The Psychology of Money
“Spending money to show people how much you have is the fastest way to have less money.”
― The Psychology of Money
Table of Contents
Financial management can be challenging, particularly when the finish line is always moving. Avoid being depressed by comparisons. Remember that “enough” is not the same as “too little.” Regardless of the potential reward, remember that certain things are too valuable to risk.
The book “Psychology of Money” examines the psychological aspects that affect our financial choices and actions as well as the emotional bond that exists between people and money. Housel provides information on why people make particular decisions and how better money management can result from an awareness of the underlying psychology. This book will help you attain long-term financial success by assisting you in cultivating a more intelligent attitude toward money management and personal finances.
There are many books on how to get wealthy, and there are a million different ways to achieve it. However, there is only one way to maintain wealth: a mix of paranoia and thrift.
Confounding Compounding
“Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.” The Psychology of Money
Compounding can be compared to a snowball. a small amount of growth that continuously stimulates more growth. It may start little, but over time, the effects can be so OMG big that it appears nearly magical. The book Psychology of Money tells you about the secret of how compounding over a large time makes a difference.
Warren Buffet’s net worth was 96% after he turned 65. Warren Buffett’s investment process has been the subject of thousands of articles, books, and films, but almost none of them concentrate on the power of compound interest and long-term investing, which are the keys to Buffett’s financial success. The major reason for his success is that he persisted, kept his money invested for many years, and allowed compounding to handle the heavy lifting. The conclusion is that in addition to achieving large profits, successful investing also requires patience and consistency over time, earning respectable returns, and adhering to a long-term strategy.
Over time, discipline and patience become superpowers. The strength of compounding is one of Housel’s strongest arguments. He cites James Simons, a hedge fund manager who has been running Renaissance Technologies, a company that has multiplied at a rate of 66% each year since 1988. In contrast, the stock market has an average yearly growth rate of 9%. For decades, Simons is 733% better.
You won’t notice much in a year of progress. After ten years, you begin to notice something. Then something exceptional can be made in fifty years. However, you must be unbreakable, be financially impenetrable, and not let any of your risks bankrupt you.
Assume that you begin saving $200 a month at an annual interest rate of 6%. You will have saved $96,000 out of your pocket by the time you are 60 if you begin saving at age 20. However, your money will have increased to almost $502,810 thanks to the miracle of compounding.
On the other hand, if you begin saving the same amount at age 40, you will have saved $48,000 out of your pocket by the time you are 60. However, the value of your investment will only be about $70,400 because compounding takes less time to do its magic.
Luck and Risk
“Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort.” The Psychology of Money
Nothing is as wonderful or awful as it first appears. We often concentrate on and attempt to learn from the experiences of successful people, but we are typically not very adept at recognizing the part that luck played in their narrative.
Think about Bill Gates, who went to one of the few computer-equipped high schools in the United States. Just one out of every million pupils in high school went to a computer-equipped high school. Without taking into account this very fortunate situation, is it even feasible to understand Bill Gates’ success?
You are less likely to be able to adapt the outcome to your circumstances if it is more dramatic. Naturally, it’s acceptable to take inspiration from Bill Gates or other accomplished people, but we shouldn’t expect to replicate their success by simply understanding how they excelled at their particular field. The world is too complicated to allow any particular result to be explained just by human effort, ignoring chance.
Instead, pay attention to patterns and trends rather than specific people. Simply put, there are simply too many moving parts, making differentiation extremely challenging. between skill, chance, and risk. Finding general trends and patterns of success and failure will bring you closer to actionable insights. You are more likely to be able to adapt a pattern to your situation if it is more prevalent.
The secret to overcoming failure is to set up your financial affairs so that a poor investment here and a financial objective missed there won’t bankrupt you and that you may continue to play until the cards turn in your favor.
Life is about taking chances, hoping for good fortune, guarding against unpleasant things, and ultimately pursuing goals you think you can accomplish. According to statistics, having any form of success is less likely than not having any success at all. Nobody has a very high chance of becoming a bestselling author, the creator of a unicorn firm, or a highly sought-after executive coach. However, because I believe in them, they are the things I would like to devote my time to. At the same time, I think it’s crucial to protect those negative risks.
