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The Psychology of Money by Morgan Housel

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The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”

People want to become wealthier to make them happier. Happiness is a complicated subject because everyone’s different. But if there’s a common denominator in happiness—a universal fuel of joy—it’s that people want to control their lives.  The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays. 

Mentions Ronald Read who worked as a janitor and acquired money over his life.  Surprisingly leaving 8 million dollars when he passed.  This compares with Richard Fuscone who was a hot shot Harvard trained investor who became greedy and lost all his money filing for bankruptcy.  Education is still important but financial outcomes are driven by luck, independent of intelligence and effort. Argues the difference between these two is a soft skill, where how you behave is more important than what you know.. 

Interestingly when you are born relates a lot to how you invest your money.  If you grew up when inflation was high, you invested less of your money in bonds later in life compared to those who grew up when inflation was low. If you happened to grow up when the stock market was strong, you invested more of your money in stocks later in life compared to those who grew up when stocks were weak. 

So, perhaps surprisingly, an individual investors’ willingness to bear risk depends on their own personal history – not intelligence, education, or sophistication.

The lowest-income households in the U.S. on average spend $412 a year on lottery tickets, four times the amount of those in the highest income groups.  It is of note that forty percent of Americans cannot come up with $400 in an emergency.  Therefore, those buying $400 in lottery tickets are by and large the same people who say they couldn’t come up with $400 in an emergency. They are blowing their safety nets on something with a one-in-millions chance of hitting it big. 

You may think this is bizarre but buying a lottery ticket is the only time in some people’s lives they can hold a tangible dream of getting the good stuff that (hopefully) you already have and take for granted. In other words paying for a dream, and you may not understand that because you are (hopefully) already living a dream.

Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.  It’s hard to quantify luck and rude to suggest people’s success is owed to it, the default stance is often to implicitly ignore luck as a factor of success. 

Economist Bhashkar Mazumder has shown that incomes among brothers are more correlated than height or weight. If you are rich and tall, your brother is more likely to also be rich than he is tall. Thinking about it intuitively it is true—the quality of your education and the doors that open for you are heavily linked to your parents’ socioeconomic status. Although if you ask two rich brothers it is unlikely they will think the study’s findings apply to them!

When compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider the potential of compounding.  Whereas, Warren Buffet has been investing consistently for three quarters of a century using compound interest.  The tactic is “just shut up and wait”.

Bear in mind Nassim Taleb’s advice: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.  Bear in mind 4 in 10 public companies fail over time this is a common story, don’t let this be you. 

Most financial advice is about today. What should you do right now, and what stocks look like good buys today?

Be very mindful – most of the time today is not that important. Over the course of your lifetime as an investor the decisions that you make today or tomorrow or next week will not matter nearly as much as what you do during the small number of days.  This is the 1% of the time or less when everyone else around you is going crazy.

Here are a few scenarios:

Invest $1 into the U.S. stock market every month, rain or shine. It doesn’t matter if economists are screaming about a looming recession or new bear market. You just keep investing. Referred to as ‘steady’.

Being an investor is at times a bit like a pilot “hours and hours of boredom punctuated by moments of sheer terror.” Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.  A very good investor is right 6 out of 10 times

If investing during a recession is too scary another option is to invest your $1 in the stock market when the economy is not in a recession, sell everything when it’s in a recession and save your monthly dollar in cash, and invest everything back into the stock market when the recession ends. We’ll call this investor ‘reactive’.

Alternatively it takes a few months for a recession to scare you out, and then it takes a while to regain confidence before you get back in the market. You invest $1 in stocks when there’s no recession, sell six months after a recession begins, and invest back in six months after a recession ends.  This one we will call ‘hesitant’. 

In the US between 1900 and 2019 these three people would have gathered:

Steady ends up with $435,551.
Reactive has $257,386.
Hesitant $234,476.

Over the 1,428 months just over 300 of them were during a recession. So by keeping her cool during just the 22% of the time the economy was in or near a recession, steady ends up with almost three-quarters more money than ‘reactive’ or ‘hesitant’. 

Richard Feynman, the great physicist, once said, “Imagine how much harder physics would be if electrons had feelings.” Well, investors have feelings. Quite a few of them. That’s why it’s hard to predict what they’ll do next based solely on what they did in the past.

United States is the richest nation in the history of the world. But there is little evidence that its citizens are, on average, happier today than they were in the 1950s, when wealth and income were much lower—even at the median level and adjusted for inflation. A 2019 Gallup poll of 150,000 people in 140 countries found that about 45% of Americans said they felt “a lot of worry” the previous day.  The global average was 39%.  Fifty-five percent of Americans said they felt “a lot of stress” the previous day. For the rest of the world, 35% said the same.  The average new American home now has more bathrooms than occupants. With faster more efficient cars and TVs that are cheaper and sharper. 

So the question is why? Because we’ve used our greater wealth to buy bigger and better stuff. But we’ve simultaneously given up more control over our time. At best, those things cancel each other out.

Remember the first message from this book the best dividend money gives is freedom to do what you want with your time.

People tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.  If someone has an expensive car you can only deduce that they spent a lot of money on that nothing more about their wealth!  By all means get fast cars but realise if your primary driving is the desire to be admired it might not pay off.

Remember humility and kindness bring more admiration than any car ever will. Spending money to show others how much you have is the fastest way to have none. 

Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.”  It is important to note a study performed in America found that people overestimate the number of calories they burned in a workout by a factor of four. They also then consumed, on average, about twice as many calories as they had just burned off … the fact is, you can quickly undo a lot of exercise by eating a lot of food, and most of us do.  Wealth is turning down that treat meal and actually burning net calories. It’s hard, and requires self-control. But it creates a gap between what you could do and what you choose to do that accrues to you over time. 

Building money has less to do about your earning rate but your saving rate. 

Passion is important.  If you’re passionate about the company to begin with—you love the mission, the product, the team, the science, whatever—the inevitable down times when you’re losing money or the company needs help are blunted by the fact that at least you feel like you’re part of something meaningful. That can be the necessary motivation that prevents you from giving up and moving on.

In terms of saving plans everyone is different.  The author’s personal saving strategy assumes the future returns he’ll earn in his lifetime will be ⅓ lower than the historic average. So he save more than he would if he assumed the future will resemble the past. It’s his margin of safety. The future may be worse than ⅓ lower than the past, but no margin of safety offers a 100% guarantee. A one-third buffer is enough to allow him to sleep well at night. And if the future does resemble the past, he’ll be pleasantly surprised.

In terms of preparation it is impossible to avoiding unknown risks, by definition it is almost impossible. You can’t prepare for what you can’t envision.  Plan on your plan not to go ahead

If there’s one way to guard against their damage, it’s avoiding single points of failure.  A good rule of thumb for a lot of things in life is that everything that can break will eventually break. Try to avoid a single point of failure.

The biggest single point of failure with money is a sole reliance on a pay check to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.

It’s fine to save for a car, or a home, or for retirement. But it’s equally important to save for things you can’t possibly predict or even comprehend.  Predicting what you’ll use your savings for assumes you live in a world where you know exactly what your future expenses will be, which no one does.  So save and realise that you don’t need a specific reason to save!

Over your life your goals will change, clearly a new parent in their 30s may think about life goals in a way their 18-year-old self making career goals would never imagine.  Long-term financial planning is essential. But things change—both the world around you, and your own goals and desires.  It is important to note that few regret education that they have obtained.

Interestingly it is worth noting ‘The End of History Illusion’ this is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.  When you accept ‘The End of History Illusion’, you realize that the odds of picking a job when you’re young enough not to legally be allowed to drink alcohol that you will still enjoy when you’re much older is low.  It is best to accept the reality of change and move on as soon as possible.  However, irrespective of life changes that will occur it is important to be consistent and keep your money plan going. 

“Every job looks easy when you’re not the one doing it” Jeff Immelt, previous CEO General Electric.  The challenges faced by someone in the arena are often invisible to those in the crowd.

When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.  Don’t let other investors who might be acting rationally with their own goals over different time frames throw you off.  Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviours of people playing different games than you are.  The smart price to pay involves knowing what you plan to exit:

  • Looking to cash out within 10 years? The price to pay can be figured out by an analysis of the industry’s potential over the next decade and whether management can execute on its vision.
  • Aiming to sell within a year? Then pay attention to current product sales cycles and whether we’ll have a bear market.
  • Are you a day trader? Then the smart price to pay is “who cares?” because you’re just trying to squeeze a few bucks out of whatever happens between now and lunchtime, which can be accomplished at any price.

An iron rule of finance is that money chases returns to the greatest extent that it can.  This iron rule explains the formation of financial bubbles.  Bubbles are not caused by people irrationally participating in long-term investing.  Instead they’re about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself. 

Be aware people pay more attention to pessimism than optimism. Mentions how newspapers took a long time to highlight the good news when the Wright brothers discovered flight but are quick to publish a negative stock market view. If you expect nothing, then you can be optimistic with what you get.

Room for error, flexibility, and financial independence are indispensable.  Be aware of the gap between what you want to be true and what you need to be true to have an acceptable outcome.

Daniel Kahneman the psychologist and economist has previously explained:

When planning we focus on what we want to do and can do, neglecting the plans and skills of others whose decisions might affect our outcomes.  This is true for both explaining the past and in predicting the future, we focus on the causal role of skill and neglect the role of luck.

We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.  This impacts business; for example if you ask a start up business they tend to perceive the outcome of the business is largely within their hands.  They tend to ignore other factors such as rival firms or changes to the world that could occur.

Ego is linked to wealth, it is best to have less ego and more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future.

A benefit of maintaining a lifestyle below what you can afford is avoiding the psychological treadmill of keeping up with the Joneses. Comfortably living below what you can afford, without much desire for more, removes a tremendous amount of social pressure that many people in the modern first world subject themselves to.

Everyone—without exception—will eventually face a huge expense they did not expect—and they don’t plan for these expenses specifically because they did not expect them. Therefore save for the unexpected.

If you are interested, the lifestyle guru Tony Robbins has written a surprisingly good book about becoming financially free – check out my extensive summary here.

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