The Psychology Of Money And Why It’s Important: Book Summary
“Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time.”Morgan Housel
If there is one great description of money, that above is it. And yet, the question arises, does money really give you control? Or does it steal it away?
And when we ask those questions, we almost always have to consider the bigger one; Why do we think about wealth and money the way we do, and how does that shape us? How can we make it so that we shape ourselves and our perceptions in ways that ultimately help us become better people, better spenders, and better savers?
These questions are difficult to answer, especially since people and money have such a complex relationship.
Still, that’s exactly what Housel has tried to do in his book, “The Psychology of Money”!
Housel utilizes 19 brilliantly crafted (and titled) chapters, along with an introduction and a postscript to tie them all up. He breaks down his theory into tiny tidbits of information to make them easier to swallow and understand. In this book summary, we will distill all the stories down to their key lessons.
The book starts off with two aspects of finance which act as the stepping stone to the rest of the book:
- Financial outcomes are driven by luck, independent of intelligence and effort.
- Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.
This soft skill is what the author calls the Psychology of money and it is greatly underappreciated.
Table of Contents
No One’s Crazy
“Your personal experiences with money make up maybe 0.00000000001% of what’s happened in the world, but maybe 80% of how you think the world works.”Morgan Housel – Psychology Of Money
People do crazy things with money, but no one is crazy. Our views of money are colored by the financial upheavals and certainty (or lack thereof) that we experience, and therefore, differ from others’ perspectives.
This means that not everything you think of while investing or saving can happen – because everything you think of is because of what you’ve experienced. Every decision people make is justified by taking in the information they have at the moment and plugging it into their unique mental model of how the world works.
Luck & Risk
Nothing is as good or as bad as it seems.Morgan Housel – Psychology Of Money
Always keep extraneous variables and possibilities of the future in mind, since “Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort…they both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes.”
In the end, it will always be more about the direction you choose and how you react to circumstances rather than the plan you had at the beginning that matters.
Another thing to keep in mind is that studying a specific person can be dangerous as we tend to only study the outliers. We study the extreme ends, a really successful person or someone with massive failures, extreme examples are often the least applicable to other situations, given the varying external factors and specific situations. In the words of Bill Gates “Success is as a lousy teacher. It seduces smart men to believe that they cannot lose.”
You should like risks because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time
“There is no reason to risk what you have and need for what you don’t have and don’t need.”Warren Buffet
The psychology of “Never Enough”, wherein the risk part of luck and risk is challenged one too many times because the wealth of even very wealthy people was “not enough”.
The hardest financial skill is getting the goalpost to stop moving. In today’s time, the generation of wealth also accompanies the generation of Envy. Envy acts as a strong force that pushes us to have more and more. One step forward pushes the goalpost two steps behind and we are just running in an endless marathon.
Social comparison is a huge problem, it is a battle that cannot be won because no matter how well you do in life there is always someone richer. The only way to win is to accept that you might have enough.
“Enough is not too little”, the notion of capping ourselves to a ceiling of “enough” sounds counterproductive since we are here to grow, but in reality, its the opposite, “Enough is realizing that an insatiable appetite for more will push us to the point of regret“.
“Many Things are never worth risking”. To protect what is most invaluable for you, be it happiness, reputation, family, love, etc. the best shot to keep them is to know when to stop taking risks that might harm them. Knowing when you already have enough.
“Our minds are not built to handle the reality that compounding leads to logic-defying results.”Morgan Housel – Psychology Of Money
Warren Buffett’s fortune isn’t due to just being a good investor. Its the longevity that plays a key role. Out of his net worth of $84.5 billion $84.2 billion was amassed after he turned 50 years old. The counterintuitive nature of compounding leads even the smartest of us to overlook its enormous power.
Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild
The compounding effect is not limited to the finance world, it plays a huge role in habit building and other aspects of our lives. For its impact on habits do check out the Top-10 Lessons from Atomic Habits.
Getting Wealthy vs. Staying Wealthy
“Good investing is not about making good decisions. It’s about consistently not screwing up.”Morgan Housel – Psychology Of Money
There’s only one way to stay wealthy: some combination of frugality and paranoia. Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risks. It requires humility, and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
You should follow the strategy of staying in the game for the longest time and let the compounding kick in. Compounding relies on good returns sustained uninterrupted for the longest periods.
You plan, God Laughs is a saying everyone can relate to in life. Planning is great but they only work if they can survive their encounter with the real world. The most important part of planning is to plan on the plan not going according to the plan. A good plan always has room for error which comes in form of a frugal budget, flexible thinking, and a loose timeline.
A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital. Sensible Optimism is being self-aware that down the line the odds will even out even if they are not in your favor at the moment.
Tails, You Win!
“Long Tails drive everything.”Morgan Housel – Psychology Of Money
Long-tails, the farthest ends of the distribution of outcomes, have tremendous influence in finance, where a small number of events can account for the majority of outcomes. This can be hard to deal with as it is not intuitive that an investor can be wrong half the time and still make a lot of money.
You need to drill the point in your head that it is normal for a lot of things to fail, all that matters is that when everything adds up you come out at the top. It is important to not tunnel vision at every investment and make it a win and instead try to optimize the bigger picture.
“Controlling your time is the highest dividend money pays.”Morgan Housel – Psychology Of Money
As found out by Angus Campell, a psychologist in the 1900s, in his research Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing or happiness than any other objective thing in life. More than your salary, house, or the prestige of a good job it is the control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
Man in the Car Paradox
“No one is impressed with your possessions as much as you are.”Morgan Housel – Psychology Of Money
The paradox here is that people tend to want wealth to signal to others that they should be liked and admired. But in reality, those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired. Possessions are the lowest form of a dividend that money pays.