Save Money
If you make wise financial decisions, you can accumulate money even on a little income. But it’s practically unattainable without a high savings rate.
Housel emphasizes in his book “The Psychology of Money” the connection between prudent investing, setting aside a sizeable amount of income, and leading a modest, economical life. By avoiding the temptation to keep up with others, you can save more money.
The finest part of saving money is that it gives you freedom, options, and the ability to wait for opportunities. It allows you the flexibility to alter your course at your own pace and provides you time to reflect.
Increasing your savings rate is more important for building wealth than your income or investment results. And you know what? You can do something about that. Yes, you can get wealthy through investment returns. But when it comes to investment, there is always a degree of uncertainty. The markets will not always cooperate, and current techniques may not be effective in the future. Guessing is a part of it, isn’t it?
Learning to be satisfied with less money could cause a gap between what you have and what you want. It’s easier and provides you more power, yet it’s comparable to getting a raise.
Your safety net is your savings. Life is full of surprises, but if you have been saving, you will be prepared for any eventuality.
You are susceptible to the vagaries of life if you lack time management abilities. You can wait for such amazing opportunities to arise, though, if you have some flexibility. Think of it as a covert return on your investment!
It takes a completely different set of talents to get money and to keep it. While the latter calls for a certain amount of humility and even dread that you might lose what you have worked so hard to obtain, the former calls for taking chances, optimism, and bravery. In order to fully capitalize on the power of compounding, staying affluent necessitates having a survivor mentality—the capacity to endure for an extended period of time without making significant mistakes.
Becoming financially unbreakable should be the primary objective. This means having the capacity to withstand financial setbacks and staying in the game long enough to reap the rewards of compounding. Think about unforeseen events like the COVID-19 pandemic, the housing crisis, and the 9/11 attacks. Such volatility is permitted by a prudent financial plan, which leaves room for error.
The US economy’s history serves as a reminder that progress and expansion are often accompanied by hardship and loss. A realistic approach that blends short-term caution with long-term optimism is necessary to navigate the uncertainty of life and the economy.
Success is Always Unlikely
“I know people who think it’s insane to try to beat the market but encourage their kids to reach for the stars and try to become professional athletes. To each their own. Life is about playing the odds, and we all think about odds a little differently.” The Psychology of Money
Life is about taking chances, hoping for good fortune, guarding against bad things, and ultimately pursuing goals you think you can accomplish. According to statistics, having any kind of success is less likely than not having any success at all. Nobody has a very high chance of becoming a bestselling author, the founder of a unicorn startup, or a highly sought-after executive coach. However, because I believe in them, those are the things I would like to devote my time to. At the same time, I think it’s crucial to protect those negative risks.
Recognize the unpredictability of financial markets and learn how to modify your personal finance plan accordingly. Understanding the past is helpful, but if you rely too much on it, you might miss the outlier events that will have the biggest impact going forward. Recognize that a small number of predictably occurring past events can be used to explain most of what is currently occurring in the global economy. Your conclusions about finance should be more general the further back in time we look. Keep in mind that historical lessons may no longer be applicable due to structural changes in the modern world.
People cannot succeed if they do not put in the necessary effort. People will be impressed, and we will be able to accomplish our goals if we work hard for hours or years. Hard work is exemplified by Michael Phelps, one of the greatest Olympic athletes of all time. At the age of seven, he began swimming, and now, each time he competes, he sets new world records that no older swimmer can match. Phelps did more than just swim; she trained virtually every day of the year. Michael Phelps is a prime example of how patience pays off, as he is now regarded as not just one of the best swimmers of all time.
Tail Events
“People who live far below their means enjoy a freedom that people busy upgrading their lifestyles can’t fathom.” Naval Ravikant
A lot of things in business and, interestingly, investing work. Long tails, or the extremes of the distribution of outcomes, wield enormous power in finance. Here, a small number of events can explain the majority of outcomes.
