The Psychology of Money by Morgan Housel Summary

Jeremy Silva

3 years ago

The Psychology of Money by Morgan Housel

Click here to listen to this summary on Spotify

My Thoughts

I love the unique perspective this book has on personal finance and investing. The way Morgan approaches the subject from a psychological perspective instead of analytical is refreshing. This is one of the best books I have read this year and I have recommended it to several friends.

The book includes interesting stories and anecdotes in each chapter to support the lessons. I recommend purchasing the book if you like this summary. The Audible version is read by the author and is just under six hours long.

My Favorite Quotes

Your personal experiences with money makeup maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.
Not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.
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.
Money’s greatest intrinsic value, and this can’t be overstated, is its ability to give you control over your time.
Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.
When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire.
The world is filled with people who look modest but are actually wealthy, and people who look rich who live at the razor’s edge of insolvency.
You can build wealth without a high income but have no chance of building wealth without a high savings rate.
At every stage of our lives, we make decisions that will profoundly influence the lives of the people we are going to become. -Daniel Gilbert
Thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investment gains to work in your favor.
Most people, when confronted with something they don’t understand, do not realize they don’t understand it.

Key Questions

Why would someone worth hundreds of millions of dollars be so desperate for more money that they would risk everything in pursuit of even more?
How should we think about and plan for the future?
Why do so many people who are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns?
Why do people listen to TV investment commentary that has little track record of success?
To what extent will the outcome of your effort depend on what you do in your firm? (The outcome of a startup depends as much on the achievements of its competitors and on changes in the market, as on its own efforts.)

Introduction: The Greatest Show on Earth

The premise of this book is that doing well with money has little to do with how smart you are, and a lot to do with how you behave.
Financial success is not a hard science, it’s a soft skill where how you behave is more important than what you know. Morgan calls this soft skill “the psychology of money.”
The aim of this book is to use short stories to convince you that soft stories are more important than the technical side of money.
To grasp why people bury themselves in debt, you need to study the history of greed, insecurity, and optimism.
The Psychology of Money is based on this blog post by Morgan Housel.

Chapter 1: No One’s Crazy

Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.
Some lessons have to be experienced before they can be understood. -Michael Batnick
We all make decisions based on our own unique experiences that seem to make sense to us in the moment.

Chapter 2: Luck & Risk

Luck and risk are siblings, they 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.
When judging financial success, both your own and that of others, nothing is as good or as bad as it seems.
Countless fortunes and failures owe their outcome to leverage.
Be careful who you praise and admire, and be careful who you look down upon.
Be careful when assuming that 100% of outcomes can be attributed to effort and decisions.
Not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.
Focus less on studying specific individuals and more on studying broad patterns.
Success is a lousy teacher, it seduces smart people into thinking they can’t lose. -Bill Gates
Failure can be a lousy teacher because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk.

Chapter 3: Never Enough

Why would someone worth hundreds of millions of dollars be so desperate for more money that they would risk everything in pursuit of even more? (A question prompted by the stories of Rajat Gupta and Bernie Madoff)
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.
If expectations rise with results there is no logic in striving for more because you’ll feel the same after putting in the extra effort.
Life isn’t any fun without a sense of enough.
Happiness equals results minus expectations.
Social comparison is the problem. The ceiling of social comparison is so high that virtually nobody will ever hit it. Which means it is a battle that can never be won. The only way to win is to not fight to begin with.
Accept that you might have enough, even if it is less than those around you.
Enough is not too little.
Enough is realizing that the insatiable appetite for more will push you to the point of regret.
There are many things never worth risking, no matter the potential gain.

