As part of our continuing series where I share highlights of some of my favorite books that have shaped the way I approach business and leadership, I’d like to introduce you to The Psychology of Money by Morgan Housel.
Money. Many of us have a love-hate relationship with it. Our personal experiences with money make up a small fraction of what has actually happened in the world, but it influences a great deal of how we think the world works.
Money is often considered a math-based area of study full of formulas and black-and-white answers.
The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness challenges us to consider a bigger view of money and how financial decisions are driven by our upbringing, our perspective of the world, our ego, and the stories we tell ourselves about money.
Top 6 Takeaways
1. Volatility is the psychological fee we pay for returns on our money.
Wealth can’t be grown in the stock market without paying the price of volatility. This “psychological fee” can be really high unless we balance other perspectives on money and withstand the avalanche of information we receive on a daily basis.
2. It is difficult to know when enough is enough.
We have all seen stories of professional athletes, celebrities, and wealthy people who have lost it all due to an unrestrained desire for more, pushed to the point of regret. For some people, it is never enough, or similar to eating, we don’t realize it is enough until we’ve pushed ourselves and have a stomach ache (regret).
3. Two of the hardest financial skills are learning to stop moving the goalpost and social comparison.
Two professional athletes on the same sports team (who are already the top 1% of the top 1%) can make significantly different amounts of money. Jeff Bezos may make more money in a single year compared to Warren Buffet, but that does not mean that Buffet doesn’t have enough.
Capitalism has done wonders for creating wealth, but it also has established a market for envy. Housel says, “Don’t risk what you have and need for what you don’t have and don’t need.” I am a believer in the capitalistic ideal of creating wealth, but I also recognize the value of knowing when enough is enough, and I feel we can channel our “more than enough” into greater opportunities for others.
4. Our actions with money are only crazy from our own viewpoint.
Our individual views about money are shaped by our different backgrounds, childhoods, parents, education, and worlds we were born into. Each of these things give us unique perspectives and values when it comes to money. In a simplistic example, we often see spenders vs. savers. One might see leveraging an investment as a very rational action, while another person may see hiding money under their mattress as equally rational.
5. “Black Swan events” shape our society but are highly unpredictable.
Black Swan events are outlier, unpredictable events that have had extreme impacts on society, such as the Great Depression, World War II, the COVID-19 pandemic. They might look predictable in hindsight, but in the moment, their disruption was never fully planned for. One thing is for sure: There will be more Black Swan events in the future.
6. While it may seem like pessimism provides protection, optimism helps consider longer time horizons.
Be careful not to view pessimistic people as the smartest ones in the room. Pessimists have the benefit of recency bias and sudden, distinct setbacks. Optimists see things over longer time periods and consider broader trends and cycles.
3 Money Lessons from History
Housel’s book often teaches through storytelling. These are a few of his stories that I found interesting in regard to our society’s view on money and its place in our lives.
Luck and Risk are Siblings
Almost every outcome in life is guided by forces other than individual effort.
Bill Gates went to one of the only high schools in the world that had a computer. The school only had the computer because a retired Navy pilot joined as a teacher and had access to the GE mainframe computers in 1968. This teacher convinced the Parent Teacher Association to use money from a rummage sale to lease the computer.
Bill Gates had a 1 in a million chance of being in that school.
Gates had two other friends at school, Paul Allen and Kent Evans, who both had a love and fascination with the computer. They spent hours and hours together working on the computer and learning the amazing functions of this electronic device. Many of us have never heard of Kent Evans because he never made it out of high school. He died in a mountaineering accident while in high school.
Kent Evans had a 1 in a million chance of dying in the mountains as a high schooler.
These are both examples of pure chance or luck.
On the risk side, Cornelius Vanderbilt (railroads) and John Rockefeller (oil) were well known for their disregard for laws that existed at the time. Their entrepreneurial spirit is applauded today as “cunning business smarts.” In many ways, we praise Vanderbilt and Rockefeller for pushing the law with the same kind of passion that we criticize companies like Enron for.
In both situations, which one was lucky, and which one was risky?
The Power of Compounding
The secret of compounding is not investment return. It is time.
Take Warren Buffet. From 1965 through 2021, Buffet’s average annual investment returns was 22%. His net worth at age 90 was $84.5 billion. He started investing in his 20s, and if he had stopped at age 60, his net worth would be $11.9 million – 99% less than his net worth today.
While Buffet is the richest investor of all time, there is another investor, Jim Simons, who has averaged annual investment returns of 66% since 1988. As of December 2022, Simons has a net worth of $21 billion, which is 75% less than Buffet. The difference is Simons started investing at age 50.
This is more money than most of us can ever dream of. But it shows the power of compounding. Think about how you could set the stage for yourself or your kids to benefit from compounding.
A couple of ideas to consider:
- Match your kids’ annual investing to encourage their commitment and experience with saving. It could be a percentage match (like 50-100%) or up to a specific dollar amount.
- Allow your kids to loan money to you, and provide them with daily interest to compound their money. Perhaps instead of an allowance, you give them an opportunity to loan you money they earn or receive as gifts. For example, calculate a daily interest amount based on a 10-12% annual interest rate, and help them watch their $100 become $150 in about three years and over $200 in about six years.
Getting vs. Staying Wealthy
There are a million ways to get wealthy today and limited ways to stay wealthy. As a point of reference, consider that 40% of publicly traded companies effectively lose all their value over time, and the annual Forbes 400 wealthiest individuals list has about a 20% turnover each decade (not including transfers due to death or estate planning).
There are two different skills involved with getting money compared to keeping money.
Getting money involves putting yourself out there, taking risks, and jumping on opportunities. Keeping money involves some frugality and healthy fear that what you have can be taken away.
There is humility in recognizing that some of what you have made is partially attributed to factors outside yourself.
Getting wealthy is less about investment returns or income. It has more to do with your savings rate (earning or keeping more than you spend). A generation ago, the U.S. experienced an oil production crisis. We were outspending our oil production, which was using up our reserves. Stopping oil spending alone was not going to solve the problem due to how oil and gas had changed society. The fastest way out of this predicament was to reduce consumption and increase our efficiency.
Our consumption never stopped, but the rate of spending decreased, and our efficiency increased. What happened was large investments in more fuel-efficient cars, a social campaign to encourage riding bikes and public transportation, and raising awareness of our individual responsibility to this “overspending.”
Staying wealthy comes down to three important things:
- Don’t risk more than you can afford to lose or that you can cover by liquidating growth assets to meet a financial surprise.
- Things don’t always go as planned. Build a margin of safety with room for error.
- Maintain a two-headed personality: optimistic of the future, with a healthy paranoia that the short term will involve downturns and challenge your optimism.A key trait for long-term success, financial and otherwise, is a survival mentality. Long-term success is not a result of brains, insight, or a growth mindset, but more of a belief that yesterday’s success does not guarantee tomorrow’s success.
Parting Words of Wisdom
The Psychology of Money taught me that our behavior with money is more important than our intelligence about finance.
A few final takeaways:
- Be careful who you praise, admire and look down on.
- Focus less on specific individuals and case studies, and look more to broad patterns.
- When judging people (and ourselves), remember that some people are born into families that encourage education. Some into war situations. Some into flourishing economies. And some into destitute places and circumstances. We can’t control where we come from, but it shapes who we become.
- Not all success is due to hard work, and not all poverty is due to laziness.
- The power of compounding is more dramatic than we realize.
I’ll leave you with a quote from the book that I think of often:
“Financial success is not a hard science. It’s a soft skill, where how you behave in more important than what you know.” – Morgan Housel