“The Psychology of Money” (Morgan Housel, 2020)

Introduction

Morgan Housel's The Psychology of Money offers an insightful look into the emotional and behavioral factors that shape our financial decisions. I found it very refreshing. Below, I’ve summarized some passages that particularly resonated with me. Note that I have rearranged, rephrased or condensed some parts. Let’s begin.

Recognize Luck & Risk

Your personal experiences with money represent a very tiny fraction of what's happened in the world, yet they may account for 80% of how you perceive the world works.

Economists discovered that people's investment choices are strongly influenced by the financial experiences of their generation, particularly those from early adulthood. An investor's risk tolerance is shaped more by personal history rather than by intelligence, education, or sophistication. It's simply the luck of when and where you were born.

Nothing is as good or as bad as it seems. When you properly account for luck and risk, it becomes clear that when evaluating financial success - whether your own or others' - things are rarely as they seem. Respect the power of luck and risk and you'll have a better chance of focusing on things you can actually control.

Luck and risk are like twins. The line between being "inspiring bold" and "foolishly reckless" is often razor-thin and only clear in hindsight. One of the greatest challenges in learning how to manage money is distinguishing between luck, skill, and risk.

The key is structuring your financial life so that a few bad investments won't ruin you, allowing you to stay in the game until the odds shift in your favor.

Know When to Stop Moving the Goalpost

The hardest financial skill is knowing when to stop moving the goalpost. No matter how great the potential reward, some things are never worth risking such as reputation, freedom, independence, family, friends, love and happiness.

Your best chance of preserving these is knowing when to stop taking risks that could jeopardize them. Knowing when you have enough.

Invest in Time and Compounding

Of Warren Buffett's $84.5 billion net worth, $81.5 billion came after he turned 65. When something compounds, a small beginning can lead to results so remarkable they seem almost impossible. Don't underestimate what’s possible and what you can ultimately achieve with the magic of compounding.

If you want to do better as an investor, the single most powerful thing you can do is to increase your time horizon. Time is the most powerful factor in investing. Charlie Munger said: "The first rule of compounding is to never interrupt it unnecessarily."

Aiming to be mostly reasonable is more effective than attempting to be purely rational. This approach is more realistic and increases your chances of sticking to it over the long term, which is what matters most when managing money.

For most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.

Build Wealth

Good investing isn't necessarily about making good decisions. It's about consistently avoiding major mistakes.

George Soros once said, "It's not whether you're right or wrong that's important, but how much 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.

Building wealth is more about your savings rate than your income or investment returns. Individuals who achieve lasting success in personal finance tend to care little about others' opinions of them. Spending money to impress others is the quickest way to have less money.

You may believe you want a luxury car, a fancy watch, or a big house, but what you truly seek is respect from others. Expensive things rarely earn you that, especially not from the people whose respect you value most.

Earn Freedom

Having control over your time is the greatest return money can provide. The freedom to do what you want, when you want, with whom you want, for as long as you want, is invaluable. It's the ultimate benefit of financial success.

By doing something you love on a schedule you can't control can feel the same as doing something you hate.

Have Survival Mindset

Applying the survival mindset to the real world comes down to appreciating three things.

1) More than seeking big returns, I want to be financially unbreakable. If I’m unbreakable, I’ll achieve the best returns because I’ll stay in the game long enough for compounding to do its magic.

2) Planning is crucial, but the most important part of any plan is to plan on the plan not going according to plan. Room for error - often called a margin of safety - is one of the most overlooked principles in finance.

3) A balanced mindset is essential - optimistic about the future but paranoid about what could prevent you from reaching it. Maintaining both paranoia and optimism simultaneously is challenging, as it’s easier to see things in black-and-white. But short-term paranoia is necessary to survive long enough to benefit from long-term optimism.

The most important part of any plan is planning on your plan not going according to plan. Particularly be cautious of single points of failure. Anything that can break is likely to do so eventually. If many things rely on one thing functioning properly, and that thing fails, you're just waiting for disaster to strike. That's a single point of failure.

Diversify and Capture Winners

The best art dealers operated like index funds. They bought everything they could, not just individual pieces they liked. They built portfolios and waited for a few winners to emerge. That’s all it took.

Warren Buffett has owned 400 to 500 stocks in his lifetime, but most of his wealth came from just 10 of them. Without them, Berkshire Hathaway's track record would be fairly average. Peter Lynch, one of the greatest investors, said, “If you're terrific in this business, you're right six times out of 10.” No one makes great investment decisions all the time. 

Many aspects of business and investing work the same way. Long tails (extreme outcomes) play a huge role in finance, where a small number of events drive the majority of results.

Ready to Pay Fees

Everything has a price. The Money Gods do not favor those who seek rewards without paying the price.

Uncertainty, doubt, loss and regret are common costs in the finance world. It's essential to view these as fees (a price worth paying for the later rewards) rather than fines that should be avoided. Market returns are never free. They demand you pay a price, just like any other product. 

Manage your money in a way that allows you to sleep peacefully at night.

Stick to Your Game

It's easy to forget that other investors may have different goals, as our psychology often leads us to believe that rational people share the same perspective. 

Few things are more important in finance than understanding your own time horizon and not being swayed by the actions and behaviors of those playing different games than you are.

Napoleon once described military genius as “the man who can do the average thing when everyone else is losing their heads.” The same applies to investing.

Be Optimistic

For most people, optimism is the best choice, as the world generally improves for the majority over time. However, pessimism holds a special appeal. It not only appears more common but also sounds more intelligent. It’s intellectually  captivating while optimism can be seen as ignoring risks. Optimism sounds like a sales pitch while pessimism sounds like someone trying to help you.

True optimists don’t believe everything will be great. That’s complacency. Optimism is the belief that favorable outcomes are ultimately achievable, despite the inevitable setbacks along the way. It's the idea that most people wake up each day trying to make things a little better and more productive, rather than causing trouble.

However, each of us has an incomplete understanding of the world, which leads us to construct narratives that fill in the gaps. Be cautious not to deceive yourself into believing something just because you want it to be true.

My investing strategy doesn't rely on picking the right sector, or timing the next recession. It relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades.

An iron law of economics states that extremely good or bad conditions rarely persist for long, as supply and demand  adapt in unpredictable ways.

Closing Remarks

This is one of the best books I've read on developing our mindset for building wealth and effectively managing money in the long term - so many valuable insights to remember.

Thanks for reading. Wish you grow rich slowly and surely!

This blog post includes excerpts from the book “The Psychology of Money”, published by Harriman House, quoted under fair use as permitted by copyright laws in relevant jurisdictions. The content includes both direct excerpts from the original work and my personal thoughts, rephrasings, and interpretations. All original text and images from the book are the property of the respective author and publisher, and are not to be used for commercial purposes.