Psychology of Money - Morgan Housel

Gems

• On risking your current capital to chase higher rates of return: "If you risk something that is important to you for something that is unimportant to you, it just does not make sense." (Buffet)
• Unbreakable: "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."
• Controlling your time is the highest dividend money pays.
  • "The highest form of wealth is the ability to wake up every morning and say, 'I can do whatever I want today.'"
• On quitting his job, "the hardest thing about this was that I loved the work. And I wanted to work hard. But doing something you love on a schedule you can't control can feel the same as doing something you hate."
• "The correct lesson to learn from surprises is that the world is surprising", and not simply that "I'll never make that mistake again."
• "Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another."
• Fine vs. fee
  • "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 investing gains to work in your favor."
  • You can't get something for free. If you want a good return, you must be willing to pay its fee of high volatility.
  • "The worthwhile tradeoff of fees is obvious when it's clear you're paying one."
• Human interest is asymmetric between losses and gains. This makes pessimism generally more compelling. But most people should choose optimism in their investor outlook, because the world generally gets better for most people over time.

Intro

• In finance and investing, people who are untrained can regularly outperform those who are far more knowledgeable. In what other profession is that the case? None. He argues this is because financial success arises from soft skills and behavior, not knowledge.
  • "The aim of this book is to use short stories to convince you that soft skills are more important than the technical side of money."

No one's crazy (chap 1)

• Why do people have different behavior with regards to money?
  • "Everyone has their own unique experience with how the world works. And what you've experienced is more compelling than what you learn second-hand."
  • The person who grew up in poverty and inflation vs. the person who grew up with the security of a trust fund
• Studying can help you understand, but it's unlikely to impact you enough to change your behavior.
  • "No amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty" as you would have if you lived through a depression.
• "Investors' willingness to bear risk depends on personal history", not intelligence or knowledge.

Luck and risk (chap 2)

• "If you give luck and risk their proper respect, you realize that when judging people's financial success, — both your own and others — it's never as good or as bad as it seems."
  • Gates had a 1 in a million kind of luck of attending a high school with a computer. Kent Evans, his best friend: 1 in a million risk, dying in a high school mountaineering accident.
  • "For every Bill Gates there is a Kent Evans who was just as skilled and driven but ended up on the other side of life roulette."
• People conclude that bad outcomes were a result of bad decisions, but like poker, we can't easily recognize that a decision which led to a poor result was in fact a good decision, because it had positive expected value in a probabilistic scenario.
• So we should neither blindly admire and replicate the actions of others, nor avoid the actions of others because we assume their failures were due to poor decisions.
• "Success is a lousy teacher. It seduces smart people into thinking they can't lose." - Bill Gates

Never enough (chap 3)

• On risking your current capital to chase higher rates of return: "If you risk something that is important to you for something that is unimportant to you, it just does not make sense." (Buffet)
• It's surprising how some with tens of millions of dollars of wealth will take aggressive risks or commit crimes to leap into the next level of wealth.
• Happiness = results - expectations
• "Social comparison is the problem here" — using wealth as a scorecard.
• Escalating desire and risk eventually push you to the point of regret.

Getting wealthy vs staying wealthy (chap 5)

• "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."
  • The goal to keeping wealth is "survival": being determined to be around in the market for a long time.
  • "You need short-term paranoia to keep you alive long enough to exploit long-term optimism."
• Compounding, to be impactful, requires that an asset have many years to grow.
• On Buffet: "he didn't panic and sell during the 14 recessions he's lived through. He didn't attach himself to one strategy, one world view, or one passing trend."
• Unbreakable: "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."
• A good plan acknowledges and embraces that there will be many black swans in our lifetime, and allows room for error in the planning.
• Flexibility: "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."
• "Economies, markets, and careers often follow a similar path — growth amid loss."
• "Stocks lost a third of their value at least 12 times." (yeesh)

Tails, you win: You can be wrong half the time and still make a fortune (chap 6)

• The "tail events" in some asset classes are what drive the returns. Many markets work like that — art, venture capital, and even public equities. In those, buy an index and hold, so that you are guaranteed to participate in the growth from tail events.
• "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." - George Soros.

Freedom (chap 7)

• Controlling your time is the highest dividend money pays.
• "The highest form of wealth is the ability to wake up every morning and say, 'I can do whatever I want today.'"
• Argues that psychological research suggests that having control over one's life is a strong, dependable predictor of happiness. And it's possible that money can buy more of that.
• On quitting his job, "the hardest thing about this was that I loved the work. And I wanted to work hard. But doing something you love on a schedule you can't control can feel the same as doing something you hate."
• Why Americans aren't happier over time, despite increasing wealth: "Part of what's happened here is that 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, these things cancel each other out."
• After interviewing 1,000 elderly people on what's important in life:
  • "What they did value were things like quality friendships, being part of something bigger than themselves, and spending quality, unstructured time with their children. 'Your kids don't want your money (or what your money buys) anywhere near as much as they want you. Specifically, they want you with them' Pillemer writes."

Wealth is what you don't see (chap 9)

• Spending money on expensive things will leave you with those things, but much less money.
• Only financial assets not yet spent gives you freedom and flexibility. That's wealth.
• "Wealth is hidden. It's 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."

Save money (chap 10)

• One's rate of saving is entirely in one's control. How a particular investing strategy pans out is not.
• "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."

Reasonable > rational (chap 11)

• "People do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night." They want a strategy which minimizes regret.
• "The reasonable investors who love their technically imperfect strategies have an edge, because they're more likely to stick with those strategies. There are few financial variables more correlated to performance than commitment to a strategy during its lean years."

Surprise! (chap 12)

• The markets are not predictable because human emotion is a driver, and it's high variance.
• "Investor Bill Bonner once described how Mr. Market works: 'He's got a 'Capitalism at Work' T-shirt on and a sledgehammer in his hand.'"
• Outlier events and surprises are what have driven the major positive movement in the market in the last century, and they were impossible to predict.
• "The correct lesson to learn from surprises is that the world is surprising", and not simply that "I'll never make that mistake again."
• Even though we have decades and centuries of economic data which we can use to predict the future, economies evolve over time, and so the recent history is the most valuable because "it's more likely to include the important conditions that are relevant to the future?"

Room for error (chap 13)

• "Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to make 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."
• Room for error: assume your future returns will be 1/3 lower than the historical average, so that your planning doesn't flirt too closely with the line, and so you don't miss a key date, like your desired age of retirement.
• "Avoid single points of failure." Avoid catastrophic risks, like leveraged bets.

You'll change (chap 14)

• Preferences and goals change. "An underpinning of psychology is that people are poor forecasters of their future selves."
• "Young people pay good money to get tattoos removed that teenagers paid good money to get. Middle-aged people rush to divorce people who young adults rushed to marry. Older adults work hard to lose what middle-aged adults worked hard to gain."
• If your financial plan can remain uninterrupted throughout your life because it accommodates changing preferences, then compounding can work uninterrupted.
• "Regrets are especially painful when you abandon a previous plan and feel like you have to run in the other direction twice as fast to make up for lost time."
  • Avoid extreme ends of financial and life planning, like working excessively hard when your children are young, so you can retire early and be present in their teens... the benefits of such strategies will wear off, and they're prone to regret.
  • Aim for moderation in your savings rate, free time, commute, time with family.
• "I have no sunk costs." Be free to abandon lifestyle or financial decisions from your past which no longer suit your changed self.

Nothing's free (chap 15)

• Framing "fee" vs. "fine"
  • A fee is "the price of admission." A fine is "a punishment for wrongdoing."
  • "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 investing gains to work in your favor."
  • You can't get something for free. If you want a good return, you must be willing to pay its fee of high volatility.
  • "The worthwhile tradeoff of fees is obvious when it's clear you're paying one."
  • "Market returns are never free."

You and me (chap 16)

• "Beware taking financial cues from people playing a different game than you are."
• "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."
• Bubbles are less about valuations rising, and more about investor time horizons shrinking.
• "The formation of bubbles isn't so much about people irrationally participating in long-term investing. They're about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself."
• "Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another."
• Author's investment mission statement: "I am a passive investor optimistic in the world's ability to generate real economic growth and I'm confident that over the next 30 years that growth will accrue to my investments."
  • With a mission statement like this, whatever happens in the market this year is irrelevant and can be ignored. This year's return and volatility are part of a different game.

The seduction of pessimism (chap 17)

• "Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you."
• "Optimism is the best bet for most people because the world tends to get better for most people most of the time." The problem is that optimism sounds oblivious to risk.
• Doom-saying gets TV airtime. It's always fashionable.
• Human interest is asymmetric between losses and gains. This makes pessimism generally more compelling.
• "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."
  • Which in turn makes the narratives about misfortune fresh and recent.
• One reason why pessimism may be so seductive: "expecting things to be bad is the best way to be pleasantly surprised when they're not."

When you'll believe anything (chap 18)

• The 2008 recession was due to a narrative change
  • "This is different from Germany in 1945, whose manufacturing base had been obliterated. Or Japan in the 2000s, whose working-age population was shrinking. That's tangible economic damage. In 2009 we inflicted narrative damage on ourselves, and it was vicious."
  • "Stories are 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." We are receptive to an "appealing fiction."
• Even worst-case projections rarely expect anything worse than just "slow-ish" growth. It's an appealing fiction, and it's easy to believe because expecting anything worse is too painful to consider.
• "Since big events come out of nowhere, forecasts may do more harm than good, giving the illusion of predictability in a world where unforeseen events control most outcomes."
• Why do investors demand forecasts when they know they're unreliable? It's because we all want to believe we live in a predictable, controllable world. Useful forecasts serve as an appealing fiction.

All together now (summary) (chap 19)

• "Manage money in a way that helps you sleep at night."
• "Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. 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."
• Uncertainty, doubt, regret about your investments: you have to view these as fees you have to pay to get a return, not fines.
• "You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time."

Confessions - author's investment philosophy (chap 20)

• The author used to pick stocks. Now he just holds index funds. "I can afford not to be the best investor in the world, but I can't afford to be the worst."
• Optimizes for simplicity and ease of mind.