18 Summarized lessons from the book "The Psychology of money"

Introduction

"The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness" is one of the best books on personal finance written by Award-winning writer Morgan Housel, a wall Street Journal columnist and partner at Collaborative Fund. The book gives a message that earning a lot of money is not necessarily make you rich but how you behave around that money matters.

The book explores the complex and often irrational nature of financial decision-making. Housel draws on a variety of real-world examples and anecdotes to illustrate how our psychological biases and misconceptions can shape our approach to money and provides practical advice for overcoming these biases and making more informed financial choices. Throughout the book, Housel emphasizes the importance of recognizing that there is no one "right" way to approach money and that what may seem like irrational behavior to one person may make perfect sense to another. Whether you are an experienced investor or just starting out on your financial journey, "The Psychology of Money" offers valuable insights and practical advice for navigating the complex and often unpredictable world of personal finance.

The book contains short stories to convince you that soft skills are more important than the technical side of money. We think about and are taught about money with rules and laws but it is more about psychology & emotions. 

1. No one's Crazy

Housel begins by emphasizing the importance of recognizing that different people have different financial priorities, and what may seem like irrational behavior to one person may make perfect sense to another. He notes that our financial decisions are often shaped by a complex array of social, cultural, and personal factors, and that there is no one "right" way to approach money.

The economists found that people’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation. Their view of money was formed in different worlds at different times. Few people make financial decisions with their own unique view of the world, ego, pride, bias, and emotions and then they mix it together into a narrative that works for them.

He notes that our tendency to focus on short-term gains or losses, our aversion to uncertainty and loss, and our tendency to compare ourselves to others can all lead us to make irrational financial choices.

However, Housel also emphasizes that it is possible to overcome these biases and make more informed financial decisions. He notes that the key is to be aware of our own biases and to take a more rational and evidence-based approach to money.

2. Luck & Risk

Housel argues that while many people may attribute their financial success or failure to their own abilities or choices, luck actually plays a much larger role than we often realize. He notes that luck can take many forms, from the family we are born into to the economic conditions of the time in which we live.

However, Housel also emphasizes the importance of distinguishing between luck and risk. While luck refers to factors that are outside of our control, risk refers to factors that we can influence through our own choices and actions. Housel notes that it is important to be aware that

Luck and risk are both reality & myth. Many things in our life are guided by invisible forces other than individual efforts. The world around us is too complex to understand which does not allow 100% of our actions to convert into 100% of outcomes. There are seven billion other people with you making efforts and there are infinite possibilities & probabilities. 

3. Never Enough

Housel argues that despite what many people may believe, wealth is not an endpoint or a destination. Rather, it is a journey that is defined by an individual's sense of "enough". Housel suggests that "enough" is a subjective and constantly evolving concept that is influenced by a variety of factors, including personal values, social norms, and cultural expectations.

Housel notes that the pursuit of more money can become a never-ending cycle that is ultimately unsatisfying, as individuals may find that they are never able to reach their goal of "enough". 

If expectations rise for what you don't need with risk more than you can bear then it is unreasonable. It gets dangerous when the taste of having more money, more power, and more prestige gets beyond limits.

We do compare with colleagues, friends, and relatives for career, wealth, lifestyle, and happiness. We take decisions, and risks beyond our capabilities just to fit in, to be more successful than others. We all have invaluable things in our life like family and their love, friends, freedom, reputation etc. The best thing we can do is we cannot endanger these by taking unreasonable risks which might affect them. We should know when is enough.

4. Confounding Compounding

More than 95 % of Warren Buffet's net worth came after he attains 65 age. It is difficult to believe, right? His skill is investing, but his secret is time that he stayed invested. That’s how compounding works.

Housel explains the power of compounding, and how it can help individuals achieve significant wealth over time. Compounding refers to the process by which investment returns are reinvested, and then earn additional returns themselves. Over time, these returns can accumulate and grow exponentially, leading to significant gains in wealth.

Housel notes that the power of compounding is often underestimated, as people tend to focus on short-term gains rather than the long-term effects of steady, consistent investing. He emphasizes the importance of starting early, staying disciplined, and avoiding emotional or impulsive investment decisions that can disrupt the compounding process.

He emphasizes the need for a balanced and diversified investment portfolio that can weather market fluctuations and economic downturns.

