Psychology of Money - My Perspective and Key Takeaways

My Reasons

Psychology of Money by Morgan Housel is an international bestseller. I recently read this book after it was recommended by James Clear in his book “Atomic Habits.” Though I’ve always wanted to learn more about finance and money, I never got around to it. So, I picked up “Psychology of Money” to gain insights into investments and money management. However, this book offers much more than that; it teaches important life lessons intertwined with money matters using real-life examples. Learning from examples, in my view, is the most intuitive way to grasp concepts. Here, I’ll summarize what I’ve learned from the book, hoping it will be useful to you.

This book imparts important lessons: your habits, work ethic, routines, and attitude towards life and challenges ultimately determine your path and shape your identity.

The Lessons Learned

The main idea of this book is that success with money has less to do with intelligence and more to do with behavior. Behavior is hard to teach, even to very smart people.

Financial success is not solely rooted in hard science; rather, it’s a soft skill where your behavior holds more significance than your knowledge.

Morgan explains that when it comes to investment, no one is crazy. We all think we know how the world works, but we have only experienced a tiny part of it. Every financial decision makes sense to the person making it based on their own experiences.

Luck and Risk

One of my favorite chapters is “Luck and Risk.” Morgan suggests that every outcome in life is influenced by forces other than individual efforts. Luck and risk are similar, and you can’t believe in one without respecting the other.

Nothing is as good or as bad as it seems.

Morgan argues that we often overlook the role of luck in success stories. Studying individual cases can be risky because extreme examples like billionaires or failures often don’t apply to most people. Instead, looking for broad patterns of success and failure provides more useful insights.

Long-term Investing and Compounding

The book emphasizes the importance of long-term investing and the power of compounding. Small, consistent actions over time can lead to significant wealth accumulation. Patience is key to financial success. Housel uses examples from nature to show how small changes can lead to substantial growth, highlighting the need to be vigilant and adaptable in financial endeavors.

Retaining Wealth

Acquiring money is one challenge, but retaining it is another, requiring patience and humility. To maintain wealth, adopting a survival mindset is crucial. This mindset prioritizes three key principles: patience, maintaining a margin of safety, and cultivating a balanced personality that is optimistic yet cautious.

The Importance of Tail Events

Morgan devotes a chapter to the significance of tail events—extreme occurrences that happen rarely but have a huge impact. Success in investing depends on how you navigate these moments of fear and uncertainty.

Freedom and Time Management

Money can provide freedom, particularly in terms of time management. Financial resources allow you to have more control over your time, which is often linked to happiness. However, today’s generation struggles to disconnect from work, leading to a perceived loss of control over time despite being financially better off.

The Hidden Nature of Wealth

Morgan clarifies that wealth often resides in financial assets that haven’t been converted into tangible possessions. People often want to spend a million dollars rather than save it, missing the essence of being wealthy.

Saving and Humility

Saving money is not tied to your income level but to your humility. Beyond a certain income level, what you truly need is often beneath your ego. Saving without a specific goal gives you options and flexibility, allowing you to wait for opportunities and seize them when they arise.

Being Reasonable

The book suggests aiming to be reasonable rather than purely rational in financial decisions.

Outliers and Surprises

Things that have never happened before happen all the time.

Outlier events often have the most significant impact. The most noteworthy events in history are the extreme outliers. Economic history is full of surprises, showing the unpredictability of the future. Recognizing that the future may differ significantly from the past is a valuable skill.

Room for Error

The book provides examples to illustrate the concept of ‘Room for Error.’ Recognizing uncertainty, randomness, and chance as inherent aspects of life is essential. A margin of safety acts as a buffer against unforeseen circumstances. While taking risks is necessary for progress, risking everything is never justifiable.

The most important part of every plan is planning on your plan not going according to plan.

Poor Forecasters

Morgan discusses how people are poor forecasters of their future selves. While imagining goals is easy, envisioning them amid real-life stresses is much harder. Since the future is uncertain, avoid extreme financial planning. Strive for balance to prevent future regret and promote endurance. Accepting that we will change our minds is crucial. The key is to embrace change and adapt quickly.

Illusion of Control

Everyone has an incomplete view of the world, yet we create complete narratives to fill in the gaps. The illusion of control is more persuasive than the reality of uncertainty, so we cling to stories that suggest outcomes are within our control. This focus on what we know, while neglecting what we don’t, makes us overly confident in our beliefs.

Last Word

“The Psychology of Money” offers several life lessons: seek humility when things go well and forgiveness and compassion when they don’t, as situations are never as good or as bad as they seem. Respect the power of luck and risk to focus on what you can control. Use money to gain control over your time. To improve as an investor, extend your time horizon—time is the most powerful force in investing. My favorite wisdom is that uncertainty, doubt, and regret are common costs in finance; we must define the cost of success and be ready to pay it. Additionally, embrace room for error, which may seem conservative but can keep you in the game and prove invaluable.