Overview of the book The Psychology of Money- When it comes to money and investment, we all run behind the returns, history, math and science behind the investment. But the most important part of finance and money is how you behave with it.
But, unfortunately, we forget the psychological relationship with money. And this is what the author Morgan Housel teaches us in the book The Psychology of Money. So let’s explore The Psychology of Money chapter by chapter book summary.
Author Morgan Housel’s Interview on The Psychology of Money
Introduction- The Greatest Show on The Earth
The core concept of the book The Psychology of Money is that doing well with money has little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people.
But in finance, people know the theory; still, they took decisions based on emotions.
In 2018, the Author, Morgan Housel, wrote the report outlining the 20 most important flaws, biases & causes of bad behavior. It was called the psychology of money. This book is the deeper version of the report. So, let’s explore the psychology of money chapters summary.
Chapter 1 Summary- No One’s Crazy
- People do crazy things with money, but no one is crazy. What makes sense to me might seem crazy to you.
- We all are from different generations, raised by different parents, born into different economics, have different experiences with money.
- People know the theory that we should make investment decisions based on our goals & characteristics of investment options we have. But that’s not what people do.
- People who have faced the economic crisis have different biases & thoughts about risk & rewards than those who have seen stable prices their entire life.
- If you grew up when the stock market was strong, you would invest more money in stocks than those who grow up when stocks were weak.
In short, we do the crazy stuff with money, but we are not crazy.
Chapter 2 Summary- Luck & Risk
Here’s the interesting story of Microsoft’s founder & Co-founder, Bill Gates & Paul Allen. This story can teach you that Luck & Risk are two siblings that can influence an individual’s success more than his efforts.
In 1968, Bill Dougall, a World War 2 navy pilot turned math & science teacher, made efforts to bring the Teletype Model 30 computer to his Lakeside School.
Bill Gates & his classmate Paul Allen were studying in the same school. Bill Gates & his friend Paul Allen got access to this computer at age 13 when most university graduates could not get it.
In 1968, roughly 303 million high school-age people were in the world, according to the UN.
- About 18 million of them lived in the United States.
- About 270K of theme lived in Washington state.
- A little over 100K of them lived in the Seattle area.
- And only about 300 of them attended Lakeside School.
- Start with 303 million, ending with 300.
One in a million high school-age students had a chance to attend a school that has a computer. And Bill Gates happened to be one of them.
Of course, Bill Gates’s success was due to his dedication & hard work. But, luck played an important role. Even Bill Gates admitted by saying, “If there had been no Lakeside, there would have been no Microsoft.”
Now, here’s the story of Bill Gates classmate Kent Evans. He experienced a powerful dose of luck’s close sibling, risk.
He was also a part of Lakeside’s computer prodigies gang and had equal skills & drive for computers. He could be the founding partner of Microsoft. But Kent died in a mountaineering accident before he graduated high school.
Every year there are around three dozen mountaineering deaths in the United States. The odds of being killed on a mountain in high school are one in a million.
Bill Gates & Paul Allen experienced 1 in a million luck by graduating from Lakeside. Kent Evans experienced one in a million risks by never getting to finish graduation. The same magnitude of force but working in the opposite direction.
Luck & risk are factors that are hard to judge in an individual’s financial success. We can’t emulate the warren buffets’ success because his results are so extreme that we don’t know how much luck is involved.
But two things can point you in a better direction.
- Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.
- Focus less on specific individuals and case studies and more on broad patterns.
But more important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves when judging failure. Nothing is as good or as bad as it seems.
Chaper 3- Never Enough
People who are millionaire wants to be a billionaire. And people who are billionaires want to be in the top 3 of the richest person on earth. Running behind more & more money is a never-ending game.
People do crazy things to reach the next level that they risk the things they need for the things they don’t need. Warren Buffet puts this in better words-
“To make money they didn’t have and didn’t need, they risked what they did have and did need. And that’s just foolish. It is just plain foolish. If you risk something that’s important to you for something that is unimportant to you, it just does not make any sense.”
If you are one of person that doesn’t know what enough is, remember few things-
1. The hardest financial skill is getting the goalpost to stop moving
There’s no point in increasing expectations with increased results. You will feel the same after putting in extra efforts to increase results.
