance was more than enough to overcome the failures.

It is likely that only a few of the investments you make over your lifetime will provide you with the majority of your returns. The challenge is knowing which investments those are, which is why venture capitalists make big bets in multiple companies but only hope to get lucky with one of them. It is also the benefit of investing in an index fund.

7. Freedom

Americans today have never had more income and wealth than they do today. Yet compared to prior generations, control over your time has diminished. Since controlling your time is such a key to happiness, Americans today don’t feel much happier despite our growth in wealth.

Controlling your time is the highest dividend money pays. Financial independence supports this.

8. Man in the Car Paradox

A bright green sports car.

Housel recalls working as a valet and seeing a beautiful car pull up. Housel envied driving the car, not being the man in the car. He didn’t even notice the man driving.

Some people with fancy toys own them while others are in debt up to their eyeballs. Either way, no one is impressed with your possessions as much as you are.

9. Wealth is What You Don’t See

Following the point above, spending money to show people how much money you have is the fastest way to have less money.

10. Save Money

Saving money is one of the only factors each of us has control over. Building wealth has little to do with your income or investment returns and lots to do with your savings rate. Good money habits also reduce your need for money in the future – making it easier to achieve financial independence.

Make saving money a habit, even if you don’t have a specific cause you are saving your money for. Be sure to read the Personal Kaizen eight tips to stop wasting your money.

11. Reasonable > Rational

Don’t aim to be coldly rational with your financial decisions, just aim to be pretty reasonable. We are all different, so invest in a way that allows you to sleep well at night.

A boy putting a coin in a piggy bank. Psychology of money.

Vanguard founder Jack Bogle did more than anyone to promote low-cost passive index investing during his lifetime. His son later became a high-fee mutual fund manager. Bogle – against his life mission – invested some of his own money in his son’s fund. Why? “We do some things for family reasons,” Bogle told the Wall Street Journal.

12. Surprise!

Nassim Taleb describes tail events (mentioned in #6 above) in his book The Black Swan. We expect the future to be similar to the past and often miss the outlier events that move the needle the most. This is not a failure of analysis; it is a failure of imagination.

Much of the financial advice that has succeeded in the past will likely not work in the future. Historians are not prophets.

13. Room for Error

Plan on your plan not going according to plan. The best strategy is to play the odds and include a safety factor. You should take some risks to get ahead, but no risk that can wipe you out is ever worth taking.

Always avoid single points of failure. The odds are in your favor when playing Russian roulette, but who cares about odds with that kind of risk!

14. You’ll Change

Change

Long-term planning is harder than it seems because people’s goals and desires change over time. Avoid the extreme ends of financial planning (huge returns or low-cost retirement). Compounding works best when you have decades ahead of you. Just accept that your life situation is going to change along the way.

15. Nothing’s Free

Everything has a price, including the “price” a long-term investor pays dealing with market volatility. The price of long-term growth in the market includes many periods where the value of your investment has dropped from previous highs. This is the price we must pay for being an investor.

16. You & Me

Different investors have different investment goals and time horizons. Know your investment goals and don’t become persuaded by investors with different goals.

For example, the share price of GameStop stock increased from less than $5 to over $80 per share during the month of January 2021. None of those stock prices would make sense to an investor with a 30-year time horizon (since the GameStop company did nothing to grow its value by more than 15X), but buying at $20 with the intention of selling a few days (or hours) later at $30 made wonderful sense to a short-term trader.

Don’t be persuaded or confused by investors with a different strategy. Here is one popular strategy.

17. The Seduction of Pessimism

Behavioral psychologists have found that most people weigh a loss more highly than an equivalent gain. This leads to pessimistic ideas about the markets and economy being more likely to be read, leading to more of these ideas being shared to get “clicks.” Reasons given for this include the ubiquity of money, undervaluing future technological innovation, and that most progress happens too slowly to notice while setbacks happen too quickly to ignore.

18. When You’ll Believe Anything

Teenage girl looking through binders on a shelf.

The confirmation bias is the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. Human nature is to “fill in the gaps” of a story with what we already believe about the world. This is why young kids and teenagers think they understand the world, despite little experience. It is also how adults (including both you and me, and the supposed experts) become overconfident in our own ability to predict the future.

Housel writes, “Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is outside of your control. And that can be hard to accept.” Investors are better off ignoring expert predictions and forecasts (even our own!) and instead trusting historical averages.

Summary of The Psychology of Money

The last two lessons of The Psychology of Money summarize the earlier 18 points and explain Housel’s personal financial decisions. I recommend you read the book for more info on the 18 points above along with his personal decisions but will let you know that they are very similar to these recommendations.

We hope you enjoyed this summary. Please leave comments and questions below!

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