This was a long pending book on my reading list that I finally completed. The book provides some very good insights about the most important flaws, biases and causes of bad behavior with respect to money. The author mentions that doing well with money has little to do with how smart you are and a lot to do with your behavior. Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that has nothing to do with formal measure of intelligence. Finance is overwhelmingly taught as a math based field which is not at all bad or wrong. It’s that knowing what to do tells you nothing about what happens in your head when you try to do it. The author delves deeper into these topics in this book. This blog “Book Review : The Psychology of Money” will provide you an overview of the author’s thoughts.

The author of this best-selling book is a person by the name Morgan Housel. He has been writing about finance since early 2008. According to him, when a financial crisis like the one in 2008 happens, no one can accurately explain what happened or why it happened. Unlike the engineering field, finance is guided by people’s behaviors. What appears to make sense to one person might seem crazy to the other. I guess the author is right when he mentions that in order to understand a financial crisis similar to the one of 2008 or an individual’s financial crisis, the lenses of psychology (greed, insecurity, and optimism) and history would be a better tool.

Driven By Luck & Risk

The author starts off with the first chapter explaining everyone’s unique experience with how the world works. People go through life with different beliefs, goals and forecasts. This is because people from different generations raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn different lessons. Hence every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. The world is too complex to allow 100% of your actions to dictate 100% of your outcomes.

The Importance Of Enough

The next chapter highlights the importance of enough. If you become self-sufficient at some point in life it is important to remember a few things.

  • The hardest financial skill is getting the goalpost to stop moving. If expectations rise with results, there is no logic in striving for more because you will feel the same after putting in extra effort. It gets dangerous when the taste of having more, increases ambition faster than satisfaction. But life isn’t any fun without a sense of enough.
  • The game of trying to keep up with other people’s wealth needs to be avoided. The ceiling of social comparison is a battle that can never be won, or that the only way to win is to not fight to begin with. Accepting that you have enough, even if it’s less than those around you is the solution here.
  • The best shot at keeping some of the invaluable things like reputation, freedom, family & friends, and happiness is knowing when it’s time to stop taking risks that might harm them.
Power Of Compounding

In the book, the author provides the analogy of ice age in-order to explain about compounding. According to the author, the big takeaway from ice ages is that you don’t need tremendous force to create tremendous results. Similarly in finance perspective, Buffet’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child. His skill is investing but his secret is time. Good investing isn’t necessarily about earning the highest returns that can be one-off hits. Its 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.

Getting Wealthy & Staying Wealthy

The topic of getting wealthy is one thing but keeping it is another. The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest difference. This should be the cornerstone of your strategy, whether it is investing or your career or a business you own. Applying the survival mindset to the real world comes down to appreciating the following.

  • More than I want big returns, I want to be financially unbreakable. And if I am unbreakable, I will be able to stick around long enough for compounding to work wonders.
  • The most important part of every plan is to plan on the plan not going according to plan.
  • Being optimistic about the future, but paranoid about what will prevent you from getting to the future is vital. Economies, markets and careers often follow a similar path,i.e., growth amid loss.
Tail Events

Tails drive everything. 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. A lot of things in business and investing work this way. Long tails, the farthest ends of a distribution of outcomes – have tremendous influence in finance. In this, a small number of events can account for the majority of outcomes. Anything that is huge, profitable, famous, or influential is the result of a tail event – an outlying one in thousands or millions event.

Control Over Time

Money’s greatest intrinsic value is its ability to give you control over your time. This is what makes people happy. Control over doing what you want, when you want to, with the people you want to. People who have lived through everything say the same thing: Controlling your time is the highest dividend money pays.

Wealth As A Benchmark

The author touches upon one more important point in the book ,i.e, people using wealth as a benchmark for their desire to be liked and admired. If respect and admiration are the goals, then one needs to be careful how to seek it. Humility, kindness and empathy will bring more respect than wealth power ever will. We rely on outward appearances to gauge financial success. But the truth is that wealth is what you don’t see. The hidden nature of wealth makes it hard to imitate others and learn from their ways. The world is filled with people who look modest but are actually wealthy and people who look rich living at the razor’s edge of insolvency. This is what one needs to keep in mind when quickly judging other’s success and setting one’s own goals.

