The Psychology of Money
The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel is one of those rare personal finance books that has something for everyone.
Ths book not only provides insights for new investors to consider at the start of their investing journey, but it also shares insights into how everyone, all of us, interact with money differently. Through a series of short stories, fact-tips collated under specific chapters, author Morgan Housel shares what he considers are the most important and often counterintuitive features of the psychology of money.
Before I offer up my personal copy to one lucky reader, in the book giveaway later below, let’s take a comprehensive look at some key chapters about what you can expect including some of my favourite takeaways and quotable moments from this well thought-out book.
The Psychology of Money
Throughout this book, Morgan’s main objective is to teach you the consequences associated with money saving and spending in terms of behaviour. This is because unlike the science of medicine so often referenced in the book, expertise (and often success) with saving, investing and finances requires a deep understanding of human psychology. As humans, we are flawed, full of attitudes and irrational patterns. These patterns manifest themselves into our decisions with money so influenced on emotions over math – that sometimes these decisions are very hard to explain or rationalize. But these decisions exist, they happen, because we all make decisions everyday based on our own unique experiences and what we think is relevant to us at the time.
Let’s explore some of these subjects now in those key chapeters to see what might reasonate for you!
Chapter 2 – Luck & Risk
Housel reminds us that “luck and risk are siblings”, citing Bill Gates’ early success with computers as an extreme form of luck: “one in a million high-school-age students attended the high school (Lakeside) that had the combination of cash and foresight to buy a computer.”
This means when it comes to money, luck and risk can be considered doppelgangers – it’s almost impossible to know only in hindsight when someone has been incredibly bold or completely reckless with any given outcome.
As such, Housel suggests when it comes to money management you “be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.”
If you are successful, then part of your success was likely due to luck. On the flipside, risk can play a major role in a situation where you or others don’t achieve success.
Chapter 3 – Never Enough
Citing more examples in the book, including the Ponzi scheme managed by corrupt investor Bernie Madoff, Housel reminds us there is no reason to risk what you already have and need for what you don’t have and don’t need.
This makes one of the hardest financial skills to master is determing “your enough” number. This “enough” is not in the mathematical sense (as in how much to save for retirement), rather, to avoid increasing your lifestyle too much as financial expectations rise over time. To put it more bluntly:
“The hardest financial skill is getting the goalpost to stop moving.”
Chapter 4 – Confounding Compounding
Here is a financial nugget to remember about the power of compouding. At the time Housel wrote this book:
“$81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday.”
The key point here is that while Warren Buffet is often cited as one of the best investors of our time, it’s actually time that Warren Buffett has invested that has been his superpower.
The lesson for you and me is clear: if you want to grow your wealth, the longer you can invest your money, earning good returns over time, that’s when compounding runs wild.
Chapter 5 – Getting Wealthy vs. Staying Wealthy
It sounds so obvious but it’s worth calling out: good investing is not really about making amazing investing decisions – although that certainly helps!
You don’t have to be a perfect investor. Getting wealthy and staying wealthy is “about consistently not screwing up.”
This means when it comes to money management, you should consider becoming “financially unbreakable” over time.
I like this concept a lot and it’s something borrowed from what Warren Buffett and Charlie Munger recently posted in their latest Berkshire Hathaway shareholder letter to investors – the concept of being “financially impregnable” when it comes to explaining why Berkshire holds so much U.S. Treasury Bills.
“Berkshire’s balance sheet includes $144 billion of cash and cash equivalents (excluding the holdings of
BNSF and BHE). Of this sum, $120 billion is held in U.S. Treasury bills, all maturing in less than a year. That stake leaves Berkshire financing about 1⁄2 of 1% of the publicly-held national debt. Charlie and I have pledged that Berkshire (along with our subsidiaries other than BNSF and BHE) will always hold more than $30 billion of cash and equivalents. We want your company to be financially impregnable and never dependent on the kindness of strangers (or even that of friends). Both of us like to sleep soundly, and we want our creditors, insurance claimants and you to do so as well.
But $144 billion?
