Timeless Lessons on Wealth, Greed, and Happiness
Life gets busy. Has The Psychology of Money been gathering dust on your bookshelf? Instead, pick up the key ideas now.
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These key insights and analysis are provided for educational purposes only. Please consult a professional before taking any action.
About Morgan Housel
Morgan Housel is a partner at Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal. He is a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers. He is also a winner of the New York Times Sidney Award and a two-time finalist for the Gerald Loeb Award for Distinguished Business and Financial Journalism. Morgan has presented at more than 100 conferences in a dozen countries.
The Psychology of Money delves into the psychology behind our financial weaknesses. Housel considers how past experiences, moving the goalposts and being coldly rational can worsen long-term financial gains. The alternative is having clear, reasonable financial goals that are not over-reliant on historical financial performance. If you can implement these approaches, you can be financially successful in the long run. So, you will also benefit from the wonders of compound interest.
StoryShot #1: We All Have Unique Experiences of Investing
Our current relationships with money are based on our past experiences. Housel uses the example of people who lived through The Great Recession and are now scared of reinvesting. Many of us won’t have lived through The Great Recession. So, the author recommends avoiding judging others for their financial decisions as no one is crazy. We have all simply had different experiences of investing. He also explains that we must learn to make investment decisions based on our goals and investment options rather than experiences. The world is always changing and relying on your experiences means you are basing your decisions on knowledge of a different world.
StoryShot #2: Bill Gates’ Competitive Advantage
Both luck and risk are an integral part of finance. Do not assume that individual effort alone will allow you or others to be successful. The author uses the example of Bill Gates. Bill Gates is highly talented and works extremely hard. But, he also obtained a competitive advantage because he attended one of the few high schools in the world at that time to own a computer.
There are infinite moving parts within the world. This means the accidental impact of actions outside of your control often have a greater influence than your conscious decisions. So, work hard and take risks but also consider the role that luck plays in finance. Focus less on specific individuals and case studies and more on broad patterns. This should also help you develop greater humility when things are going right and compassion when they are going wrong.
StoryShot #3: Rich People Are More Likely to Make Crazy Decisions
Rich people are often the ones who make crazy financial decisions. Housel explains the goalposts seem to move the more you earn. There are countless rich individuals who have lost everything because they felt the millions they had were not enough. The lesson you can learn from these failures is you shouldn’t risk what you have and need for what you don’t have and don’t need. Saying “enough” is realizing that an appetite for more will push you to the point of regret.
StoryShot #4: Warren Buffett Is a Prime Example of the Power of Compound Interest
Compound interest can bring you financial freedom. That said, the human brain struggles to understand the power of compounding. Housel uses Warren Buffet as an example. Many believe his wealth is entirely due to his knowledge of sound investments. More importantly, he has been making good investments since a young age. His current net worth is $84.5 billion, but he accumulated $84.2 billion after his 50th birthday. This shows the power of compounding. The key to compounding isn’t about earning the highest returns. You want pretty good returns that you can stick with for the longest period of time.
StoryShot #5: Good Investing Is About Not Screwing Up
Housel doesn’t describe effective investing as making sound decisions. Good investing is about consistently not screwing up. He believes that financial success can be summarized by one word: survival. The most financially successful are those who have been able to stick around for a long time. You can only grow your wealth if you have given an asset time to compound.
Getting money requires risk taking, optimism and putting yourself out there. Keeping money requires the opposite: humility. So, try to make yourself financially unbreakable rather than focusing on big returns. Humility is also about planning with the expectation your plan won’t go according to plan. This is your margin of safety and is one of the most underappreciated forces in finance. Here are a few examples of ways you can start establishing a margin of safety:
- Frugal budget
- Flexible thinking
- Loose timeline
StoryShot #6: Do the Average
The most successful, rich and famous are there because of a one-in-a-million event. As most of our attention goes toward these huge events, it can be easy to forget their rarity. Try to avoid underestimating how rare and powerful these events are. These events mean that investors can be wrong half the time and still make a fortune. So, Housel describes an investing genius as an individual who can do the average thing when all those around them are going crazy.
StoryShot #7: People Believe Wealth Will Make Them Popular
The Man in the Car Paradox is that people rarely think somebody is cool if they see them driving a nice car. Instead, people imagine how cool people would think you are if you had that car. This is a paradox because others would have the same thoughts and not consider you cool. Housel applies this more broadly to wealth. People acquire wealth because they believe this will make them liked and admired. But, wealth just makes others use this as a benchmark for their own desire to be liked and admired.
