Distilling the Lessons Learnt From The Psychology of Money(Morgan Housel)
Numbers isn’t everything when it comes to investing or anything money related. In fact, when I first started out on my personal finance and investing journey, someone that i looked up to told me that “ Investing and managing money is 30% technical skill and 70% emotions”. I didn’t know what he meant back then, and almost thought that he was speaking gibberish. Yet, 2.5 years into my journey, it has been clear that emotions and mindset play a big role in investing, and even applies in our day to day personal finances. I had the opportunity to read this amazingly simplified book by Morgan Housel this summer break and I thought that I could try to convey the lessons learnt, coupled with my own experiences.
Lesson 1: Ordinary Folks with no education can be wealthy if they have a handful of behavioural skills.
The book starts out by highlighting the example of the late philanthropist, Mr Ronald Read. Mr Read was fixing cars at a gas station for 25 years and swept floors at JCPenny for 17 years — a simple life. Yet, what shocked the world was how he had a net worth of 8 million dollars, which he donated more than 6 million to the local hospital and library. Where did this wealth came from? No surprises, it came from him saving as much as he could and invested it in blue chip stocks. Thereafter, he waited and repeated consistently for decades, until the small compounded to something unfathomable.
Mr Read had no formal financial background and yet still managed to achieved what many that have formal education couldn’t. This suggested two things, one, financial outcomes are driven by luck, to a certain extent and two, perhaps financial outcomes are determined by soft skills, and how you behave is more important than what you know.
Lesson 2: We do not have the right to judge how others manage their money, because everyone’s definitions of safety and risky is different.
No one’s insane, especially when it comes to managing their own money. We are born into different circumstances and raised up in different environments, where these experiences shape our view of the world and our view of money. What seems crazy to you might make sense to me and vice versa. This experience that we have may make up 80% of our perception of how the world works when in reality it is only 0.00001%. Your personal history will most likely impact the way you manage your money.
Along these 2 years, I have met many people that have vastly different ways of managing their money. One friend of mine does not believe in holding investments for the long term, another one of mine is an avid follower of “hype” stocks, and another believes in passive investing through ETFs, etc. Are all of my friends wrong? In reality, no, they believe in what works from them and I shouldn’t have any right in judging what they do. It’s their money and I don’t have the right to do so.
Lesson 3: Luck and risk plays an important role in our financial outcome, and in our life.
Luck and risk are often unquantifiable, and perhaps that is why it is simpler for us to safely ignore it — or is it? Bill Gates admitted that “If there had been no Lakeside, there would have been no Microsoft.” Lakeside was the high school that had the foresight and financial resources to buy a computer, which gave Bill Gates and Paul Allen a head start.
Sometimes, attributing success to luck and blaming luck for failure can be seen as jealousy and excuses respectively, but you definitely cannot discredit the role of luck in whatever we do. Does a bad investment or a failed business idea mean that we didn’t think it through or try hard enough? Maybe, but we can never be 100% sure, and risk is just what happens when luck is not in your favour.
Lesson 4: Have a goal in mind, and know when is enough.
Having a goal in mind and setting a concrete numerical aim will prevent you from taking on unnecessary risk and making irrational decisions to gain something you don’t need while risking things you need. Furthermore, it will help you feel that you are making progress, instead of feeling burnt out trying to chase a goal that is always moving further from you as you progress.
“Comparison is the thief of joy”. Often times, making comparisons lead to manifestations of greed, which causes us to be tempted to take unnecessary leverage. Knowing when is enough will help to restrain yourself and ensure a stable emotional well-being.
Lesson 5: You can make a ton of mistakes, and still end up making a fortune. Outliers drive most of the results.
Outliers drive most of our investment returns, which is a real life application of the Pareto Principle, where 20% of causes account for 80% of the results. In venture capital, which focuses on investments in start-ups, majority of these investments do not bear fruits. Less than 5% of these investments actually go 10X to 50X, yet it drives the returns for majority of the industry. Similarly, it’s the same for public markets as well, where not all listed companies are of equal quality. Some business models are just more superior than others. This may also explain why a selective few companies in the index drive most of the returns.
Perhaps, this is why “Time in the market matters more than timing the market”. You can continue to do Dollar Cost Averaging and be wrong half of the time(investing on a down market), and still have decent returns in the long run.
Lesson 6: Being in control of your time pays the best dividend. Freedom pays the best dividend.
Angus Campbell — a psychologist at the university of Michigan, wanted to know what made people happy, and the common denominator was the ability to control one’s own time. It seems obvious but some people often lose sight of this in our busy lives. After all, having money to buy you options in life is better than luxury goods, such as taking a break from work for your health or even being able to pay for medical bills in times of a medical emergency.
The author also cited that when gerontologist Karl Pillemer interviewed a thousand elderly Americans looking for the most important life lessons that they have learnt, these elderly said that they valued quality friendships, being part of something bigger than themselves and spending quality time with their children. No one said that being super wealthy or buying the things you want were the most important. It was the intangible things that mattered, the ones that money can hardly buy.
Freedom and having the choice to spend your time matters.
Lesson 7: Wealth is what you don’t see, don’t be quick to judge or envy.
Often times, we are quick to react when we see a luxury good such as a Ferrari or even a Porsche, where we assume that that particular person is wealthy. Yet, this is not always the case. Wealth is income not spent and there will be no “item” such as a luxury good to show off. For all you know, the random guy that you always see on the subway that wears the same T-shirt everyday has a huge savings or even a huge portfolio of investments.
Being rich and wealthy are two different notions, perhaps the person who bought the Porsche or Ferrari is rich, because you need a certain level of income to afford it. However, true wealth is hidden from the eyes of others.
