The Psychology of Money is a top-notch book written by Morgan Housel. The book is shedding more light on an underappreciated approach towards money, investing and forecasting, stating that “Financial success is not a hard science. It’s a soft skill, how you behave is more important than what you know.”
It focusses on how people view money, why they take debt, and how they can create and save wealth. Unlike other books that talk about interest rates, stock markets, etc., Morgan’s book says — “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.”
Morgan Housel shows that the essential topic of money is influenced by emotions and one’s personal experiences, family history and the times they were brought up in. He surprisingly points out that only few people make financial decisions purely with a spreadsheet, while a greater number make them at the dinner table being influenced by emotional and unique variables. His insights touch areas such as our approach to money in general as well as spending, investing and saving.
Here are the top takeaways that are mind blowing in terms of how people think of money in their everyday lives.
WE JUDGE A BOOK BY ITS COVER
We should be less judgemental and more understanding when looking at other people’s seemingly terrible or odd financial decisions. We should realize that we all have different reasons for making our financial choices. We all have a completely different approach to money in general – we were all raised by different parents who passed on different values and set an example of different ways to make income.
When adding various cultures, traditions, and a country’s economy, it becomes very clear that one’s perception of actions and behaviour required to take care of one’s family is tremendously different from another’s. How one feels about making, investing, saving, and spending money depends on where and when one was born and in what circumstances one was brought up in.
An individual investor’s willingness to bear risk depends on personal history. 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 compared to those who grew up when stocks were weak. Your perspective on money and how you approach it depends on your personal experiences, including your family’s financial situation.
WE UNDERESTIMATE THE POWER OF LUCK AND RISK
It is reality that every outcome in life is guided by forces in addition to the individual effort one puts when trying to achieve their goal. As Bill Gates once said ”Success is a lousy teacher because it seduces smart people into thinking they can’t lose.” Regardless of your effort and preparation, things tend to spin in their own unpredictable ways, so as a result both luck and risk can happen even to the smartest person. We tend to explain someone else’s failure as a bad decision while our own failure is considered a calculated risk.
You could be lucky in buying stock in a game production company just before the world premiere of a new game edition, which was promoted everywhere, so then you’re luckily at 20% higher stock price. On the other hand, as Housel says you could buy stock, and 5 years later it’s gone nowhere or even dropped. It’s possible that you made a bad decision by buying it, but it’s also possible that you made a good decision because you had an 80% chance of making money, but happened to end up part of the 20% of unlucky ones.
In both cases you can fail or succeed, but there are many different variables and circumstances that influence the outcome other than just your individual effort and preparation. This is why you should learn to deal with failure and plan your financial life in a way such single decisions don’t wipe you out so you keep making new ones.
WE NEVER HAVE ENOUGH
As Housel pointed out, once we reach our goal we can’t stop and always thrive for more. “The hardest financial skill is getting the goalpost to stop moving”. You could call such an attitude towards money very ambitious, because who wouldn’t want to earn more money, get nicer and more expensive stuff, and buy a bigger house? This can be a very tricky approach to making money as well as spending money.
Not knowing when to stop can become dangerous once we get a taste of having more. It can mean many things – either sacrifice your family life to earn more money and work longer hours, but it could also mean committing crime in order to make your business earn more money. Either way, there are definitely certain things like your family, reputation, or just sleeping well at night, that you just don’t risk.
The example of Rajat Gupta, how he rose from the slums of Calcutta and rose to the higher positions in McKinsey, all this did not stop him from carrying out a well-planned insider trading scam. This happened as he lacked the sense of enough.
TRY TO GET WEALTHY AND STAY WEALTHY
Everyday we search for new possibilities to get closer to a general dream of getting wealthy. This is great, but have you ever considered what it means to be wealthy? What is the ultimate outcome we look for and what happens when we get there?
Well, the author draws a line between being wealthy which is invisible and being rich which is more artificial and to show off. We can earn more or have big returns, but if we spend proportionally more we probably don’t get to keep what we could. It is important and very underappreciated to keep in mind that getting more money is one side of the coin, but the other one is having the ability to keep it this way.
We should definitely plan our finances and investments, however a wise tactic is to also design a “Plan B” for darker times so we don’t ruin what we have worked on for years. It could mean being more cautious when making decisions like new investments, changing jobs or even professional paths.
WE SEEK FREEDOM
Controlling your time is the highest dividend money pays as Housel states. This is probably what we all long for – being free and independent, enjoy without financially constraining ourselves too much. Independence does not mean stop working. It means you only do the work you like, with people you like, at the times you want, for as long as you want.
