One of the better books about financial education that I have read is Morgan Housel’s book, The Psychology of Money: Timeless lessons on wealth, greed, and happiness. This book started as a blog post that can be read here.
Some sharp insights in this book struck me, and I will discuss them in more detail in the following paragraphs.
Investing is not the study of finance but how people behave with money
The premise of this book is that doing well with money has little to do with how smart you are and a lot to do with how you behave. And behaviour is hard to teach, even to really smart people.
Ordinary people with no financial education can become wealthy if they employ behavioural skills that have nothing to do with standard measures of intelligence.
Housel gives the example of Ronald Read, an American janitor, gas station attendant, philanthropist and investor, who gained a fortune of almost $8 million by investing patiently and living frugally. His investing strategy was simple, as he did not invest in companies he didn’t know about (technology companies or other hot stocks).
His neighbours and family didn’t know how much money Read genuinely had. He donated a large part of his fortune to a library and a hospital in his testament. Both donations were the most significant donations the respective library and the hospital ever received.
Then, there is the story of Richard Fuscone, former vice-chairman of Merrill Lynch, who declared personal bankruptcy after the 2008 global financial crisis came around. Fuscone borrowed massively to expand his mansion, with “two swimming pools, two elevators, six fireplaces, 11 bathrooms and a seven-car garage”.
Ronald Read was patient; Richard Fuscone was greedy. That’s all it took to eclipse the massive education and experience gap between the two. The lesson here is not to be more like Ronald and less like Richard —though that’s not bad advice.
The fascinating thing about these stories is how unique they are to finance. In what other industry does someone with no college degree, no training, no background, no formal experience, and no connections massively outperform someone with the best education, the best training, and the best connections? I struggle to think of any.
There is no way that Ronald Read would have performed a heart transplant better than a Harvard-trained trained surgeon. Nor Read could have designed a better skyscraper than an architect. But these stories where an ordinary person can outperform others with much better education, background or connections, do happen in investing because how we behave around money is much more important than what we studied about money.
We might believe that we think about money in a cold and detached manner as we would talk about mathematics or physics. However, money implies emotions, feelings, and behaviours, sometimes rational but all too often irrational.
Financial success, to an extent, is driven by luck
We tend to attribute someone else’s failures to bad decisions, but when we talk about our failures, we usually believe they happened because of bad luck.
After his son was born, Housel wrote him a letter:
Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging of entrepreneurship; others are born into 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 due to laziness. Keep this in mind when judging people, including yourself.
Warren Buffet, one of the world’s wealthiest people, acknowledged that he had a significant privilege because, in his words, “he won the ovarian lottery“, as many of the advantages we get in life, such as nationality, race, gender, health, are determined by chance.
Being rich versus being wealthy
Money has many ironies. Here’s an important one: 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 (or $100,000 more in debt). That’s all you know about them.
Wealth is what you don’t see. Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone, and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.
The difference between being rich versus being wealthy is more than semantics.
Being rich is about current income: someone driving a $100,000 car is most undoubtedly rich to afford to either buy it or the monthly payments.
Being wealthy is about income not spent, the hidden richness, and it is far more valuable than visible richness.
Too often, we are biased in our thinking about someone’s appearance. We all know people who look modest but don’t know their hidden wealth, whereas people who look rich might be barely scraping.
After he died, Ronald Read became a sensation and cherished for his investments strategy. But his wealth was hidden while he was alive, so he was nobody’s financial role model then.
We don’t make money to spend money but to have options and flexibility.
There is no faster way to feel rich than to spend lots of money on really nice things. There’s no faster way to not be rich as well. That’s the paradox of wealth.
And how to become wealthy?
The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth.
A few factors contribute to building wealth: income, investment returns, and savings rate. We might believe that we can’t truly control any of these variables, but we do. Sometimes, we might fall prey to “lifestyle inflation”, where we start spending more because our income increased. After all, wealth is income not spent.
You can build wealth without a high income, but there is no way you can build wealth without a high savings rate.
When most people say they want to be a millionaire, what they might actually mean is, “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.
Gaining money versus keeping money
Getting money is about taking action and risks.
Keeping money is about opposite skills, playing it safe, lots of inaction, and it
requires humility and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
Recognize when we have enough
The hardest financial skill is getting the goalpost to stop moving. Modern capitalism is a pro at two things: generating wealth and generating envy. Perhaps they go hand in hand; wanting to surpass your peers can be the fuel of hard work. But life isn’t any fun without a sense of enough.
After a strenuous and arduous road, we are there. We reached all the things we dreamt about, and we came on top. But why, why should we stop now? We worked so far and had some lucky combinations, so why not accumulate more? Why should we be denied a bigger slice of the pie?
And so, the vicious cycle begins, moving our goals further and further away until, as king Midas learnt, excessively loving the riches leaves no space for richness in our lives.
Happiness, as it’s said, is just results minus expectations. Which means it’s a battle that can never be won, or that the only way to win is to not fight to begin with — to accept that you might have enough, even if it’s less than those around you.
Good investing is boring
Warren Buffett is a great investor, but his wealth is not just because of being a great investor. There are far better investors than him. His wealth, apart from being a great investor, is driven by the number of years for which he has been investing now – 75 years. His skill is investing, but his secret is time. Of his USD 84.5 billion net worth, USD 84.2 billion was accumulated after the age of 50, i.e. after investing for 40+ years.
Good investing strategies are not about wild returns but about obtaining decent returns over decades, and that is how Ronald Read got his fortune from his meagre salary. The keyword is “decades”, as the exponential function of compounding interest produces astonishments over decades. The longer the decades, the higher the returns.
Linear thinking is so much more intuitive than exponential thinking. Michael Batnick once explained it. If I ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). If I ask you to calculate 8x8x8x8x8x8x8x8x8, your head will explode (it’s 134,217,728).
Things that have never happened before happen all the time
We should know that by now, as 2020 taught us. When we make plans, we would be wise to plan for errors and unthinkables.
Margin of Safety—you can also call it room for error—is the only effective way to safely navigate a world that is governed by odds, not certainties.
While investing, we need to plan for error. What if our assets decline by 30% -40%? On paper, we might answer yes, but mentally? Can our family survive this? Looking over spreadsheets is not the same as looking into our spouse and children’s eye. Did we gamble their futures?
It’s fine to save for a car, or a home, or for retirement. But it’s equally important to save for things you can’t possibly predict or even comprehend.
We cannot underestimate the importance of an emergency fund, and I talked more about it in another article.
Money does not buy happiness, money buys freedom
The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.” People want to become wealthier to make them happier. Happiness is a complicated subject because everyone’s different. But if there’s a common denominator in happiness—a universal fuel of joy—it’s that people want to control their lives.
The ability to do what you want, when you want, with who you want, for as long as you want, is priceless.
Having a bit of wealth means the possibility of taking time off from work when feeling burned out or sick, waiting for a good job instead of taking the first offer, handling an economic recession or medical bills, and freedom to grow roots to stay and wings to fly.
Your personal experiences make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.
And so, our worldview is inherently biased because a financial strategy that might work for a married couple with no children is different from the strategy of a retired widow/er, a teenager’s strategy, or a single parent with children.
Personal finance is deeply personal, so we should never imitate someone else’s financial strategy that has a different time horizon than us.
Beware of taking financial cues from people playing a different game than you are.
In this article, I didn’t even manage to touch all the wonderful ideas from this book. I plan to reread this book next year and see if my perception changed or if I gather new lessons.