The Psychology of Money by Morgan Housel

The Book in A Few Sentences

Success in finance is mostly a result of low spending, high savings, time and compounding. But if you get wiped out financially, you will not be able to take advantage of time and compounding. Investing in stocks is very difficult, therefore most people would benefit from investing in low-cost index funds.

The Psychology of Money summary

This is my book summary of The Psychology of Money by Morgan Housel. My notes and summary include the key lessons and most important passages from the book.

Introduction: The Greatest Show On Earth

The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people.
In what other industry does someone with no college degree, no training, no background, no formal experience, and no connections massively outperform someone with the best eduction, the best training, and the best connections?

2: Luck & Risk

…people who have control over their time tend to be happier in life…

3: Never Enough

But life isn’t any fun without any sense of enough. Happiness, as it’s said, is just results minus expectations.

4: Confounding Compounding

If something compounds—if a little growth serves as the fuel for future growth—a small starting base can lead to results so extraordinary they seem to defy logic.
But 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.

5: Getting Wealthy vs. Staying Wealthy

Getting one is one thing. Keeping it is another.
There are two reasons why a survival mentality is so key with money.
One is the obvious: few gains are so great that they’re worth wiping yourself out over.
The other…is the counterintuitive math of compounding
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 margin of safety—is one of the most under appreciated forces in finance.
Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.
But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.

6: Tails, You Win

It is not intuitive that an investor can be wrong half the time and still make a fortune. It means that we underestimate the how normal it is for a lot of things to fail. Which causes us to overreact when they do.
Most public companies are duds, a few do well, and a handful become extraordinary winners that account for the majority of the stock market’s returns.
Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.
A good definition of an investing genius is the man or woman who can do the average thing well when all those around them are going crazy.

7: Freedom

The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want to today.”
But if there’s a common denominator in happiness—a universal fuel of joy—it’s that people want to control their lives.
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.
But doing something you love on a schedule you can’t control can feel the same as doing something you hate.
Controlling your time is the highest dividend money pays.

8: Man in the Car Paradox

Humility, kindness, and empathy will bring you more respect than horsepower every will.

9: Wealth is What You Don’t See

We should be careful to define the difference between wealthy and rich.
Rich is a current income.
But wealth is hidden. It’s income not spent. Wealth is an option not yet taken to buy something later.
They [we] want freedom and flexibility, which is what financial assets not yet spent can give you.

10: Save Money

…building wealth has little to do with your income or investment returns, and lots to do with your savings rate.
When you define savings as the gap between your ego and your income you realize whey many people with decent incomes save so little.
Having more control over your time and options is becoming one of the most valuable currencies in the world.

11: Reasonable > Rational

There are few financial variables more correlated to performance than commitment to a strategy during its lean years—both the amount of performance and the odds of capturing it over a given period of time.
The historical odds of making money in the U.S. markets are 50/50 over one-day periods, 68% in one-year periods, 88% in 10-year periods, and (so far) 100% in 20-year periods.
Anything that keeps you in the game has a quantifiable advantage.

12: Surprise!

“Things that have never happened before happen all the time.” — Stanford professor Scott Sagan
But investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing, which can make even smart people nervous, greedy and paranoid.
The most common plot of economic history is the role of surprises.
The correct lesson to learn from surprises is that the world is surprising.

13: Room for Error

We can look at history and see, for example, that the U.S. stock market has returned an annual average of 6.8% after inflation since the 1870s.

14: You’ll Change

Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily.
The trick is to accept the reality of change and move on as soon as possible.

15: Nothing’s Free

“Every job looks easy when you’re not the one doing it.” — Jeffrey Immelt, former CEO of GE
Most things are harder in practice than they are in theory.
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.
It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing a kind of mindset that lets you stick around long enough for investing gains to work in your favor.
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.

16: You & Me

Bubbles do their damage when long-term investor playing one game start taking their cues from those short-term traders playing another.
A takeaway here is that few things matter more with money than understanding your own horizon and not being persuaded by the actions and behaviors of people playing different games than you are.

17: The Seduction of Pessimism

Optimism is the best bet for most people because the world tends to get better for most people most of the time.
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.
There are a lot of overnight tragedies. There are rarely overnight miracles.
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.

18: When You’ll Believe Anything

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.
It can’t be overstated: there is no greater force in finance than room for error, and the higher the stakes, the wider it should be.
Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
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.

19: All Together Now

Time is the most powerful force in investing.
…a small minority of things account for the majority of outcomes.
The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance.
No one is as impressed with your possessions as you are.

20: Confessions

Half of all U.S. mutual fund portfolio managers do not invest a cent of their own money in their funds, according to Morningstar.
…independence has always been my financial goal.
Comfortably living below what you can afford, without much desire for more, removes a tremendous amount of social pressure that many people in the modern first world subject themselves to.
Good decisions aren’t always rational. At some point you have to choose between being happy or being “right.”
But everything I’ve learned about personal finance tells me that everyone—without exception—will eventually face a huge expense they did not expect…
And I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.
One of my deeply held investing beliefs is that there is little correlation between investment effort and investment results.
The reason is because the world is driven by tails—a few variables account for the majority of returns.

Postscript

The first thing we did to keep the economy afloat after the war was keep interest rates low.
An era of encouraging thrift and saving to fund the war quickly turned into an era of actively promoting spending.
And the economic facts of the years between the early 1970s through the early 2000s were that growth continued, but became more uneven, yet people’s expectations of how their lifestyle should compare to their peers did not change.
The biggest difference between the economy of the 1945-1973 period and that of the 1982-2000 period was that the same amount of growth found its way to totally different pockets.
Americans held onto two ideas rooted in the post-WW2 economy: That you should live a lifestyle similar to most other Americans, and that taking on debt to finance that lifestyle is acceptable.
Household debt-to-income stayed about flat from 1963 to 1973. Then it climbed, and climbed, and climbed, from around 60% to more than 130% by 2007.
…since the 1980s: The economy works better for some people than others. Success isn’t as meritocratic as it used to be and, when success is granted, it’s rewarded with higher gains than in previous eras.