Book Notes: The Psychology of Money

TL;DR: Read this Book, when…

• you want to start investing money, but don’t know how
• you want to confirm your investment mindset
• you enjoy reading a financial adviser’s view on investing money

Book Facts

• Title: The Psychology of Money
• Authors: Morgan Housel
• Word Count: ~ 80,000 (ca. 5 hours at 250 words / minute)
• Reading Ease: easy to medium
• Writing Style: easy to medium language, short chapters, a few financial terms
• Year Published: 2020

Overview

{% include book-link.html book=“psychology-of-money” %} is about how we think and feel about money, and how that affects how we act about our money.

It’s an easy read with chapters that can be finished in a lunch break (just the way I like it). Each chapter tells a story about how people act and why they do so, with some anecdotes by the author himself.

The author was a financial adviser, so he’s learned a bit in his time.

The book doesn’t give concrete investment advice, but communicates a clear mindset that is beneficial for investing.

Notes

Here are my notes, as usual with some comments in italics.

1 - No One’s Crazy

• we’re all biased by our lives - everyone thinks and acts differently and we all have good reason to
• “We all think we know how the world works, but we’ve all experienced only a tiny fraction of it.”
• we can’t really take advantage of history, because reading about history is not the same as experiencing it
• also, the history of saving money is very short - not much to learn from (this is what I find frustrating about the software industry, as well, by the way)

2 - Luck & Risk

• “Nothing is as good or bad as it seems”
  • success or failure always has to do with luck or risk
  • but we don’t talk about it because it’s rude to imply that someone else’s success has been luck
• “Not all success is due to hard work, and not all poverty is due to laziness.”
• we should focus more on broad patterns than on individual stories about success of failure

3 - Never Enough

• some people that own unimaginable amounts of money risk everything to get even more money
• “There is no reason to risk what you have and need for what you don’t have and don’t need.” (This strikes me as a very healthy mindset when working with your money)
• “Life isn’t any fun without a sense of enough” - you can never enjoy the status quo if you always want more
• social comparison is a game you can’t win unless you’re the richest person in the world (which you probably aren’t)

4 - Confounding Compounding

• “You don’t need tremendous force to create tremendous results.”
  • the ice ages started because every year, a bit more snow was left over from last winter which eventually compounded to a thick layer of ice
• Warren Buffet got a return of about 22% on his investments every year on average - he’s only as wealthy as he is today because he’s been doing it forever
• “The most powerful and important book [about investing] should be called ‘Shut Up and Wait’”

5 - Getting Wealthy vs. Staying Wealthy

• getting money is a very different skill from keeping money
  • getting money requires taking risks
  • keeping money requires humility and paranoia about not losing what you have
• the key to successful investment is survival - stick around long enough to let the compunding work for you
• be financially unbreakable instead of going after the big returns
• allow for error in your financial planning to become financially unbreakable
• be short-term paranoid to keep your wealth and long-term optimistic to grow it

6 - Tails, You Win

• “An investor can be wrong half the time and still make a fortune.”
• we overreact when things fail, even though it won’t make a dent in the long run (I invested a (for me) serious amount of money into index funds a couple weeks before the stock market crashed due to COVID-19 in early 2020 … I almost overreacted by selling with a loss, but it’s good I didn’t)
• anything successful is the result of a “tail event” - an event in the “long tail” of events in a distribution curve that are rare, but have an immense impact
• do something a lot to be rewarded with such a tail event (this speaks my heart and has inspired me to write about it in this newsletter)
• 4 in 10 publicly traded companies experience a catastrophic loss from which they don’t recover
• very few companies have stellar growth, most because of a single or a few products that outperform all others by orders of magnitude - but that’s enough to win with if you have a diversified portfolio
• “Your success as an investor will be determined by how you respond to punctuated moments of terror, not years spent on cruise control.” (i.e. don’t sell every time you experience a hiccup)
• “Tails drive everything.” - tail events have the strongest impact on your investment strategy

7 - Freedom

• happiness means being able to do what you want, when you want, with who you want - i.e. controlling your own life
• we’re working more with our heads than with our hands today, so we tend to take work with us everywhere - this means less control over our lives
• “Controlling your time is the highest dividend money pays.” (while my blog started out as a platform for me learning things, I’m now growing it to bring me that dividend)

8 - Man in the Car Paradox

• when we see a driver in an expensive car, we’re usually impressed by the car and not by the driver - we imagine ourselves driving that car instead of admiring the driver’s achievements
• “No one is as impressed with your possessions as much as you are.”

