The Psychology of Money – Book Notes and Summary

Psychology of Money - Morgan Housel
A refreshing take on money for the 21st century.

One-sentence summary: In The Psychology of Money, Morgan Housel shares the most valuable money tips out there: focus on the payoffs, don’t interrupt compounding, and embrace enough.

Rating: 7/10

Author: Morgan Housel

Date Completed: January 13th, 2021

Tags: Money, Psychology, FIRE, Mental Models, Frameworks, Risk, Luck, Decision-Making

Hot take: Finally, a book about money and investing that treads some new ground (and that straight out of 1995). The Psychology of Money is a light, refreshing read for someone who’s spent his adult life thinking about finance. For anyone who hasn’t, this might be genuinely eye-opening stuff.

“The odds of many lucrative things are in your favor. Real estate prices go up most years, and during most years you’ll get a paycheck every other week. But if something has 95% odds of being right, the 5% odds of being wrong means you will almost certainly experience the downside at some point in your life. And if the cost of the downside is ruin, the upside the other 95% of the time likely isn’t worth the risk, no matter how appealing it looks.”

Morgan Housel, The Psychology of Money

Big Ideas

The three things that matter in choosing any investment:

  • How much you get when you win
  • How often you stand to win
  • What’s the worst that could happen?

Never interrupt compounding.

  • Compounding doesn’t require gigantic returns each year. Instead, it’s about getting good returns that compound uninterrupted over long periods.
  • $81.5B of Warren Buffett’s $84.5B net worth came after his 65th birthday. Being in the game for a long time is much better than being a star investor – Buffett only had incredible returns because he’s been a star investor for more than half a century.
  • Since the tails produce every excellent outcome, that means you want to do anything you can to not get in the way of compounding as a driving force in your investing.
  • “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.”
  • Think about holding a stockpile of cash in an up market. You look like a fool, right? But suppose that money provides a buffer, so you don’t have to sell your shares during a bear market. In that case, your return on the cash could be higher than you thought – because “preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.”
  • “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 freedom to do what you want when you want to do it for as long as you want is the prime asset in life. 

  • Karl Pillemer interviewed a thousand elderly Americans to learn what he could from their life experiences. From his research:
    • “No one – not a single person out of a thousand – said that to be happy you should try to work as hard as you can to make money to buy the things you want. No one – not a single person – said it’s important to be at least as wealthy as the people around you, and if you have more than they do it’s real success. No one – not a single person – said you should choose your work based on desired future earning power.”
    • Instead, people valued time. With their children, to work on things they wanted, to spend with friends.
  • “Money’s greatest intrinsic value – and this can’t be overstated – is its ability to give you control over your time.”
  • Even doing something you love on someone else’s schedule can feel a lot like doing something you hate: “People like to feel like they’re in control – in the driver’s seat. When we try to get them to do something, they feel disempowered. Rather than feeling like they made the choice, they feel like we made it for them. So they say no or do something else, even when they might have originally been happy to go along.” -Jonah Berger
  • “Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.”
  • “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.” -Angus Campbell. That’s more than income, where you live, education level, etc.

“There is no reason to risk what you have and need for what you don’t have and don’t need.”

  • Invest time and effort in ensuring that the goalpost stops moving.
  • “Modern capitalism is a pro at two things: generating wealth and generating envy.”
  • That’s why we should endeavor to get to enough – money, power, prestige, etc. – and stop. That’s not leaving stuff on the table; it’s the opposite, knowing when your appetite for more will get you into trouble.
  • “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.”

Bits and Pieces

  • Avoid single points of failure.
    • Nearly everything you rely on will break eventually. So if a lot of things depend on one thing working, you’ll eventually pay the price for this.
    • The best example of this in the financial world is relying solely on a paycheck to support short-term spending needs. If you have a cushion of cash and shares, you can easily avoid this single point of failure.
  • “The correct lesson to learn from surprises: that the world is surprising.”
    • “Things that have never happened before happen all the time.” -Scott Sagan
    • The things that will change the world the most in the next ten years will be some of the most unexpected things – unprecedented events that will nevertheless happen and shape the world we live in. Nassim Taleb makes his living by reminding us of this.
    • “The twelve most dangerous words in investing are, ‘The four most dangerous words in investing are, ‘it’s different this time.”” -Michael Batnick
  • Ignore everyone else.
    • Understanding your time horizon and not being persuaded by other people playing different games is an investing superpower.
    • The best way to do this is to know what game you’re playing.
    • “Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them. But when you don’t know why someone behaves like they do you won’t know how long they’ll continue acting this way, what will make them change their mind, or whether they’ll ever learn their lesson.”
    • “A genius is the man who can do the average thing when everyone else around him is losing his mind.” -Napoleon
  • Pessimism gets in the way.
    • Pessimism sounds smarter than optimism. It also gets a lot more airtime than optimism.
    • It’s easy to predict that something ugly will stay ugly – or get uglier. But problems eventually resolve, and people adapt. Threats (e.g., famine, oil shortage, etc.) incentivize solutions.
    • The real seduction of pessimism is that it reduces expectations, narrowing the gap between possible outcomes and outcomes you want. Expecting things to be bad means you’re pleasantly surprised when they’re not. Which, as Housel says, is something to be optimistic about.
  • “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” – Bill Gates
    • Nothing is as good or bad as you think.
    • That means individual successes and failures should be treated cautiously for their explanatory power – but that we should try to identify broad trends from those who have succeeded.
  • There are many ways to get wealthy, but only one way to stay wealthy: frugality and paranoia.
    • “Keeping money requires the opposite of taking risk. 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.”
    • “Few gains are so great that they’re worth wiping yourself out over.”
  • Your results as an investor are due to how you respond in a small handful of situations – not how you behave on a typical day. The payoffs for being right in the right situations are gigantic – much larger than the penalties for being wrong on an average day. 

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Related reading:

Thinking in Bets – Annie Duke

Optionality: How to Survive and Thrive in a Volatile World – Richard Meadows

Mr. Money Mustache

The End of Jobs – Taylor Pearson

Antifragile – Nassim Taleb (book notes coming soon!)