The Psychology of Money -Book Summary
The Psychology of Money book is based on the premise that doing well with money has a little to do with how smart you are and a lot to do with how you behave. People who lose control of their emotions can lead to emotional disaster.
While Morgan Housel mentions that ordinary people like you and me can be wealthy if we have a handful of behavioral skills that have nothing to do with a formal measure of intelligence.
Psychology of money mentions a story of a janitor who went on to be a millionaire at a later stage of his life while on the other Havard educated Richard Fuscone, after earning $90,000 per month, ended up being broke.
The story highlights that financial success is not hard science but a soft skill of how you behave with your money. Finance is mostly taught as physics but not enough like psychology.Finance is about people’s behaviour, a decision that may look wise one to you may look foolish to me.
Did you know Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works. Everyone in this world has a life anchored to a set of views about how money works wildly varies from person to person.
We all think that we know how the world works, but a matter of fact we have just experienced a tiny bit of it. The risk-bearing ability of each of us depends upon personal history. This directly affects what we think about those opportunities when they are presented to us.
Every decision people make with money is justified by taking into the information they have at the movement and using it into their thinking. Considering an example, lower-income house-hold in the US spend on average about $412, which is four times the amount those in the highest income group.
Few individuals take financial decisions based on spreadsheets, while others make them at the dining table or company meeting.
Understanding Luck & Risk and its effects in Finance
To understand the impact of Luck, the Psychology of money book mentions an example of Bill gates. One in a million high-school-age students attended high school with the combination of cash and foresight to buy a computer. Bill Gates happened to be in one of them.
Morgan Housel explains Risk and Luck wonderfully in the book. He says that Luck and Risk are both realities of every outcome in life as guided forces compared to an individual effort. They both happen because the world is too complex to allow 100% of your action to dictate 100% of your outcome. We as individuals are one person in a game of with seven billion other people and an infinite moving part.
Since Luck is hard to quantify and rude to suggest people’s success is owed to it. Another side is the business magazine does not celebrate the poor investor who experienced the unfortunate side of Risk. But certainly cover the individuals who made an ok or reckless decision and happened to be lucky.
Be careful who you praise and admire, Be careful who you look down upon and wish to avoid becoming. The book mentions that not all success is due to hard work, not all poverty is due to laziness, and we should keep this point in our mind when judging people.
Hence it is important to focus less on individual and case studies but focus more on the broad pattern. Studying individual CEO, or billionaires can be dangerous as per Morgan, because it is more likely that extreme ends of Luck or Risk influenced the outcome.
The Greed for Money Story
The book cites the example of Rajat Gupta who was the CEO of Mckinsey in early 40s had to lose all the millions of dollars just in the pursuit of even more, risking everything in the chase of more.
While pursuing goals, approach should be where there is no need to risk everything for what you don’t have and don’t need. Some point to keep in mind
- The hardest financial skill is getting the goalpost to stop moving
- Social comparison is the problem
- “Enough” is not too little
- There are many things never worth risking, no matter the potential gain
Path to wealth
Things can grow from a relatively small change in conditions. You don’t need tremendous forces to create tremendous results.If something compounds, then a little growth serves as the fuel for future growth-a small starting base can lead to results so extraordinary they seem to defy logic.
Psychology of money book mentions that Warren Buffet’s fortune isn’t made just due to being a good investor, but being an investor since he was literally a child. The real skill to his success is that he has been a phenomenal investor for three-quarters of a century.
The point the author is trying to get across in the books is that the small changes in assumptions can lead to ridiculous, impractical numbers. We often tend to overlook the key drivers of success.
The book psychology of money mentions that investing goal should be earning good returns that can stick through, which can be repeated for the longest time. Compared to the highest return which is one-off and cannot be repeated.
Getting Wealthy Vs Staying Wealthy.
“Investing is not necessarily about making good decisions, Its about consistently not screwing up.”
Getting money is one thing and keeping is another thing. Keeping money required the opposite of taking Risk. It requires the combination of fear and humility about the money you made quickly can be taken away quickly as well. It requires frugality and acceptance of some part of Luck involved so past success cannot be repeated indefinitely.
A year of compounding can never be compared to compounding growth that is made about 50 years.Having a Survival mindset will help a person in investing and staying wealthy which are as follows
- More than achieving a big return, aim to become financially unbreakable. This will help in to stay invested for longer, and the compounding will work its magic
- Planning is important, but the most important part of the plan should be to plan for things not working as per plan
- A barbelled personality – Optimistic about the future but paranoid about what will prevent you from getting to the future.
Your success as an investor depends upon how you respond to movements of terror in the markets and not the years spend on cruise control.
George Soros says that it’s not whether you are right or wrong but how much money you make when you are right and how much money you lose when you are wrong.
Freedom -Safety Vs Status
The highest form of freedom that wealth can provide is the ability to do whatever you want to do after you wake up every morning. Money’s greatest intrinsic value is its ability to give you control over your time.
Humans live to feel they are in control of their lives which is achieved by having control over their own time. But over time, we have used wealth to buy greater wealth to buy bigger and better stuff. But in the process, we have simultaneously given up control over our time.
The jobs have even changed, which means that the jobs don’t end when we leave our offices, but the thoughts of work keep on lingering in your head, even post office time. You may be thinking about the project in commute to your home or while at dinner time.