“It gets dangerous when the taste of having more – more money, more power, more prestige- increase in ambition faster than satisfaction.”
2. Social comparison is the problem here
Comparing your wealth with other people is a never-ending game. It’s the battle that can never be won or that the only way to win is not to fight to begin with- to accept that it might have enough, even if it’s less than those around you.
3. “Enough” is not too little
Having enough doesn’t mean you will not have a comfortable lifestyle. Enough is realizing the point ahead of which you will start regretting. The regret may come in the form of burning out at work for “extra money” or the risky investment allocation you can’t maintain.
4. There are many things never worth risking, no matter the potential gain
- Reputation is invaluable.
- Freedom is invaluable.
- Family and friends are invaluable.
- Happiness is invaluable.
Knowing enough is the key to not taking the risk that will harm these things. And there’s a better and simple tool to “knowing enough” that you will find in the next chapter.
Chapter 4- Confounding Compounding
There are more than 2000 books on Warren Buffet, which focus on his investment strategies. But no one focus on simple things that he is investing in since he was ten years old.
The Buffet is the richest investor of all time. But this doesn’t mean he is the greatest investor.
In fact, Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1998. No one comes too close to his income.
And Warren Buffet has compounded at roughly 22% annually. But simons Net worth is $21 billion & Buffet’s net worth is $84 billion. Why is the difference?
Because Simons did not find his investment stride until he was 50 years old. He had less money to compound.
More than the investment strategies, Buffet’s financial success lies in the simple fact that he started investing at the age of 10 & earned pretty good returns till today.
A good investment is not about trying the strategies to earn the highest interest rates. It seems intuitive, but the highest interest rates tend to be one-off hits that can’t be repeated. Instead, good investing is about earning pretty good returns for a long period of time.
And knowing enough is knowing how small investment over a long period of time can fuel huge returns. To do this, you don’t need to risk valuable things that we talked about in the last chapter for the huge potential gain.
The opposite of compounding- earning the highest returns that can’t be held onto- leads to some tragic stories. We will see in the 5th chapter of the psychology of money.
Chapter 5- Getting Wealthy Vs. Staying Wealthy
Author Morgan Housel summarizes money success in a single word & that word is “survival.” Earning money & keeping money are two different things. Earning money requires taking risks, putting yourself out there, being optimistic.
Keeping money requires humility. It requires having fear in mind that whatever we have earned can be lost. It requires acceptance that some part of our earning is dedicated to luck & past success can’t repeat infinitely.
We can spend years to understand how Warren Buffet found the great companies & made the best investments. But what equally important is he didn’t carry away with debt. He didn’t panic & sell during the 14 recessions he’s lived through. He didn’t rely on one strategy. He didn’t quite.
He survived. And the survival gave him longevity & it helped compounding to make wonders for him.
Appreciate these three things to learn the survival mindset.
1. More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable, I think I’ll get the biggest returns because I will be able to stick around long enough for compounding to work wonders.
No one wants to hold cash during a bull market.
But if that cash prevents you not to sell the stocks during the bear market, the actual return you earned on that cash could be multiple. Because preventing ill-timed stock sell can do more for your lifetime returns than picking dozens of big-time winners.
Compounding doesn’t rely on earning big returns. But it relies on earning merely good returns sustained uninterrupted for the longest period of time.
2. Planning is important, but the most important part of every plan is to plan on not going according to plan.
You will learn this concept in detail in Chapter 13.
3. A barbelled personality- optimistic about the future but fearful about what will prevent you from getting to the future- is vital.
Optimism is the belief that things will go well. But the realistic optimism is that over a long time, things will balance out. You might fear the loss in the short term, but after a loss, you will see the growth. This cycle will continue.
You need a mindset that can be fearful and optimistic at the same time. Short-term fear will keep you alive long enough to exploit long-term optimism.
Chapter 6 is about growing in the face of adversity.
Chapter 6- Tails, You Win
In the business or investment, few events cause the majority of outcomes. Let take the example of Amazon, from books to Fire Phone to travel agencies.
They experimented with lots of things, many failed, but few Tails succeeded like Prime and Web Services & made a huge impact on their business.
Take the example of Apple. iPhone was the tail product & it made a huge impact on the companies growth.
