Learning From Literature

The Psychology of Money by Morgan Housel

Cover of The Psychology of Money by Morgan Housel

The Psychology of Money: Timeless Lessons On Wealth, Greed, and Happiness by Morgan Housel is a behavioral finance book published in 2020.

In 2018, Housel wrote a report on the top 20 flaws, biases, and causes of bad behavior that affect people when dealing with money. It became so popular that he decided to go more in-depth and write a book with 20 corresponding chapters.

With over a million copies sold, The Psychology of Money explains how behavior matters more than knowledge when it comes to money. Housel helps readers understand unconscious elements that influence financial decisions.

He writes:

“Money – investing, personal finance, and business decisions – is typically taught as a math-based field, where data and formulas tell you 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.”

Purchase the book by clicking this link!

Enjoy!

Table of Contents

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Ch 1 – No One’s Crazy

“Your personal experiences with money make up maybe 0.000001% of what’s happened in the world but maybe 80% of how you think the world works.”

Morgan Housel
  • Everyone grows up in a different environment with different issues – social, economic, etc.
  • Different experiences are not small either:
    • S&P 500 yield – 1970s & 1980s vs. post-1990s
    • Inflation and Interest Rates – 1980s vs. post-2000s
  • First-hand experience is more compelling than simply learning about something
    • This is why equally intelligent people end up with different beliefs and goals
  • People should invest based on the quality and characteristics of the investment, but studies of people show that willingness to bear a specific risk is almost always based on personal history and not numbers
  • Even though we sometimes make stupid decisions with money, it doesn’t mean we are crazy
Ch 2 – Luck & Risk
  • Outcomes are guided by forces other than individual effort
    • 100% of actions ≠ 100% of outcomes
  • Bill Gates and high school friend Kent Evans → luck & risk at work
    • 1968 → 300 million high-school-aged people in the world
    • Only 300 attended Lakeside School in Seattle, the only high school in the world to have a computer at that time – meaning there was only a 1 in a million chance your school would have a computer 
    • Bill Gates and Paul Allen were two of these students, which led to them eventually founding Microsoft
    • Kent Evans also attended Lakeside School, was a close friend who studied computers with Bill Gates, and was claimed to be an even brighter student
    • However, Evans died in a mountaineering accident at 17 years old, before even graduating
    • There are about 36 mountaineering deaths in the US every year – meaning there was only a 1 in a million chance of Evans dying that day
  • When you fail, it is common to believe you got hit with the slim risks involved, but when others fail, you judge their bad decisions
    • Recognizing the impacts of risk mean you should be more forgiving to yourself and others in the face of failure (as long as it was an external event and not that you made a bad decision)
  • The more extreme the outcome → the more likely the outcome was affected by luck/risk → the less likely it is applicable to you
    • Therefore, examine general patterns and not individual examples
    • Don’t try to emulate exactly what Elon Musk did to succeed, examine the common themes out of all millionaires (hard work, etc.)
Ch 3 – Never Enough
  • When ambition rises faster than satisfaction, it can lead to feeling behind, and so you take more risk than needed
  • If you can meet your goals without taking extra risk, it makes no sense to introduce risk unnecessarily and possibly move further from your goals
    • If your plans do require excess risk, you should revise your goals rather than introduce other risks
  • Paco de Leon in Finance For The People describes how the more your income rises, the more your spending increases to match
    • The most challenging financial skill is to keep the goalpost from moving 
  • Stop social comparisons – there will always be someone with more money
  • “Having enough” doesn’t mean extreme frugality and restricting your lifestyle; it means realizing always pushing for more leads to regret
    • Many only stop when they are burnt out or their risky investments can’t be maintained
  • There are many things not worth risking, no matter the financial gain (love, freedom, happiness, etc). Your overall goal in life shouldn’t be money.
Ch 4 – Confounding Compounding

“Compound interest is the eighth wonder of the world.”

Albert Einstein
  • A small investment over a long period of time can be worth a lot of money
  • Trees & Ice Ages → Tremendous force is not needed to achieve tremendous results
  • Time is the secret to becoming wealthy
  • Look at these diagrams:
The impact of compounding investments
The impact of compounding investments
The impact of compounding investments
Ch 5 – Getting Wealthy vs. Staying Wealthy
  • Survival is the most important factor that determines financial success (not foresight or anything else)
    • Survival allows time for money to compound
  • Warren Buffet is the perfect example
    • Don’t focus on his what stocks he owns in his portfolio; appreciate how he has no debt, never sold during recessions, and didn’t burn out
    • He simply survived long enough for his money to work for him
    • Over 98% of his wealth came after he turned 65
  • Rather than strive for significant returns, try to become financially unbreakable and let time work for you
    • Paradoxically, if you are unbreakable, you will end up with the most significant returns over the long-run because you will have allowed compounding to work wonders
  • Having a high margin of safety (room for error) increases the odds for success by increasing the chances of survival
    • Many bets fail not because they are totally wrong, but because the margin of safety is low (point spread, parlay, etc.)
Ch 6 – Tails, You Win

“A good definition of an investing genius is the man or woman who can do the average things when all those around them are going crazy.”

