The Psychology of Money

The book Psychology of Money is written by the former financial journalist Morgan Housel. He explores why your psychology or your behaviours of money is important than your math skills. Have you heard the story about Ronald Reid, the janitor that had $8 million in savings when he died in 2014? He didn’t win the lottery or inherit the money either. He just saved consistently throughout his life. The moral is that your behavior with money is often times more important than how intelligent you are. Even if you don’t have a diploma from Harvard or work on Wall Street, you can become rich by just behaving in a right way.

There will be the top three takeaway in this Summary of The Psychology of Money.

Takeaway One: Pay the Price

Let’s say that you want a new, nice watch. You go to the store to check out the offerings you are really after something that will impress your friends and the lovely lady that you’re dating. You now have a choice either you pay for the watch or you steal it and run. My guess is that you would choose option one. No matter your physical capacity, you would take out your card and swipe that thing. Do the right thing. 

The point is that you know that having a new watch comes with a price, a fee. And it’s the same with investing. It comes with a price too. Your portfolio may even volatile. But this is the price or the fee for having high returns in the stock market over the long term. 

If you don’t have the stomach to stay the course when your net worth decreases by, say, 20% during a single week. And two of your major holdings report quarterly earnings below what analysts expected. At that time, don’t aim to maximize your returns, because the higher the returns, the higher this fee typically is. 

Let’s say you already ten years ago, could visualize Netflix bright future. You invested a large portion of your net worth in the stock. Well, they would be quite a rich person today. However, could you afford paying the price for this journey? During this period, Netflix had many major downturns. Would you have sat still in that boat during 2011, when Netflix lost tons of customers and the stock price fell 80% from its peak? During these months, your portfolio returns would look terrible. What would you tell your spouse and your kids? Could you stomach facing them, knowing that you might have endangered their future? Would you still think that being almost all in Netflix is a good idea? This is, of course, an extreme example. 

But even if you have something less extreme than an all in Netflix approach to investing, you’ll have to pay the price of volatility nonetheless. Yeah, that’s tough, but Stock market investing is a great thing that enables wealth creation like few other options. However, don’t try to fool yourself. It doesn’t come for free. All investors will experience volatility, and you have to look at this as the price you pay for a brighter future. 

Takeaway Two: Never Enough 

It’s a very interesting phenomenon that you can hand somebody $2 million bonus and they’re fine until they find out that the person next to them got 2,000,001, and then they’re sick for the next year.

Capitalism is great at doing two things generating wealth and generating envy. The urge to surpass your neighbours, peers and friends can help energize your hard work and strive to really make it. And, of course, being motivated into becoming more productive and do meaningful work is a good thing. But social comparison can also cause us to feel like we’re never enough. 

Let’s look at some statistics about the top 1% of highest income earners in the US. You’d have to earn somewhere around $500,000 a year. That’s what a highly specialized doctor let’s call him Bill Earns. And by almost any standard, Bill would be considered rich. He can afford to drive nice cars, go on long vacations to exotic countries, and perhaps hire someone to do work which he thinks is tedious. Bill has been feeling good about himself and what he has achieved financially in his life. Well, that was only until he bought a vacation home in the Hamptons and realized that he had Stan as his neighbour. Stan belongs to the top 1% of the 1%. He is a CEO of quite a large public company and earns a staggering $10 million per year.

Now, you’d hope that at least Stan would be satisfied with his financial achievements. The answer is no. This guy was a childhood friend of Michael Jordan. And this all-time great basketball player is someone who belongs to the 1% of the 1% over the 1%. And, well, compared to Michael’s fortune of about $2 billion, stan’s yearly salary of $10 million suddenly seems like peanuts. Does it end here? 

Well, no, it doesn’t, because Michael occasionally attends parties with celebrities where a guy named Jeff Bezos shows up. Bezos is in the top 1% of the 1% of the 1% of the 1%, and he increased his net worth by about 75 billion in 2020. Now, sitting at something like $200 billion, there’s always a bigger fish. The type of envy which has emerged from comparisons of this kind has caused a lot of people to do foolish things throughout history. Some have leveraged their portfolios to the teeth in order to move up to a higher pyramid just to lose it all and then commit suicide. Some have acted on insider information and lost both personal reputations and then later their freedom when they’ve gone to jail, many have forsaken their families and then had their partners leaving them or cheating on them, or both.

As a result. you will at some point reach a level of financial freedom that the average Joe can only dream about. But you need to at some point accept that enough is enough. We will not trade something that we have a need for, something that we don’t have and don’t need, even if we kind of like to have it.

Takeaway Three: Crazy is in the Eye of the Beholder

At a first glance, it seems like a lot of people do crazy things with their money. Some spend it in ridiculous amounts on ridiculous items and others hide it under their mattresses. But the thing to remember is that people come from different backgrounds with different childhoods, different life experiences and educations. All this adds up to different perspectives and values. What seems crazy to you might make total sense for me. Morgan uses the example of lottery tickets in the book. The lowest income households in the US spend more than $400 per year on the lottery. 

This is four times more than the average in the highest income group. Combine this with the fact that more than a third of Americans cannot come up with $400 for an emergency. Do these people spend their emergency money on lottery tickets? Seems crazy, doesn’t it? But again, we do not have the same perspective as these individuals. Try to see it from their perspective. They live paycheck to paycheck with little room to save money. And they often lack education, and thus they also lack a nice career trajectory.

They can’t afford a nice vacation or a new car, and they can’t put their children through college without a mountain of debt. Buying a lottery ticket is their way of buying into the dream that many of us already live. That is why they buy more lottery tickets than we do. Not so crazy after all, perhaps. So how does this make you a better investor? For one thing, by acknowledging that we are different, we become less tempted to copy an investment portfolio or strategy which doesn’t suit our own goals. For example, our risk profile might be higher than that of billionaires, as our focus is more on the getting rich part and not so much about staying rich copying the billionaires’ portfolio might be suboptimal for your goals.

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