Compounding only works if you can give an asset considerable years to grow. It’s like planting trees: A year of growth will never show much progress, 10 years can make a meaningful difference, and 25 years can create something extraordinary. Importantly we should not get paranoid about our investment portfolio seeing it every day similar to a growth of a tree cannot be visible in a day.

5. Getting Wealthy vs. Staying Wealthy

There are a million ways to get wealthy but there’s only one way to stay wealthy: some combination of being economical about money and being fearful.

Housel notes that while many people focus on accumulating wealth, the true measure of financial success is the ability to maintain that wealth over time. This requires a focus on not only growing one's assets but also preserving them through smart financial planning and risk management.

Housel highlights the importance of living below one's means, avoiding debt, and investing in a diverse range of assets that can provide both growth and stability. He also notes that it is essential to avoid making emotional or impulsive financial decisions, and to be patient and disciplined in one's approach to investing.

Intelligent investing is not necessarily about making good decisions. It’s about consistently not ruining things.

If we need extraordinary growth or success, it requires surviving all the unforeseen ups and downs that everyone inevitably experiences over time. We can spend years trying to figure out how Buffett got so rich, and what was his investing strategy, how he selected good company stocks. It is hard, correct?

Then what he did differently?

He didn’t get dragged in debt. 

He didn’t panic and sell during the recessions or when the market was down.

He didn’t attach himself to one strategy. He didn’t rely on others’ money.

He didn’t quit or retire. He survived. Survival gave him longevity. Compounding through that long period of time is what matters the most.

The ability to show up consistently for a long time, without giving up, is what makes the biggest difference. Whether it’s in investing, your career, or a business you own. 

6. Tails, You Win

In this chapter, Housel discusses the importance of preparing for and taking advantage of rare and unexpected events, also known as "tail events."

Housel notes that while we often focus on the most likely outcomes when making financial decisions, it is important to consider the potential impact of rare but significant events, such as market crashes or economic downturns. These events can have a profound impact on our financial well-being, and failing to prepare for them can be costly. 

Many times in business and investing, it happens that a small number of events can account for the majority of the outcome. 

How you behaved as an investor during a few months in late 2008 or the crash of the pandemic will likely have more impact on your lifetime portfolio returns than everything you did from 2000 to 2023.

An investing genius is a man or woman who can behave average when other investors in the market are going crazy. 

Housel argues that by adopting a "barbell" approach to investing, which involves putting a significant portion of one's portfolio in low-risk, low-return investments while also taking on a small amount of high-risk, high-return investments, investors can prepare themselves for tail events while still taking advantage of potential opportunities for growth.

Housel also notes that it is important to have a plan in place for managing unexpected events, such as an emergency fund or insurance coverage, and to avoid making impulsive or emotional decisions in response to market fluctuations.

7. Freedom

This chapter explores the concept of financial freedom and how it can be achieved through saving, investing, and living below your means. Housel argues that financial freedom is not about being wealthy, but rather having the freedom to make choices without being constrained by financial considerations.

Becoming wealthy means the ability to have control over time. The ability to do things you want to do, when you want to do them, with whom you want to do them, for as long as you want to do them. It is priceless, don't you think?. 

Some people say money can't buy happiness. Don't you think that money can give you control over time which same time you can be with your family, you can do things you like, the things you can buy, the things you can do for others?

Financial Freedom does not mean you stop working. It means you work where you like, with people you like, the only time when you want to work.

8. Man in the Car Paradox

"No one is impressed with your possessions as much as you are."

Here it examines the relationship between money and happiness and how it changes as people become wealthier. Housel asserts that while money can certainly provide a sense of security and comfort, beyond a certain point it has diminishing returns in terms of happiness. He also explores the "hedonic treadmill" effect, in which people's happiness levels adapt to their circumstances, and claims that focusing on non-financial sources of happiness can be more fulfilling.

People generally desire to be respected and admired by others and use the money to buy luxury things but in actuality, it may bring less of it than you imagine. If respect and admiration is your only goal, be careful how you desire to get them. 

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.”

Housel explores the idea that true wealth is not just about what you have, but also what you don't spend. He argues that by making smart choices about what we spend our money on, we can create a margin of safety that allows us to weather unexpected financial storms. Housel also emphasizes the importance of thinking long-term and considering the opportunity cost of spending money now versus investing it for the future.

We tend to judge wealth by what we see because that’s the information we have in front of us. we see their cars, we see their homes, we see their social media accounts but we can’t see people’s bank accounts or portfolio statements. So some people fake it until they can.

True wealth is what you don’t see. Wealth is the big car not purchased, that gold jewelry not bought, the expensive watch not bought. People always make mistakes, they want to think about wealth in a materialized way.

10. Save Money

“Building wealth has little to do with your income or investment returns, and lots to do with your savings rate.”

The chapter focuses on the importance of saving money for long-term financial security. Housel argues that saving money is not just about creating a financial cushion, but also about giving ourselves the freedom to make choices without being constrained by financial considerations. He also explores the idea of "hyperbolic discounting," in which people tend to discount the value of future rewards in favor of immediate gratification, and provides strategies for overcoming this tendency.

Wealth is just the accumulated leftovers after you spend. It is possible to build wealth without a high income but with a high savings rate.

A high savings rate means having lower expenses than you otherwise could, and having lower expenses means your savings go farther than they would if you spent more.

11. Reasonable > Rational

“Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable." 

In this chapter, Housel argues that while rationality is important in financial decision-making, it is often trumped by the need for reasonableness.

Housel notes that rationality is based on logical and objective analysis, while reasonableness takes into account the subjective and emotional factors that can influence decision-making. He argues that while rationality can lead to sound decisions in a controlled environment, real-life financial decisions are often made in uncertain and unpredictable conditions, where emotions and biases can play a significant role.

Housel provides examples of how reasonableness can lead to better financial outcomes than pure rationality. For instance, he notes that holding a diversified portfolio that takes into account one's emotional attachment to certain assets may be a more reasonable approach than investing purely based on logic.

Housel also emphasizes the importance of recognizing our own biases and limitations and being reasonable in our financial expectations and decision-making. He notes that seeking out diverse perspectives and challenging our own assumptions can help us make more reasonable financial decisions.

12. Surprise!

“The correct lesson to learn from surprises is that the world is surprising. In this chapter, Housel explores the role of unexpected events and surprises in financial decision-making."

Housel notes that surprises are a constant in life, and can have a significant impact on our financial outcomes. Some surprises, such as market downturns or unexpected expenses, can lead to financial stress and setbacks. Others, such as unexpected windfalls or successful investments, can lead to unexpected gains.

Housel argues that our ability to deal with surprises is often more important than our ability to predict them. He notes that while many financial experts and analysts focus on predicting market movements or economic trends, it is often more valuable to develop the resilience and flexibility to deal with unexpected events.

Housel provides examples of how unexpected events can shape financial outcomes, including the impact of unexpected health problems, job losses, or natural disasters on personal finances. He notes that being prepared for surprises, such as by maintaining an emergency fund or having a diversified investment portfolio, can help mitigate their impact.

“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 to today’s world.”

13. Room for Error

“Margin of safety—you can also call it room for error or redundancy—is the only effective way to safely navigate a world that is governed by odds, not certainties." 

In this chapter, Housel discusses the importance of leaving room for error in financial decision-making.

Housel notes that financial decisions are often made with imperfect information and a degree of uncertainty, which can lead to unexpected outcomes. He argues that leaving room for error, or margin of safety, can help mitigate the impact of unexpected events and increase the likelihood of long-term success.

Housel provides examples of how leaving room for error can lead to better financial outcomes. For instance, having an emergency fund or insurance policy can provide a buffer against unexpected expenses, while maintaining a diversified investment portfolio can reduce the impact of market downturns.

Housel also notes that leaving room for error requires a willingness to sacrifice short-term gains for long-term stability. This may involve forgoing high-risk investments in favor of more conservative options or maintaining a larger-than-necessary emergency fund.

14. You’ll Change

“Long-term planning is harder than it seems because people’s goals and desires change over time.”

In this chapter, Housel explores how our perspectives and priorities can shift over time, and how this can impact our financial decision-making.

Housel notes that personal experiences, aging, and external factors such as economic conditions can all influence how we view money and make financial decisions. He argues that recognizing and anticipating these changes is crucial for making informed decisions that align with our long-term goals and values.

Housel provides examples of how our changing perspectives can impact financial decision-making, such as shifting priorities as we age, or changes in financial goals based on personal experiences or life events. He also notes that external factors, such as economic recessions or changes in government policies, can impact our financial decision-making.