Morgan Housel
  • A very, very small amount of things actually move the needle
  • From 1980-2019, the Russell 3000 index (group of the 3000 largest US companies) grew 73x
    • BUT 40% of the companies went bankrupt and 53% of companies balanced out with 0% return
    • So just SEVEN percent of the companies produced all the returns
  • In 2018, 13% of the S&P 500 index return was ONLY Apple and Amazon
  • Warren Buffet had 400-500 stocks over his lifetime but credited only about 6-10 stocks for 99% of his wealth
  • It is almost impossible to guess what and when will be the best investment
Ch 7 – Freedom 
  • Money’s greatest value is the ability to give you control over your time
    • The highest form of wealth is to say I can do whatever I want
  • Psychologists have found that the number one indicator of happiness (more than income or location) is time
    • America → On average, people have more money and “nicer stuff” than other countries but have the same stress levels (if not higher) and the same work hours
  • Understand the role money can play in your life so you don’t waste time and effort chasing after the wrong goals
Ch 8 – Man in the Car Paradox 
  • 99% of the time, you don’t want the house, car, or watch; you want the respect and admiration that comes with it
    • Many people strongly deny this
    • “I only like Louis Vuitton purses because they hold up well”… Is there no cheaper, non-designer purse that holds up well?
  • Paradox → people will like your stuff and think your possessions are cool, but it doesn’t change their perception of you
  • Humility and kindness will bring more respect than stuff ever will
  • Again, understand the role money can play in your life so you don’t waste time and effort chasing after the wrong goals
Ch 9 – Wealth is What You Don’t See 

“Spending money to show people how much money you have is the fastest way to have less money”

Morgan Housel
  • Someone that spent $200k on a Ferrari to show they have a lot of money means now they have $200k less money
  • Outward appearance doesn’t show anything about the financial position
    • The man with a Ferrari could have taken a loan
    • The man in sweatpants could be a billionaire
  • High income and fancy things = rich… but “rich” can run out
    • The average salary for an NBA player last year was over $8 million
    • Over 60% of basketball players go broke within five years of retirement
  • Wealth → flexibility and options to purchase more one day than you could now
    • You can’t see this ability in material things, which means wealth is invisible to the eye
  • Understanding the difference between rich and wealthy will help you make sound financial decisions on the path to your goals
Ch 10 – Save Money
  • No matter your income or investment returns, you can’t get wealthy without saving money
  • Finding more income is challenging and possibly out of our control, but we can always choose how much to save
    • Thousands of financial analysts study financial statements to get an extra .01% return, but it’s a lot easier to simply save an additional .01% more a year 
    • For a $50,000 salary, that would equal $5 a year
  • Exploit your lifestyle bloat
    • Lifestyle Bloat — where spending rises to match income
  • Savings are created by spending less
    • You spend less if you desire less
    • You desire less if you care less about other people’s opinions
  • You don’t need a specific reason to save — it protects you from life’s curveballs, expands the margin of safety, and gives you more control of your time (the unseen return on investments)
  • The more you save, the faster you become wealthy
Ch 11 – Reasonable > Rational 
  • What is mathematically the best choice isn’t always the best decision for everyone
    • The best decision → whatever allows you to get the maximum amount of sleep at night
  • Author Morgan Housel paid cash for his house; no mortgage
    • He describes this as “one of the worst financial decisions we’ve ever made and one of the best money decisions we’ve ever made.” He explains, “the independent feeling I get from owning a house outright far exceeds the known financial gain I [could] get.”
    • In How I Invest My Money by Joshua Brown and Brian Portnoy, 25 professionals including Housel are interviewed about their personal investment strategies
  • Decide what allows you to minimize future regret and live the most comfortably
Ch 12 – Surprise!

“History is a study of change, ironically used as a map of the future.”