Savings Rate

Building wealth has little to do with your income or investment returns and lots to do with your savings rate. A high savings rate means having lower expenses than you otherwise could. Having lower expenses means your savings go farther than they would if you spent more. People with enduring financial success – not necessarily those with high incomes- tend to have a propensity to not give a damn what others think about them. Savings does not require a goal of purchasing something specific. Savings need to be done for savings sake. The return on this is incalculable and should not be overlooked. Having more control over your time and options is becoming one of the most valuable currencies in the world.

Being Reasonable

In the book, the author mentions the philosophy of aiming to be reasonable instead of rational, when making decisions with money. Reasonable is more realistic and you have a better chance of sticking with it for the long run. This is what matters most when managing money. Whereas a rational investor makes decisions based on numeric facts. If lacking emotions about your strategy or the stocks that your own increases the odds, you will walk away from them when they become difficult. The rational investors who love their technically imperfect strategies have an edge. This is because they are more likely to stick with those strategies.

History Can Be Misleading

The cornerstone of economics is that things change over time. This is because the invisible hand hates anything staying too good or too bad indefinitely. The author points out two dangerous possibilities when relied too much on investment history as a guide to what would happened next.

  • One will most likely miss out on the outlier events, or the record breaking events that move the needle the most.
  • History can be a misleading guide to the future of economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.
Avoid Single Point Of Failure

The author quotes one of Nassim Taleb sentences, “You can be risk loving and yet completely averse to ruin”. The idea here is that you have to take risk to get ahead, but no risk that can wipe you out is ever worth taking. However, avoiding unknown risks is almost impossible. If there is one way to guard against their damage, its avoiding single point of failure/a single source of income. It is important to save for things that you can’t possibly comprehend. The most important part of every plan is planning on your plan not going according to plan.

Points To Note About Long Term Financial Decisions

Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily. Part of the reason some of the people in the world became successful is that they kept doing the same thing for decades on end, letting compounding run wild. However, the author points out 2 things to be kept in mind when making long term decisions.

  • We should avoid the extreme ends of financial planning. Assuming that you will be happy with a low income or choosing to work endless hours in pursuit of a higher one.
  • We should also come to accept the reality of changing our minds. Embracing the idea that financial goals made when you were a different person should be abandoned or dragged on can be a good strategy to minimize future regret.
Price Of Success

Like everything else worthwhile, successful investing demands a price. Its volatility, fear, doubt, uncertainty, and regret – all which are easy to overlook until you are dealing with in real time. The price of investing success is not immediately obvious. The trick in convincing yourself that the market’s fee for volatility 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 a fee worth paying.

Different Goals And Time Horizons

When investors have different goals and time horizons – prices that look ridiculous to one person can make sense to another. This is because the factors those investors pay attention to are different. For example, bubbles affect the long-term investors playing one game, start taking cues from the short-term traders. A takeaway here is understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different ball games than you are.

Financial Pessimism

Optimism is the best bet for most people because the world tends to get better for most people most of the time. But, pessimism just sounds smarter and more plausible than optimism to most. Tell someone that they are in danger, and you have their undivided attention. This is the same with financial pessimism.

  • Since money is ubiquitous, something bad happening tends to affect everyone and captures everyone’s attention.
  • Pessimists often extrapolate present trends without accounting for how markets adapt.
  • Progress happens too slowly to notice, but setbacks happen too quickly to ignore.
Points To Note In The Story Driven World

This is a story driven world and there are two things to keep in mind when managing your money.

  • The stronger your desire for something to be true, the more likely you are to believe an exaggerated story that aligns with your wish. If you offer the prospect of investing alongside ‘the next Warren Buffet,’ you will see people wholeheartedly believing, risking their life savings in the process.
  • Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps. The illusion of control is more persuasive than the reality of uncertainty. So we cling to stories about outcomes being in our control. This is true about market forecasts in which we are very bad at. Forecasts can create an illusion of predictability in a world. These unforeseen events largely dictate outcomes, potentially doing more harm than good.
Beware Of The Curve Balls

As per the author’s insights on personal finance, everyone without exception will face a huge expense that they did not expect and plan for. It is a good practice to save in a world where curve balls are more common than we expect. Avoiding the need to sell stocks for expenses increases the likelihood of allowing owned stocks to compound for an extended period.

The author’s investment strategy relies on a high savings rate, patience and optimism. This is what the global economy will create value over the next several decades.

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