The Psychology of Money Book Notes
Updated: Oct 28, 2022
by Morgan Housel
My personal book notes/summary on Morgan Housel's book, The Psychology of Money.
Table of Contents
Doing well with money has little to do with how smart you are and a lot to do with how you behave. Behavior is hard to teach, even to really smart people
Financial success isn't a hard science. It's a soft skill, behavior is more important that knowledge.
Chapter 1: No One's Crazy
Your personal experiences with money make up maybe 0.000000001% of what's happened in the world, but maybe 80% of how you think the world works.
No amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty
People's view of money is formed differently, a view about money that one group of people thinks is outrageous can make perfect sense to another
"Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works"
Chapter 2: Luck & Risk
Nothing is a s good or as bad as it seems
Everything worth pursuing has <100% odds of succeeding, risk is what happens when you're on the unfortunate side of those odds
Someone else's failure is attributed to bad decisions, while your own failures are attributed to the dark side of risk
"The cover of Forbes magazine does not celebrate poor investors who made good decisions that happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who make OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side"
Line b/w "inspiringly bold" and "foolishly reckless" can be a millimeter thick and only visible with hindsight
Risk and luck are doppelgangers
Focus less on specific individuals and case studies and more on broad patterns
Chapter 3: Never Enough
When rich people do crazy things
When rich people do crazy things they have no sense of enough
There is no reason to risk what you have and need for what you don't have and don't need
The hardest financial skill is getting the goalpost to stop moving - dangerous when the desire of having more increases ambition faster faster than satisfaction
Social comparison is the problem here - ceiling of social comparison is so high that virtually no one will ever hit it.
"Enough" is not too little - "enough" is realizing that the opposite - an insatiable appetite for more - will push you to the point of regret
There are many things never worth risking, no matter the potential gains - reputation; freedom; independence; being loved; happiness; and the best bet at keeping these is knowing when it's time to stop taking risk that might harm them
Chapter 4: Confounding Compounding
$81.5 billion of Warren Buffett's $84.5 billion net worth came after his 65th birthday. Our minds are not built to handle such absurdities
Lessons from one field can often teach us something important about unrelated fields
Ice age analogy - if something compounds, little continuous growth, a small starting base can lead to extraordinary results
Warren Buffet's key to success is the time he's been in the market (roughly 75 years); he built a solid financial base in his pubescent years and maintained it through his older years
When compounding isn't intuitive we often ignore it
Good investing isn't about rare one-off returns, because it's basically a one hit wonder, success is pretty good returns that can be repeated for a long time
Chapter 5: Getting Wealthy vs. Staying Wealthy
Good investing is not necessarily about making good decisions. It's about consistently not screwing up.
Money = "survival"
Getting money and keeping money are two different skills:
getting money - risk, being optimistic, putting yourself out there
keeping money - humility, fear that what you've made can be taken away, frugality
Survival Mindset to money, you need to appreciate:
Become financial unbreakable so you can stick around long enough for compounding to do its thing - stay in the market
Planning is important, but understand that sometimes nothing goes to plan - the more specific elements that need to go right, the more fragile your financial life becomes. "Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right". It's not being conservative, it's having a margin of safety
Be optimistic about the future but paranoid about what will prevent you from getting to the future - need short term paranoia to keep you around for long-term optimism
Chapter 6: Tails, You Win
You can be wrong half the time and still make a fortune.
Anything that's huge, profitable, famous or influential is a result of a tail event (an outlying event). But most of our attention goes to these things. Most of what we pay attention to is the result of a tail, they are rare and powerful = tails drive everything
Index funds - buying stock in a lot of different companies. Most of the companies will be failures but those few that are not, will be enough to offset the duds
To be a successful investor it's not about the years spent on cruise control, doing the usual, it's about doing the average thing (putting money in the stocks) when everyone else goes crazy
Most successful people have a lot of terrible ideas that they act upon, but it's those few extraordinary ideas that make a difference
Chapter 7: Freedom
Controlling your time is the highest dividend money pays.
Wealth = the ability to do what you want, when you want, with who you want, for as long as you want
More control in your life brings more happiness
Doing something you love on a schedule you can't control can feel the same as doing something you hate
Controlling your time is the highest dividend money pays
Chapter 8: Man in the Car Paradox
No one is impressed with your possessions as much as you are.
Paradox: people tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don't think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired
In other words, people want fancy possessions to signal to others they should be liked and admired but when you're looking at those possessions you aren't thinking about the people who own them, you aren't admiring them, you're thinking about yourself and what you could do with that fancy possession
Chapter 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.
We judged wealth by what we see, because that's all that's available to us but that isn't a true look into someone's financial life.
Difference between rich and wealth:
Rich is a current income, if you have an expensive item you need a certain level of income to afford it, even if in debt
Wealth is hidden. Income not spent, it offers you options, flexibility and growth to one day purchase more
Most of us want to be wealthy (freedom and flexibility) but most of us fall into that rich trap that our economy emphasizes
Chapter 10: Save Money
The only factor you can control generates one of the only things that matters. How wonderful.
Past a certain level of income people fall into three groups: (1) those who save; (2) those who don't think they can save; (3) those who don't think they need to save
Building wealth has little to do with your income or investment returns, and a lot more to do with your savings rate
Wealth is just the leftovers after you spend what you take in, value of wealth is relative to what you need
learning to be happy with less money creates a gap b/w what you have and what you want, the less you spend the further your money goes
Past a certain level of income, what you need is just what sits below your ego
The ability to save is more in people's control than they think = savings can be created from spending less -> spend less if you desire less -> if you desire less you care less about what others think about you
You don't need a specific reason to save
Chapter 11: Reasonable > Rational
Aiming to be mostly reasonable works better than trying to be coldly rational.