When you accept that some events make a huge impact, you embrace the short-term fears & uncertainty. How you behaved in 2008’s recession will likely have more impact on your lifetime returns than everything you did from 2000 to 2008.
“A good definition of an investing genius is the man or woman who can do the average things when all those around them are going crazy.”
Chapter 7- Freedom
Angus Campbell, a psychologist, researched to know what makes people happy. What he found is quite surprising.
He found that more than income, education or geography, having control over one time no matter what conditions of life are is the common denominator of happiness.
Money’s greatest intrinsic value is its ability to give you control over your time. The ability to do what you want, when you want, with whom you want, for as long as you want is priceless. It is the highest dividend money pays.
The next short chapter is about one of the lowest dividends money pays.
Chapter 8- Man in the Car Paradox
“No one is impressed with your possessions as much as you are.”
Seeing a guy driving a Lamborghini, Tesla or Rolls Royce seems cool. You dream of owning a cool car. You might think having these cars send a signal to people that you are rich. You did it. You are smart & important.
The irony here is that no one gives a shit about the driver. People don’t think the driver is cool. They think if I had this care, people would think I’m cool.
Here’s the paradox in the author’s words- “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.”
What you want is admiration and respect from other people & you think that having expensive stuff like cars or big homes will bring it. It rarely does.
If this is how you seek money, then be careful. Humility, kindness and empathy will bring you more respect than horsepower.
Chapter 9- Wealth Is What You Don’t See
Say a person buys a Ferrari of $100K. The irony of money is that now he has $100K less money than before buying such an expensive car.
And we don’t know did he pay in full or took a loan to pay that amount. So he is rich but not wealthy.
There is a difference between being wealthy & being rich. Rich is the current income & wealth is the income not spent. Wealth is invisible because we can’t see people’s bank account & the money they are not spending.
Wealth is the expensive cars not purchased. Wealth is an expensive watch not worn. Wealth is financial assets that haven’t yet been converted into stuff, you see.
Everyone can become rich by buying big houses, expensive cars but not wealthy. Because to become wealthy you have to save & that’s the next chapter is about.
Chapter 10- Save Money
No matter how much income or investment returns you get, there’s no way to become wealthy if you are not saving.
That means you can build wealth without high income. Then despite having a decent income, what stops most people from saving? It’s their ego.
The Author Housel Morgen puts it in this way- “your savings is the gap between your ego & your income. Beyond your basic & comfort needs, the money you spent on is your ego approaching money. You just spent to show the people that you have money.“
And to stop showing off people, you have to care less about people & what they think about you.
Another important idea author put is you don’t need to save for a specific goal. Of course, it’s great to save for a specific goal, but if you don’t have a specific goal, then just save for the sake of saving. It gives you the hidden return.
What’s the hidden return of saving?
Today’s economy is Winner-all-take economy. You can hire the best in the world and so good person to do your work. This is the time when flexibility matters the most.
You need a flexibility to work on new changes, skills to stay relevant in the market or just to wait for a good offer to come your way.
And money in your savings account gives you that flexibility. It gives the freedom, control or flexibility that we can’t calculate.
It gives you the ability to change your course on your terms. It is the hidden return of savings. That’s why more and more people should save money.
Note- From last year, I’m investing my money in mutual funds, giving me the freedom to leave the job & work on this blog. Thanks to ET Money App. (You can invest too!)
Chapter 11- Reasonable > Rational
With finance & investment, making rational decisions doesn’t always work. You’ve to make some reasonable decisions that will work for you.
The difference between reasonable & rational is Rational decisions are based on facts, math, data & science. And the reasonable decisions are based on what you think is correct, although it may seem logical or not.
Here’s an example- Julius Wagner-Jauregg, a psychiatrist, found that fevers play an important role in helping the body fight infection. He found a cure for treating syphilis- a mental disease by inducing fever. He won a Nobel Prize in medicine in 1927.
He was the only person in history who recognized fever’s role in fighting infection and prescribed it as a treatment.
Here’s where science ends, and reality takes over. Science proves fever is good but can we induce it in reality? Of course not, because fevers hurt. And people don’t want to hurt. So it’s reasonable for us not to inject fever in treatment.