9 - Wealth is What You Don’t See

• wealth is the expensive car that you didn’t buy
• being a millionaire is the opposite of spending a million dollars
• “Wealth is an option not yet taken to buy something later.”
• what we see is richness, not wealth - money spent on cars, houses, and other visible things

10 - Save Money

• getting money is largely out of our control - saving money is not
• reducing lifestyle bloat is often easier and has more potential than increasing income
• savings are the gap between your income and your ego - more humility will raise your savings rate
• saving money gives you flexibility to take opportunities you would otherwise have to decline - a lower paying, but more rewarding job, learning something new, retiring early, …

11 - Reasonable > Rational

• being rational about investments means to be passionless
  • it means you might sell a stock when it’s going down instead of keeping it and making more with it in the long run
• being reasonable instead of being rational (i.e. allowing a bit of passion) helps you sleep at night
• being strictly rational will get you in uncomfortable situations

12 - Surprise!

• “Things that have never happened before happen all the time.”
• it’s dangerous to use history as a guide for the future
• history tells us how people behaved under greed and stress, but not about trends - these will always be surprises

13 - Room for Error

• “You have to plan on your plan not going to plan.” (that’s what I preach in every software project where I’m asked for estimates)
• “Room for error lets you endure a range of outcomes” - instead of only one
• don’t invest all your cash - having some in the bank gives options during surprises
• take risks with one portion of the money and be terrified about losing the other portion
• avoid a single point of failure (also something that we do when building software)
• you don’t need to save money for a specific reason - how can you know today what you’ll need the money for in the future?

14 - You’ll Change

• as a child we want to drive a tractor, but later we don’t
• the “End of History” illusion is believing that we won’t change as much in the future as we did in the past - the History lies behind us and we’ve learned all there is

15 - Nothing’s Free

• we pay for high dividends with high volatility
• trying to get high dividends without high volatility is the equivalent of grand theft auto - you’re not paying the price for it and if you get caught, you lose a lot
• if you try to make high gains without paying the price of uncertainty, it will bite you later
  • example: Every quarter, General Electric wanted to have their revenue look just a bit better than the forecast, so they wouldn’t pay the price of uncertainty in front of their investors - they did that by pulling some of next quarters revenues into this quarter - this only went well for so long
• viewing volatility as a fee rather than a fine makes it easier to live with it

16 - You & Me

• short-term trading and long-term investing are very different games - don’t take advice from a short-term trader if you are investing long-term
• bubbles happen when long-term investors start taking cues from short-term traders

17 - The Seduction of Pessimism

• optimism is the best attitude for most people because things are getting better for most people most of the time
• pessimism is taken more seriously than optimism - when someone says the stocks will rise, they are ignored, but when they say the stocks will fall, we sell
• financial bad news are expecially impactful because money is a topic that touches everyone
• “Progress happens too slowly to notice, but setbacks happen too quickly to ignore.”
• we pay attention to failures more than to successes

18 - When You’ll Believe Anything

• stories are the most powerful force in finance - more powerful than tangible facts
• you’ll believe just about anything when the stakes are high
• we tell ourselves stories to explain things we don’t understand

19 - All Together Now

• “Less ego, more wealth.” - save more money
• manage your money so that you can sleep well
• the longest lever to increase your wealth is to increase the time period in which you save
• use money to gain control over your time

20 - Confessions

• what works for the author (but may not work for others):
  • buying a house without a mortgage because the feeling of owning the house is worth more than the lost revenue from higher-return investments (looking at the Sydney property prices, I don’t believe I will ever be in the position to pay for a house in cash …)
  • keeping 20% of all assets in cash for unexpected expenses instead of investing it
  • investing only in a handful of index funds because they have the highest odds for long-term success
• “There is little correlation between investment effort and investment success.”

Conclusion

While the book didn’t contain any mind-blowing revelations about money (at least for me), it was an entertaining and interesting read that confirmed me in my thinking about money.

I will continue to invest in index funds and maybe invest a little play money into single stocks for short-term trading.

The main takeaway for me was the fact that rare “tail events” are mainly responsible for investment success. That’s something I only have control over when I keep investing, so I’ll do just that.