There are people who look modest but are actually wealthy and people who are rich but living on the edge of insolvency. Don’t be too quick to judge the success of others and setting your goals based on that judgement.
Lesson 8: The importance of savings — just do it for no reason at all.
Savings is probably the most important and underrated part of personal finance. It’s the only component that we have 100% control over it. Can we control how the stock market moves? No. Can we control how much our salaries are? Maybe, but the decision lies with the employer. Can we control our savings rate by controlling how we spend? Most certainly we can.
Often times, we save because of a goal, perhaps to buy that tablet you wanted etc. Yet, do we really need a goal of spending to save? Not exactly, instead, the author argues that we save for no reason at all, so that it gives you more options — to invest, to be able to protect yourself against unpredictable situations.
Moreover, we can certainly control how we spend, because past a certain level of income, after we are able to cover our essentials, savings is just the gap between your income and your ego.
Lesson 9: We all have emotions, and that’s why we can’t be 100% rational, but we can strive to be reasonably rational.
We are all humans, and we have emotions, which makes fear an extremely wild card in personal finance. In theory, we always want the mathematically optimised strategy to supercharge our finances, but in reality, it is hardly the case. No one wants to risk it all, and in reality, we just want a strategy that can allow us to sleep soundly at night. What we can do to bridge this gap between theory and reality is to be reasonably rational. There is a social component in money related matters such as investing, and we cannot ignore it. Losing money means something — perhaps affecting your loved ones, and that’s why we can only be reasonably rational.
Lesson 10: History cannot be used to predict the future.
The unique thing about civilisation is that we as humans, always progress forward by thinking of new ways of doing things and innovating. Structural Changes that changes the way we live and interact with each other will definitely impact the way we invest as well. For instance, the idea of Software As A Service(SAAS) wasn’t prevalent in the past, and tech companies were mainly selling softwares for a one time license fee. Yet, now, people are able to enjoy better and improving software by subscription on a more affordable basis per month, and the companies are able to have predictable revenue and increase in lifetime value of the customer. These changes are impossible to see from the history of investing.
History is always filled with ground breaking events, outliers, as the book puts across. These outliers such as the great depression and even the pandemic right now, will be impossible to predict ahead of time. Moreover, these events most likely will have repercussions that leave effects on the economy for many years down the road, which are even harder to predict.
Lesson 11: Always have a margin of safety for whatever you do and avoid single points of failure.
In a financial system such as the stock market, where odds and certainties play a role, catering expectations to include some room for error is critical to increase the odds of long term success for one’s personal finance journey.
This includes downplaying precise expectations, and to not rely too much on one component of your personal finance, such as income, because things will not consistently go the way you want it to be.
Warren Buffet announced that he needed someone that was “genetically programmed to recognise and avoid serious risk, including those never encountered before”, to be his eventual successor. We should try to adopt this in our personal finance journey as well, where we try to achieve decent and sustainable returns on our investments, and not risk or leverage everything to get the highest possible returns.
Lesson 12: Be flexible and adaptable with yourself.
We all evolve and change as we age. Priorities and goals will inevitable change during the different different life stages and we should be flexible in our goals to ensure endurance in our personal finance journey.
While sticking to goals originally is admirable and could even push you harder, it may not necessarily be sustainable. Being sustainable will increase your odds of success, rather than continuously chase after an impossible goal.
For instance, Only 27% of college grads have a job related to their major, and honestly, I think it’s really important to not limit yourself to something you chose at 18 or 19. Don’t put an imaginary box onto yourself, and not realise your true potential. This is something that I believe can be applied to our personal finances as well.
Lesson 13: Nothing is free.
Everything has a price and that is imperative to be aware of, so that we know what do we need to pay. This “price” can be hard to see initially because everything seems easy to do in theory and our notion of “price” are usually limited in a monetary sense.
In investing, “prices” manifest as such :
- Volatility. Holding on to your investments during a down market seems easy to say, but experiencing it is a different story. Our emotions go out of control and doubts come creeping in. This is one of the unspoken price that we have to pay for decent returns, and it requires conviction and great mental stamina. This brings me to the next point.
- Conviction — which comes from doing sufficient due diligence in terms of stock picking and research in terms of the broad market if one is looking at the indexes. It’s the price you have to pay for above average returns, and frankly, it’s not easy.
Above average returns require a price, like most things in life.
Lesson 14: Be careful about who you take advice from.
There isn’t one “rational” price when financial assets are in concern. What is a reasonable price to pay for Stock A today? It depends. It depends on the time horizon that you are looking at. Everyone’s circumstances is different but everyone is participating in the same market.
You need to identify what are you trying to achieve across how long of a timeline and what is the game that you are trying to play. Playing someone else’s game in your circumstances can bring about dire consequences.
This applies in spending as well. Don’t let other people’s spending influence you because their spending may be justified, such as a professional need to maintain an image etc. What really matters is understanding yourself, your needs and adjust your personal finance actions towards it.
Lesson 15: Pessimism is often seductive.
Tracing back in history, paying attention to the negative threats was essential because it meant survival. This has sort of been hardwired into us, where we pay attention to the negativity of everything more than the positivity. In investing, this may be a counter productive trait to have, given that the world has generally progressed to have improvements in the way we do things.
However, progress takes time and slow incremental progress that goes unnoticed on a daily basis can actually compound into a huge progress. Trying to stay optimistic while maintaining the context of the facts is extremely important.
I hope the summary of the takeaways of the book has benefitted you! Having the mindset needed to take charge of your finances is essential to starting your personal finance journey and having a good relationship with your finances. Let me end off with my favourite sentence from the book:
“Money’s greatest intrinsic value — and this can’t be overstated — is its ability to give you control over your time.”
Thank you for taking the time to read this article. Please do share it with others whom you think might benefit from this article as well!
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
