Book Summary - The Psychology of Money (Morgan Housel)\

Many finance books focus on the technical aspects of money and investment, e.g. how to select stocks or build a portfolio. In this book, Morgan Housel addresses the often-neglected fact that we are irrational, emotional beings, not ROI-optimizing machines. Your financial success depends more on your soft skills (how you manage your psychology and emotional impulses) than your technical skills on financial analyses, market rules/laws. In this free version of The Psychology of Money summary, we’ll outline the key highlights from the book.

Morgan Housel has been writing about finance since 2008. Through his research, he realized that luck and human behaviors play a much bigger role in determining one’s financial success than spreadsheets and analyses. In this book, he shares his discoveries, beliefs and approach to money, using a series of short stories and chapters to presents 18 related biases, flaws, behaviors or attitudes that affect your financial outcomes. These jointly make up your psychology of money.

Understanding the Psychology of Money

We’ll now zoom in on 3 of the 18 concepts in detail, and briefly outline the remaining ideas. Do get a the full version of The Psychology of Money summary for a detailed break down of all 18 chapters.

People have Different Views about Money

We think we know how the world works, but our worldview is actually very limited. Each of our personal experiences reflect just a tiny fraction of the collective human experience over the generations.

Our worldview is shaped by our life experiences. So, people from different generations, background and life experiences perceive money differently. Someone who grew up with poverty/ starvation will interpret “risks” and “rewards” differently from someone from a wealthy family who never had to worry about money. Someone who survived WWII or lived through a recession would see money in a different light from someone who grew up in a stable economy. Others’ financial decisions may seem crazy to you, but it makes perfect sense to them. You’ll never understand someone’s financial insecurities just by reading about it; you must experience it personally to fully grasp it.

In fact, most of our modern investment/financial tools are actually very new. For example, USA’s 401(k)—the backbone of their retirement planning—was introduced in 1978, and the Roth IRA was added only in 1998. Even index funds were developed only in the 1970s. We’ve only had <50 years to master these new tools/concepts, making us collectively inexperienced in the modern money game.

Luck & Risk have a Bigger Impact than Financial Skills

We tend to over-emphasize skills and effort, when outcomes are often influenced more by luck and risk.

No success/failure is purely due to hard work or sound decisions. Your circumstances define the opportunities available to you. Every action you take also has unintentional ripple effects. Take Microsoft for example. Bill Gates was smart, hardworking, and had a rare affinity with computers. However, he was also lucky to attend one of the only high schools in his time with a computer (which Housel estimates to be a 1 in a million chance). Gates eventually co-founded Microsoft with his classmate Paul Allen. They had a close friend, Kent Evans, who shared their skills and passion with computers. Yet, Evans wasn’t a part of Microsoft because he died on a mountaineering accident, another rare event. Both Gates and Evans were smart and loved computers, but they fell on 2 extreme ends of luck and risk.

Luck and risk exist in every situation. To be more objective:

Don’t draw conclusions from extreme examples, since they’re likely to be strongly influenced by luck/risk and hard to replicate. Look for broader patterns across many examples. For example, it’s hard to be the next Warren Buffett, but it’s much easier to gain time and money freedom.
Remember: things are never as good or as bad as we think. Don’t be too quick to judge people, including yourself. Nothing (e.g. hard work, pride) is 100% good or bad. When things are going well, know that you’re not invincible. When things are going badly, know that you’re not a disaster.

Leverage the Power of Compounding

Warren Buffett may be a brilliant investor, but his biggest secret isn’t his investment strategy or formula; it’s time. Unlike most people, he started investing when he was 10 years old, so by the time he was 30 (when most people start investing), he already had a net worth of $1million. Even then, $81.5 billion of his $84.5 billion net worth came after his 65th birthday. That’s the power of compounding and time.

Scientists now estimate that there were 5 ice ages in Earth’s history (not just one). They theorize that a small sliver of ice left over from a cool summer is enough to trigger compounded changes in global temperatures to cause an ice age.

Compounding only works if you can give an asset years to grow, like an oak tree slowly reaching maturity. You don’t need high returns; you need decent and consistent returns.

Don’t take big risks in hope for the highest-possible returns. Go for decent returns that can be sustained over a long time.
Extend your time horizon: start as early as possible, and wait for the money to grow.

Other Elements in the Psychology of Money

Here’s a quick overview of all 18 biases, flaws, behaviors or attitudes that jointly form our psychology of money. You can get more details of each idea from our full book summary:

Basically, the ideas above center around 3 main themes: (i) we’re overconfident of our knowledge of and control over the market, (ii) the surest way to make money from investments is through compounding (with consistent returns over a long period of time), and (iii) stick to your financial goals instead of trying to impress others. Know when you have enough, and realize that the biggest value of money isn’t to buy luxury goods but to gain control over your time and life.

Housel ends off by sharing his family’s financial approach, which sums up his views about finance and money:

Housel’s family has 1 main financial goal: independence or the ability to do what they want on their own terms. They’re contented with a decent house, a car, and a modest lifestyle. As their income increased over the years, they saved most of it because they were already comfortable with their lifestyle. They enjoy free/low-cost activities like exercising and reading, and don’t see the need to spend money to impress others. In short, they stopped moving their goalpost.
In fact, they bought their house without a mortgage. This makes no financial sense, but it gives them a peace of mind which they value above all else. Housel also maintains 20% of his assets (besides his home) in cash as a safety net.
Housel started out as a stock picker but no longer invests in individual stocks. All his stock market investments are in low-cost index funds. So long as he’s financially independent, he doesn’t care whether he beat the market or maximizes his returns.

Obviously, the approach above works for Housel, but it may not work for you. The key is to get clear on your own goals, design your own game accordingly, and manage your relationship with money so you can have a happy and fulfilling life.

Getting the Most from The Psychology of Money

In this article, we’ve briefly outlined some of the key insights and strategies you can use to achieve desired change. For more examples, details, and actionable tips to apply these strategies, do get our complete book summary bundle which includes an infographic, 13-page text summary, and a 26-minute audio summary.

This is an easy-to-read book written in a light, conversational style. Morgan Housel presents short stories and empirical research to explain each of the overlapping concepts above. The book also includes a postscript about why consumers in the USA think the way they do. Do get a copy of the book for the full details, or check out more articles by Housal at collaborativefund.com.

About the Author of The Psychology of Money

The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness is written by Morgan Housel–a partner at The Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal. He is a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers, winner of the New York Times Sidney Award, and a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism.