The Psychology of Money

The Psychology of Money

by Morgan Housel

The Psychology of Money uncovers truths about the world of money. It focuses on aspects such as risk, luck, long-term planning, uncertainty, savings, the difference between becoming wealthy and staying wealthy, and much more. This summary offers an insight into the motivations and thought processes of investors. Finally, it provides practical advice about how to become a better investor while avoiding traps that can lead to failure.

Summary Notes

Luck & Risk

“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.”

Managing money is a complex task, which means there are several contributing factors to your success. The greatest issue is pinpointing what is luck, what is a skill, and what is a risk. Fortunately, there are two pieces of advice that we can follow to make our life easier.

First, be careful who you admire and who you disapprove of. Judging a person’s character and achievements is not a straightforward process. Keep in mind that not all outcomes are the result of effort and decisions. Sometimes success is not the result of hard work, just like sometimes failure is not the result of idleness.  

Second, there are rules and there are exceptions to the rules. Sometimes, we focus on the lives and achievements of extreme examples, such as billionaires. Those are specific individuals, and they are exactly that - specific. Therefore, you should focus more on broad patterns of success and failure because those patterns are more likely to apply to you. 

Both success and failure can be bad teachers. Success can give people a false sense of security, whereas failure can make people doubt everything they have done. Regarding failure, it is of utmost importance that your financial life is established in a way you can take the hit of a bad investment.

Actions to take

Never Enough

“There is no reason to risk what you have and need for what you don’t have and don’t need.”

It appears that the wealthiest and most powerful people in the world haven’t fully grasped the meaning of “enough.” The reason for that is their inability to satisfy their ambition, which often seems to rise much faster than the level of their satisfaction. 

However, it is tremendously important to realize which goal post represents the end. Afterward, it might become too dangerous to try and fulfill your ambition, especially if such a pursuit requires a great amount of risk. Modern capitalism embraces generating wealth, but also envy. In your blind desire to outperform your peers, you risk too much unnecessarily. Life is more than the constant fight to achieve more - it involves enjoying what you do have. 

The battle to achieve and do more is a never-ending one that cannot be won. Therefore, at some point, it is advisable to accept that you might have enough.

Bear in mind that when you accept that, it doesn’t mean that you have settled for too little. On the contrary, it means that you’ve finally taken control of your appetite without making regrettable decisions driven by ego and overpowering ambition. 

Finally, consider the fact that there are things which are never worth risking, such as your reputation, your freedom, your friends and family, and your happiness. 

Actions to take

Getting Wealthy vs. Staying Wealthy

“But there’s only one way to stay wealthy: some combination of frugality and paranoia.”

Getting wealthy involves being out in the world, taking risks, and being optimistic that those risks will pay off. However, getting wealthy is only the first part of success. The second is staying wealthy. 

This can be challenging because staying wealthy requires stability, humbleness, and fear that what has been earned can easily be lost. Since luck can be a factor in your success, it’s important to accept it as something that may not be repeated. 

Staying wealthy is a form of survival that can give you longevity. To adopt a survival mindset, you should consider that earning good returns can make wonders of compounding if it continues uninterrupted for a longer period. Moreover, when making plans, always leave room for error because that will, in turn, leave room for some flexibility. 

By leaving room for error when making a plan, you are preparing to endure different potential outcomes without experiencing crippling failures. This endurance is what gives you longevity. 

Finally, nurturing sensible optimism will help you realize your bright future without blinding you to the possibility of obstacles on the road to success. 

Actions to take

Save Money

“Savings without a spending goal gives you options and flexibility.”

Acquiring and keeping wealth is undeniably linked to the simple concept of saving. Unfortunately, it is an idea that many people tend to overlook, so their focus is primarily on their income and investment returns. It’s a known fact that returns will help you make money, however, it’s also a known fact that the markets can be unpredictable, so there is always an air of uncertainty around investing. 

Savings, on the other hand, are more controllable. People with a high savings rate have lower expenses. Once you cover the basics of what would make your life comfortable, spending anything beyond is often a reflection of a big ego. Big spenders often spend their money to show the people around them that they are rich. People’s egos are frequently the key reason why people save so little. 

There are various ways in which you could save more. If you spend less, you’ll save more. If you desire fewer things, you’ll spend less on them. Desiring less means that your ego is not in control of you and that you don’t care about what others think of you. 

Sometimes people save money with a specific goal in mind. However, you don’t need a particular reason to save money. When you save without a specific purpose, you become more flexible and have more options. It means that you’ll be ready when a good business opportunity presents itself. 

Having savings will give you a lot of freedom, which is invaluable. With savings, you can easily change careers, retire early, or simply be carefree about many aspects of life. 

The flexibility you get from savings is incalculable.

Actions to take

You’ll Change

“People from age 18 to 68 underestimate how much they will change in the future.”

Change is the only constant in life. People experience changes in their desires, plans, expectations, and worldviews. While most people accept the fact that they don’t know what the future holds, very few can make long-term decisions and stick to them for a long period. 

Although people are very likely to acknowledge and admit how much they’ve changed, they are less likely to comprehend how much they will change in the future. This is what psychologists term the “End of Illusion”. Research has shown that adults often underestimate the level of change they will experience in the future.

Still, when trying to make somewhat long-term decisions regarding your financial planning, keep in mind that you should stay away from extreme ends of financial planning as a lot of people experience regret as a result of such extremes. 

The answer to avoiding regret lies in moderation. If you aim to have moderation in your savings, leisure time, and quality time spent with your loved ones, your long-term plan will likely not be spoilt by regret. 

Accepting the “End of Illusion” means that you accept change and that you are willing to move on.

Actions to take

When You’ll Believe Anything

“Stories are, by far, the most powerful force in the economy.”

As a person who manages their own money, bear in mind that you live in a world that is filled with stories. Just because you desperately wish for something to be true, it doesn’t mean that it is. 

The so-called “appealing fictions” deeply influence the way we think about investments and markets. Such an appealing fiction happens in situations when a person wants to find solutions but is challenged by “limited control and high stakes.” People are blinded by the possibility of earning high returns, so they hold a strong belief in something for which they have no grounds. In such situations, when making any investment plan, people should leave room for error. In fact, if the stakes are higher, the room for error should be wider. 

Since we cannot know everything, but we do want to have a complete view of the world, we tend to fill in the gaps of the narrative. The world of finance is uncertain and unpredictable, and yet a lot of investors demand forecasts. This can be attributed to people’s desire to live in a predictable and safe world, so as a result, we ask for confirmations of this from people we consider authorities on the subject.

Actions to take

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