The Psychology of Money by Morgan Housel (2020) examines personal finance through the lens of human behavior. It’s a fresh take on a well-trod subject; many personal finance books focus on exogenous considerations: e.g. how the stock market works, how to select stocks or build a portfolio, how to time the market, etc. Housel’s focus is the relationship between people and money—with particular emphasis on the human variable of the equation. “To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism.”
Housel’s conviction is that behavior trumps other considerations in the pursuit of financial success. “Doing well with money has a little to do with how smart you are and a lot to do with how you behave.” Engage in the right behaviors and you are likely to succeed. Similarly, no amount of intelligence, savvy, or inside information will save you from the wrong set of behaviors.
Each of the first 18 chapters in the book explores an individual human behavior or attitude towards money (the final two chapters are a summary of the lessons and a commentary on Housel’s personal financial practices). Certain behaviors induce positive outcomes while others guarantee failure. For instance, the first chapter titled “No One’s Crazy” considers the limits of our understanding vis-à-vis the limits of our personal experiences. Consider that we are all, in the grander scheme of things, woefully inexperienced. “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.” In other words, there’s a huge gap between firsthand knowledge and how we parlay those limited insights into making sense of the world. Our experiences color our judgment, but the foundations of that judgement are dubious, incomplete, and full of blind spots.
For example, consider two different people born in different decades and their attitudes towards the stock market, one born in the 1950s and the other in the 1970s. The first individual, as a teenager and young adult would have witnessed the anemic stock market returns of the 1960s-70s (low single digit returns in the decade aggregate). The second individual, as an adolescent and young adult, would have watched the double-digit returns for both the 1980s and 1990s (see this article for a graph showing decade-by-decade stock market returns). The latter is more likely to enter adulthood with a bullish attitude towards equities. The former is likely skeptical of the stock market having witnessed two decades of negligible returns. The lesson: you cannot discount the impact of personal experience on your decision-making process (nor can you discount the unique set of circumstances that influence the decisions made by others).
Housel’s book is filled with these sorts of lessons. Some lessons caution us against certain behaviors, other lessons encourage us to embrace beneficial habits. The beauty of these lessons is that they are accessible to anyone: they are not the sole domain of high-income earners or those with elite education degrees. Reading this book won’t give you a profound knowledge about investment instruments, asset allocation, or tax-advantaged strategies; it will, however, improve your relationship with money and your attitude regarding personal finance. It isn’t difficult, Housel assures us, financial wealth just requires discipline, patience, and a handful of constructive behaviors.
Note: For those interested in an abbreviated version of Housel’s book, check out an article he wrote in 2018 with the same title: “The Psychology of Money” (collaborativefund.com). The book expands upon the ideas introduced in the 2018 article but you can get a good taste of his ideas there.
Pros: Could become a classic in the personal finance space. Strong focus on individual attitudes and behaviors (which are within the reader’s locus of control). Ideas and themes have broad application beyond personal finance.
Cons: People looking for advice on specific financial instruments, strategies, and the like will be disappointed (his primary strategy is save and hold and let compounding work its magic). Housel’s clear, breezy style sometimes belies the profundity of his ideas.
Introduction: The Greatest Show on Earth
“The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave.”
“A genius who loses control of their emotions can be a financial disaster. The opposite is also true. 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.”
Two contrasting examples:
- Ronald James Read: Gas station attendant, janitor and American philanthropist. Read saved throughout his life, lived frugally and amassed an $8 million net worth at time of death. The majority of his fortune was left to a local hospital and library.
- Richard Fuscone: Harvard-educated Merrill Lynch executive. Borrowed heavily and spent lavishly, got hit by the 2008 financial crisis, declared bankruptcy.
- “Ronald Read was patient; Richard Fuscone was greedy. That’s all it took to eclipse the massive education and experience gap between the two.”
Two explanations that explain existence of stories like Read and Fuscone:
- “Financial outcomes are driven by luck, independent of intelligence and effort.” (true to some extent)
- “Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.” (Housel believes this is the more common of the two explanations).
