The Psychology of Money by Morgan Housel
This is the first finance book I've read that isn't just about recommending investing methods in a black and white fashion.
The book is in an easy-to-read format with 20 bite-sized lessons. Rather than diving into the specifics of finance, he analyses our relationship with this ancient creation called money.
He describes the psychology of money as a soft skill and notes that money management is too often taught as a deterministic process with steps to follow. What is not covered however is the relationship of your thoughts with money.
“Two topics impact everyone, whether you are interested in them or not: health and money.” - Morgan Housel
Throughout the book, Housel teaches us to change perspective and consider the variety of factors that affect our relationship with money. I will talk about the 3 lessons from my 3 favourite chapters from the book.
1. Man in the car paradox
No one is as impressed by your car as you. Reflecting back on his time as a valet, Housel notes the number of luxury cars he got to drive. Often people buy expensive possessions in an effort to gain admiration and respect. They might even be fooled into thinking that they're getting those things when they notice strangers admiring their car.
What happens instead is the observer admiring the thought of them owning that item in an effort to achieve their own vision of getting admiration and respect.
“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.” - Morgan Housel
This is such a simple yet powerful observation. I wonder if people would buy the same expensive car or house if no one could see them?
2. Nothing's Free
Dow Jones Industrial index follows the 30 leading companies in the US. Over a 69 year period from 1950-2019, the index was lower than the previous all-time high 94% of the time. Despite this, the index returned an annual return of 11%.
This fact was eye-opening to me. In this chapter, Housel talks about the cost of investing and paying your dues. He uses the example of buying a new car.
“Say you want a new car. It costs $30,000. You have three options: 1) Pay $30,000 for it, 2) find a cheaper used one, or 3) steal it. In this case, 99% of people know to avoid the third option, because the consequences of stealing a car outweigh the upside.” - Morgan Housel
Translated into the context of investing as told by Housel:
- You pay full price and accept the volatility
- You find an asset with less uncertainty and a lower payoff
- Get maximal return with the lowest risk potential
Many investors opt for option 3) which most times doesn't pan out. Housel uses the example of tactical mutual funds that arrange their assets in an effort to achieve better than average returns by lowering their portfolio risk during market crashes. The funds in question had a simple portfolio allocation of 60/40 stock-bond. During the 2010-2011 high US market volatility period (fears of a recession), 112 such funds existed. Less than 25% had a lower maximum drawdown than index funds. The majority were more volatile and riskier investments - exactly what the tactical funds strive to avoid being.
My biggest takeaway from this chapter is to accept volatility as a natural part of an investment. There is no avoiding it. This is true when it comes to index funds as I believe in being patient to reap the rewards of compound interest. But I wouldn't apply this logic when it comes to volatility with single stocks or the cryptomarket.
3. The Seduction of Pessimism
Pessimism is more fashionable and seems more plausible than optimism. Media outlets are more likely to showcase negative news rather than positive ones. Housel highlights that pessimism is also more intellectually captivating and is given more attention.
For example, he explains that a 1% rise in stock is hardly mentioned in the media whereas a 1% loss is all over the news. In reality, markets are always in flux. And the coverage asymmetry leads to an over-valuation of pessimistic scenarios.
“ ... progress happens too slowly to notice, but setbacks happen too quickly to ignore.” - Morgan Housel
Housel illustrates the point by highlighting the progress of medicine over the last century. He notes that it's hard to quantify the progress looking back 1 year or even 10 years. But over the last half-century, there has been a 70% decline in the age-adjusted death rate due to heart disease. This translates the lives of 500,000 people saved every year. However, this news is less likely to be talked about than sudden acts of terrorism and natural disasters.
“Every group of people I ask thinks the world is more frightening, more violent, and more hopeless—in short, more dramatic—than it really is,” - Hans Rosling