Psychology of Money
Morgan Housel
Thought-provoking.
A book that distills down the meaning of money and difference between wealth and richness. It doesn’t preach how to invest or save; whether to ride the next big wave or not. It however tells us to concede —luck plays a role we often overlook/ignore, being rich & possession of luxurious items is matter of status symbol which does more to please your ego than impress others. It briefly explains what bubbles are, how shortening of timelines is the real cause of bubble and soaring prices is a symptom. It does a decent job of explaining importance of keeping room for error, staying optimistic and reasonable rather than coldly rational, and overall to give importance to what gives you a good night sleep over what’s recommended by so-called experts.
Ronald Read, who died, at age 92 as a philanthropist. Worked as a janitor for his entire life, gave 2mn to his step kids and 6mn to local hospital.
Same year, Richard Fuscone died. Richard was everything Ronald wasn’t. Richard was Harvard-educated Merril Lynch executive with an MBA, Forbes “40-under-40” guy only to file for bankruptcy few years later.
Financial success is not hard science. It’s a soft skill, where how you behave is more important than what you know. This soft skill is Psychology of Money.
Reason why we haven’t mastered money management is because its taught too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance).
Physics isn’t controversial because its governed by laws. Finance is different since it’s guided by people’s behaviors.
History never repeats itself; man always does. — Voltaire
Some lessons have to be experienced, before they can be understood.
The individual investor’s willingness to bear risk depends on their personal history, according to 50 yr survey of Consumer Finances by National Bureau of Economic Research
A generation which experienced high inflation will look at bonds as wealth incinerators; for another generation which has seen collapsing interest rates and stable prices would see bonds as wealth generators.
A teen/20yr old in 1950 would see stocks going nowhere while a same age person in 1970s would see S&P500 rise by 10x.
King Alyattes of Lydia, now part of Turkey, is thought to have created the first official currency in 600 BC
Idea of private pension is new.
“The 401(k) — the backbone savings vehicle of American retirement — did not exist until 1978. The Roth IRA was not born until 1998.”
Luck & risk
Nothing is as good or as bad as it seems.
Luck and risk are siblings. Bill gates was luck, Kent was risk.
If there had been no Lakeside, there’d be no Microsoft
In 1968, 303mn high school kids in the world, 18mn in USA, 270k in Washington state and 100k in Seattle. 300 of these kids attended Lakeside.
“One in a million high-school-age students attended the high school that had the combination of cash and foresight to buy a computer. Bill Gates happened to be one of them”
Kent Evans, Gates’ second friend in the trio of Paul Allen, Bill and Kent. By Gates account, Kent was the best student in his 8th grade class. Kent died in a mountaineering accident before graduating, with the odds of being killed on a mountain in a high school to be one in a million.
Luck and risk are both the reality that every outcome in life is guided by the forces other than individual effort. They both happen because world is too complex to allow 100% of your actions to dictate 100% of your outcomes.
The accidental impact of the actions outside your control are more consequential than the ones you consciously take.
Another person who’s success is hard to pin down on skill or luck
Cornelius Vanderbilt, king of railroad empire.
You can praise Vanderbilt for flaunting the law with as much passion as you criticize Enron for doing the same. Perhaps one got lucky by avoiding the arm of the law while the other found itself on the side of risk.
John D. Rockefeller is similar. His frequent circumventing of the law — a judge once called his company “no better than a common thief” — is often portrayed by historians as cunning business smarts.
When does the narrative shift from, “You didn’t let outdated laws get in the way of innovation,” to “You committed a crime?” Or how little would the story have to shift for the narrative to have turned from “Rockefeller was a genius, try to learn from his successes,” to “Rockefeller was a criminal, try to learn from his business failures.” Very little.
“What do I care about the law?” Vanderbilt once said. “Ain’t I got the power?”
He did, and it worked. But it’s easy to imagine those being the last words of a story with a very different outcome. The line between bold and reckless can be thin. When we don’t give risk and luck their proper billing it’s often invisible
Benjamin Graham, father of value investing and mentor of Warren Buffet. But the majority of Benjamin Graham’s investing success was due to owning an enormous chunk of GEICO stock which, by his own admission, broke nearly every diversification rule that Graham himself laid out in his famous texts.
Where does the thin line between bold and reckless fall here? I don’t know. Graham wrote about his GEICO bonanza: “One lucky break, or one supremely shrewd decision — can we tell them apart?” Not easily.
We credit Mark Zuckerberg for turning down Yahoo!’s 2006 $1bn offer to buy his company. He saw the future and stuck to his guns. But we discredit Yahoo for turning down its own big buyout offer from Microsoft.
“The customer is always right” and “customers don’t know what they want” are both accepted business wisdoms. The line between “inspiringly bold” and “foolishly reckless” can be millimeter thick and only visible in hindsight.
Risk and luck are doppelgangers.
Be carefuly who you praise and admire. Be careful who you look down upon and wish to avoid becoming.
To son,
Some people are born in a family that encourages education; others are against it. Some are born into flourishing economies; others in war and destitution. I want you to be successful and I want you to earn it. But realize that not all success is due to hard work and not all poverty is down to laziness. Keep this in mind when judging people, including yourself.
Therefore, focus less on specific individuals and case studies and more on broad patterns.
Success is a lousy teacher; it seduces smart people into thinking that you can’t lose. — Bill Gates.
Same is true on the other side. “Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk”
“How you behaved as an investor during a few months in late 2008 and early 2009 will likely have more impact on your lifetime returns than everything you did from 2000 to 2008.
There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing. Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.”
“A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.
Tails drive everything.”
“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”
Paradox: “People tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.”
