Learnings from The Psychology of Money
As a consequence of the digital surge in the past few years and the subsequent increase of information on the internet, it is difficult to comprehend which piece of information/influencer to trust. The amount of information floating around the internet does create a labyrinth, which is distressing to navigate. As such, it is imperative to find someone you can trust, especially with money.
I recently read The Psychology of money, a book by Morgan Housel. The book very clearly explains the basics of finance, majorly about savings and investing. Morgan talks about human behaviour and how our attitude towards money is shaped. Below I have taken a few quotes from the book and added my reflections on those. It is not a summary of the book. These are a few key takeaways that I think will help make better financial decisions.
“The hardest financial skill is getting the goalpost to stop moving”
This is one of the most important lessons from the book. How much is enough? At what income level do you get your best lifestyle - the lifestyle you want to have and what happens after that? Surely, we need basic stuff. Forget about basic stuff, we also need stuff that makes us happy. And we need a specific income level to achieve that.
However, what happens when we meet our financial goals? Does greed to get more money impact our strategies to get that money? While it is important to have goals and strategies to achieve those goals, we should not try to pursue growth for its own sake. While considering strategies to gain more income, consider questions such as: what are we compromising for that extra marginal growth, are we going against our values to achieve these new goals? ‘Enough’ does not have to be too little, rather it is the amount that makes you feel satisfied. For instance, some people might have a great lifestyle with $abc amount, while others may prefer $abc+1, both are fine as long as you know what is ‘enough’ for you. So essentially, you need to differentiate between your goals and greed, and your wants and gluttony. Morgan talks about greed and gives an example of a successful businessman, who had achieved a lot in life but later went to prison for insider trading.
There is another quote from the book which summarises this well: “There is no reason to risk what you have and need for what you don’t have and don’t need.”
The point also ties to the next two quotes from the book.
"If you buy too many things from your money, all you have is too many things and no money."
“The only way to be wealthy is to not spend the money that you do have. It's not just the only way to accumulate wealth; it's the very definition of wealth.”
What is unnecessary shopping? Do we separate our needs from our wants? Do we separate our wants from unnecessary wants? Are we buying stuff to impress others or to fit in? And where does it stop? The upper limit of social comparison is very high, so when do we stop comparing our possessions with others?
Wealth is not the pair of shoes you own, it is the money you have in your bank account.
Morgan Housel also says that you do not necessarily need to be saving for a specific goal. For instance, I might think that I only need to save when I need to buy a specific thing, like a phone or a car. But instead, he says that we should save for the sake of saving and not just for some specific goals. Saving for just a phone/car would make sense in a predictable world, but our world is certainly nowhere near predictable.
The author mentions in the book that he wrote a letter to his son which says “You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does especially from the people you want to respect and admire you.”
“Things that have never happened before happen all the time.”
Humans are hardwired to hope. We think that things would never go wrong. We do not save because we feel we have stable jobs and money would keep coming in. However, unprecedented times in the last couple of years have been a twisting reminder that things sometimes do not go according to plan. The pandemic had affected so many industries and so many people lost their jobs. If we keep spending all that we earn, we would be left stranded in unforeseen times. As such, it becomes very important to have an emergency fund. Experts recommend around six months of an emergency buffer.
“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.”
This means that in the long run, we all just want to be happy. Some people derive happiness from working all day, others get it from spending time with family or travelling or pursuing a hobby that they like. If our ultimate goal is happiness (and we also need money at the same time), we should focus on using money to gain control of our time. For instance, if a person is stuck in an unsatisfying job but also does not have the means to take the risk to find some other job, then the money spent on unnecessary luxurious items is not worth it. And referring back to the previous point, savings give you a chance to wait for better job opportunities.
Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key. And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance.
Morgan Housel basically says that for compounding to work, there should not be any speed bumps. It works when you give an asset time to grow. A longer time makes a big difference. He gives an example of a tree and notes that a year makes little difference in the growth of the tree, while 10 years would make a big difference. In essence, time is the magic ingredient. It made me ponder that compounding works everywhere - in career, relationships, good habits, and exercise. It is not one workout that makes you fit, it is the compound effect of all the workouts.
Adopt a reasonable strategy, not an ultra-rational one. The plan that you are able to stick to is better than the one that looks good on a spreadsheet.
While talking about investing and saving, Morgan says that it is important to be reasonable than rational. We are emotional beings, not rational computerised machines, which means our decisions are affected by our emotions. For instance, it might be more rational to get a mortgage on your house than to buy the house one-off (if the interest rate is low and savings can be used to get a better return elsewhere) (also assuming that there is a large chunk of money to buy the house one-off), but having a big loan might weigh heavily on your mental health. When it comes to investing, do not go for risky options, if they take your sleep away. It does not have to be the best financial decision, it needs to be reasonable and within what you feel your risk tolerance is. At the end of the day, choose what makes you sleep better (I am not talking about a mattress here).
The financial game has one fundamental parameter - the time horizon. Never copy someone working with a different time horizon than you.
Everyone is working towards different goals - some people expect income from their portfolio, some expect capital gains, some may just be day trading, while others may have a combination of all. Understand your financial (long-term and short-term) goals, your appetite for risk, your time horizon, your values in investing (some people may prefer ESG stocks over coal mining stocks), and your expenses and then make investing decisions. Morgan Housel emphasises that your friend, a day trader, may be investing in some stock because he feels that the stock would move in a favourable direction in the short time he is in the market. However, the stock might not have a great value in the long run. And if you are a long-term investor, that stock might be your worst decision. Always do due diligence before investing.
We are amidst a fun time in the financial cycle. In a time when most of our life is impacted by money, we must meticulously handle our wealth. These are a few of several lessons in the book. If you want to learn more about money, I highly recommend reading The Psychology of Money. I am also very happy to go through the mechanics of money or unpack any of this further, so feel free to message me.