Housel argues that being aware of these potential shifts in perspective and priorities can help individuals make more informed financial decisions. This may involve reevaluating financial goals periodically, maintaining flexibility in financial plans, and seeking out advice and guidance from trusted sources.

15.Nothing’s Free

“Everything has a price, but not all prices appear on labels.”

In this chapter, Housel explores the concept of opportunity costs and how they impact our financial decision-making.

Housel notes that every decision we make regarding money involves an opportunity cost - the value of the next-best alternative that we could have chosen instead. He argues that being aware of opportunity costs can help us make more informed financial decisions and maximize the value of our money.

Housel provides examples of how opportunity costs can impact financial decision-making, such as choosing between investing in the stock market or paying off debt, or deciding between buying a house or continuing to rent. He also notes that opportunity costs can be difficult to measure, as they often involve comparing intangible benefits or costs.

Housel argues that being aware of opportunity costs requires a willingness to think beyond immediate gratification and consider the long-term implications of financial decisions. He suggests that individuals can make more informed financial decisions by taking the time to weigh the potential benefits and costs of different options, and by focusing on maximizing the long-term value of their money.

16.You & Me

“Beware taking financial cues from people playing a different game than you are.”

In this chapter, Housel explores the social and cultural factors that shape our financial beliefs and behaviors.

Housel notes that financial decisions are not made in a vacuum - they are influenced by our social and cultural surroundings, including family, friends, and the broader societal context. He argues that recognizing and understanding these external factors is important for making informed financial decisions that align with our personal goals and values.

Housel provides examples of how social and cultural factors can impact financial decision-making, such as the influence of family background on financial habits, the impact of societal norms and expectations on spending and saving behaviors, and the role of peer pressure in financial decision-making.

Housel argues that being aware of these external influences requires a willingness to reflect on our own beliefs and behaviors and to question the assumptions and expectations that are placed upon us by society and those around us. He suggests that individuals can make more informed financial decisions by seeking out diverse perspectives and experiences, and by surrounding themselves with people who share their values and priorities.

17.The Seduction of Pessimism

“Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.”

In this chapter, Housel explores the allure of pessimistic thinking in financial decision-making and the potential drawbacks of this mindset.

Housel notes that pessimistic thinking can be tempting when it comes to money, as it can feel safer and more secure to focus on the potential risks and downsides of financial decisions. However, he argues that this mindset can also lead to missed opportunities and a failure to take necessary risks to achieve financial goals.

Housel provides examples of how pessimistic thinking can impact financial decision-making, such as avoiding investing in the stock market due to fear of a market downturn or choosing to save excessively rather than investing in opportunities for growth.

Housel argues that being aware of the seductive nature of pessimism requires a willingness to question our own biases and assumptions and to consider the potential benefits and drawbacks of different financial strategies. He suggests that individuals can make more informed financial decisions by seeking out diverse perspectives and experiences, and by focusing on the long-term benefits of taking calculated risks.

18.When You’ll Believe Anything

“Stories are, by far, the most powerful force in the economy." 

In this chapter, Housel explores the concept of belief and how it can influence financial decision-making.

Housel notes that beliefs can be incredibly powerful, shaping how we view the world and guiding our actions and decisions. However, he also notes that beliefs can be easily influenced and distorted by external factors, such as social pressures, emotions, and cognitive biases.

Housel provides examples of how beliefs can impact financial decision-making, such as investing in a hot stock based on hype and speculation or holding onto an underperforming investment due to a strong belief in its potential.

Housel argues that being aware of the potential for belief to be distorted requires a willingness to question our own assumptions and biases and to seek out diverse perspectives and experiences to challenge our beliefs.

He also notes that being aware of the power of beliefs can help us to make more informed financial decisions, by avoiding the trap of blind faith or overconfidence in our own beliefs and instead taking a more measured and rational approach.

In conclusion, "The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness" by Morgan Housel is an insightful and thought-provoking book that provides readers with a unique perspective on the often complex and irrational nature of financial decision-making. Housel is able to offer practical advice for overcoming our psychological biases and making more informed financial choices. Housel covers a wide range of topics that are relevant to anyone seeking to improve their financial literacy and build long-term wealth. Whether you are an experienced investor or just starting out, "The Psychology of Money" is a must-read book that will challenge your assumptions and provide you with valuable insights into the psychology of wealth and happiness.