“Nobel Prize in medicine in 1927. ”
“Things that have never happened before happen all the time”
“Avoiding these kinds of unknown risks is, almost by definition, impossible. You can’t prepare for what you can’t envision.”
“A good rule of thumb for a lot of things in life is that everything that can break will eventually break. So if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe. That’s a single point of failure”
“the most important part of every plan is planning on your plan not going according to plan.”
“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.”
“Like everything else worthwhile, 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”
General Electric — capitalism’s shining e.g. of corporate aristocracy
40$ in 2007 to 7$ in 2008
Immelt stepped down [2001–2017] criticized for leadership, acquisitions, cutting dividend, laying off workers and plunging stock price.
“Every job looks easy when you’re not the one doing it.”
Jack Welch [predecessor of Immelt] “Welch became famous for ensuring quarterly earnings per share beat Wall Street estimates. He was the grandmaster. If Wall Street analysts expected $0.25 per share, Jack would deliver $0.26 no matter the state of business or the economy. He’d do that by massaging the numbers — that description is charitable — often pulling gains from future quarters into the current quarter to make the obedient numbers salute their master.”
Forbes reported — “[General Electric] for two years in a row ‘sold’ locomotives to unnamed financial partners instead of end users in transactions that left most of the risks of ownership with GE”
Straight from the gut [autobio of Jack Welch]
“The response of our business leaders to the crises was typical of the GE culture. Even though the books had closed on the quarter, many immediately offered to pitch in to cover the [earnings] gap. Some said they could find an extra $10 million, $20 million, and even $30 million from their business to offset the surprise.
The result was that under Welch’s leadership, stockholders didn’t have to pay the price. They got consistency and predictability — a stock that surged year after year without the surprises of uncertainty. Then the bill came due, like it always does. GE shareholders have suffered through a decade of mammoth losses that were previously shielded by accounting maneuvers. The penny gains of Welch’s era became dime losses today.”
On the other side, Freddie mac and Fannie Mae were caught under-reporting the profits so as to spread them over the years; to signal smoothness, predictability
“Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. Monster Beverage returned 319,000% from 1995 to 2018 — among the highest returns in history — but traded below its previous high 95% of the time during that period.”
Psychology towards long-term investing: View volatility as fee rather than fine
“It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor”
Investing explained as recreation
“Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee — the price of returns — is the cost of admission to get returns greater than low-fee parks like cash and bonds.”
Trick is to convince yourself that the market fee is worth it. There’s no guarantee it will be; just like it may rain at Disneyland.
Find the price; then pay it.
Learning from bubbles
“Part of why bubbles are hard to learn from is that they are not like cancer, where a biopsy gives us a clear warning and diagnosis. They are closer to the rise and fall of a political party, where the outcome is known in hindsight but the cause and blame are never agreed upon”
“Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term”
“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”
“Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them. But when you don’t know why someone behaves like they do you won’t know how long they’ll continue acting that way, what will make them change their mind, or whether they’ll ever learn their lesson.”
“A takeaway here is that few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are.”
“I am a passive investor optimistic in the world’s ability to generate real economic growth and I’m confident that over the next 30 years that growth will accrue to my investments”
Seduction of pessimism
Optimism sounds like sales pitch; pessimism sounds like someone is helping you.
“For reasons I have never understood, people like to hear that the world is going to hell.” : Historian Deirdre McCloskey
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.
Pessimism just sounds smarter and more plausible than optimism.
“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
Intellectual allure of pessimism
“I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage” — John Mill in 1840s
There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. Pessimists often extrapolate current trends without accounting for ways in which markets adapt. Extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways.
Barrel of oil sold for 20$ in 2001 and rose to 138$ in 2008
This made fracking a viable option now. In US, oil production went from 5mn barrel / day [2008] to 13mn barrel/day [2019]
Progress happens too slowly to notice, but setbacks happen too quickly to ignore.
Progress of human flight.
Jan 5 1889, Detroit Free Press — “long-held dream of human flight is impossible” Why? Nature. Flying machine couldn’t be less than 300/400 lbs and 50lbs is low limit of weight beyond which animal can’t fly. 6months later, Orville wright dropped out of school. 1905 they had first flight. It was only in 1908 that reporters took notice. Even after they caught onto the wonder, it took years to actually be in prod. The Washington Post wrote in 1909: “There will never be such a thing as commercial aerial freighters. Freight will continue to drag its slow weight across the patient earth.” The first cargo plane took off five months later.
- 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 instant.
- The short sting of pessimism prevails while the powerful pull of optimism goes unnoticed
- In investing you must identify the price of success — volatility and loss amid the long backdrop of growth — and be willing to pay it
“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.” — Daniel Kahneman
“Risk is what’s left over when you think you’ve thought of everything.” — Carl Richards
Dan Kahneman — “Both in explaining the past and in predicting the future, we focus on the causal role of skill and neglect the role of luck. We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.”
- All lifestyles exist on a spectrum, what feels decent to one person can feel like royalty or poverty to another
- We just got the goalpost to stop moving.
- Secondary benefit of maintaining a lifestyle below what you can afford is avoiding the psychological treadmill of keeping up with the Joneses.
Nassim Taleb — “True success is exiting some rat race to modulate one’s activities for peace of mind”
First rule of compounding is to never let it interrupt unnecessarily — Charlie Munger
- Not having to liquidate/sell stocks to cover expenses is important
Objective function = good nights sleep
Invest & save in a way as to Maximize for the objective function
Post war growth 1945–1973 vs 1982–2000 growth was different
“Between 1993 and 2012, the top 1 percent saw their incomes grow 86.1 percent, while the bottom 99 percent saw just 6.6 percent growth.”