It’s a subtle recognition that people generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine. If respect and admiration are your goals, be careful how you seek them. Humility, kindness, and empathy will bring you more respect than horsepower ever will.
Wealth is What You Don’t See
“Spending money to show people how much money you have is the fastest way to have less money.”Morgan Housel – Psychology Of Money
We tend to judge wealth by what we see because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Instagram photos.
Our perception of wealth is very flawed. In reality, wealth is a financial asset that is not converted into the materialistic stuff around us. It is hidden away and hence harder to contextualize.
“Building wealth has little to do with your income or investment returns, and lots to do with your savings rate.”Morgan Housel – Psychology Of Money
The value of wealth is relative to what you need. A high savings rate means having lower expenses than you otherwise could and having lower expenses means your savings go farther than they would if you spent more. Personal savings and frugality are parts of the money equation that are more in your control and have a 100% chance of being as effective in the future as they are today.
Savings can be created by spending less. You can spend less if you desire less. And you will desire less if you care less about what others think of you. Savings without a spending goal gives you options and flexibility, the ability to wait, and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms
Reasonable > Rational
“Aiming to be mostly reasonable works better than trying to be coldly rational.”Morgan Housel – Psychology Of Money
Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.
Investing has a social component that’s often ignored when viewed through a strictly financial lens and this is often overlooked.
“History is the study of change, ironically used as a map of the future.”Morgan Housel – Psychology Of Money
History is often a misleading indicator of how the future will look since it fails to take into account structural changes in society. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff and not for specific trends, specific trades, specific sectors, specific causal relationships about markets, and what people should do with their money.
The most economically impactful events in history are often outliers like wars, innovation, disasters, etc. Their unprecedented nature means we won’t be prepared for them, which is part of what makes them so impactful so overly relying on historical data is dangerous.
Room For Error
“The most important part of every plan is planning on your plan not going according to plan.”Morgan Housel – Psychology Of Money
Room for error or redundancy is the only effective way to safely navigate a world that is governed by odds, not certainties. You can’t guarantee that your plan will go to plan. It’s important to have margin room for error, in case your plan doesn’t work. Room for error is often misunderstood as a conservative hedge but it’s usually the opposite in practice. It lets you endure the randomness and lets you stay long enough so that the odds are in your favor.
One way to protect yourself from uncertainty is to avoid a single point of failure. The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.
“Long-term planning is harder than it seems because people’s goals and desires change over time.”Morgan Housel – Psychology Of Money
An underpinning of psychology is that people are poor forecasters of their future selves. With so many unknown variables(Including us) it can be difficult to plan for future financial goals and to this end you should avoid extreme ends of financial planning
Do not rely completely on the past – and in a more general way, not to rely on one thing period, since everything changes (even you). It is worth accepting that we might change our minds. We should be prepared to do this.
“Everything has a price, but not all prices appear on labels.”Morgan Housel – Psychology Of Money
Everything has a price, and in a lot of cases figuring out what that is and being willing to pay it is the key. The real cost of successful investing is volatility, fear, doubt, uncertainty, and regret, all of which are easy to overlook until you’re dealing with them in real-time. Thinking of market volatility as a fee instead of a fine is an important part of developing the kind of mindset that can let you wait for investment gains to work in your favor.
Define the cost of success and be ready to pay for it. Because nothing worthwhile is free.
You and Me
“Beware taking financial cues from people playing a different game than you are.”Morgan Housel – Psychology Of Money
People don’t always invest or generate wealth in the same way. If you keep that in mind you’ll be able to ignore unneeded advice and focus on your own game.
It’s hard to grasp that other investors have different goals than we do because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own. A takeaway from this point is to be mindful of the short and long-term success you would like for yourself. Don’t get caught up in what other people may be doing, playing a different game than your own.
The Seduction of Pessimism
“Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.”Morgan Housel – Psychology Of Money
Let us try to understand why the world is becoming more pessimistic every day but first let us look into what actually is optimism. The more meaningful definition of optimism is “A belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.”
Having money is convenient, but it can also mean that you are vulnerable to economic shocks. These things tend to happen everywhere and flare the attention of everyone. Pessimists often look at current trends without taking into account how markets can adapt.
Progress happens too slowly to notice, but setbacks happen too quickly to ignore which, in turn, sensationalizes the pessimism a lot more and makes it more seductive. The sort of sting of pessimism prevails while the powerful pull of optimism goes unnoticed.
When You’ll Believe Anything
“Appealing fictions and narratives are more powerful than statistics.”Morgan Housel – Psychology Of Money
Just like children who have very limited information and fill in the voids with their creativity Everyone has an incomplete view of the world and we form a narrative to fill the gaps. Wanting to believe that we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated and solved. It’s easy to think that we’ll dictate the course of our future when in reality, we’re largely in the dark about what is going to happen. The more power we feel like we have in a situation, the more likely it is that we will cling to narratives that maintain this illusion.
If you really want something to be true, then their probability of belief in a story that overestimates its probability is stronger.
A Concluding Note
The Psychology of Money is a treatise on the relationship between man and money and improving or analyzing that very relationship. It chronicles psychology more thoroughly than other finance self-help books and is, therefore, brings a unique and fresh perspective on the topic.
It is a brilliant guide on how to improve yourself, even if it doesn’t include the factual side of the topic in as great detail as other finance books do. All in all, Morgan Housel presents a book that does teach one the tricks to making money and saving money; Less ego, more wealth! Irrespective of how old your relationship with money is, be it a student fresh out of University or someone working for a few years Psychology of money is a must-read and would surely change your perspective about wealth.
Check out The Psychology of Money by Morgan Housel below