The Psychology of Money

The Psychology of Money - by Morgan Housel #

Date Read: 2023-10-31 #

Notes #

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.

There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. In a connected system where one person’s decisions can affect everyone else, it’s understandable why financial risks gain a spotlight and capture attention in a way few other topics can.

1. No One’s Crazy #

Everyone has their own unique experience with how the world works. And what you’ve experienced is more compelling than what you learn second-hand.

The challenge for us is that no amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.

2. Luck & Risk #

Nothing is as good or as bad as it seems.

3. Never Enough #

There is no reason to risk what you have and need for what you don’t have and don’t need.

If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.

4. Confounding Compounding #

$81.5B of Warren Buffett’s $84.5B net worth came after his 65th birthday.

5. Getting Wealthy vs Staying Wealthy #

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.

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.

It’s different from being conservative. Conservative is avoiding a certain level of risk. Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival.

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.

6. Tails, You Win #

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.

A small number of wins can make up the majority of return in your investments.

7. Freedom #

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.

8. Man in the Car Paradox #

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.”

9. Wealth is What You Don’t See #

10. Save Money #

A hyper-connected world means the talent pool you compete in has gone from hundreds or thousands spanning your town to millions or billions spanning the globe. This is especially true for jobs that rely on working with your head versus your muscles: teaching, marketing, analysis, consulting, accounting, programming, journalism, and even medicine increasingly compete in global talent pools. More fields will fall into this category as digitization erases global boundaries—as “software eats the world,” as venture capitalist Marc Andreesen puts it.

A question you should ask as the range of your competition expands is, “How do I stand out?”

“I’m smart” is increasingly a bad answer to that question, because there are a lot of smart people in the world. Almost 600 people ace the SATs each year. Another 7,000 come within a handful of points. In a winner-take-all and globalized world these kinds of people are increasingly your direct competitors.

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.

If you have flexibility you can wait for good opportunities, both in your career and for your investments. You’ll have a better chance of being able to learn a new skill when it’s necessary. You’ll feel less urgency to chase competitors who can do things you can’t, and have more leeway to find your passion and your niche at your own pace. You can find a new routine, a slower pace, and think about life with a different set of assumptions. The ability to do those things when most others can’t is one of the few things that will set you apart in a world where intelligence is no longer a sustainable advantage.

11. Reasonable > Rational #

Lacking emotions about your strategy or the stocks you own increases the odds you’ll walk away from them when they become difficult.

The reasonable investors who love their technically imperfect strategies have an edge, because they’re more likely to stick with those strategies.

12. Surprise! #

Things that have never happened before happen all the time.

History helps us calibrate our expectations, study where people tend to go wrong, and offers a rough guide of what tends to work. But it is not, in any way, a map of the future.

Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.

  1. You’ll likely miss the outlier events that move the needle the most.
  2. 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.

13. Room for Error #

  • Can you survive your assets declining by 30%? But what about mentally? You—or your spouse—may decide it’s time for a new plan.
  • What if future returns are lower? “You won’t be able to retire like you once predicted.” Which can be a disaster.

You have to take risk to get ahead, but no risk that can wipe you out is ever worth taking.

A good rule of thumb for a lot of things in life is that everything that can break will eventually break. So if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe. That’s a single point of failure.

Plan on your plan not going according to plan.

14. You’ll Change #

At every stage of our lives we make decisions that will profoundly influence the lives of the people we’re going to become, and then when we become those people, we’re not always thrilled with the decisions we made. So young people pay good money to get tattoos removed that teenagers paid good money to get. Middle-aged people rushed to divorce people who young adults rushed to marry. Older adults work hard to lose what middle-aged adults worked hard to gain. On and on and on.⁴⁸

“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.

But there are two things to keep in mind when making what you think are long-term decisions.

We should avoid the extreme ends of financial planning. Assuming you’ll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you’ll one day find yourself at a point of regret. The fuel of the End of History Illusion is that people adapt to most circumstances, so the benefits of an extreme plan—the simplicity of having hardly anything, or the thrill of having almost everything—wear off. But the downsides of those extremes—not being able to afford retirement, or looking back at a life spent devoted to chasing dollars—become enduring regrets. Regrets are especially painful when you abandon a previous plan and feel like you have to run in the other direction twice as fast to make up for lost time.

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. And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance.

Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.

We should also come to accept the reality of changing our minds. Some of the most miserable workers I’ve met are people who stay loyal to a career only because it’s the field they picked when deciding on a college major at age 18. When you accept the End of History Illusion, you realize that the odds of picking a job when you’re not old enough to drink that you will still enjoy when you’re old enough to qualify for Social Security are low.

The trick is to accept the reality of change and move on as soon as possible.

15. Nothing’s Free #

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.

The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.

16. You & Me #

Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are. (e.g. short term traders)

17. The Seduction of Pessimism #

Pessimism isn’t just more common than optimism. It also sounds smarter. It’s intellectually captivating, and it’s paid more attention than optimism, which is often viewed as being oblivious to risk.

Forecasts of outrageous optimism—are rarely taken as seriously as prophets of doom.

  • Money is ubiquitous, so something bad happening tends to affect everyone and captures everyone’s attention.
  • Pessimists often extrapolate present trends without accounting for how markets adapt. e.g. Peak Oil FUD
  • Progress happens too slowly to notice, but setbacks happen too quickly to ignore.

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.

18. When You’ll Believe Anything #

  1. 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.
  2. Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

Business, economics, and investing, are fields of uncertainty, overwhelmingly driven by decisions that can’t easily be explained with clean formulas, like a trip to Pluto can. But we desperately want it to be like a trip to Pluto, because the idea of a NASA engineer being in 99.99998% control of an outcome is beautiful and comforting. It’s so comforting that we’re tempted to tell ourselves stories about how much control we have in other parts of our life, like money.