The same goes for finance. To quote the author- “Most forecasts about where the economy is headed, and the stock market are heading next is terrible, but making forecasts is reasonable.”
People don’t want to live without a clue of what the future holds. Predicting is human nature. It’s reasonable.
Chapter 12- Surprise!
You should not take the decisions based on historical events. They should not be the guide to future investments. The world changes. It is full of surprises. You don’t know what will be the next surprise.
To put in author’s word- “The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff.”
The question then is how we should think about and plan for the future. You will learn it in the next chapter.
Chapter 13- Room for Error
“The most important part of every plan is planning on your plan, not going according.”
When you are planning, you should consider the margin of safety. In addition, you should consider things may not go as you planned. For example, you may retire in the mid of a financial crisis, or a bear market is powerful when considering an exit.
These things are often overlooked. That’s why you should consider the margin of error & odds that things may not be in your favor. The trick to creating a margin of safety is to save for nothing. Save with no goal. Save for things that will happen in the future that you can’t predict.
Chapter 14- You’ll Change
Long-term planning is hard. Because we evolve, change our minds. You don’t have a guarantee that the job that thrills you today will thrill you after five years.
Young people pay good money to remove the tattoos that teenagers pay to get it. Middle-age people rushed to divorce people who young adults rushed to marry.
We change mentally & emotionally over time. And our financial decisions may change as well. So we should avoid extreme ends of financial planning. Don’t assume that you’ll live with a low income for a lifetime or choose extra work hours for the pursuit of a higher goal. It will increases the odds to the point that you will regret it.
Chapter 15- Nothing’s Free
Netflix stock returned more than $35,000% from 2002 to 2018 but traded below its previous all-time high on 94% of days. Market returns are never free. It comes with the cost of volatility.
You have two options. Choose an asset that is less volatile, less uncertain with low pay-off or chooses an asset with higher uncertainty with a higher return.
Now some people choose the third option- To avoid uncertainty.
Every investor knows that market is volatile still they try to avoid it by trading out when the market is about to collapse trade-in when the market is about to boom. Some get success & some people get caught & punished.
If you consider volatility as a fee you pay, you will see the magic of compounding. However, if you consider the fee as a fine, you will never enjoy the magic.
Chapter 16- You & Me
Everyone plays a different game.
For example, some people buy expensive stocks in the bull market because it makes sense to them. And they would sell it when their stock becomes more expensive than their purchased price. So they were playing a short-term game.
The problem comes when a long-term investor invest buy a stock at expensive just by seeing many people are buying it.
To put in the author Morgen Hosel’s word- “Beware taking financial cues from people playing a different game than you are.”
Chapter 17- The Seduction of Pessimism
- People used to think that Airplanes are impossible. Then, in 1903, the Wright brothers did their first flight successfully. Still, it took four years six months for people to start taking it seriously.
- Pessimism draws more attention than optimism. Growth takes time. For destruction, it takes only a moment.
- Pessimism reduces expectations. It narrows the gaps between possible outcomes & the outcomes you feel good about. That’s why it is seductive.
Chapter 18- When You’ll Believe Anything
The more you want something to be true, the more you believe in a story that overestimates the odds that it is true.
After the end of World War 1, if you had asked people what the happiest day of their life was, they would be told Armistice Day, i.e., the 1918 agreement that ended World War 1. Why?
Because they thought there would be no war after. And 21 years later, World War 2 happened to kill 75 million people.
We tell the stories to ourselves that we want to believe in.
Think about the market forecasts. Every investor knows we are very bad at it. And after thinking a lot about market forecasts, the only thing that remains is a risk. Still, there is a huge demand for forecasts because we want to believe that we are in control.
With this, we come to an end to The Psychology of Money Summary. Hope you liked the chapter by chapter summary. The 3rd, 8th & 10th chapter was a paradigm shift for me. Do let me know which chapter made you think.
My Personal Review of The Psychology of Money
- The book was easy to read & digest.
- The concepts in this book are easy to understand.
- The book is devided into small chapters.
Who should you read Morgan Housel’s Psychology of Money book?
- If you are a beginner & serious about money, this would be a perfect start for you.
- Someone like me who understand importance of saving & investing, but want to dig deeper.