Review: The Psychology of Money by Morgan Housel

A short, well-written book dense with useful insights on how to deal with money. This book doesn’t give you specific financial advice like “invest in asset class A, but don’t invest in asset class B”, but instead provides a set of higher-level principles about how to think about money.

In particular, the key idea in this book is that where most people struggle with money is not with understanding the basic mechanics of finance, but with the psychological aspects: e.g., emotions, biases, impatience, overconfidence, greed, fear, etc. Learning how to change these behaviors, rather than learning any specific aspects of money management, is the focus of this book.

Here are some of the the key takeaways for me:

• “Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting.”

• “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.” How you grew up is going to have the biggest impact on how you think about money, and therefore, your financial outcomes. “Two brothers rich and tall” are more likely to both be rich than to both be tall.

• It’s hard to separate luck from risk from skill. For example, you could make an investing decision that has an 80% chance of success, and as luck may have it, you end up in the 20% failure case. So your investment fails, but it was still a good decision. The opposite could happen too: you make a poor decision to invest in something with only a 20% chance of success, but you get lucky, and it works out anyway. Is it a lucky break or a shrewd decision? Was Mark Zuckerberg a genius to turn down a $1B acquisition offer from Yahoo, as a few years later Facebook was worth a hundred times that amount? If he was a genius, then were the folks at Yahoo also geniuses to turn down a $44B acquisition offer from Microsoft, only to end up being worth a tenth of that years later?

• “At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, ‘Yes, but I have something he will never have … enough.’” Knowing what is “enough” is the key to feeling successful and satisfied in life. If you keep moving the goalposts as you become more successful, you’ll never feel like you have enough.

• The single most important thing is survival. No return is ever worth the risk of total ruin; even if there are some massive potential gains for taking this risk, it’s never worth it if the cost is total loss. Russian Roulette has pretty good odds, but the cost of losing is so high, that it’s never worth playing. “There is no reason to risk what you have and need for what you don’t have and don’t need.”

• The most powerful force with money is compounding. But it only works over a very long time frame. “As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s.” Buffet is a better investor than you ever will be, but even with him, the vast majority of his success comes from the fact that he’s being investing and compounding since he was 10 years old.

• This is another reason survival is so important: compounding only works over a very long time frame, and over a long enough time frame, even very unlikely events are going to happen, so it’s essential you aren’t wiped out by these unlikely events, or compounding fails. Survival means that you should optimize for being “financially unbreakable” more than you should optimize for big returns.

• The most important thing to plan for is things not going according to plan. You must have room for error in your plan. The more things that must go right for your plan to work, the more fragile you are, and the less likely you are to survive.

• Aim for a barbell personality: you set aside some money for taking risks and you set aside some money for a rainy day. The idea is to be both optimistic and paranoid. That may seem like an odd combination, but it’s a powerful one. You assume that things will be good in the long term (optimism), but you expect that things can go very wrong at any point in the short term (paranoia). You need that paranoia, that money set aside, to survive the short term bumps so you can survive benefit from long term growth.

• Success in many aspects of life comes from the long tails: that is, a tiny minority of events that produce a disproportionally huge percentage of the value. For example, with art, the idea is to buy a huge portfolio of different types of art; almost all of those art pieces will be worth nothing, but a tiny few may turn out to be worth a fortune. Same with investing: for example, with the Russell 3000 index, which is an index of the largest 3,000 public companies in America, almost all of its returns since the 80s come from just 7% of the companies. In fact, over the last several decades, ~66% of the companies in the index lost value, ~40% of the companies went out of business, and yet, the index has had a 79x return. As another example, Warren Buffet has picked over 500 stocks in his life, but the vast majority of his returns come from just 10 of those stocks. So almost all the value comes from the tails. In fact, the fact that life itself exists may be the ultimate long tail event!

• Success in some activities in life requires a 100% success rate: e.g., being a pilot. Success in other activities requires a very high success rate, but perhaps not quite 100%: e.g., being a chef. However, for some activities, you can be successful with a much lower success rate: e.g., if you’re successful 50% of the time as an investor, you can make a fortune. The same is true of product development: e.g., Amazon is known for a number of significant product failures (e.g., the Amazon Fire phone), but they also have a couple of tail products (Amazon Prime, AWS) that bring in the vast majority of their revenue. You can fail the great majority of the time and still be very successful (especially with a few tail events).

• Napoleon’s definition of a military genius: “The man who can do the average thing when everyone else around him is losing his mind.” The same is true of investing: even during recessions, the key is not to panic, and keep doing the average thing.

• “Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time. […] Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance.”

• Increasing your returns by 5% is MUCH harder than decreasing your spending by 5%. So reduce your spending and save money. Save not for specific items (e.g., being able to buy something fancy), but for optionality. Having money saved gives you far more options in life: you can leave a job; you can jump on a new opportunity; you can have more control over your time; you can deal with an unexpected problem.

• “Rich” is what’s visible: e.g., fancy houses and cars. “Wealth” is what’s not visible: it’s the money you didn’t spend. Focus far more on wealth than on riches. “Spending money to show people how much money you have is the fastest way to have less money.”

• Don’t be fooled by investors playing a different game than you. Day traders are looking for something very different in their investments (e.g., some temporary edge or market fluctuation to be able to quickly flip a stock at a profit) than someone planning to hold an investment for 30 years (e.g., business and market fundamentals). Take the time to write down what sort of game you’re playing. Then, figure out what factors matter in your game, and focus only on those items, and nothing else.

• Don’t be fooled by pessimism. It always sounds smarter than optimism, but that doesn’t mean it is. E.g., If you prophesize the economy will grow by 100X, people will look at you like a quack; but if you prophesize doom and predict the economy will crash by 100X, everyone will listen. And yet, the former has actually happened over the years.

Rating: 5 stars