StoryShot #8: Stop Judging People By Their Visible Wealth
Some people use newfound wealth as an opportunity to show off. Housel suggests you stop judging people’s wealth by what you see. Remember that people’s true wealth is what you do not see. Those who decide not to buy something now to buy something later will stay wealthy for longer. Wealth’s value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.
StoryShot #9: Your Savings Rate Is Key
Your income or investment returns are less important than your savings rate. Housel also explains that your value of wealth should always be relative to what you need. A high savings rate means having lower expenses than you otherwise could. Having lower expenses means your savings go farther than they would if you spent more. Your savings rate is the financial decision you have the greatest control over. When you define savings as the gap between your ego and your income you realize why many people with decent incomes save so little.
Savings in the bank that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate.
StoryShot #10: Being Rational Is Draining
Being coldly rational with your financial decisions will lead to burnout. So, you are better off being reasonable and realistic about your financial decisions. Adopting a financial plan, you can stick to over the long run is more important than being completely rational about every financial decision.
A rational investor makes decisions based on numeric facts. A reasonable investor makes these decisions in a conference room surrounded by co-workers who want to think highly of you. Investing has a social component that’s often ignored when viewed through a strictly financial lens.
StoryShot #11: Stop Focusing on Historical Data
Housel describes a mistake several investors make called the Historians as Prophets Fallacy. This mistake is an overreliance on historical data to predict future financial interest. The reality is that innovation and change are integral to finance. Because the world changes, basing your investments solely on past performance is a bad decision. History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.
StoryShot #12: Leave Room For Error
You should always leave room for error when estimating your future returns. Housel calls this planning on your plan not going according to plan. So, the author assumes his future returns will be ⅓ lower than the historical average. This simple decision means he saves more than he usually would. This is his margin of safety.
StoryShot #13: Avoid the Extreme Ends of Financial Planning
People’s goals and desires change over time and you are no different. So, this means long-term financial planning can be difficult. Our inability to predict our future selves is called the End of History Illusion. If you look back, I imagine you can visualize how much you have changed. That said, Housel believes you will underestimate how much you will change in the future. To counteract this, you should avoid the extreme ends of financial planning. Accept that you will likely change your mind in the future.
StoryShot #14: Market Volatility Has a Fee
Everything in life has a price. The key to a lot of things with money is just figuring out what that price is and being willing to pay it. Housel highlights that the price of investing won’t be immediately obvious. You should view any market volatility as a fee rather than a fine. If you can do this, you are more likely to stay in the game long enough for investment gains to work for you.
The trick is convincing yourself that the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty. Work out whether it is an admission fee worth paying as there’s no guarantee that it will be.
StoryShot #15: Find Your Personal Financial Identity
You can speak to knowledgeable friends or read books from financial experts to develop your understanding of finance. That said, you should always avoid taking financial advice from those who have different quantities of money and end goals. Try to find your personal financial identity and you can then listen to those who complement this identity.
StoryShot #16: Be a Financial Optimist
Finance has a knack for bringing out the pessimist in everyone. Pessimists often extrapolate present trends without accounting for how markets adapt. Housel believes that true financial optimism is expecting things to be bad and being surprised when they’re not. Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.
StoryShot #17: Appealing Fictions Affect Our Investments
The more you want something to be true, the more likely you will believe a story that overestimates the odds of it being true. Housel uses the example of World War I. After this war, few believed there would ever be another world war. The reality is that another was just around the corner. Housel calls these events we want to be true “appealing fictions.” Crucially, these appealing fictions have a significant impact on our investments.
Final Review, Analysis, and Criticism of The Psychology of Money by Morgan Housel
Psychology of Money is a collection of tips from a two-time winner of the Best in Business award. This book highlights the importance of noticing the difference between being rich and being wealthy. People who are rich often make risky decisions based on historical data. People who are wealthy realize that protecting their money by avoiding mistakes is the key to success.
The book is relatively short but packed with fun and timeless financial lessons on how to deal with money. The title of the book may lead readers to believe it’s a deep-dive into the behavioral economics and decision analysis of all aspects of money but it may turn out to be a rudimentary take (albeit an insightful one) on these topics to some readers.
We rate this book 4.5/5.
How would you rate The Psychology of Money?
PDF, Free Audiobook, and Animated Summary of The Psychology of Money
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