3 Solid Takeaways from The Psychology of Money

Psychology of Money by Morgan Housel
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At the beginning of 2021, like many others, I wanted to set some new goals for myself this year. One of the goals I try to set every year, involves some form of self-education, be it learning new skills or through reading new books.

So with this year, I began the year with the goal to complete 12 books by the end of the year. 1 book per month.

My first book for this year was a common book recommendation by many investors and finance bloggers, The Psychology of Money: Timeless lessons on wealth, greed, and happiness by Morgan Housel.

Morgan Housel is a partner at the Collaborative Fund and a former columnist for The Motley Fool and The Wall Street Journal. He has also won several awards for writing and has done conferences around the world. His focus lies in behavioural psychology and finance, especially in how investors handle risk and how we can better manage it.

The Psychology of Money spans 20 short chapters in which Housel considers various aspects of how psychology and finance intersect and impact each other through short anecdotes, some famous and some lesser known. It’s a pretty short read at only about 200 pages long.

Takeaway 1: No One’s Crazy

The first chapter of the book talks about how no one makes financial decisions because they are crazy. Housel talks in this chapter about how our behaviour and decisions are largely shaped by our experiences during our lives. What is normal to them may seem completely insane to us.

US Inflation

US Historical Inflation Rate from 1960 to 2020 from MacroTrends

For example, those who lived through the 70s (in the US), faced the highest inflation rates ever seen in 20th Century USA will definitely have different perceptions regarding inflation as compared to those who were born in the 90s and beyond, where inflation was so much lower that most of us never even considered it as much of a factor in our lives.

s&p 500 rolling returns

Another example of course, would be looking at stock market performance. Looking at 20-year rolling returns of the S&P 500 index, we note that the index returns differ vastly over different years. Those who were invested in the 20 year period lasting from 1959 to 1978 experienced only a 6.53% per annum return while those who were invested from 1980 to 1999 experienced almost 18% per annum returns! Naturally, these two groups of people will have vastly differing opinions on investing and as a result make different decisions as well regarding their investments.

I think what this teaches us is that we must be careful not to judge others for their financial decisions too quickly, for the experiences we have been through are likely very different from those of the people we know.

I know I have been guilty of this myself. I always wondered why property investing was always advocated for by my parents and those in their age group. This was opposed to stock market investing which seemed to be the main focus for younger Singaporeans nowadays as a more accessible way to riches.

Well, on further thought, it should have been clear. After all, for my parents and those in their generation, property investment has always been one of the ways to get rich as a Singaporean. Many who were able to snag good properties in the 90s or early 2000s were likely sitting on quite significant capital appreciation now. In that same period, many of them probably felt the impact of the two major crashes, the Dot-Com Bubble and the Global Financial Crisis as well. As such, naturally, these investors who had benefited from property investing and saw the volatility wreaked upon stock market investors and as such favoured property investing over the stock market.

On the other hand, the younger generation, such as those born in the 90s, have only known a roaring bull market since we were old enough to enter the markets. As such, it would only be equally natural for us to see the stock market as the ‘best form of investing’.

Takeaway 2: Wealth is What You Don’t See

In this chapter, Housel discusses how we often judge the financial position of others by their material possessions. However, one of the greatest ironies of money is that wealth is often not about what we are able to see, but what we are not.

In fact, the only conclusion you can infer from seeing someone drive a $100,000 car, is that they are now $100,000 poorer than they were before they got it (or at least $100,000 more in debt).

Takeaway 2: Wealth is what you don't see
Photo by serjan midili on Unsplash

This is interesting because when we are asked to think of rich people, we always imagine them with their jets, sports cars and luxury homes, when wealth is really hidden.

But, Housel also explains that this is not unexpected as we only judge based on what we can see and (most of the time) we can’t see into the brokerage accounts and bank accounts of the people we look up to. As such, it is not easy to get good financial role models.

I think this is an important takeaway to keep in mind as many of us move up the career ladder and similarly see our incomes climb. As our incomes grow, we feel entitled to spend more to reward ourselves for our effort for getting this far. But alas, it is easy for spending to get out of hand if we don’t keep ourselves under control. Hence, this takeaway keeps us grounded and to keep our financial habits in order even if we are suddenly presented with a windfall or a promotion.

Like Investor Bill Mann once said, “There is no faster way to feel rich than to spend lots of money on really nice things. But the way to be rich is to spend money you have, and to not spend money you don’t have. It’s really that simple.”

Takeaway 3: Luck and Risk

In this chapter, Housel tells the story of two men, Bill Gates and Kent Evans. We all know Bill Gates, the founder of Microsoft. Some know the other founder of Microsoft, Paul Allen. But very few people have heard of the man who would likely have been a third co-founder at Microsoft, Kent Evans.

Let’s talk Luck first. Bill Gates, Paul Allen and Kent Evans first met in Lakeside School, a private school, in 1968. Bill Gates himself has always acknowledged the immense luck that he and his friends were all blessed with, to be enrolled in one of the few schools in the United States to even have a computer in 1968.

It was through this stroke of luck which the three became hooked on it. They were such prodigies at it that the school even tasked them to use the computer to design class schedules for the students. It was likely through this stroke of luck, which Bill Gates and Paul Allen had their exposure to computers which eventually culminated in the founding of one of the largest companies in the world, Microsoft.

But then, what happened to Kent Evans? Unfortunately, Kent Evans fell to his death in a mountaineering accident even before leaving high school. Housel referred to this as Luck’s cousin, Risk.

Here we have two prodigies, who received both sides of the coin, Luck and Risk.

I think the key takeaway from this chapter is that everything we do is affected by factors that are beyond our control or understanding. I;m sure many of us have been guilty of blaming our own failures on bad luck while being able to explain the failures of others by their bad decisions. I know I have.

Likewise, in the past year, many investors in the stock market have profited by a large amount. How much of that success was due to luck though? While I have also been blessed by the incredible rally, I am still able to accept that luck probably had a role to play in these gains.

As such, when it comes to judging people and their decisions, don’t be too quick to judge. Be it good or bad outcomes, luck and risk had their respective roles to play and often the impact cannot be so easily quantified. Instead when looking for role models to emulate, look for broader patterns as these are less likely to have been impacted as much by the effects of luck and risk.

Summary

These are just some of my takeaways from the book, The Psychology of Money by Morgan Housel. Of course, aside from these, there are 17 more riveting stories and thought provoking questions throughout the book.

I feel that the book really makes you question your own biases and preconceived notions, especially in the finance aspect. However, beyond finance, I do think that many of the lessons here are also applicable to our lives as a whole as well and that this book is well worth a read for anyone.

Interested in getting a copy? Check it out on Amazon here!

Photo by Sharon McCutcheon on Unsplash

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