Chapter 4: Confounding Compounding

Lessons from one field can often teach us something important about unrelated fields.
You do not need tremendous force to create tremendous results.
If something compounds, a small starting base can lead to extraordinary results.
Linear thinking is so much more intuitive than exponential thinking. You never get accustomed to how quickly things can grow with compounding.
The counterintuitiveness of compounding may be responsible for the majority of disappointing trades, bad strategies, and successful investing attempts.
Good investing isn’t necessarily about earning the highest returns. Good investing is about earning pretty good returns that you can stick with, and which can be repeated for the longest period of time. That is when compounding runs wild.
This chapter compares investors Warren Buffett and Jim Simons. Jim Simons has the highest annual returns of any investor but has earned less than Buffett because Buffett has been investing for much longer (with lower annual returns) and has had more time for compounding.
$81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday.

Chapter 5: Getting Wealthy vs. Staying Wealthy

There are a million ways to get wealthy. The only way to stay wealthy is some combination of frugality and paranoia.
Getting money is one thing, keeping it is another.
To summarize money success in a single word: survival.
Getting money and keeping money are two different skills.
Getting money requires taking risks, being optimistic, and putting yourself out there.
Keeping money requires the opposite of taking risks, it requires humility and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made can be attributed to luck.
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 in investing, your career, and your business.
Two reasons why a survival mentality is key with money. One: few gains are so great that they’re worth wiping yourself out over. Two: the counterintuitive math of compounding. Compounding only works if you can give assets years and years to grow.
Having an edge and surviving are two different things, the first requires the second. You need to avoid ruin at all costs. -Nassim Taleb

Applying the Survival Mindset to the Real World Comes Down to Appreciating Three Things

More than I want big returns, I want to be financially unbreakable. If I’m unbreakable, I think I’ll get the biggest returns because I’ll be able to stick around long enough for compounding to work wonders.
Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
A barbell personality is vital. Optimistic about the future, but paranoid about what will prevent you from getting to the future.

Preventing one desperate ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.
Compounding doesn’t rely on earning big returns, merely good returns sustained uninterrupted for the longest period of time, will always win.
Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right.
Room for error, often called the margin of safety, is one of the most underappreciated forces in finance.
A mindset that can be paranoid and optimistic at the same time is hard to maintain.
You need short-term paranoia to keep you alive long enough to exploit long-term optimism.

Chapter 6: Tails, You Win

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, where a small number of events can account for the majority of outcomes.
It is not intuitive that an investor can be wrong half the time and still make a fortune.
Anything that is huge, profitable, famous, or influential is the result of a tail event, an outlying one-in-thousands or millions event.
Most of our attention goes to things that are huge, profitable, famous, or influential. When most of what we pay attention to is the result of a tail, it’s easy to underestimate how rare and powerful they are.
The idea that a few things account for most results is not just true for companies, it is an important part of your own behavior as an investor.
Tails drive everything.
When you accept that tails drive everything in business, investing, and finance, you realize that it’s normal for lots of things to go wrong, break, fail, and fall.

Chapter 7: Freedom

The highest form of wealth is the ability to wake up and say “I can do whatever I want today.”
The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.
“Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any objective conditions of life we have considered.” Source: The Sense of Wellbeing in America by Angus Campbell.
Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
Money’s greatest intrinsic value, and this can’t be overstated, is its ability to give you control over your time.
To obtain bit by bit, a level of independence and autonomy that comes from unspent assets that give you greater control over what you can do and when you can do it.
A small amount of wealth means the ability to take a few days off work when you are sick without breaking the bank.
A bit more means waiting for a good job to come around after you get laid off, rather than having to take the first one you find.
Having six months of emergency expenses means not being terrified of your boss, because you know that you won’t be ruined if you have to take some time off to find a new job.
More still means having the ability to take a job with lower pay but flexible hours or a shorter commute.
Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.
We’ve used our greater wealth to buy bigger and better stuff, but we’ve simultaneously given up more control over our time. At best, those things cancel each other out.
John Rockefeller’s job wasn’t to drill wells, load trains, or move barrels, it was to think and make good decisions. His product, his deliverable, wasn’t what he did with his hands or even his words, it was what he figured out inside his head. So that’s where he spent most of his time and energy. He was constantly working in his mind thinking problems through.

Chapter 8: Man in the Car Paradox

When you see someone driving a nice car, you rarely think, “Wow, the guy driving that car is cool.” Instead, you think, “Wow, if I had that car people would think I’m cool.” Subconscious or not, this is how people think.
The paradox of wealth is that people tend to want wealth to signal to others that they should be liked and admired.
You might think you want an expensive car, a fancy watch, and a huge house. But I am telling you that you don’t, what you want is respect and admiration from other people. You think having expensive stuff will bring it, but it almost never does, especially from the people you want to respect and admire you. This is from a letter Morgan wrote to his son when he was born.
People generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine.
If respect and admiration are your goals, be careful how you seek them. Humility, kindness, and empathy will bring you more respect than horsepower ever will.

Chapter 9: Wealth is What You Don’t See

Money has many ironies, here is an important one: wealth is what you don’t see.
Many people driving Ferrari’s are mediocre successes who have spent a huge percentage of their paycheck on a car.
Someone driving a $100,000 car might be wealthy, but the only data point you have about their wealth is that they have $100,000 less than they did before they bought that car, or $100,000 more debt.
We tend to judge wealth by what we see because that is the information we have in front of us.
Wealth is the nice cars not purchased, the diamonds not bought, the watches not worn, and the first class upgrade declined.
Wealth is financial assets that have not yet been converted into the stuff you see.
When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire.
The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth, it is the very definition of wealth.
We should be careful to define the difference between rich and wealthy, not knowing the difference is a source of countless poor money decisions.
Rich is a current income. Someone driving a $100,000 car or living in a big house is almost certainly rich, because you need a certain level of income to afford the monthly payment. It’s not hard to spot rich people. They often go out of their way to make themselves known.
Wealth is hidden, it is income not spent. Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.
It is easy to find rich role models, but it is harder to find wealthy ones. By definition, their success is more hidden.
It is so ingrained in us that to have money is to spend money, that we don’t get to see the restraint it takes to actually be wealthy. Since we can’t see it, it is hard to learn about it. The hidden nature of wealth makes it hard to imitate wealthy people and learn from their ways.
The world is filled with people who look modest but are actually wealthy, and people who look rich who live at the razor’s edge of insolvency.

Chapter 10: Save Money

People need to be convinced to save money! Past a certain level of income, people fall into three groups.

Those who save.
Those who don’t think they can save.
Those who don’t think they need to save.

Building wealth has little to do with your income or investment returns, and lots to do with your savings rate.
If you view building wealth as something that will require more money or big investment returns, you may become too pessimistic.
Wealth is just the accumulated leftovers after you spend what you take in.
You can build wealth without a high income but have no chance of building wealth without a high savings rate.
Learning to be happy with less money creates a gap between what you have and what you want.
Spending beyond a pretty low level of materialism is mostly a reflection of ego approaching income. A way to spend money to show people that you have (or had) money.
One of the most powerful ways to increase your savings isn’t to raise your income, it is to raise your humility.
Savings is the gap between your ego and your income.
The intangible benefits of money can be far more valuable and capable of increasing your happiness than the tangible things that are obvious targets of our savings.
Flexibility and control over your time is an unseen return on wealth.
Having more control over your time and options is becoming one of the most valuable currencies in the world.

Chapter 11: Reasonable > Rational

Do not aim to be coldly rational when making financial decisions, aim to just be pretty reasonable.
The reasonable investors who love their technically imperfect strategies have an edge because they are more likely to stick with their strategies.
There are few financial variables more correlated to performance than a commitment to a strategy during its lean years.
This historical odds of making money in US Markets are 50:50 over one-day periods, 68% in one-year periods, 88% in ten-year periods, and 100% in twenty-year periods. Anything that keeps you in the game has a quantifiable advantage.

Chapter 12: Surprise!

Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.
One: you will likely miss the outlier events that move the needle the most.
Two: 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. Examples: the 401K is 42 years old and the Roth IRA was created in the 1990s.
The most common plot of economic history is the role of surprises.
Realizing that the future might not look anything like the past is a special kind of skill.
How should we think about and plan for the future?

Chapter 13: Room for Error

Good ideas taken too far are indistinguishable from bad ideas.
People underestimate the need for room for error in almost everything they do that involves money.
Room for error lets you endure a range of potential outcomes. Endurance lets you stick around long enough to let the odds of benefiting from a low probability outcome fall in your favor.
The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound.
The person with 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 are wrong.
Can you survive your assets declining by 30%? On a spreadsheet maybe yes, but what about mentally? It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest.
Having a gap between what you can technically endure versus what’s emotionally possible is an overlooked version of room for error.
An important cousin of room for error is optimism bias in risk-taking. This is defined as an attachment to favorable odds when the downside is unacceptable in any circumstances.
Leverage is the devil. Leverage: taking on debt to make your money go further, pushes routine risks into something capable of producing ruin. Rational optimism most of the time masks the risk of ruin some of the time.
Morgan thinks of his own money as a barbell. He takes risks with one portion and is terrified with the other.
The ability to do what you want, when you want, for as long as you want has an infinite ROI.
You can’t prepare for what you can’t envision.
Avoid single points of failure. If many things rely on one thing working, and that thing breaks, you are counting the days until catastrophe.
The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs.
The most important part of every plan is planning on your plan not going according to plan.

Chapter 14: You’ll Change

An underpinning of psychology is that people are poor forecasters of their future selves.
Imagining a goal is easy and fun. Imagining a goal in the context of the real-life stresses that grow with competitive pursuits is something entirely different.
Only 27% of college graduates have a job related to their major (according to the Federal Reserve).
It is one thing to say “we don’t know what the future holds.” It’s another to admit that you, yourself, don’t know today what you will even want in the future. The truth is, few of us do.
The End-of-History Illusion is what psychologists call the 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.
At every stage of our lives, we make decisions that will profoundly influence the lives of the people we are going to become. When we become those people we are not always thrilled with the decisions we’ve made. -Daniel Gilbert
Many of us evolve so much over a lifetime that we don’t want to keep doing the same thing for decades on end.
Rather than our money having one 80-year life span, it has perhaps four distinct 20-year blocks.
We should avoid the extreme ends of financial planning.
Assuming you’ll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you’ll one day find yourself at a point of regret.
Compounding works best when you can give a plan years or decades to grow. This is true for savings, careers, and even relationships. Endurance is key.
Balance at every point in your life becomes a strategy to avoid future regret and encourage endurance.
We should come to accept the reality of changing our minds.
Some of the most miserable workers are people who stay loyal to a career only because it is the field they picked when deciding on a college major at age 18.
Sunk costs (anchoring decisions to past efforts that can’t be refunded) are a devil in a world where people change over time. Have no sunk costs. They make our future selves prisoners to our past different selves.

Chapter 15: Nothing’s Free

Everything has a price and the key to a lot of things with money is figuring out what that price is and being willing to pay it.
The problem is that the price of a lot of things is not obvious until you’ve experienced them firsthand when the bill is overdue.
Most things are harder in practice than they are in theory. This is often because we are not good at identifying what the price of success is, which prevents us from being able to pay it.
The price of successful investing is volatility, fear, doubt, uncertainty, and regret.
The inability to recognize that investing has a price can tempt us to try to get something for nothing.
Why do so many people who are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns? Answer: the price of investing success is not immediately obvious. When the bill comes due, it doesn’t feel like a fee, it feels like a fine for doing something wrong.
Thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investment gains to work in your favor.

