Highlights for The Psychology of Money by Morgan Housel

0. Introduction

Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence.

1. No One’s Crazy

Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works.

The economists found that people’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation—especially experiences early in their adult life.

No one is crazy—we all make decisions based on our own unique experiences that seem to make sense to us in a given moment.

2. Luck & Risk

Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort.

If you give luck and risk their proper respect, you realize that when judging people’s financial success—both your own and others’—it’s never as good or as bad as it seems.

Focus less on specific individuals and case studies and more on broad patterns.

When things are going extremely well, realize it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly.

As much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures.

3. Never Enough

There is no reason to risk what you have and need for what you don’t have and don’t need.

If expectations rise with results there is no logic in striving for more because you’ll feel the same after putting in extra effort.

It [social comparison] is a battle that can never be won, or that the only way to win is to not fight to begin with—to accept that you might have enough, even if it’s less than those around you.

“Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret.

Your best shot at keeping these things [reputation, freedom and independence, family and friends, love, happiness] is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.

4. Confounding Compounding

If something compounds—if a little growth serves as the fuel for future growth—a small starting base can lead to results so extraordinary they seem to defy logic.

It [good investing] is 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.

5. Getting Wealthy vs. Staying Wealthy

Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risk. 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.

Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.

The more you need specific elements of a plan to be true, the more fragile your financial life becomes.

Room for error—often called margin of safety—is one of the most under appreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline— anything that lets you live happily with a range of outcomes.

You need short-term paranoia to keep you alive long enough to exploit long-term optimism.

6. Tails, You Win

Long tails—the farthest ends of a distribution of outcomes—have tremendous influence in finance, where a small number of events can account for the majority of outcomes.

It is not intuitive that an investor can be wrong half the time and still make a fortune. It means we underestimate how normal it is for a lot of things to fail.

Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.

A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.

Part of why this [tails drive success] isn’t intuitive is because in most fields we only see the finished product, not the losses incurred that led to the tail-success product.

7. Freedom

The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.

Take it from those who have lived through everything: Controlling your time is the highest dividend money pays.

8. Man in the Car Paradox

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.

If respect and admiration are your goal, be careful how you seek it. Humility, kindness, and empathy will bring you more respect than horsepower ever will.

9. Wealth is What You Don’t See

Wealth is financial assets that haven’t yet been converted into the stuff you see.

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.

Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.

10. Save Money

Personal savings and frugality—finance’s conservation and efficiency—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.

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.

People with enduring personal finance success—not necessarily those with high incomes—tend to have a propensity to not give a damn what others think about them.

Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.

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.

If you have flexibility you can wait for good opportunities, both in your career and for your investments.

11. Reasonable > Rational

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.

The reasonable investors who love their technically imperfect strategies have an edge, because they’re more likely to stick with those strategies.

12. Surprise!

The majority of what’s happening at any given moment in the global economy can be tied back to a handful of past events that were nearly impossible to predict.

The correct lesson to learn from surprises is that the world is surprising. Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next.

The further back you look, the more likely you are to be examining a world that no longer applies to today.

The further back in history you look, the more general your takeaways should be. 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.

13. Room for Error

Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor.

The idea is that you have to take risk to get ahead, but no risk that can wipe you out is ever worth taking.

You can plan for every risk except the things that are too crazy to cross your mind. And those crazy things can do the most harm, because they happen more often than you think and you have no plan for how to deal with them.

Predicting what you’ll use your savings for assumes you live in a world where you know exactly what your future expenses will be, which no one does.

In fact, the most important part of every plan is planning on your plan not going according to plan.

14. You’ll Change

An underpinning of psychology is that people are poor forecasters of their future selves.

It’s hard to make enduring long-term decisions when your view of what you’ll want in the future is likely to shift.

The End of History Illusion is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.

We should avoid the extreme ends of financial planning. Assuming you’ll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you’ll one day find yourself at a point of regret.

Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.

Sunk costs—anchoring decisions to past efforts that can’t be refunded—are a devil in a world where people change over time. They make our future selves prisoners to our past, different, selves.

Embracing the idea that financial goals made when you were a different person should be abandoned without mercy versus put on life support and dragged on can be a good strategy to minimize future regret.

15. Nothing’s Free

Most things are harder in practice than they are in theory. Sometimes this is because we’re overconfident. More often it’s because we’re not good at identifying what the price of success is, which prevents us from being able to pay it.

Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.

It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

16. You & Me

An idea exists in finance that seems innocent but has done incalculable damage. It’s the notion that assets have one rational price in a world where investors have different goals and time horizons.

When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.

Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.

Bubbles aren’t so much about valuations rising. That’s just a symptom of something else: time horizons shrinking as more short-term traders enter the playing field.

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 here is that few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are.

17. The Seduction of Pessimism

Optimism is the best bet for most people because the world tends to get better for most people most of the time.

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.

Pessimism just sounds smarter and more plausible than optimism.

Money is ubiquitous, so something bad happening tends to affect everyone and captures everyone’s attention.

Problems correct and people adapt. Threats incentivize solutions in equal magnitude. That’s a common plot of economic history that is too easily forgotten by pessimists who forecast in straight lines.

Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.

It’s easier to create a narrative around pessimism because the story pieces tend to be fresher and more recent. Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together.

18. When You’ll Believe Anything

Stories are, by far, the most powerful force in the economy. They are the fuel that can let the tangible parts of the economy work, or the brake that holds our capabilities back.

The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.

There are many things in life that we think are true because we desperately want them to be true. I call these things “appealing fictions.” They have a big impact on how we think about money—particularly investments and the economy. An appealing fiction happens when you are smart, you want to find solutions, but face a combination of limited control and high stakes. They are extremely powerful. They can make you believe just about anything.

The bigger the gap between what you want to be true and what you need to be true to have an acceptable outcome, the more you are protecting yourself from falling victim to an appealing financial fiction.

There is no greater force in finance than room for error, and the higher the stakes, the wider it should be.

Most people, when confronted with something they don’t understand, do not realize they don’t understand it because they’re able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world, however limited those experiences are.

When planning we focus on what we want to do and can do, neglecting the plans and skills of others whose decisions might affect our outcomes. Both in explaining the past and in predicting the future, we focus on the causal role of skill and neglect the role of luck. We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.

20. Confessions

Comfortably living below what you can afford, without much desire for more, removes a tremendous amount of social pressure that many people in the modern first world subject themselves

If you can meet all your goals without having to take the added risk that comes from trying to outperform the market, then what’s the point of even trying?

Simple investment strategies can work great as long as they capture the few things that are important to that strategy’s success.

21. Postscript

My investing strategy doesn’t rely on picking the right sector, or timing the next recession. It relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades.