the psychology of money - how we think might have more to do what we do than we expect

2020 has been an interesting year for most; COVID-19 was certainly something many didn’t foresee (some did see the impact it could have earlier on though - here). 2020 gave me an all-important wakeup call to think about what is most important in my life. Prior to the outbreak, my husband and I were seriously discussing moving overseas sometime in 2020 or 2021 - as I read through many accounts of people who have lost their friends and family members, and being isolated due to lockdowns and quarantines, I have learned to value the quiet moments with family and friends and the knowledge work job I was able to hold onto thanks largely to the technological advances that allowed me to work from home. Needless to say, as of January 2021, the world has not ‘re-opened’ and our plans to move overseas have been put aside indefinitely.

As the year that was defined by COVID-19 came to an end, I have had this growing uncomfortable feeling that, while I have been fortunate enough to keep my job through this difficult time, I wasn’t well prepared for any financial outlier/risk event, should I be blessed again to survive through it but lose my job.

In comes “The Psychology of Money” by Morgan Housel (thanks to Ali Abdaal’s recommendation in this video). Reading this book was an attempt to assuage some of my fears by taking action.

From my point of view, the book’s main takeaways are as follows:

1. Money gives us freedom, flexibility and control back to our lives as that makes us the happiest;
2. Getting money to give you freedom is in large part done through leaving money to compound (or as the author puts it humourously “shut up and wait”) - save, give it time, and let compounding do its thing; and
3. Even understanding the above two, what we do with money (how we invest, how we spend, how we save) will inevitably have more to do with our psychology and experience than any amount of knowledge we have on investments or guesses. So our job really is to make sure we understand how money works and how we work so that we can be happy doing our part (saving, managing the downside of risks we take and letting it compound) in spite of the changing market conditions and insecurities.

Money gives us freedom

Housel’s view is that money gives us ability to control our own time, which then gives us a level of independence and autonomy, and quotes a psychologist Angus Campbell in his book “The Sense of Wellbeing in America”:

Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.

I am not sure what lifestyle the reader of this blog finds themselves leading, but I am at present a fulltime employee. This comes with a steady paycheck, but also comes with its steady request on my time (at least a solid 8.30am to 5pm Monday - Friday). During the year, I and my colleauges were forced to take more leave days to reduce holiday leave accural that’s required to be on the employer’s books. While at first I resisted this (I wanted to be able to take leave when I could leave the house/country and travel, not when we were holed up in our houses), I did find that I enjoyed the extra day when I had full control over my time - when I don’t work, I spend my morning reading and reflecting which I immensely enjoy, and am able to relax in the afternoon. I can imagine that if money weren’t an issue, I may wish to reduce my hours to optimise happiness.

I am sure you, the reader, can dream up a few things you’d like to do differently if money was able to afford you the freedom to choose.

Gain wealth through time and managing risks

The book illustrates we tend to underestimate the power of compounding. One example he gives is that of Warren Buffett, who started investing when he was 10 years old. If he started at 30 (like many of us may do) with a standard net worth of $25,000, then assuming he generates 22% returns each year (which is quite extraordinary, I understand), his networth would be $11.9m at 60, not $84.5B like he was able to obtain in real life in his 60s.

Given the power of compounding, the author states good investing is about “earning pretty good returns that you can stick with and which can be repeated for the longest period of time”, to see “compounding run wild”.

In order to get compounding working, the author seems to suggest doing this: (1) getting money through saving (and not spending) and getting a return on this continuously - saving/not spending to ‘feel rich’ is the part of equation in money that we have control over (we may not determine how much a market returns for our investments, but we can determine how much we can save); (2) when you have money, keep it.

Keeping money vs. getting money

There are two separate mindsets that are involved - getting money requires discpline around keeping our ego in check (so not to overspend) and taking risks to make gains (aside from the straight-up saving income I suspect).

On the other hand, keeping money requires fear that what we’ve made can be taken away just as fast. The latter attitude means we don’t take unnecessary risks - including aiming for “more” gains due to not understanding our “enough” point (the example being Rajat Gupta who was worth $100M at some point, trading on insider information to be a billionaire). Here he states something I found very insightful - that this requires acceptance from our part that at least some of what we’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.

Understand how the world works and how our psychology works to keep going

This book does a good job of educating the reader on how wealth is usually created so we are aware that what we are going through is normal, and that there is no need to panic, all in an attempt to help us stay on course.

He comforts us that:

1. things will go wrong - but take heart, as a small minority of “Good” will likely outweigh the “bad” over the long run (much like the Pareto Principle):

Take venture capital. If a VC makes 50 investments they likely expect half of them to fail, 10 to do pretty well, and one or two to be bonanzas that drive 100% of the fund’s returns. Investment firm Correlation Ventures once crunched the numbers.20 Out of more than 21,000 venture financings from 2004 to 2014: 65% lost money. Two and a half percent of investments made 10x–20x. One percent made more than a 20x return. Half a percent—about 100 companies out of 21,000—earned 50x or more. That’s where the majority of the industry’s returns come from.

1. it’s okay not to be rational with investing - as we are emotional beings, if attempting rationality is going to make us quit (and get us off track with the “time” view laid out above), then rational thinking becomes a liability. Instead, he beckons us to be “reasonable” rather than rational. An example he gives is in his life - he paid off the mortgage on his house to feel that he is independent, rather than investing the money that would’ve gone into the repayment given the low mortgage rates.

2. as with the above, risk and luck happen to us all - not all of our outcomes are because of our actions or efforts. This is comforting for when things don’t go our way, but also when things are going well and we are inclined to believe it’s all our hard work (and therefore falsely may believe we can “repeat” the success)

luck and risk

I started this book at the same time as I was reading “Fooled By Randomness” by Nassim Taleb. Taleb goes into the luck and risk bit more so in his book, where he talks about ‘Nero’ who trades conservatively and avoids risk, as he looks not to maximise his profits but to shoot for “longevity”:

Nero believes that risk-conscious hard work and discipline can lead someone to achieve a comfortable life with a very high probability. Beyond that, it is all randomness: either by taking enormous (and unconscious) risks, or by being extraordinarily lucky. Mild success can be explainable by skills and labor. Wild success is attributable to variance.

Whilst I don’t belive Nero’s way of trading would work for everyone, there’s something to be said about being aware of the risk and the fact that we may not be the sole reason for our success, that’d make us pause to reconsider how we “keep” the money.

My views on the book

This book sets out common behaviours that surround money - while this book is about investing and growing wealth, it’s less about the solid “how to” but more about why we might do what we do currently with our money, and how we might be aware of our psychology (in spite of thinking something is “rational” we are not rational) in order to win at this money thing.

Precisely because it’s about how we think more than what to do, I’d wholeheartedly recommend everyone read it and get what’s relevant for them out of it.

For me, I am taking away the following learnings:

1. to be diligent in savings as this is the only part of the money equation I truly control (I am guilty of this not being my priority..).
2. to be nicer to myself for being reasonable vs. doing the perfect thing (rational).
3. to be patient and let time do its thing.

Here’s to my first year of consciously letting money grow - I am looking forward to getting an inch closer to freedom each day.