Chapter 16: You & Me

An iron rule of finance is that money chases returns to the greatest extent that it can.
Short-term traders ignore the rules governing long-term investing, particularly around valuation. Because those rules are irrelevant to the game they are playing.
Bubbles do their damage when long-term investors playing one game start taking their cues from short-term traders playing another game.
It is hard to grasp that other investors have different goals than we do.
An anchor of psychology is not realizing that rational people can see the world through a different lens than your own.
While we can see how much money other people spend on cars, homes, clothes, and vacations, we don’t get to see their goals, worries, and aspirations.
Few things matter more with money than understanding your own time horizon, and not being persuaded by the actions and behaviors of people playing a different game than you are.
Beware of taking financial cues from people playing a different game than you are.
Morgan’s recommendation is to go out of your way to identify what investing game you are playing.
Years ago, Morgan Housel wrote this as his investment philosophy: “I am a passive investor, optimistic in the world’s ability to generate real economic growth, and I am confident that over the next thirty years that growth will accrue to my investments.”

Chapter 17: The Seduction of Pessimism

Optimism is the belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.
Two topics will affect your life whether you are interested in them or not, money and health.
An iron law in economics: extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard to predict ways.
Progress happens too slowly to notice, but setbacks happen too quickly to ignore.
Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence which can happen in an instant.

Chapter 18: When You’ll Believe Anything

Narrative economic damage (as opposed to tangible damage) is one of the most potent economic forces that exists.
Stories are, by far, the most powerful force in the economy.
The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.
Why do people listen to TV investment commentary that has little track record of success?
85% of active mutual funds underperformed their benchmark over the 10 years ending 2018. That figure has been fairly stable for generations.
Everyone has an incomplete view of the world, but we form a complete narrative to fill in the gaps.
“Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense. That’s a big deal in producing mistakes in many fields.” –Daniel Kahneman
Most people, when confronted with something they don’t understand, do not realize they don’t understand it. This is because they are able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world, however limited those experiences are.
When I am blind to parts of how the world works, I might completely misunderstand why the stock market is behaving like it is. In a way that gives me too much confidence in my ability to know what it might do next.
Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is out of your control.
The illusion of control is more persuasive than the reality of uncertainty.
To what extent will the outcome of your effort depend on what you do in your firm? The outcome of a startup depends as much on the achievements of its competitors and on changes in the market, as on its own efforts.

Chapter 19: All Together Now

This chapter is summary of the book, it has several concise lessons taken from the rest of the book. This is a good chapter to come back and re-read if you’ve already read the book.
Go out of your way to find humility when things are going right, and forgiveness and compassion when things are going wrong.
Less ego equals more wealth.
Become okay with a lot of things going wrong.
Use money to gain control over your time, because not having control of your time is a powerful and universal drag on happiness.
Be nicer and less flashy. Nobody is as impressed with your possessions as much as you are.
You are more likely to gain respect and admiration through kindness and humility than horsepower and chrome.

Chapter 20: Confessions

In this chapter Morgan tells what he does with his own money.
What works for one person may not work for another, you have to find what works for you.
Billionaire investor Sandy Gottesman is said to ask one question when interviewing candidates for his investment team: “What do you own, and why?”
This question highlights what can often be a mile-wide gap between what makes sense (which is what people suggest you do) and what feels right (which is what people actually do).
“I did not intend to get rich, I just wanted to be independent.” – Charlie Munger

What Morgan Housel Does with His Own Money

Independence has always been his personal financial goal.
Independence, to Morgan, doesn’t mean you’ll stop working. It means you only do the work you like, with people you like, at the times you want, for as long as you want.
Achieving some level of independence is mostly a matter of keeping your expectations in check and living below your means. Independence at any income level is driven by your savings rate.
Morgan paid off his mortgage early, even though it may not be a wise financial decision, it is the right peace of mind decision for him.
His views on investing: every investor should pick a strategy that has the highest odds of successfully meeting their goals.
Morgan believes that for most investors, dollar cost averaging into a low-cost index fund will provide the highest odds of long-term success (that is what he does).

Related Book Summaries

Hope you enjoyed this and got value from my notes.
This is the 20th book read in my 2021 reading list.
Here is a list of my book summaries.