Knowing how to do something is insufficient. In many situations you also need to battle against your internal emotional and mental turmoil as well which will influence or alter your planned response.
“We think about and are taught about money in ways that are too much like physics (with rules and laws) and note enough like psychology (with emotions and nuance).”
“To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism.”
Chapter 1: No One’s Crazy
Everyone has a unique idea of how the world works. This worldview is influence by a unique set of circumstances, values, and external influences.
“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.”
“No amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.”
“We all think we know how the world works. But we’ve all only experienced a tiny sliver of it.”
- If you were born in 1950, the stock market was flat during your teens and 20s (adjusted for inflation).
- If you were born in 1970, the S&P 500 increased 1000% during your teens and 20s (adjusted for inflation).
- Which generation is more likely to have a bullish view of the stock market?
“Their view of money was formed in different worlds. And when that’s the case, a view about money that one group of people think is outrageous can make perfect sense to another.”
Consider people most likely to purchase lottery tickets in the U.S.: low-income households who spend, on average $400/year. Number seems crazy to people in higher income households. But some might justify the purchase by saying they are paying for hope and a dream. Without being in their shoes, it’s hard to fully appreciate why they behave the way they do.
Modern financial planning is relatively new. For instance, individual retirement accounts are a recent phenomenon. 401k were created in 1978. Roth IRA was created in 1998. Index funds were developed in the 1970s.
As Housel says, many of the poor financial decisions stem from our collective inexperience: “there is not decades of accumulated experience...we’re winging it.”
Chapter 2: Luck & Risk
Outcomes are determined by more than effort. Luck and risk often figure prominently in individual outcomes.
Story of Bill Gates: Gates attended one of the only high schools in the world that had a computer in 1968. Were it not for the efforts of a teacher, Bill Dougall, to procure a $3000 teletype computer, it is unlikely that Bill Gates would enjoyed the same career success.
- Gates himself admits as much: “If there had been no Lakeside [High School], there would have been no Microsoft.”
- At Lakeside there were three standout computer students (all friends): Bill Gates, Paul Allen, and Kent Evans. Kent Evans was destined for success but met an untimely death in a mountaineering accident before graduation. This is used as an example of bad luck.
“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.”
“The accidental impact of actions outside of your control can be more consequential than the ones you consciously take.”
“Focus less on specific individuals and case studies and more on broad patterns.”
- Extreme outcomes are low probability outcomes. Applying the lessons of those who achieved these outlier results isn’t always helpful since external forces of luck and risk may have played immeasurable and non replicable roles.
- Instead look at broad patterns that offer directional insights. For instance, happy people tend to be those who control their time and energy.
Chapter 3: Never Enough
Story about writers Kurt Vonnegut and Joseph Heller (Catch-22) attending a party hosted by a billionaire. Vonnegut remarks that the billionaire makes more money in a single day than Heller made from his popular novel. Heller responds: “Yes, but I have something he will never have...enough.”
Examples of Rajat Gupta and Bernie Madoff: People who had everything but wanted more. They brought ruin upon themselves because the were greedy and didn’t know when to stop.
“There is no reason to risk what you have and need for what you don’t have and don’t need.”
- “The hardest financial skill is getting the goalpost to stop moving.”
- Comparing ourselves to others is often the culprit. Capitalism is good at generating both wealth and envy. But social comparison is a process without end: there’s always someone higher up on the ladder.
- Enough doesn’t mean you have to go without. Enough means you know when to avoid doing something you will regret.
- Many things are not worth the risk, regardless of the gains. A short list: reputation, freedom, family and friends, love, happiness.
The only way to win is to refrain from playing the game.
Chapter 4: Confounding Compounding
- The simplest fact about Warren Buffett’s fortune: He wasn’t just a good investor, he was a good investor for 75+ years.
- “Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time.”
- “Good investing isn’t necessarily about earning the highest returns...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.”