Consider this: most public companies fail, a few succeed, and only a few emerge as extraordinary winners, accounting for most of the stock market’s returns.
Disney’s Turnaround is another example. Walt Disney’s early forays into animation were financially disastrous, but “Snow White and the Seven Dwarfs” transformed everything. This single film eliminated all debts and charted a new course for the company. Similarly, venture capital investments frequently fail, but a few successes can be transformative.
The majority of outcomes are usually caused by a few events. Recognize that many things in business and investing operate in this manner. Long tails—the farthest ends of a distribution of outcomes—are extremely important in finance. Only 7% of the stocks that make up the Russell 3000 index, which roughly represents the US economy, have explained the overall returns since 1980. 40% of stocks lost more than 70% of their value and never recovered during the same period. Charlie Munger recognized that “if you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.” Remember, in investing, tails drive everything, and correctly identifying the needle in the haystack is extremely challenging.
Tail events can occur both internally and externally. Amazon’s web services and Prime membership are examples of successful bets, among many that failed. The lesson here is about perseverance and the willingness to pursue multiple paths, knowing that a few will drive the majority of the success.
Rare, unexpected outcomes—tail events—frequently drive success more than we realize. Housel uses the example of Heinz Berggruen, who rose from humble beginnings in Germany to become a billionaire art dealer. Even though the majority of his art collection did not increase in value significantly, a few key pieces by artists such as Picasso skyrocketed, making his portfolio extremely valuable. This principle is similar to the strategy behind index funds: spread your bets widely and let the few winners pay off big.
The most significant impacts frequently come from unexpected places. Whether in art, venture capital, or personal investing, spreading out your bets and staying the course through the ups and downs can lead to outsized success, thanks to the power of tail events.
So, if you believe that tails drive everything in business, investing, and finance, you will find it perfectly normal for many things to go wrong, break, fail, or fall. It is all part of the game!
The ultimate goal
“The ability to do what you want, when you want, and with who you want, for as long as you want, is priceless. It is the highest dividend money pays.” The Psychology of Money
The ability to manage your time is the greatest inherent value of money. According to Housel, people’s desire to be in charge of their own lives is the one thing that unites all happy people. I believe that many of us can relate to this; even for people who genuinely enjoy their jobs, working on an unpredictable schedule can feel like doing something unpleasant at times.
There is no proof that Americans are getting happier, even though they are the richest nation in history. According to the author, this is partly because we have relinquished more control over our time. Many employees still consider working during their leisure time because white-collar jobs are evolving. The fact that we are constantly working in our minds makes it seem like work never ends. Keep in mind that the most valuable dividend money can provide is time control.
To a certain extent, money is significant. After that, having more money doesn’t always translate into being happier, so sacrificing your freedom to increase your income will only make your life and yourself even worse. Therefore, if you want to be happy, invest in financial freedom rather than a larger home or a fancy car. However, we give up more control over our time when we spend our increased wealth on larger and better items.
The key to our happiness is not having a lot of money; rather, it is feeling in control of our lives, making our own decisions, and living our lives as we see fit.
Embracing the amazing sensation of being in charge of your own life is a more reliable way to promote happiness and well-being than any of the objective life conditions we’ve discussed.
Housel reminds us that the ultimate goal of investing and financial planning is to free up our time so we can do as we please. We take charge of our time and lives when we make prudent financial choices that increase our wealth. Success, after all, is simply having the freedom to live the life we desire.
What could be better, really, than living a life in which you are free to choose?
The psychology of money review
“The Psychology of Money” is a gripping, short read that demonstrates how acquiring wealth frequently depends more on sound behavioral skills than intelligence, and that behavior is frequently challenging to teach. Through a series of short stories about people’s financial decisions, author Morgan Housel demonstrates his points.
According to Housel, the book delves deeper into the subjects he discussed in his widely read report of the same name from 2018. Housel, a partner at venture capital firm Collaborative Fund, was formerly a writer for The Wall Street Journal and The Motley Fool.
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