I recently read the book- The Psychology of Money by Morgan Housel, Timeless Lessons on Wealth, Greed, and Happiness; the most intriguing investing book I have ever read.
Top 20 learnings from this book as follows:
Financial success is not hard science. It’s a soft skill, where how you behave is more important than what you know.
If you are short of time jump directly to points 19 and 20.
1. No One’s Crazy
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.
Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives.
The economists wrote: “Our findings suggest that individual investors’ willingness to bear risk depends on personal history.”
The New York Times wrote in 1955 about the growing desire, but continued inability, to retire: “To rephrase an old saying: everyone talks about retirement, but apparently very few do anything about it.”
2. Luck and Risk
Nothing is as good or bad as it seems.
If you give luck and risk their proper respect, you realize that when judging people’s financial success—both your own and others’—it’s never as good or as bad as it seems.
When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.
Say I buy a stock, and five years later it’s gone nowhere. It’s possible that I made a bad decision by buying it in the first place. It’s also possible that I made a good decision that had an 80% chance of making money, and I just happened to end up on the side of the unfortunate 20%. How do I know which is which? Did I make a mistake, or did I just experience the reality of risk?
The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side.
People who have control over their time tend to be happier in life is a broad and common enough observation.
Bill Gates once said, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.”
When things are going extremely well, realize it’s not as good as you think.
You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly.
Failure can be a lousy teacher because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk. The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.
But more important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures.
Nothing is as good or as bad as it seems.
3. Never Enough
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.”
If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.
There is no reason to risk what you have and need for what you don’t have and don’t need.
Remember a few things;
• The hardest financial skill is getting the goalpost to stop moving. Happiness, as it’s said, is just results minus expectations.
• Social comparison is the problem here. “The only way to win in a Las Vegas casino is to exit as soon as you enter.”
• “Enough” is not too little. The only way to know how much food you can eat is to eat until you’re sick. Few try this because vomiting hurts more than any meal is good. For some reason, the same logic doesn’t translate to business and investing, and many will only stop reaching for more when they break and are forced to.
• There are many things never worth risking, no matter the potential gain. Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable. Being loved by those who you want to love you is invaluable. Happiness is invaluable. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough. The good news is that the most powerful tool for building enough is remarkably simple, and doesn’t require taking risks that could damage any of these things. That’s the next chapter.
4. Confounding - Compounding
$81.5 billion of Warren Buffet’s $84.5 billion net worth came after his 65th
birthday. Our minds are not built to handle such absurdities.
His skill is investing, but his secret is time. That’s how compounding works.
Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.
5. Getting Wealthy Vs. Staying Wealthy
Good investing is not necessarily about making good decisions. It’s about consistently not screwing up.
If I had to summarize money success in a single word it would be “survival.”
Capitalism is hard. But part of the reason this happens is that getting money and keeping money are two different skills.
Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risks. It requires humility, and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
There are two reasons why a survival mentality is so key with money.
One is obvious: few gains are so great that they’re worth wiping yourself out over.
The other, as we saw in point 4, is the counterintuitive math of compounding. (Example of Warren Buffet.)
Applying the survival mindset to the real world comes down to appreciating three things.
• More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.
• Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right. Room for error—often called the margin of safety—is one of the most underappreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes. It’s different from being conservative. Conservatives is avoiding a certain level of risk. The margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.
• A barbell personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And in fact, you know it will be filled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is filled with landmines, and always will be. Those two things are not mutually exclusive.
Destruction in the face of progress is not only possible, but an efficient way to get rid of excess.
6. Tails, You Win
You can be wrong half the time and still make a fortune.
Napoleon’s definition of a military genius was, “The man who can do the average thing when all those around him are going crazy.”
A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.
7. Freedom
Controlling your time is the highest dividend money pays.
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.
Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered. More than your salary. More than the size of your house. More than the prestige of your job. Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
8. Man in the Car Paradox
No one is impressed with your possessions as much as you are.
The letter I wrote after my son was born said, “You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t.
What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does—especially from the people you want to respect and admire you.”
9. Wealth is What You Don’t See
Spending money to show people how much money you have is the fastest way to have less money.
Wealth is financial assets that haven’t yet been converted into the stuff you see. If you spend money on things, you will end up with the things and not the money.
The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth.
Rich is a current income. Someone driving a $100,000 car is almost certainly rich because even if they purchased the car with debt you need a certain level of income to afford the monthly payment. Same with those who live in big homes.
It’s not hard to spot rich people. They often go out of their way to make themselves known. But wealth is hidden. Its income not spent. Wealth is an option not yet taken to buy something later.
Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.” 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.
10. Save Money
The only factor you can control generates one of the only things that matter. How wonderful.
You can build wealth without a high income but have no chance of building wealth without a high savings rate, it’s clear which one matters more.
Think of it like this, and one of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.
So people’s ability to save is more in their control than they might think.
Savings can be created by spending less.
You can spend less if you desire less.
And you will desire less if you care less about what others think of you.
And you don’t need a specific reason to save.
Flexibility and control over your time is an unseen return on wealth.
Having more control over your time and options is becoming one of the most valuable currencies in the world.
That’s why more people can, and more people should save money.
11. Reasonable > Rational
Aiming to be mostly reasonable works better than trying to be coldly rational.
12. Surprise!
Stanford professor Scott Sagan once said something everyone who follows the economy or investment markets should hang on their wall: “Things that have never happened before happen all the time.”
Doctors operate kidneys the same way in 2020 as they did in 1020.
But investing is not hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing which can make even smart people nervous, greedy, and paranoid.
Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.
1. You’ll likely miss the outlier events that move the needle the most.
The majority of what’s happening at any given moment in the global economy can be tied back to a handful of past events that were nearly impossible to predict.
The correct lesson to learn from surprises is that the world is surprising. Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next.
2. History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.
13. Room for Error
The most important part of every plan is planning on your plan not going according to plan.
The room for error is underappreciated and misunderstood. It’s often viewed as a conservative hedge, used by those who don’t want to take much risk or aren’t confident in their views. But when used appropriately, it’s quite the opposite.
Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor. The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong.
Bill Gates understood this well. When Microsoft was a young company, he said he “came up with this incredibly conservative approach that I wanted to have enough money in the bank to pay a year’s worth of payroll even if we didn’t get any payments coming in.” Warren Buffett expressed a similar idea when he told Berkshire Hathaway shareholders in 2008: “I have pledged—to you, the rating agencies and myself—to always run Berkshire with more than ample cash ... When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.”
Nassim Taleb says, “You can be risk loving and yet completely averse to ruin.” And indeed, you should. The idea is that you have to take risks to get ahead, but no risk that can wipe you out is ever worth taking. The odds are in your favor when playing Russian roulette. But the downside is not worth the potential upside. There is no margin of safety that can compensate for the risk.
14. You’ll Change
Long-term planning is harder than it seems because people’s goals and desires change over time.
At every stage of our lives, we make decisions that will profoundly influence the lives of the people we’re going to become, and then when we become those people, we’re not always thrilled with the decisions we made.
Charlie Munger says, the first rule of compounding is to never interrupt it unnecessarily.
Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships.
Endurance is key. And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance.
The trick is to accept the reality of change and move on as soon as possible.
Embracing the idea that financial goals made when you were a different person should be abandoned without mercy versus put on life support and dragged on can be a good strategy to minimize future regret.
15. Nothing’s Free
Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds. The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty—not just putting up with it, but realizing that it’s an admission fee worth paying.
16. You & Me
Beware taking financial cues from people playing a different game than you are.
17. The Seduction of Pessimism
Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.
Optimism is the best bet for most people because the world tends to get better for most people most of the time.
Real optimists don’t believe that everything will be great. That’s complacency. Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.
Tell someone they’re in danger and you have their undivided attention.
The intellectual allure of pessimism has been known for ages. John Stuart Mill wrote in the 1840s: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.”
There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. In a connected system where one person’s decisions can affect everyone else, it’s understandable why financial risks gain a spotlight and capture attention in a way few other topics can.
There are lots of overnight tragedies. There are rarely overnight miracles.
Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.
In investing you must identify the price of success—volatility and loss amid the long backdrop of growth—and be willing to pay it.
18. When You’ll Believe Anything
Why do people listen to TV investment commentary that has a little track record of success? Partly because the stakes are so high in investing. Get a few stocks picks right and you can become rich without much effort. If there’s a 1% chance that someone’s prediction will come true, and it coming true will change your life, it’s not crazy to pay attention—just in case.
Carl Richards writes: “Risk is what’s leftover when you think you’ve thought of everything.”
People know this. I have not met an investor who genuinely thinks market forecasts as a whole are accurate or useful. But there’s still tremendous demand for forecasts, in both the media and from financial advisors.
Why?
Psychologist Philip Tetlock once wrote: “We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”
Satisfying that need is a great way to put it. Wanting to believe we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated and solved. The illusion of control is more persuasive than the reality of uncertainty. So we cling to stories about outcomes being in our control.