Striving for financial independence is desired just like freedom to control your time the way you want, so you can live life to the fullest.
HAVE A MARGIN OF SAFETY
Margin of safety or room for an error means, as the author sums up, “To plan on your plan not going according to your plan.” What does it mean? It means that regardless of how well you made your financial forecast, there is always uncertainty and no gains are guaranteed.
Moreover, not only the gains are not guaranteed, but failures and bad decisions we spoke about before can come true and then we need to be sure to have enough money to surpass and survive bad luck. It could be a bad investment including a 50% drop as well as a disappointing career so you seek to shift career paths which impacts your household’s finances since you start from scratch.
The author calls out the renowned Benjamin Graham and his famous concept of margin of safety made to render the forecast unnecessary, because it perfectly describes the fact that nothing is certain and obvious in the world. This is why margin of safety is supposed to protect us from worst case scenarios and keep you safe long enough to wait for the odds to be in our favour again.
DON’T TAKE ADVICE FROM PEOPLE PLAYING A DIFFERENT GAME THAN YOU ARE
It is very typical to listen to advisors’, experts’ or work colleagues’ advice and feel pressured or even enlightened enough to say “He knows what he’s doing, why haven’t I thought about this earlier?” Well, we should develop an inner critique that questions each advice before you take action on it.
The reason for it is simple – regardless of how smart, intelligent and experienced people we listen to are, they may look at a completely different game to play than we want to play. It means that what works for them, as a result could be disastrous to us.
The best example and yet most infamous one is a bubble. Bubbles do their damage when long-term investors playing one game of looking to invest for years if not decades, start taking hints from short-term investors playing a totally different game of day trading and looking for a quick rise of a stock price. This is why every investor should pick a strategy that has the highest odds of successfully meeting their goals.
START SAVING MONEY FOR NO REASON
When we save money we tend to save it having a specific reason in mind. So whether we save to buy a new car, go on vacation or downpayment on a house, there always seems to be something already waiting in line to spend money on.
Housel argues that we should be saving money for no specific reason – say, for darker and uncertain times. Saving 20% of our disposable income each month could provide us with a high savings rate which would mean having lower expenses than we otherwise could.
Wealth is just the accumulated leftovers after you spend what you take in. You can build wealth without a high income, but you cannot build wealth without a high savings rate. How come? Well, one of the fundamental triggers for most people to spend money rather than spend less and save more money, is social pressure and caring what others talk about us – how we dress or what car we drive. We should probably pay more attention to our ability to sleep well at night and be prepared for the unprepared thanks to saving more rather than thinking of ways to spend money to show that we can afford something that is not a necessity.
THE MAGIC OF COMPOUNDING – TIME IS YOUR ALLY
We all hear these stories of wealthy investors accumulating fortunes and we wonder when and what was this one momentum that made them so wealthy. What the author shares with us is plain simple, though it’s not easy – the vast majority of them, like Warren Buffet, are so successful because they are patient, persistent and they know that time is their ally. Warren Buffet himself has been investing consistently for three quarters of a century.
Time is the key factor of success in various areas, including investing. Often it’s not a matter of hours, it doesn’t happen overnight. It takes years if not long decades for the decent returns to compound and make a significant success. So we should learn to wait, take our time and watch the magic of compounding happening.
WE BELIEVE WHAT WE WANT TO BELIEVE
Even though the author mentions late Hans Rosling, a world famous educator and statistician, to prove a point that people are influenced mostly by tragic news, terrible events and rare incidents rather than facts and statistics showing that life on Earth generally is better in so many different ways, he also makes his point that we still can’t predict the future and we cannot be certain of everything going according to our plan.
Moreover, there are many events we don’t understand fully or at all, but we forget that we all are biased and already have an opinion. What it means is that we often believe something so much we don’t even care to look for the factual answers. We make assumptions, fill in the gaps of the incomplete picture we have. We either think that everything is terrible, everything is perfect and nothing unexpected can happen, or that an expert sharing his knowledge doesn’t know what he’s talking about and wants to manipulate us. We should observe, take time to understand things and then have an opinion and make decisions.
CONCLUSION
The book Psychology of Money is very relevant and could be a helpful guideline for everyone who thrives to become financially independent, everyone who invests money, saves money or makes financial forecasts, as Housel said, and everyone who wants to sleep well at night without worrying about making poor financial decisions too much.
His observations are supposed to help us make better financial decisions, and a good financial decision can be different to everyone.
Reading this book makes you more humble in many ways thanks to embracing how much people’s perspective towards money can differ.
And remember: We all should make financial decisions that let us sleep at night.