Book Notes: The Psychology of Money

Table Of Contents

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.

Written By:

Tom Hombergs

Written By:

Tom Hombergs

As a professional software engineer, consultant, architect, general problem solver, I've been practicing the software craft for more than fifteen years and I'm still learning something new every day. I love sharing the things I learned, so you (and future me) can get a head start. That's why I founded reflectoring.io.

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