NASA’s New Horizons spacecraft passed by Pluto two years ago. It was a three-billion mile trip that took nine and a half years. According to NASA, the trip “took about one minute less than predicted when the craft was launched in January 2006.”
Business, economics, and investing, are fields of uncertainty, overwhelmingly driven by decisions that can’t easily be explained with clean formulas, like a trip to Pluto can. But we desperately want it to be like a trip to Pluto because the idea of a NASA engineer being in 99.99998% control of an outcome is beautiful and comforting. It’s so comforting that we’re tempted to tell ourselves stories about how much control we have in other parts of our life, like money.
19. All Together Now
Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong. Because it’s never as good or as bad as it looks. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control. You’ll also have a better chance of finding the right role models.
Less ego, 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. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today.
Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions.
If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve.
Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune because a small minority of things account for the majority of outcomes. No matter what you’re doing with your money you should be comfortable with a lot of stuff not working. That’s just how the world is. So you should always measure how you’ve done by looking at your full portfolio, rather than individual investments. It is fine to have a large chunk of poor investments and a few outstanding ones. That’s usually the best-case scenario. Judging how you’ve done by focusing on individual investments makes winners look more brilliant than they were, and losers appear more regrettable than they should.
Use the 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.
Be nicer and less flashy. No one is impressed with your possessions as much as you are. You might think you want a fancy car or a nice watch.
But what you probably want is respect and admiration. And you’re more likely to gain those things through kindness and humility than horsepower and chrome.
Save. Just save. You don’t need a specific reason to save. It’s great to save for a car, or a down payment, or a medical emergency. But saving for things that are impossible to predict or define is one of the best reasons to save. Everyone’s life is a continuous chain of surprises.
Savings that aren’t earmarked for anything, in particular, is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.
Define the cost of success and be ready to pay it. Because nothing worthwhile is free. And remember that most financial costs don’t have visible price tags.
Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid).
Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge, but if it keeps you in the game it can pay for itself many times over.
Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the more you may regret them as you evolve.
You should like a risk because it pays off over time. But you should be paranoid about ruinous risk because it prevents you from taking future risks that will pay off over time.
Define the game you’re playing, and make sure your actions are not being influenced by people playing a different game.
Respect the mess. Smart, informed, and reasonable people can disagree in finance because people have vastly different goals and desires. There is no single right answer; just the answer that works for you.
20. Conclusion
Important financial decisions aren’t made with the intention of maximizing returns but minimizing the chance of disappointing a spouse or child.
Charlie Munger once said “I did not intend to get rich. I just wanted to get independent.”
I mostly just want to wake up every day knowing my family and I can do whatever we want to do on our own terms. Every financial decision we make revolves around the goal of creating an independence fund.
Nassim Taleb explained: “True success is exiting some rat race to modulate one’s activities for peace of mind.”
The independent feeling I get from owning our house outright far exceeds the known financial gain I’d get from leveraging our assets with a cheap mortgage.
Eliminating the monthly payment feels better than maximizing the long-term
value of our assets. It makes me feel independent.
Good decisions aren’t always rational. At some point, you have to choose between being happy or being “right.”
I’m saving for a world where curveballs are more common than we expect. Not being forced to sell stocks to cover an expense also means we’re increasing the odds of letting the stocks we own compound for the longest period of time. Charlie Munger put it well: “The first rule of compounding is to never interrupt it unnecessarily.”
A lot of this view comes from our lifestyle of frugal spending. If you can meet all your goals without having to take the added risk that comes from trying to outperform the market, then what’s the point of even trying? I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one.
No matter how we save or invest I’m sure we’ll always have the goal of independence, and we’ll always do whatever maximizes for sleeping well at night.
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Readers who like investing and want to understand money psychology should definitely read this book.
You may contact us in case you need to ask or tell something.
With respect,
Aaditya Chhajed
Aaditya Chhajed
E: chhajedaaditya@gmail.com
M: +91-9404055222.
M: +91-9404055222.
You can connect me on Instagram at @chhajedaaditya
Aaditya is the founder of Aaditya Chhajed Financial Services.
He loves helping family, friends, and, clients make better financial decisions. He believes learning is perpetual.
He is a commerce postgraduate and Chartered Accountant. He has also cleared all levels of CFA(US) in the first attempt.
Disclaimer:
Investors should seek the advice of their financial advisor prior to making any investment decision based on this report or for any necessary explanation of its contents. Future estimates mentioned herein are personal opinions and views of the author. This post is not a recommendation to buy or hold or sell securities. Investments are subject to market risks. Please read all investment-related documents carefully.
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