Compared to the previous generation, we have made things efficient but do not feel happier than the previous generation even though we are richer compared to the previous generation.
Gaining Respect in Real World
The book psychology of money cites that there is a paradox that people tend to want wealth to signal others that they should be liked and admired. But in most cases, people just bypass admiring you.
If you are seeking respect, admiration and respect through richness then it is not an effective way to seek it. Instead, humility, kindness and empathy will bring in more admiration and respect.
Wealth is what you don’t see.
The common ironies we think is that driving luxury car and showing off the car is wealth but in fact it’s other way around. Wealth is what we don’t see (investment, savings, FDs)
A person driving a Ferrari may be in debt and on the verge of bankruptcy. Modern capitalism helps People to fake it until they make it. Wealth in simple words, is assets that you have not converted into the stuff you see.
Most people say that they want to be a millionaire but in fact do the things which are exactly opposite which are needed to be a millionaire.
As the wealth which is not visible hence it is harder to understand what you cannot see and which makes it harder to build wealth.
Personal savings and frugality are finances conservation and efficiency and part of the money equation that we feel we are more in control of it. Spending beyond a level of materialism is mostly a reflection of ego approaching income as a way to show off people that you have money.
You spend less when you desire less and when you desire less, you care less about what people think about you. Saving has the potential to gain control over time. Money has the power to buy intangible stuff and this intangible stuff is where your brain cannot wrap around it.
Consider savings as taking a point in the future that would have been owned by someone else and giving back to yourself. Also saving gives the opportunity to invest that fall on your lap which appears no brainer. This is the hidden return on savings.
Reasonable > Rational
Aim to be pretty reasonable, because being reasonable has better chances of sticking with the choice for a longer run compared to rational decisions.
The reasonable investors who love their technically imperfect strategies have an edge as they are more likely to stick with those strategies compared to rational investors who walk away from when things become difficult.
Investing is a massive group of people making decisions with information that is available at the movement of time. This is why it is hard to predict what they will do next based solely on what they did in the past.
Experiencing certain events does not necessarily qualify one to know what will happen next.
Room For Error
While investing, you have to give yourself room for error. You have to plan on your plan, not going according to plan. The only way to deal with Risk in the world of investing is to increase the gap between what you think will happen and what can actually happen; this will ensure that you are capable of fighting another day.
This concept is called the margin of safety – which will help one to navigate safely a world that is governed by odds and not certainties. An example is the in-home renovation generally here is an overshoot of budget by 25%-50%
Morgan mentions that he assumes that he will earn ⅓ lower than the historical average returns. This helps him to save more and invest providing the margin of safety for his return if the actual returns do not actually give out those returns.
The psychology of money mentions that no risk is worth taking that wipes out everything you have. The biggest single point of failure with money is sole reliance on paycheck to fund short-term spending needs with no paychecks to fund short-term spending with no savings to create a gap between what you think your expenses are and what they might be in the future.
You will change
When we are making long term decisions we need to keep things in mind that we should avoid extreme ends of financial planning. Assuming that you will be happy with a very low income, or choosing endless hours in pursuit of a high one increases the odds that you will one day find yourself at a point of regret.
We should also accept the reality of changing our minds, that with time our thinking changes which also changes the goal
Nothing is Free
Every job looks easy until you are the one doing it. More often, we are not good at identifying what the price of success is, which prevents us from being able to pay it.
Many people want to seek the rewards without paying the price for it but the Money god does not look highly upon these people. Irony is that by trying to avoid the price , investors actually end up paying double especially in the case of investing.
Generally, people are ready to pay the price for houses, cars, food but not for good investments. The simple answer is the price of investing success is not immediately obvious it is not the price tag we can see, and hence it does not feel like a fee.
Thinking of volatility in markets as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investment gains to work in your favor.
The trick here is to convince yourself that the market fee is worth it.
How the Psychology of Money Affects Your Decisions
People make financial decisions they regret, and they often do so with scare information and without logic. But the decision made sense to them when they were made.
The author mentions that investors innocently take cues from other investors who are playing a different game than they are. Each investor has 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.
The financial bubble does its damage when long-term investors start playing one game and start taking cues from those short-term traders playing another game.
The things that matter apart from returns in investment is understanding your time horizon and not being persuaded but the action and behaviour of people playing different games than you are.
Putting it all together – Conclusion
Go out of your way to find humility when things are going right and forgive when they go wrong.So when judging others and yourself, respect the power of Luck and Risk, you will have a better chance of focusing on this you can control
Less Ego, More Wealth – Wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future.Manage your money in a way that helps you sleep at night.
If you want to do better as an investor, the single most powerful thing that you can do is increase the time horizon. Become Ok with a lot of things going wrong. You can be wrong half the time and still make a fortune.
Use the money to gain control over your time. Time flexibility is the highest dividend that exists in finance. Save and just save just without a specific reason. Define the cost of success and be ready to pay it.
Avoid the extreme ends of financial decisions. Define the game you’re playing, not being influenced by the people playing a different game.
One-Line Take Away
- Start Saving even if you don’t have any specific goals for purchase , but in future you may get an opportunity which is no brainer.
- Every investor has different goals and investment time horizons; do not copy other investors’ strategies until you know their investment goals and strategy.
- Play the status and say good-bye to control on your time or Say Goodbye to Status and gain control over your time.
The book Psychology of money should be read by every individual which will help to understand the psychology that is need in investing