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The psychology of money by Morgan Housel


My notes

Doing well with money has a little to do with how smart you are and a lot to do with how you behave.

Knowing what to do tells you nothing about what happens in your head when you try to do it.

To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism.

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.

No amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.

Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.

Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works.

Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.

Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes.

The accidental impact of actions outside of your control can be more consequential than the ones you consciously take.

When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.

Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation.

Studying a specific person can be dangerous because we tend to study extreme examples—the billionaires, the CEOs, or the massive failures that dominate the news—and extreme examples are often the least applicable to other situations, given their complexity. The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was influenced by extreme ends of luck or risk.

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 extra effort.

the ceiling of social comparison is so high that virtually no one will ever hit it. Which means it’s a battle that can never be won, or that the only way to win is to not fight to begin with—to accept that you might have enough, even if it’s less than those around you.

good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.

There are a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia.

Capitalism is hard. But part of the reason this happens is because getting money and keeping money are two different skills.

Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risk. 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 is attributable to luck, so past success can’t be relied upon to repeat indefinitely.

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, whether it’s in investing or your career or a business you own.

Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.”

More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually 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 plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality. A good plan doesn’t pretend this weren’t true; it embraces it and emphasizes room for error. The more you need specific elements of a plan to be true, the more fragile your financial life becomes.

Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right.

Conservative is avoiding a certain level of risk. Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.

A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.

Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. And 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.

Most financial advice is about today. What should you do right now, and what stocks look like good buys today? But most of the time today is not that important. Over the course of your lifetime as an investor the decisions that you make today or tomorrow or next week will not matter nearly as much as what you do during the small number of days—likely 1% of the time or less—when everyone else around you is going crazy.

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.

performs in dozens of small clubs each year is just OK. That is by design. No comedic genius is smart enough to preemptively know what jokes will land well. Every big comedian tests their material in small clubs before using it in big venues.

“It’s not whether you’re right or wrong that’s important,” George Soros once said, “but how much money you make when you’re right and how much you lose when you’re wrong.” You can be wrong half the time and still make a fortune.

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.

doing something you love on a schedule you can’t control can feel the same as doing something you hate.

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.”

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.

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 the car (or $100,000 more in debt). That’s all you know about them.

Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see. That’s not how we think about wealth, because you can’t contextualize what you can’t see.

When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.

Investor Bill Mann once wrote: “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.”

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

Past a certain level of income, what you need is just what sits below your ego.

One of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.

Savings without a spending goal gives you options and flexibility, the ability to wait and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms.

Every bit of savings is like taking a point in the future that would have been owned by someone else and giving it back to yourself.

Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.

The most important driver of anything tied to money is the stories people tell themselves and the preferences they have for goods and services.

The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound. How, for example, 9/ 11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $ 1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans, but that’s what happens in a world driven by a few outlier tail events.

An interesting quirk of investing history is that the further back you look, the more likely you are to be examining a world that no longer applies to today. Many investors and economists take comfort in knowing their forecasts are backed up by decades, even centuries, of data. But since economies evolve, recent history is often the best guide to the future, because it’s more likely to include important conditions that are relevant to the future.

“the purpose of the margin of safety is to render the forecast unnecessary.”

people underestimate the need for room for error in almost everything they do that involves money.

Harvard psychologist Max Bazerman once showed that when analyzing other people’s home renovation plans, most people estimate the project will run between 25% and 50% over budget. 43 But when it comes to their own projects, people estimate that renovations will be completed on time and at budget.

Can you survive your assets declining by 30%? On a spreadsheet, maybe yes—in terms of actually paying your bills and staying cash-flow positive. 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. You—or your spouse—may decide it’s time for a new plan, or new career.

Spreadsheets are good at telling you when the numbers do or don’t add up. They’re not good at modeling how you’ll feel when you tuck your kids in at night wondering if the investment decisions you’ve made were a mistake that will hurt their future.

no risk that can wipe you out is ever worth taking. The odds are in your favor when playing Russian roulette. But the downside is not worth the potential upside. There is no margin of safety that can compensate for the risk.

