Although there is a saying that “Money doesn’t buy happiness”, money impacts almost every aspect of our modern society.
The Psychology of Money by Morgan Housel is a book that will help you better understand money and wealth, by going through some of the most important flaws, biases and causes of bad behaviors affecting people when dealing with money. Here are 10 lessons I learnt after reading through the book.
1. Everyone has different attitude towards money
“Everyone has their own unique experience with how the world works”, and this unique experience shapes how we view money. We shall be less judgemental about how people (including ourselves) deal with money.
As an example, most lottery ticket buyers in the US are from low-income households who on an average spend $412 a year, but many can’t come up with $400 in an emergency. This may seem crazy to someone with much higher income, but the low-income group may see winning the lottery is the only way for them to earn big money and change their lives.
2. Luck is an important factor in successes and failures
“Not all success is due to hard work, and not all poverty is due to laziness”. Luck sometimes plays a significant role in someone’s success, or failure for the lack of it. Keep this in mind when judging people, including yourself.
When learning from success or failure, it’s a good idea to look at broader patterns from many examples at different times, instead of focusing too much on individual person or case study.
3. Knowing what is enough will help manage expectations and risks
“It gets dangerous when the taste of having more – more money, more power, more prestige – increases ambition faster than satisfaction”.
Without defining what “enough” is, the more you achieve, the even more you desire, and you will always feel that you are one step behind. The constant pursuit may lead you to take great risks or burn out, just to temporarily satisfy the insatiable desire of having more.
4. Compounding is the most powerful instrument for growing wealth
“$81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday”. A good investment doesn’t necessarily mean the highest return, as high returns are often unsustainable and less likely to consistently repeat itself. A good investment is more about getting an OK return that is more consistent, and can be repeated over a longer period of time.
What made Warren Buffett the most wealthy investor in the world, is more about being in the market for over 80 years getting consistent returns, and less about having the highest return investment strategy.
5. Focus on wealth preservation instead of aggressively chasing higher returns
Instead of seeking big returns, one should aim for becoming financially indestructible. Becoming financially indestructible provides longevity, which will allow more time in the market for compounding to work wonders and deliver even higher returns.
Whereas purely aiming for big returns is often associated with taking higher risks, which is great if it works, but can be detrimental and irreversible when it doesn’t.
6. Money’s greatest intrinsic value is to give you freedom
“Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered”.
Sure, money can buy luxury items, better cars, bigger houses, but the broadest lifestyle variable that makes one happy is having control over doing what you want, when you want, who you want to do it with.
7. Wealth building has less to do with how much you make, and more to do with how much you save
You may not be able to control how much money you make from your work or investment, but you most certainly can control how much you save.
Wealth is the accumulated leftovers after you spend what you bring in. You can build wealth without a high income over time with consistent savings and compounding, but have no chance of building wealth without a high savings rate.
8. History can’t predict the future of economy and stock market
History is a study of past events, which may show us how things happened the way they did, but using history to predict the future events, more specifically of the economy and the stock market may be misleading, as we now live in a different condition and environment compared to the past.
As an example, most of the formulas from the holy grail investment book The Intelligent Investor, first published in 1949, are no longer relevant in today’s world. The further back in history you look, the more general your takeaway should be. Historians are not prophets.
9. Leave room for error
Always make plans for when things don’t go according to plan, such as planning for market volatility, buffer needed to quit your day job and retirement saving targets.
Leave a wider range when setting a target for what you think might happen. It helps protect you from things you’d never imagine, which can be the most troublesome for us to face. E.g. how will it impact your financial and mental status if the stock market were to crash 30%.
10. Stick to your game
When it comes to money and investment decisions, try to define and understand your own strategy instead of following others who may be playing a different game.
For example, buying an overvalued stock may make sense for short term day-traders as they will close the position at the end of day. If you are an investor who buys and holds stocks, buying a richly valued stock won’t do any favor to your investment portfolio in the long run.