The Psychology of Money
CONTENTS
Three Big Take-Aways
Who Should Read the Book?
Chapters and Notes
Three Big Takeaways
You need to let compounding work for you. You need to consistently build a diversified portfolio and let compounding do the rest without disrupting it in the long run.
You need to save money and keep investing consistently for the odds to work in your favor by virtue of sheer volume. Because the odds are, it’s only a small percentage of your picks that will actually account for big returns.
You need to develop emotional maturity to endure short-term market downturns. Think of this as the fees you have to pay to realize long-term returns. You get what you pay for.
Who Should Read It?
Everyone!! This summary definitely does not do justice to the book. However, I have noted things that felt most impactful to me. It's filled with demonstrations, stories, and anecdotes in every chapter; each reader could walk away with something personal. It is a very compelling book, even for a newbie reader.
The Psychology of Money: Timeless lessons on wealth, greed, and happiness
Amazon Link
Chapters and Notes
1. No One's Crazy
Even the most bizarre sounding finance decision did have fair reasoning in the mind of the person who took the decision at that moment. However, they may have been based on the unique experience the individual has had rather than the rational value that the investment has the potential to provide.
2. Luck & Risk
The role of luck in investment success stories is often underrated. This is demonstrated with the example of Bill Gate's story in the book. When he was 13 years old in Lakeside school with access to a computer in 1968, he was among 308 million high school-age students in the world. About 18 million were in the United States, 300 in lakeside school, and yet Bill Gates had the advantage of having the interest and access to work on computers. That puts Gates in a fairly advantageous position to go on later to do things that he did.
Risk plays a role just as important. It's unfair to judge in hindsight, considering there are factors beyond our zone of control or influence. Instead, we should forgive ourselves and leave room for understanding when judging failures.
3. Never Enough
Some downsides are never worth risking, no matter how good the upside is. You can get blindsided by greed and not realize if what you have is really good enough or not. This leads to really well-off individuals making bad decisions, not knowing when is it enough.
Money Advice: Find a personal definition of what is enough for you. That does not include things you want to possess to impress others.
4.Confounding and Compounding
Little know fact about Warren Buffet's investments is that over 90% of his wealth was built after he turned 60. Before that, he had been consistently investing since the age of 30 and letting compounding work its magic.
Money Advice: Shut up and wait. A good investment is not about very high returns because they can be one-off instances. Instead, focus on pretty good returns that can be consistent and repeated over time.
5.Getting Wealthy and Staying Wealthy
While there may be several ways to get wealthy, frugality and conscious paranoia (towards questionable investment ideas) are the only ways actually to stay wealthy. Humility is appreciating the role of luck in getting wealthy and paranoia against one-off financial bets with extremely high downsides.
6. Tails, You Win.
Warren Buffet said he had owned 300 to 400 stocks in his lifetime, and only 10 of them (tail events) are responsible for most of his returns.
Money Advice: It's nearly impossible to be right when you pick only one bet (among millions of choices). But if you consistently make fair bets, the odds start to work for you. You should be picking enough volume so that the "tail-picks" make up for all the bad investments and make you wealthy in the long run.
7. Freedom
Having enough wealth to give yourself the freedom to choose what to do with your time is the biggest dividend that money can pay. Freedom equates to happiness. Being able to decide what you want to do with your time when you wake up in the morning makes you happy. You do not have to be stuck to a 9 to 5 job if you don't like it. You don't have to take that job immediately after you have been laid off. You can wait around to do the job that you enjoy the most.
8. Man in the Car Paradox.
We buy fancy cloth and cars to impress and be admired or liked by others. Ironically, people are not usually impressed with the "Man" in the Car. They are just impressed with the car and mostly imagine themselves in the car. They look at the car and see a benchmark for themselves to achieve. Horsepower does not buy you respect; humility does.
9. Wealth is what you don't See.
We tend to judge wealth with what we see, but in reality, all a fancy car shows is that person is $100,000 poorer than earlier. We don't see their bank accounts or brokerage statements. Being seen in a fancy car is not equivalent to being wealthy. Trying to look wealthy is the easiest way to lose wealth.
Money Advice: "Spending money to show that you are wealthy is the easiest way to lose money."
10. Save Money
Spending less leads to saving more. When you stop caring about what others think about you, you desire less, and in turn, you spend less. When you spend less - you save more. That's it.
Money Advice: Financial frugality and personal savings are the two most important factors that are entirely in your control and the only two factors that will help you build your wealth.
11. Reasonable > Rational
Being reasonable is more important than being rational when you make financial decisions. Being reasonable lets you sleep better at night, and you increase the chances of your future self sticking to the plan in the long run. This gives the much-needed consistency required for the compounding to work in your favor.
Money Advice: Do not always rely on spreadsheets to make your financial investment decisions. You may have to decide between a stock of a company that does things you are passionate about and another that makes cold financial sense. You may end up deciding to invest in the former just so that it helps you sleep better when things go bad.
12. Surprise
We often look at history to predict the future. But history seldom repeats itself, considering all the one-off financial events that occurred since the great depression.
Money Advice: Plan to be surprised. Plan to be disappointed.
13. Room for Error
Plan for your plan to not go according to the plan.
Money Advice: Save for no reason because you never know what emergency will present when you need to use the emergency fund. Having a cushion of at least 6 months worth of emergency funds will keep you safe from being bankrupt.
14. You’ll Change
In the long term, account for the fact that - things change. That includes yourself, your wishes, what you want to be, what you want to do, your preferences, your friends, where you live, and most importantly, things you don’t even know.
Research shows we tend to underestimate how much we will change between age 18 to 68 when we were young.
Money Advice: Do not interrupt the compounding effect unnecessarily. Avoid extreme ends of financial planning and accept the reality of changing minds midway. Be open to reassess but do not disrupt your compounding. Do not get caught up in the past - Sunk costs of your financial planning decisions will drag you down.
15. Nothings Free
Jeff Immelt, on his way out from GE in 2017, taking the blame for 2009, said: “Every job is easy when you are not the one doing it.”
Be prepared to pay the price for long-term investment through cycles of recession and boom. Trying to avoid the cycle or avoid paying the price; will disrupt compounding, as demonstrated by the example of GE.
Money Advice: Think of market volatility as a fee rather than a fine for investment gains to work in your favor. If you sit one out and avoid paying the price of the volatile cycle, the price could be your long-term financial gains. The fee is the mental stress you go through while the market is in recession (95% of the time stocks trade 5% less than their previous high at any given point) is the fee you pay to get better returns in comparison to the alternatives like holding cash, or bonds.
16. You & Me
The notion that shares have one rational price for investors with different goals and time horizons is questionable. Short-term investors and traders are willing to pay the spot price with utter disregard of a bubble looming and an impending bust. The larger volume of trade means more short-term trades than long-term investors are trading the stock, which means short-term demand drives the current market price.
Money Advice: Watch out for overpriced stocks when you are picking for long-term investments. These prices may make sense for short-term traders who will sell the same day, but not for you. So, short-term volatility should not bother the long-term investors as that’s not the game you are playing.
17. The Seduction of Pessimism
Pessimism just sounds smarter and more plausible than optimism.
Money Advice: Single events of disaster seems to overshadow longer-term gains. In reality, the gains over time still outweigh the losses from such apparent setbacks.
18. When you’ll believe anything.
We tend not to comprehend how much we don’t know and yet make decisions based on what we know and filling in the gaps with our own stories. We look at history to confirm our biases. We ignore narratives that do not confirm our biases.
Money Advice: Same as in chapter 17, be wary of things we don’t know and following advice from people with different opinions, perspectives, and time horizons for financial decisions.
19. All Together Now
This chapter sums up the takeaways from most of the previous chapters. The idea that most resonated with me is the power of humility. Nobody cares about the car you drive or the watch you wear. People pay attention to the car or the watch itself rather than the owner.
20. A Brief History of Why the US Consumer Thinks the Way they Do.
Notable events post World War II in the United States- like the productivity boom, credit availability, and subsequent improvement in quality of life shaped consumer psychology today. Until the early 80s, a relative parity in living standards existed between the middle class and the super-rich. Households in the median income range could afford more or less the same sized housing in the same neighborhood as that of higher-income class households. Then came the events that lead to the dot-com bubble and the huge wealth gap. The millennials responded to the inequality in the form of the tea party, Occupy Wall Street, and Donald Trump phenomena. This is their way of saying, whatever this is, it's not working for us, so - “Stop the ride, I want off.” With this, the author argues, we may even have come to a full circle with similar conditions that existed post World War II.