Chapter 5: Getting Wealthy vs. Staying Wealthy
There are many ways to get wealthy. There is one way to stay wealthy: through a combination of frugality and paranoia.
Getting money and keeping money entirely different things and require entirely different mindsets and strategies.
- “Getting money requires taking risks, being optimistic and putting yourself out there.”
- “Keeping money requires the opposite...it requires humility, and fear that what you’ve made can be taken away from you just as fast.”
Michael Moritz (venture capitalist): “We assume that tomorrow won’t be like yesterday. We can’t afford to rest on our laurels. We can’t be complacent. We can’t assume that yesterday’s success translates into tomorrow’s good fortune.”
Nassim Taleb: “Having an edge and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.”
Having a “survival mindset” requires three things:
- Aim to be financially unbreakable: be able to stick out swings in the market and stay in the game long enough for compounding to work its magic.
- The most important thing to plan for: the plan won’t go according to plan. A good plan leaves room for error. “The more you need specific elements of a plan to be true, the more fragile your financial plan becomes.”
- Be optimistic about the future but paranoid about the obstacles to your success.
Chapter 6: Tails, You Win
Story of the art collector Heinz Berggruen. He amassed an amazing collection of Picassos, Braques, Klees and Matisses.
- People were amazed by his art investing acumen.
- The reality was that he bought massive quantities of art. Only a subset of his collection was valuable.
- “Berggruen could be wrong most of the time and still end up stupendously right.”
“Anything that is huge, profitable, famous, or influential is the result of a tail-event—an outlying one-in-thousands or millions event.”
This is the venture capital model: If a fund makes 100 investments, they expect 80% to fail, a handful to do reasonably well and 1-2 to drive the funds returns.
Consider the distribution of winners and losers in the stock market: most public companies fail, a few do ok and a few generate extraordinary returns.
“When you accept that tails drive everything in business, investing, and finance you realize that it’s normal for lots of things to go wrong, break, fail, and fall.”
Warren Buffett stated at the 2013 Berkshire Hathaway shareholder meeting that he’s owned shares in 400-500 different companies over his life. His significant gains came from just a handful: 10.
We see outsized results from a mere fraction of the events or actions in our lives.
Chapter 7: Freedom
- “The ability to do what you want, when you want, with who you want, for as long as you want, is priceless.”
- “Money’s greatest intrinsic value...is its ability to give you control over your time.”
Chapter 8: Man in the Car Paradox
- “When you see someone driving a nice car, you rarely think, ‘Wow, the guy driving that car is cool.’ Instead, you think, ‘Wow, if I had that car people would think I’m cool.’ Subconscious or not, this is how people think.”
- In other words, when we signal that we’re wealthy and that people should like an admire us, what really happens is people ignore the person in possession of of the object of envy and just focus on the possession.
Chapter 9: Wealth Is What You Don’t See
“Someone driving a $100,000 car might be wealthy. But the only data point you have about their wealth is that they have $100,000 less than they did before they bought the car.”
“Wealth is financial assets that haven’t yet been converted into the stuff you see.”
Housel reminds us that when people say they want to be millionaires, what it really means is that they want to spend a million dollars.
Spending a million dollars is “literally the opposite of being a millionaire.”
Difference between wealthy and rich:
- People who live in big homes and drive fancy cars are rich. People with big incomes are rich. They display the fact that they are rich.
- Wealth is hidden. Wealth is income that is saved, not spent. Wealth is optionality, flexibility and growth. Wealth is the ability to purchase stuff if you needed to.
Chapter 10: Save Money
Three types of people (past a certain level of income):
- Those who save.
- Those who don’t think they can save.
- Those who don’t think they need to save.
Your savings rate is more important than your income or investment returns.
Analogy: The 1970s oil crisis.
- Problem: Oil supply was insufficient to keep up with demand and economic growth.
- Solution: Oil supply increased 65% but fuel efficiency and conservation doubled what could be done with that energy.