A good rule of thumb for a lot of things in life is that everything that can break will eventually break. So if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe. That’s a single point of failure.

The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.

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. And the truth is, few of us do. It’s hard to make enduring long-term decisions when your view of what you’ll want in the future is likely to shift.

Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily.

Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key. And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance.

Some of the most miserable workers I’ve met are people who stay loyal to a career only because it’s the field they picked when deciding on a college major at age 18. When you accept the End of History Illusion, you realize that the odds of picking a job when you’re not old enough to drink that you will still enjoy when you’re old enough to qualify for Social Security are low.

Most things are harder in practice than they are in theory. Sometimes this is because we’re overconfident. More often it’s because we’re not good at identifying what the price of success is, which prevents us from being able to pay it.

The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good. It feels like a fine for doing something wrong. And while people are generally fine with paying fees, fines are supposed to be avoided. You’re supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserve to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines.

Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland.

The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty—not just putting up with it, but realizing that it’s an admission fee worth paying.

An idea exists in finance that seems innocent but has done incalculable damage. It’s the notion that assets have one rational price in a world where investors have different goals and time horizons. Ask yourself: How much should you pay for Google stock today? The answer depends on who “you” are. Do you have a 30-year time horizon? Then the smart price to pay involves a sober analysis of Google’s discounted cash flows over the next 30 years. Are you looking to cash out within 10 years? Then the price to pay can be figured out by an analysis of the tech industry’s potential over the next decade and whether Google management can execute on its vision. Are you looking to sell within a year? Then pay attention to Google’s current product sales cycles and whether we’ll have a bear market. Are you a day trader? Then the smart price to pay is “who cares?” because you’re just trying to squeeze a few bucks out of whatever happens between now and lunchtime, which can be accomplished at any price.

Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term. That process feeds on itself. As traders push up short-term returns, they attract even more traders. Before long—and it often doesn’t take long—the dominant market price-setters with the most authority are those with shorter time horizons. Bubbles aren’t so much about valuations rising. That’s just a symptom of something else: time horizons shrinking as more short-term traders enter the playing field.

It’s hard to grasp that other investors have different goals than we do, because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own.

Being swayed by people playing a different game can also throw off how you think you’re supposed to spend your money. So much consumer spending, particularly in developed countries, is socially driven: subtly influenced by people you admire, and done because you subtly want people to admire you.

A takeaway here is that few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are. The main thing I can recommend is going out of your way to identify what game you’re playing.

Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.

Pessimism just sounds smarter and more plausible than optimism. Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention.

money is ubiquitous, so something bad happening tends to affect everyone and captures everyone’s attention.

There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. In a connected system where one person’s decisions can affect everyone else, it’s understandable why financial risks gain a spotlight and capture attention in a way few other topics can.

progress happens too slowly to notice, but setbacks happen too quickly to ignore.

It’s easier to create a narrative around pessimism because the story pieces tend to be fresher and more recent. Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together.

Expecting things to be great means a best-case scenario that feels flat. Pessimism reduces expectations, narrowing the gap between possible outcomes and outcomes you feel great about. Maybe that’s why it’s so seductive. Expecting things to be bad is the best way to be pleasantly surprised when they’re not.

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.

An appealing fiction happens when you are smart, you want to find solutions, but face a combination of limited control and high stakes. They are extremely powerful. They can make you believe just about anything.

The problem is that viewers can’t, or don’t, calibrate low odds, like a 1% chance. Many default to a firm belief that what they want to be true is unequivocally true. But they’re only doing that because the possibility of a huge outcome exists.

The bigger the gap between what you want to be true and what you need to be true to have an acceptable outcome, the more you are protecting yourself from falling victim to an appealing financial fiction.

When thinking about room for error in a forecast it is tempting to think that potential outcomes range from you being just right enough to you being very, very right. But the biggest risk is that you want something to be true so badly that the range of your forecast isn’t even in the same ballpark as reality.

Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

Most people, when confronted with something they don’t understand, do not realize they don’t understand it because they’re 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. We all want the complicated world we live in to make sense. So we tell ourselves stories to fill in the gaps of what are effectively blind spots.

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. And that can be hard to accept.

“We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”