We spend most of our life dealing with money - earning it, spending it, saving it, losing it, investing it. Yet, most of us don’t understand its relationship with our psyche. We just believe that more money is desirable and it promises to solve all our problems. We don’t question what “more” money means and does it actually solve all our problems?
Morgan Housel’s “The Psychology of Money” helps you tackle these questions. It's my favourite read of the last couple of years.
The book is as much about finance as it is about life. Most of the takeaways can be applied to life in general. It’s also unintentionally topical. Specifically the last couple of years as we saw historic low interest rates creating cheap capital, trillions of dollars of stimulus that led to asset inflations of historic proportions. As bored ape NFTs and shiba inu dog cryptos captured our collective imaginations, we went from the great resignation to the great layoffs in a matter of 6 months. The psychology of money reveals a lot of great insights about money and our relationship with it. The author also provides a framework to the reader on managing money - be it saving, spending or investing it.
I am far from being an expert on money. This post is basically a note to self summarising the key takeaways from the book, meant to be reflected on regularly as a guideline of sorts for decisions related to money. (If you like this post you will love the book)
Everyone’s lens of looking at money is different
Our past experiences drive our relationship with money. How you have grown up, where and when you have spent your entire life determines your relationship with money. A 25 year old software engineer’s choices with money will be very different from a 45 year old. The 25 year old has probably only seen a booming economy, near zero fed interest rates and an abundance of job opportunities. But the 45 year old faced the dotcom bubble at the start of their career, the housing crisis of 2008, probably lost their job, lost a significant portion of their net worth. Their risk appetite and relationship with money will be totally different. So, a choice about money that may look extremely low risk and rational to one may seem utterly stupid and irresponsible to another person. Our worldviews play a major role in the decisions we make with money.
The purpose of money is freedom
Naval Ravikant, the angel investor says “The reason to win the game is so that you can be free of it”. For most of us when we say that we want a lot of money, what we really want is control over our time. To be able to spend our time the way we want to. Not beholden to attend meetings that we don’t want to, with people we don't like, discussing topics we don’t truly care about. But we don't control our time. Even if we dislike it, we need to make it to the meeting on the calendar. We have to get ready to jump on the call when the reminder notification pops up. The ultimate purpose of money is to be able to buy us the freedom to choose how we spend our time and who we spend it with. Being aware of this is important. Otherwise we will become slaves to the feeling of chasing money, endlessly running after it only to eventually realize not enough time is left to enjoy it.
The power of compounding
99% of Warren Buffet’s 100 billion net worth was accumulated after this 50th birthday. And 97% of it after his 65th birthday. Let that sink in! There are very few sentences that summarise the power of compounding better than that.
Most gains in life come with compounding over a long time - be it becoming expert in your chosen field, relationships, body building or creating wealth. Technology development also follows the same pattern. Think of the history of the processing power of computers or the storage space inside them. They started with modest numbers and very quickly blew up exponentially.
Compounding is the most powerful tool for creating wealth. You have to give it time and you have to be patient. It’s so easy but so hard. It’s hard because it’s boring and requires you to wait. We all want to become rich quickly. No one wants to wait 30 years to become rich. But for most of us that is the only reasonable way to truly become wealthy.
Staying wealthy is more difficult than becoming wealthy
Creating real wealth requires us to not spend money on all the things that make us look wealthy. When income increases we want to feel “rich”. And the way we feel rich is by buying the expensive car, house, clothes and the next shiny thing. The irony is that this ends up making us less rich. Wealth is what we don't see. Becoming truly wealthy requires the discipline to not increase spending as income increases. We become wealthy by keeping the expenses flat and increasing the income.
Don’t aim for perfection with financial planning
Financial decisions are personal. What seems like a rational choice for your friend may not be the best for you. Buying a house with only 5% down may be a viable decision for your friend but for you doing the 20% down may be a less stressful one. Do what helps you sleep better every night. Not what a finance article or a colleague suggests you to do. Just because it looks like a smart decision on a spreadsheet, it may not be the best. End of the day we are humans and not robots. Make decisions that help you be happy and not the ones that make you come across as the smartest in the room.
Dollar cost average in index funds
In 2007, Warren Buffet made a famous bet with a hedge fund manager - that a low cost unmanaged S&P 500 index fund would outperform actively managed hedge funds over the next 10 years. Suffice to say, he won the bet. S&P 500 outperformed the hedge funds returns. And the competition wasn't even close.
Regular consistent investments in index funds over a long time yields better returns than the most sophisticated hedge funds. That's the boring truth.
Keeping up with the Joneses
The biggest challenge with running after money is learning when to stop and realising it’s enough. Our targets with money is like a goal post that's constantly moving. We start with a milestone and once we reach it we invent another milestone. The milestone has less to do with what we really want and more to do with what our friends, colleagues and acquaintances around us have.
Planning for the unexpected
The pandemic is the most recent large-scale unexpected event that changed most of our lives in some significant way. We will experience many surprising events which will throw our plans astray. These are impossible to predict but have a major impact in our lives. Planning for such events is crucial. Single points of failure, too much leverage on an investment, too much exposure on a singular asset can be devastating. It’s important to make sure we don't get completely wiped out in case of an unexpected event. Survival is key. It ensures we live to fight another day. I think of it as buying insurance against every important financial decision. For instance, having a cash savings of 6 months or even 1 year of your salary gives you insurance against a sudden layoff. It prevents you from settling for a job that you don't want or selling your house because you can no longer make the mortgage payments. So always plan for the worst case scenario.
The role of luck in success
This is how we usually think - when we succeed, it’s because of how smart and hardworking we are but when we fail it’s either someone else's fault or because of our bad luck. Clearly it’s a little disingenuous. Truth is that a lot of our successes are because of our circumstances and a crazy case of luck. The book talks about how both Bill Gates happened to be a student of a school in Seattle that received a computer as a donation in the most crazy circumstances. Getting access to a computer in the 70s was extremely rare and expensive. Bill learnt programming and was able to apply his genius from the school days which barely other school kids got to do during that time. This had something to do with the success that this wizkid found a few years later. Malcolm Gladwell in his 2008 bestseller, “The Outliers : The story of success” talks about this same example. So success could be because of both intrinsic and extrinsic factors. And sometimes the extrinsic factors have a much larger role to play in your success compared to your own talent and skills.
In the words of professor Scott Galloway “nothing is as bad or as good as it seems”. It’s important to not congratulate ourselves too much when we succeed and at the same time it’s better to not be too hard on ourselves when we have a failure.
In conclusion, your behaviour determines your financial success
Doing well with money has less to do with how smart you are and more to do with your behaviour, habits and discipline with money. Understanding and introspecting your relationship with money can go a long way in creating wealth. Making simple, easy and practical decisions are better than complex, cold and rational ones. Optimise for saving more than you spend, invest in time-tested assets with a long term horizon and be aware of what you ultimately trying to achieve with money.
Notes about the book & the author
“The Psychology of Money” was published in Sep, 2020 during the pandemic. So far it has sold a staggering 2 million copies. This is the author’s first book. Before writing the book, Morgan Housel wrote 10 years for the Motley fool. The book was initially rejected by almost every publishing house. It eventually found a small publisher named Harriman house. Crazy that so many big publishers passed on this mega bestseller. I can understand why. It's not your traditional finance book. That’s also the reason why the book has been such a success and resonated with so many like me.