- Supply side was out of people’s control but the demand side was completely within the control of the individual.
“You can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.”
“Learning to be happy with less money creates a gap between what you have and what you want—similar to the gap you get from growing your paycheck, but easier and more in your control.”
“Past a certain level of income, what you need is just what sits below your ego.” Solution: Don’t worry about what other people think or feel the need to keep up with the Joneses.
“The flexibility and control over your time is an unseen return on wealth.”
“Having more control over your time and options is becoming one of the most valuable currencies in the world.”
Chapter 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.”
- Historical odds of making money increase over time. Lesson: stick to your guns and don’t let short-term volatility force a bad decision. Example: Positive returns over a one-year period are 68% likely, 88% likely over 10 years, and 100% likely over 20 years.
Chapter 12: Surprise!
Scott Sagan (political scientist): “Things that have never happened before happen all the time.”
“History helps us calibrate our expectations, study where people tend to go wrong, and offers a rough guide of what tends to work. But it is not, in any way, a map of the future.”
Remember: Past performance is not an indicative of future results, as the ubiquitous financial disclaimer states.
Focusing on past history and past patterns may cause two things:
Overlooking outlier events that move the needle.
- Example: 15 billion people were born in the 19th and 20th centuries. But consider the handful that inordinately influenced historical events: Hitler, Stalin, Mao, Edison, Gates, MLK, etc.
- Example: Consider the projects, events and innovations of the last century: The Great Depression, WW2, Vaccines, Antibiotics, the Internet, the fall of the Soviet Union.
- Certain people and events have influence that is orders of magnitude more than others. Housel calls these “tail events.”
- Tail events cause 2nd and 3rd order repercussions. “It is easy to underestimate how things compound...for example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans...”
- “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.”
- These surprise events are nearly impossible to predict because they are so improbable and depend on the luck and occurrence of many similarly unlikely precursor events.
- “This is not a failure of analysis. It’s a failure of imagination.” It is difficult to imagine a future that looks nothing like today or anything we have seen before.
- Daniel Kahneman (psychologist and economist): “The correct lesson to learn from surprises: that the world is surprising.”
- Similarly we should be skeptical of those who profess to know with great certainty how the future will unfold.
Misreading the present by looking to the past because the past DOESN’T account for the structural changes that are relevant in today’s world.
- Example: Certain financial mechanisms are new. Advice that predates these realities is obsolete. For instance: 401ks appeared in 1978. Venture capital barely existed 25 years ago. The S&P 500 did not include financial stocks until 1976.
- Recent history is the most relevant to the future since it accounts for some of the important or relevant innovations and conditions that will impact the future.
- “The further back in history you look, the more general your takeaways should be.”
Chapter 13: Room for Error
- Blackjack and poker players know they are dealing with probabilities not certainties.
- The best plan is to plan for things to not go according to plan.
- “Margin of safety—you can also call it room for error or redundancy—is the only effective way to safely navigate a world that is governed by odds, not certainties.”
- “The odds are in your favor when playing Russian roulette. But the downside is not worth the potential upside. There is no margin of safety that can compensate for the risk.”
- It is impossible to prepare for or anticipate what you cannot envision.
- Minimize the impact of failure by avoiding single points 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.”
- Rainy-day funds are a good idea: save for things you cannot anticipate or predict.
Chapter 14: You’ll Change
- We are terrible predictors of our future selves. Our present needs, wants, and reams are not the same as our future needs, wants, and dreams.
- “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.”
- The result is that long-term plans and decision-making is very difficult to do effectively.
- Accept the reality that individuals are prone to change. What matters to you today, may be viewed as inconsequential in a decade.
- “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. It’s the equivalent of a stranger making major life decisions for you.”
Chapter 15: Nothing’s Free
- “The key to a lot of things with money is just figuring out what that price is and being willing to pay it.”
- “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.”
- “Few investors have the disposition to say, ‘I’m actually fine if I lose 20% of my money...but if you view volatility as a fee, things look different.”
- When you invest in the long term, you need to be willing to accept the short-term price of market fluctuations.
Chapter 16: You & Me
- One reason for market bubbles: “Investors often innocently take cues from other investors who are playing a different game than they are.”
- Short term momentum attracts investors with short time horizons. “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.” But note that the short-term investors will only stick around so long as the momentum continues, but that this momentum is transient.
- “Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.”
- “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.”
Chapter 17: The Seduction of Pessimism
“Pessimism isn’t just more common than optimism. It also sounds smarter. It’s intellectually captivating, and it’s paid more attention than optimism, which is often viewed as being oblivious to risk.”
“Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention.”
Daniel Kahneman: “This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms treat threats as more urgent than opportunities have a better chance to survive and reproduce.”
“Pessimists often extrapolate present trends without accounting for how markets adapt.”
- Remember the story from chapter 10 about the 1970s oil crisis: pundits failed to account for innovation in fuel efficiency and cheaper, more efficient oil extraction.
- Similarly, in the 2000s, as oil prices increased, certain type of oil extraction became economically feasible such as fracking.
Necessity is the mother of all invention and humanity is endlessly innovative. People respond to adversity and problems with new and novel solutions.
“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.”
Progress is slow, but setbacks and disaster happens quickly and impactfully. “There are lots of overnight tragedies. There are rarely overnight miracles.”
“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 instance.”
Chapter 18: When You’ll Believe Anything
“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.”
“Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.”
B.H. Liddell Hart (historian) in his book “Why Don’t We Learn from History?”: “History cannot be interpreted without hte aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art. Those who read history tend to look for what proves them right and confirms their personal opinions.”
Daniel Kahneman: “Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense. That’s a big deal in producing mistakes in many fields.”
Rather than accept that we don’t know something we actively attempt to develop personal theories (stories) that creates illusory understanding that is psychologically comforting. Illusion of control vs. the reality of uncertainty.
Recognize that there is much you do not know and much that is outside of your control.
Philip Tetlock (psychologist): “We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”
Kahneman identified relevant errors in cognition:
- When planning we focus on what we want to do and can do and neglect the plans, actions, and decisions of others who might impact our personal outcomes.
- When studying the past and forecasting the future we overemphasize individual skill and discount luck.
- We focus on what we know and ignore what we don’t know. This results in overconfidence.
Chapter 19: All Together Now
- Chapter is a summary of the lessons in the preceding chapters: humility, less ego, wealth vs. riches, financial decisions that offer peace of mind, use the power of time and consistency, accept failure and risk, strive for time freedom, frugality, make saving a core habit, be prepared to pay the price required for successful outcomes, prepare a margin of safety, avoid extremes, define the game you’re playing.
Chapter 20: Confessions
This chapter highlights some of the financial behaviors and beliefs of the author:
- Independence drives all Housel’s financial decisions.
- Live below your means.
- Derive pleasure from free or low cost activities: exercise, reading, podcasts, learning.
- Owns his house without a mortgage. Admits that this is a terrible financial decision but a great money decision (peace of mind).
- Maintains 20% of his assets in cash (outside of the value of his primary home). He does this to maintain a safety net and to avoid being forced to sell his stock market investments in an emergency.
- Charlie Munger: “The first rule of compounding is never interrupt it unnecessarily.”
- No longer invests in individual stocks. All Housel’s stock market investments are in low-cost index funds.
- “Some people can outperform the market averages—it’s just very hard, and harder than most people think.”
- “Every investor should pick a strategy that has the highest odds of successfully meeting their goals...for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.”
- Max out your retirement accounts and contribute to your kid’s 529 plans.
- His financial situation is simple. All of his net worth consists of a house, a checking account and Vanguard index funds.
“One of my deeply held investing beliefs is that there is little correlation between investment effort and investment results.”
Three key elements of Housel’s approach: a high savings rate, patience, and long-term optimism.