Morgan Housel
  • You should not take historical events as the guide for future decisions / investments because we can see from historical events that life is full of surprises
  • Living through surprises doesn’t give you experience for the future
    • If anything, it’s detrimental because now you think you know what is going on
  • A very, very small amount of events move the needle the most, most of them unpredictable at the time
    • The Great Depression, WWII, the invention of vaccines, 9/11, COVID
  • Housel’s advice → look at history for general trends:
    • “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.”
Ch 13 – Room for Error
  • Often, this is the most crucial part of a financial plan
  • The biggest financial point of failure is not saving for a surprise (with an emergency fund)
  • You never have a good enough plan to bet every chip (because of surprises, remember?)
    • The world works on odds, not certainties
  • The best strategy is to increase the room for error so you can survive and allow compounding
  • Avoid a single point of failure
    • Anything that can break will break eventually, so don’t let that break be your ruin
  • Specific places to think about room for error:
    • Volatility (can you mentally/financially handle a 30% decrease overnight?)
    • Savings (can you afford a surprise emergency? Don’t make it where you have to retire later because of an injury or overestimating future abilities – see next chapter)
Ch 14 – You’ll Change
  • Long-term planning is complicated because your goals and desires will change
  • People consistently underestimate how much they will change over time
  • Avoid extreme ends of a plan. Don’t:
    • Assume you will work endless hours 
    • Assume you will need very little
  • Avoid sunk cost bias (or loss avoidance tendency)
    • Anchoring decisions to past efforts that can’t be refunded
    • An expert in How I Invest My Money recommends to examine the opportunity cost you are giving up by continuing the losing position
  • Build your financial plan with flexibility to account for how you and your situation will change in the future
Ch 15 – Nothing’s Free
  • The price of investments is volatility
    • From 2002-2018 Netflix’s stock price generated a return of over 35,000% 
    • BUT spent 95% of the days in that period below its all-time-high stock price
  • Investments with less volatility (historically think bonds) give less long-term return than investments with high volatility (equities)
  • Some people try to avoid the volatility altogether by “timing the market” or selling right before a recession and buying right before a huge boom
  • Attempting to beat the market return through timing also introduces the very probable possibility you will underperform the market
    • About 85% of active portfolio managers do not beat the market, and a significantly higher percentage do not beat the market over a more extended time frame (decades in a row)
    • If experts can rarely do it, why should an average individual try?
    • If you can reach your goals without taking the added risk of attempting to beat the market, why should even an expert try??
  • Consider volatility as the fee you pay in order to get the benefits of compounding
    • If you view volatility as a fine, then this leads to trying to avoid it, which further leads to consequences such as underperforming the market.
Ch 16 – You & Me 

“Beware taking financial cues from people playing a different game than you are”

Morgan Housel
  • Your plan depends on your time horizon, goals, mindset, and risk tolerance
  • Financial analysts saying so-and-so is a good stock is ridiculous because they don’t take into account people’s goals and situation
  • Bubbles form when short-term traders (who are attracted by momentum) outnumber long-term investors
    • This results in day-traders controlling the price
  • Consumer spending is socially driven
  • It is vital to identify the game you are playing
    • Are you invested for long-term wealth? Then why would you care about a short-term recession?
Ch 17 – The Seduction of Pessimism 

“Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.”

Morgan Housel
  • Negativity is more seductive and simply easier to believe than optimism
    • At the beginning of 2022, multiple CEOs of Fortune 500 companies publicly stated that we are in a recession…With corporate profits rising, payrolls increasing, and extremely low unemployment
  • Pessimism lowers expectations
    • It allows you to feel better about whatever happens because you weren’t expecting much anyway (this is why it’s seductive)
  • Pessimists interpret things without accounting for the world’s ability to adapt
    • Around 1900, there was a widely-held belief that heavier-than-air flying machines were impossible
      • In 1903, the Wright Brothers completed their first flight
      • There are now around 42,000 flights a day in the US alone
  • True optimism isn’t blind faith; it is a belief that setbacks will occur along the way, but that odds will be in your favor over the long-run
Ch 18 – When You’ll Believe Anything 
  • In our society, stories are worth more than data
  • 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 
  • Confirmation Bias
    • The tendency to search for, interpret, favor, and recall information in a way that confirms or supports one’s prior beliefs or values
    • For example, during elections, people tend to strongly believe any information that seems to paint their candidate in a positive light but automatically dismiss any negative narratives (even if they are factually proven)
  • Everyone has an incomplete view of the world, but people form complete narratives to fill in the gaps
  • Be cautious believing any stories without looking at the whole situation in-depth
Ch 19 – All Together Now 
  • Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong
  • Less ego = more wealth
  • Move your money in a way that helps you sleep best at night
  • If you want to be a better investor, the most critical thing is to increase your time horizon to allow compounding
  • Use money to gain control over your time
  • Be nicer and less flashy, no one cares about your possessions as much as you
  • Save, even if there is not a pressing emergency at the moment
  • Worship room for error – more means a higher chance of survival, which leads to your money having more time to compound, which generates a higher chance of becoming wealthy
  • Avoid the extremes of financial plan – goals and desires change over time
  • Define your game in life, and don’t listen to others
Ch 20 – Confessions
  • There is no single “right” answer when making financial decisions (although there can definitely be choices worse than others)
  • Every investor should pick a strategy with the highest odds of reaching their goals in life
    • Since everyone’s goals are different, not everybody’s financial strategy should be the same

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