Aim to be reasonable over rationale. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money
If you try to be strictly rationale focusing on numbers and statistics only, it is difficult to stick by, no matter how "rationale" you think you are, it's not easy to watch all of ones retirement evaporate and then continue the plan like nothing happened
Focus on being reasonable on getting 80% of the way there with your financial plan and you'll have a better chance to stick with it long-term, which matters the most when handling money
Chapter 12: Surprise!
History is the study of change, ironically used as a map of the future.
Two dangerous things happen when you rely too heavily on investment history as a guide on what's going to happen next:
likely miss outlier events that move the needle the most - most of what's happening in the global economy now can be tied back to a handful of past events that were nearly impossible to predict
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 in today's world - the advice previously given changes because the times have changed
The further back in history you look, the more general your takeaways should be
Chapter 13: Room for Error
The most important part of every plan is planning on your plan not going according to plan
Chance "unknowns" and randomness are a part of life, increasing the gap b/w what you think will happen and what can happen is how you can handle it
A person w/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 when they're wrong
Use room for error when estimating your future returns
optimism bias - attachment to favorable odds when the downside is unacceptable in any circumstances
Avoid a single point of failure - if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe
W/money this is solely relying on a paycheck to fund short-terms spending needs w/no savings to create a gap b/w what you think your expenses are and what they might be in the future
Chapter 14: You'll Change
Long-term planning is harder than it seems because people's goals and desires change over time
People are poor forecasters of their future selves
End of History Illusion - tendency for people to be keenly aware of how much they've changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future
We should avoid the extreme ends of financial planning
ex. being happy with a very low income or high one (most people are happy being in the middle) and there are downsides to those extremes
Aim for moderate in all aspects of life: savings, free time, commute, time with family - more likely to stick with plan long term
Accept the reality of changing our minds
Sunk costs - anchoring decisions to past efforts that can't be refunded, a devil in a world where people change over time
Chapter 15: Nothing's Free
Everything has a price, but not all prices appear on labels
Every job looks easy when you're not the one doing it b/c the challenges faced by someone in the arena are often invisible to those in the crowd
The price of investing success is not immediately obvious (it doesn't feel like a fee = good, but instead a fine = wrong)
Chapter 16: You & Me
Beware taking financial cues from people playing a different game than you are
Investors often innocently take cues from other investors who are playing a different game than they are
Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another
Go out of your way to identify what game you're playing
Chapter 17: The Seduction of Pessimism
Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.
Why? For money if something bad happens it tends to affect everyone and captures everyone's attention
Pessimism forgets about how markets adapt
Progress happens too slowly to notice, but setbacks happen too quickly to ignore
Growth is driven by compounding, which always takes time. Destruction is drive by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant
Easier for a narrative around pessimism = story comes together quicker and is more recent; optimism = looking at long stretch of history and developments, which people tend to forget and take more effort to piece together
Investing - identify the prices of success - volatility and loss amid the long backdrop of growth and be willing to pay it
Chapter 18: When You'll Believe Anything
Appealing fictions, and why stories are more powerful than statistics
"The more you want something to be true, the more likely you are to believe a story that overestimates the odds of being true"
Appealing fiction - you are smart, want to find solutions, but face a combination of limited control and high stakes (people don't calibrate low odds. Many create a firm belief that what they want to be true is unequivocally true b/c the possibility of a huge outcome exists)
"Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps"
"Risk is what's left over when you think you've thought of everything"
We believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need - Psychologist Philip Tetlock
Illusion of control (gravitate towards these stories) is more persuasive than the reality of uncertainty
Chapter 19: All Together Now
What we've learned about psychology of your own money.
There are universal truths in money, even if people come to different conclusions, about how they want to apply those truths to their own finances:
Find humility when things go right and forgiveness/compassion when they go wrong
Less ego, more wealth - saving money is the gap b/w your ego and your income, wealth is what you don't see
Manage your money in a way that helps you sleep at night - even if it's "logical", if you can't be at peace with it, it's a bad decision
To be better investor -> increase your time in the market
Become okay w/things going wrong, you can be wrong half the time and still make a fortune
Use money to get control of your time
Be nicer and less flashy - don't be concerned about what others think of your "wealth"
Save. Don't need a specific reason to save
Define the cost of success and be ready to pay it
Worship room for error - gap b/w what could happen in the future and what you need
Avoid the extreme ends of financial decisions
You should like risk b/c it pays off over time
Define the game you're playing
Respect the mess - no single right answer, just the answer that works for you
The Psychology of my own money
"I did not intend to get rich. I just wanted to get independent" - Charlie Munger
Comfortable living below what you can afford, w/o much desire for more, removes a tremendous amount of social pressure that many people in the modern first world subject themselves to
Every investor should pick a strategy that has the highest odds of successfully meeting their goals
There's little correlation b/w investment effort and investment results
The book in 3 sentences.
Aim to be reasonable over rationale because it is more realistic and you have a better chance of sticking with it in the long run
Sh*t happens in life, if you don't want it to ruin you then you need to increase the gap between what you think will happen and what can happen, giving a large margin of error
No one is "crazy", people have formed their own views of money and often times they are playing a different game from you.