That imposing sum, I assure you, is not some deranged expression of patriotism. Nor have Charlie and I lost
our overwhelming preference for business ownership. Indeed, I first manifested my enthusiasm for that 80 years ago, on March 11, 1942, when I purchased three shares of Cities Services preferred stock. Their cost was $114.75 and required all of my savings. (The Dow Jones Industrial Average that day closed at 99, a fact that should scream to you: Never bet against America.)
After my initial plunge, I always kept at least 80% of my net worth in equities. My favored status throughout
that period was 100% – and still is. Berkshire’s current 80%-or-so position in businesses is a consequence of my failure to find entire companies or small portions thereof (that is, marketable stocks) which meet our criteria for longterm holding.
Charlie and I have endured similar cash-heavy positions from time to time in the past. These periods are
never pleasant; they are also never permanent. And, fortunately, we have had a mildly attractive alternative during 2020 and 2021 for deploying capital. Read on.”
What. A. Gem.
In Chapter 5, Housel will explains that keeping cash is a hedge against any unknown future with any plan.
“Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.”
The strive to become financially optimistic for the future yet somewhat paranoid about it at the same time will help you immeasurably over time.
Chapter 7 – Freedom
“Controlling your time is the highest dividend money pays.”
Indeed. I’m striving for that. I suspect you might be too!
Housel references the work of gerontologist Karl Pillemer who interviewed a thousand elderly Americans looking for the most important of life’s lessons to share with others. Pillemar concluded from those interviews:
- Not a single person said you should try to work as hard as you can (to make money) to buy things you want.
- Not a single person said it’s important to be at least as wealthy as the people around you – to define your success.
- Not a single person said you should choose any work based on your desired future earnings power.
Instead, consider things that offer more value in life: quality friendships, being part of something bigger than yourself, and spending quality, unstructured time with others including your children.
Chapter 9 – Wealth is What You Don’t See
Although you can absolutely decide to spend your money on things or possessions, The Psychology of Money highlights that long-term wealth is something that people don’t see.
In this chapter, you’ll find prominent examples of people that have over-leveraged themselves (to create an appearance of wealth) when it’s really the role models that don’t share flashy assets is what you are looking for.
“There are, of course, wealthy people who also spend a lot of money on stuff. But even in those cases what we see is their richness, not wealth. We don’t see the savings accounts, retirement accounts, or investment portfolios.”
“The world is filled with people who look modest but are actually wealthy and people who look rich who live at the razor’s edge of insolvency.”
Chapter 10 – Save Money
We all know that saving money, at least some money, is important but Housel puts things into deeper perspective for us: it’s your savings rate that really matters and what you and I should focus on over time.
Because your savings rate is in your direct control.
Unlike taxation, government legislation, rates of return, inflation and more – the first idea concept behind building wealth is so simple to overlook because so much attention is talked about elsewhere.
“Building wealth has little to do with your income or investment returns, and lots to do with your savings rate.”
…and people’s ability to save is usually in more control than they think:
- Savings can be created from a higher income, sure, but savings is often created by spending less.
- You can spend less if you desire less.
- If you desire less, you will probably care less about what others think of you.
- Focusing on you, your savings rate, is essential for wealth-building because a high savings rate offers an unseen return on wealth: flexibility and control over your time.
Chapter 11 – Resaonable > Rational
I loved this chapter, personally.
Although the math on any spreadsheet is compelling to me, personal finance is and will always be more mind over math. And this reality comes from a Nobel Prize winner as well who Housel referenced in this book that wanted to “minimize future regret” so he invested in a 50/50 split between bonds and equities even when a higher percentage of stocks would have done better…
Quite the teachable moment.
Further still, even the legendary late-great Jack Bogle, founder of Vanguard, who spent his career on a crusade of sorts promoting low-cost passive index investing to millions – invested some of his own money in his son’s higher cost mutual funds. Yes, it’s true.
What on earth was the explanation in Housel’s book?
“We do some things for family reasons,” Bogle told The Wall Street Journal. “If it’s not consistent, well, life isn’t always consistent.”
Further, if you search a bit, you’ll find the following when Bogle was asked about his son’s active money management approach:
He is making money for clients and for himself. “Is there anything wrong with that?” he said once in response.
And there you go.
Chapter 12 – Surprise!
