Book Summary: The Psychology of Money by Morgan Housel
🚀 The Book in 3 Sentences
20 short essays on money from the lens of human behaviour
Savings, compounding, consistency, and time is key to being wealthy
The ultimate goal of money is independence and control of your time
🎨 Impressions
Best book that explained the behavioural aspects of money and why people do what they do. And also how to manage money in a way that suits your psychology (and to avoid the pitfalls) because a lot of how money works (e.g. compounding, wealth) are not intuitive.
🙋🏻♀️ Who Should Read It?
Everyone interested in personal finance
☘️ How the Book Changed Me
I was very close to do crypto trading but realized that this speaks more to my greed than my happiness.
Budgeting for room for error in finances (by having a savings cushion)
To think more long-term and ride out the short-term volatilities (2021 recession)
✍️ My Top Quotes
Controlling your time is the highest dividend money pays.
Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see.
You have to plan on your plan not going according to plan.
Independence, at any income level, is driven by your savings rate.
📒 Summary + Notes
Money has more to do with behaviour rather than intelligence
Everyone does what makes sense to them
But every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences.
Luck & Risk = X factors
Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort. Nothing is as good or as bad as it seems.
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.
Focus less on specific individual / case studies and more on broad patterns.
Acknowledge your “Enough”
On having enough: If you risk something that is important to you for something that is unimportant to you, it just does not make any sense. 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 (your target) to stop moving.
Social comparison is problematic.
“Enough” is not too little. “Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret.
There are many things never worth risking, no matter the potential gain.
Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable. Being loved by those who you want to love you is invaluable. Happiness is invaluable. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.
Compounding is king, it’s just not intuitive
Let time do its thing and let your investments compound. Compounding doesn’t work with our math intuition, which is why it is so hard for us to have faith in it. The danger here is that when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider compounding potential.
Staying Wealthy after Getting Wealthy
Keeping money is a different skill set from making money. There’s only one way to stay wealthy: some combination of frugality and paranoia.
What Warren Buffet didn’t do: He didn’t get carried away with debt. He didn’t panic and sell during the 14 recessions he’s lived through. He didn’t sully his business reputation. He didn’t attach himself to one strategy, one world view, or one passing trend. He didn’t rely on others’ money (managing investments through a public company meant investors couldn’t withdraw their capital). He didn’t burn himself out and quit or retire. He survived.
Survival mindset in the real world
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.
Room for error—often called margin of safety—is one of the most underappreciated forces in finance.
It comes in many forms: A frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes.A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And in fact you know it will be filled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is filled with landmines, and always will be. Those two things are not mutually exclusive.
On short-term paranoia: 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.
Tails events are highly influential
Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. The idea that a few things account for most results is not just true for companies in your investment portfolio. It’s also an important part of your own behavior as an investor.
Warren Buffet and tails: Warren Buffett said he’s owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger followed up: “If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.”
Wealth = independence and freedom
Wealth can get you to freedom/control over your life. The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.” Controlling your time is the highest dividend money pays.
How a bit more wealth can help:
A small amount of wealth means the ability to take a few days off work when you’re sick without breaking the bank. Gaining that ability is huge if you don’t have it. 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. That can be life changing. Six months’ emergency expenses means not being terrified of your boss, because you know you won’t be ruined if you have to take some time off to find a new job.
Man in the Car Paradox
You think you’re cool by owning the latest shiny car, but other people will only see the car and dream they own it themselves, and won’t see you in it.
Don’t seek admiration by owning flashy, shiny things.
Wealth is What You Don’t See
Wealth is the stuff not purchased. 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. (Location 1011)
Rich is current income. Wealth is income not spent.
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. (Location 1016)
Save Money for flexibility
Building wealth is correlated with savings rate. Independence, at any income level, is driven by your savings rate.
Wealth is relative; it depends on what you need.
Saving money is the gap between your ego and your income. Past a certain level of income, what you need is just what sits below your ego. Everyone needs the basics. Once they’re covered there’s another level of comfortable basics, and past that there’s basics that are both comfortable, entertaining, and enlightening.
Ability to save = desiring less. People’s ability to save is more in their control than they might think.
You don’t need a specific reason to save. 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.
Flexibility and control over time = unseen return on wealth, one of the most valuable currencies. Flexibility allows you to say yes to the good opportunities.
When you don’t have control over your time, you’re forced to accept whatever bad luck is thrown your way. But if you have flexibility you have the time to wait for no-brainer opportunities to fall in your lap. This is a hidden return on your savings. Savings in the bank that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate. And that hidden return is becoming more important.
Having more control over your time and options is becoming one of the most valuable currencies in the world.
Aim to be reasonable (incl. emotional component) and sleep well at night, rather than rational
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.
Adopt strategies that lets you sleep well at night. Investing has a social component that’s often ignored when viewed through a strictly financial lens.
Surprise events
We should be wary of overconfidence that comes with experience
Don’t rely on history as a predicting guide, surprises WILL happen
Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.
You’ll likely miss the outlier events that move the needle the most. The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound.
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. → anything happening just 2 decades ago cannot apply to now & the future because it’s out of date
The further back in history you look, the more general your takeaways should be.
Room for Error
You have to plan on your plan not going according to plan.
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. (Location 1423)
Room for error = endurance to last you long enough to get a favourable outcome, e.g. endure a market downturn. Having a gap between what you can technically endure versus what’s emotionally possible is an overlooked version of room for error.
Margin of safety can allow you to take risks
Room for error is a safety net for surprise events
Everyone—without exception—will eventually face a huge expense they did not expect—and they don’t plan for these expenses specifically because they did not expect them.
Paycheck-to-paycheck: 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.
You’ll Change
You are planning for a future self that will change
Don’t interrupt compounding unnecessarily by avoiding the extreme ends of financial planning. Leave room for some sway. We should avoid the extreme ends of financial planning. → FIRE vs YOLO mentality
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.
Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.
We should also come to accept the reality of changing our minds.
Nothing’s Free
Volatility is a fee for investing. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.
Find the price, then pay it.
You & Me
Everybody is playing a different game, don’t blindly take advice or copy best practices. Investors often innocently take cues from other investors who are playing a different game than they are.
Different time horizons and goals When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.
Identify the game you are playing.
The Seduction of Pessimism
Our brains are wired to think more negatives than positives. Optimism is the belief that over the long run, there will be more good than bad
Growth is driven by compounding, destruction is driven by single points of failure
When You’ll Believe Anything
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.
Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
Daniel Kahneman on how we think we can control money:
When planning we focus on what we want to do and can do, neglecting the plans and skills of others whose decisions might affect our outcomes.
Both in explaining the past and in predicting the future, we focus on the causal role of skill and neglect the role of luck.
We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.
Book summary template from Ali Abdaal.