The Psychology of Money is about the soft skill of managing money. It aims to convince the readers that soft skills are more important than the technical side of money. I saw this book being recommended in an investment blog, so I was interested to know how it relates to investing.
Morgan Housel is a partner at The Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal. He is a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers, winner of the New York Times Sidney Award, and a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism.
The Psychology of Money consists of an introduction, 20 chapters and a postscript (A Brief History of Why the U.S. Consumer Thinks the Way They Do).
The chapters are 1) No One’s Crazy, 2) Luck & Risk, 3) Never Enough, 4) Confounding Compounding, 5) Getting Wealthy vs. Staying Wealthy , 6) Tails, You Win, 7) Freedom, 8) Man in the Car Paradox, 9) Wealth is What You Don’t See, 10) Save Money, 11) Reasonable > Rational, 12) Surprise!, 13) Room for Error, 14) You’ll Change, 15) Nothing’s Free, 16) You & Me, 17) The Seduction of Pessimism, 18) When You’ll Believe Anything, 19) All Together Now, and 20) Confessions.
In The Psychology of Money, the author uses a lot of short stories to illustrate his points. The themes of this book include room for error, flexibility, and financial independence. I will share some of its salient points in this review.
According to the author, wealth is financial assets that have not yet been converted into tangible stuffs. To stay wealthy requires some combination of frugality and paranoia, which is different from being rich. The highest form of wealth is the freedom to do anything you want.
Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. It is important to recognize the role of luck in success while the role of risk means leaving room for understanding when judging failures. Every job looks easy when we are not the one doing it because the challenges faced are often invisible to those in the crowd. We need to accept that what happens in the world sometimes is out of our control.
How should we deal with failures? By arranging financial life in a way that a bad investment here and a missed financial goal there won’t wipe us out so we can keep playing until the odds fall in our favour. The most important part of every plan is to plan on the plan not going according to the plan. This is where margin of safety (or room for error) comes in. It raises odds of success at a given level of risk by increasing chances of survival.
The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance are an ever-present part of life. The higher the stakes, the wider it should be. By having room for error, it also means to have a gap between what you can technically endure versus what is emotionally possible (rational vs reasonable).
The author mentions a concept known as single point of failure. If many things rely on one thing working, and that thing breaks, you are counting days to catastrophe because everything that can break will eventually break. He advises the readers to avoid these single points of failure. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant while growth is driven by compounding which always takes time.
Long-term growth trajectory is up but the road between now and then is filled with landmines. Treat volatility/uncertainty/loss as a fee (the price of returns) to get greater returns than low-fee parks like cash and bonds, instead of as a fine. Investing has a social component to it which is often overlooked. We are always comparing results with others. However, enduring personal finance success often entails ignoring people’s opinion. The author thinks that bubbles are the symptoms of time horizon shrinking as more short-term traders enter the playing field rather than about valuation rising. Thus, understand your own time horizon and avoid being influenced by the actions and behaviours of people playing different games than you are.
Anything that is huge, profitable, famous, or influential is the result of a tail event. But it is easy to underestimate how rare and powerful they are when we only pay attention to the result of a tail. In short, tails drive everything but they are not as common as we think they are.
Experience actually leads to overconfidence more than forecasting ability but it does not mean we should ignore history. The caveat is the further back in history we look, the more general our takeaways should be. Furthermore, one’s mental model of how the world works is unique to each person. It is important to have an open mind to learn from others or be more forgiving.
The mastery of the psychology of money is to do whatever maximizes for sleeping well at night. The author’s investing belief is that there is little correlation between investment effort and investment results. Thus, he only invests in index funds. His investing strategy relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades, rather than depending on individual stocks. The foundation of his optimism is that most people wake up in the morning trying to make things a little better and more productive than wake up looking to cause trouble. This strategy might not be suitable to everyone, so we need to find our own style. As the author says, to each their own.
Though it is not directly related to investment, I can understand why the blogger recommended this book in the investment blog. It is only by having a clear and realistic expectations that we can do well in investing. If you do not have the time and just want to get the gist of this book, read chapter 19. It is the summary of this book and contains concise and actionable lessons.
- People do some crazy things with money. But no one is crazy.
- There is no reason to risk what you have and need for what you don’t have and don’t need.
- Happiness, as it’s said, is just results minus expectations.
- 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.
- Everyone’s life is a continuous chain of surprises.
Interested in The Psychology of Money?
You may get the book from through the link below*.
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