Valuable Lessons From the Psychology of Money by Morgan Housel
Master your mind to master your money
Overview of The Psychology of Money
This book uses stories of real world people to illustrate points to help readers change their behavior and make better financial decisions. In particular, it teaches financial concepts such as saving, spending, investing, debt, and retirement planning.
Award-winning author Morgan Housel is most known for his writings on personal finance. He's a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers. And he won the New York Times Sidney Award as well as a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism.
Housel is also a partner at the Collaborative Fund - which is a collection of fund managers looking for profitable investments that also do good in the world. I'm not sure how their performance is, but they have an impressive collection of fund managers contributing to their brain trust. If you want to read his latest thoughts, his blog is here.
Like most top-selling personal finance books, this one teaches basic financial skill in attempt to get people better financial outcomes by retirement. The Psychology of Money is a bit basic for hardcore readers of barbellalpha.com, but if you're just starting out, this book can help the average person achieve a better financial outcome in life by increasing investment returns over a long period of time.
For a recap of his bestselling book on financial success, continue reading.
Gaining Experiences with Money Makes for Better Investment Decisions
As we learned in Chapter 2, there are many different ways to save money. Saving is often associated with putting something away in a jar. But there are many other types of savings, including setting aside money for future expenses, having a rainy day fund, and even just making sure you always have some cash on hand.
In Chapter 3, we looked at the difference between a budget and a plan. A budget is simply a list of things you want to spend money on; a plan is a set of goals that you work toward over time. He discussed why it is important to develop both a frugal budget and a plan, and we looked at several examples of budgets and plans.
We also explored the importance of understanding where our money goes each month. This includes tracking every purchase we make, whether it is online or offline. By keeping track of our purchases, we can see exactly where our money goes, and we can adjust our spending habits accordingly.
Chapter 4 focused on the topic of credit cards. Credit cards allow us to pay for items without immediately paying cash. However, credit card companies charge interest on outstanding balances, meaning that we end up paying more over time. As long as we keep our balance low, though, credit cards can be useful tools.
Chapter 5 examined the concept of debt. Debt is sometimes necessary, but it is usually best avoided. There are many reasons why debt is a problem. One reason is because it makes us feel like we don’t have enough money. Another reason is because it forces us to live beyond our means. Finally, it creates problems down the road. When we owe money to others, we have less money left over to spend on ourselves.
The Magic Ingredient in Compounding Is Time
Compound interest is the most important concept in investing. Housel calls it "confounding compounding" but compounding need be confounding.
His example in the book is Warren Buffett. Of his $84.5 billion net worth at the time of publication, $81.5 Billion Came After His 65th Birthday.
Now we don't need $3 billion to achieve financial independence, but it's important to understand how compounding works.
Over a long time horizon, interest can compound to make an extraordinary return. For example, if you put away $100 per week for 40 weeks, you'd have $3,200 saved. At 5% interest compounded annually, you'd have about $65,000 by the time you retired in a few decades.
Just a little bit of savings can create a huge impact down the road.
Getting money vs. keeping money
A correct money mindset is important in our financial life. Getting money involves taking risks, whether it's going to college to get a better job, or leaving that job to start your own business.
But keeping money involves avoiding risk and bad decisions. I'm reminded of Warren Buffett's rules of investing: #1 Do not lose money, #2 Never forget rule #1.
Finding out what 'enough' is
A Lot of People Think Saving Money Is Boring
Many people think that saving money just involves sitting around counting pennies. They believe that saving is boring, and that it takes too long. They feel that spending is fun, and that they shouldn't deprive themselves of anything they want.
But saving money doesn't have to be boring. In fact, it's one of the best ways to enjoy life. When you spend less than you earn, you have more money left over to do whatever you want. You can go out to dinner, take a vacation, donate to charity, or pay off bills. You can splurge on yourself once every few months. Or you can use your extra cash to help others.
Money doesn't buy happiness, and there are plenty of people who make more money than you do. But there are many ways to measure success in life. One way is to look at how much money we spend versus how happy we feel. We've found that those who are happiest tend to live within their means, while those who are less happy often overspend.
In fact, according to research conducted by the University of Chicago Booth School of Business, being able to say no to spending money is one of the most important factors in determining whether or not someone is happy.
In a study published in the Journal of Consumer Research, researchers asked participants about their feelings of satisfaction and self-esteem based on different levels of income. They discovered that the number one factor influencing both measures of well-being is having enough money to meet basic needs.
The researchers concluded that "the ability to say no to spending is critical to achieving happiness."
So why do some people find themselves struggling financially even though they work hard? And why do some people seem to have everything they want, while other people struggle to keep up with bills and credit.
That's a good question. But how do you know what's enough?
We need to think about the lifestyle we want to live when we retire, how much that will cost, and how much we need to invest and what rate of return you'll need to get there.
Leave room for error
When coming up with these calculations, you'll want to leave a little room for error. Maybe over the next 30 years we won't make a 10% average return on our stocks. And if that's the case, we don't want to be short and impede our lifestyle choices.
For example if you find you need to save $500 a month to fund your retirement lifestyle while earning a 10% rate of return, you may want to up it to $600 a month. That way if returns don't quite live up to expectations... Or you get more conservative with your investments as your wealth grows... You will still meet those retirement goals.
Or if you're like most people, you probably don't know how much money you'll have when you retire. And even if you do, you might not understand compounding. But there are some things that you can control. You can make sure that you save enough each month. You can avoid debt. And you can invest wisely. If you do those three things, you'll end up with a nice nest egg.
Knowledge Meets Its Match with Emotion
Emotions are powerful motivators. Because of this, people often believe that if they knew all the information, they'd behave better. But research shows that knowing doesn't always mean acting; sometimes it just makes people feel things. A recent study showed that people who knew that they could lose money if they gambled weren't much less likely to gamble than those who didn't know they could lose money. And while some people might say that they wouldn't gamble if they knew they couldn't win, others would say they'd continue gambling anyway because they enjoy it.
So, while knowledge may motivate us to take action, it doesn't always translate into behavior.
It's important to make proper financial decisions in real time to avoid an accidental impact on our future savings. And Morgan Housel's latest book helps people realize the psychological impact of money.
The correct lesson to take away from this book is that even though we know what we need to do, behavioral finance says many will make poor decisions... Especially in the event of a stock market crash.
This is important to remember right now as the forces in finance push the market lower. But it's important to stick to your plan. Many people talk about how "time in the market" is more important than "timing the market."
And in fact, with some stocks down 80% or more it could be a good life business decision to look into these stocks for asymmetric growth opportunities. These are the kind of investments that could go to $0 and you'd lose 100%, but they have an equal chance of going up 1,000% or more. We want these kind of investments to fill the ends of our barbell portfolios. And there are plenty of these opportunities in the market right now.
Summary
This book can help the average person achieve a reasonable level of independence financially. And shows how any reasonable investor can beat the money game with proper asset allocation and conservative investing strategies.
Morgan Housel is right. And this top-selling book is written for that person... The person who wants to take a hands on approach to investing, but doesn't want to spend all their time following the markets. If that sounds like you, please read the book for all the details to successfully implement these strategies... And to master your mind around money.
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