Life and the future in general is full of surprises that you nor anyone else simply cannot see coming. Yes, it’s important that we learn from history as best we can. However, events that shape our history are often marked by outlier events that no one can predict.
“Historians are not prophets.”
Chapter 13 – Room for Error
“The most important part of every plan is planning on your plan not going according to plan.”
I’ve often touted planning, while very good, is not nearly as important as the process of planning and re-planning.
Further Reading: How much is enough for retirement?
Housel suggests we continue the thinking and behaviours around being “barbelled”. That is, take some risks, but ensure you have a plan that is adaptable and flexible to succeed.
Housel: “I just want to ensure I can remain standing long enough for my risks to pay off. You have to survive to succeed.”
“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.”
Chapter 15 – Nothing’s Free
As consumers, we pay for everything. Everything has a price. Even the stock market.
“But say you want to earn an 11% annual return over the next 30 years so you can retire in peace. Does this reward come free? Of course not.”
Housel explains the price of long-term stock market gains is the riding out the shorter-term market volatility. This is the price of market returns. This is the price of admission. “And it hurts” from time to time.
Chapter 16 – You & Me
In this chapter of The Psychology of Money, Housel again points out that different people will have different financial goals. Best keep that in mind when investing.
My plan and decisions will likely be very different than yours – understandably so.
The 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.”
Chapter 18 – When You’ll Believe Anything
Humans try to make sense of the world around them by telling themselves a narrative (a story) that fits into their worldview.
“Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.”
We all do this, and often. We have to. The world is a very complex place and it would be hard to get out of bed to begin to understand it if you didn’t tell yourself some stories or have a narrative to connect it all.
Chapter 19 – All Together Now
This chapter summaries some of the lessons you should have learned in the previous chapters – before Housel highlights how he manages his own money in chapter 20 as part of his confessions.
On that note, some of Housel’s confessions:
- “We own our house without a mortgage, which is the worst financial decision we’ve ever made but the best money decision we’ve ever made.” “On paper (paying off a mortgage with rates so low), it’s defenseless. But it works for us.”
- “Over the years I came around to the view that we’ll have a high chance of meeting all of our family’s financial goals if we consistently invest money into a low-cost index fund for decades on end, leaving the money alone to compound.”
- “We also keep a higher percentage of our assets in cash than most financial advisors would recommend – something around 20% of our assets outside the value of our house. This is also close to indefensible on paper, and I’m not recommending it to others. It’s just what works for us.”
“We do it because cash is the oxygen of independence, and – more importantly – we never want to be forced to sell the stocks we own.”
Housel goes on with his cash wedge philosophy to reference Charlie Munger in saying:
“The first rule of compounding is to never interrupt it unnecessarily.”
The Psychology of Money Summary
The Psychology of Money is a gem of a personal finance book – tying together many short stories, facts and personal anecdotes to provide a comprehensive picture of how psychology impacts money decisions – all of us very universally but also differently.
Reading this book will undoutedly provide some simple, straightforward advice on how to recognize the power of psychology in your personal finance journey.
Some key reminders as I leave this book review and share my own reflections of personal finance frequently shared on this site:
- Personal finance is and will always be, personal.
- The best answer for you when it comes to your money management decisions will usually be: “it depends”.
- The best investing strategy is not an index-investing approach or absolutely nothing. I believe the best investing strategy for you will ultimately be your high, sustained savings rate and a financial plan that meets your investing objectives – nobody else’s.
- Financial independence should be the main goal – not any form of “retire early”.
- Cashflow is always king and second to that, keeping a healthy cash wedge is always smart to weather any market volatility or financial surprise.
- You don’t have to be a great investor. You just have to be a good one by avoiding many financial mistakes.
The Psychology of Money by Morgan Housel (About the Author)
Morgan Housel is a well-known financial journalist who is currently a partner at The Collaborative Fund.
In the past, Morgan was a columnist for both The Motley Fool and The Wall Street Journal and won awards for his journalism. Currently, he lives in Seattle with his family.
The Psychology of Money – Enter to Win!
Related reading including from my site:
Why is a cash wedge so important? Read on to learn why and how you can easily implement one.
The Psychology of Money from Morgan Housel via The Collaborative Fund blog.