This book combined my favorite topic psychology with finance, which I’ve been subconsciously avoiding for a long time. I got a good definition of freedom - being able to wake up one morning and change what I’m doing on my own terms. In other words, do the work you like with people you like at the times you want for as long as you want.
Here are my notes from The Psychology of Money:
- Every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences.
Take a simple example: lottery tickets.
Americans spend more on them than movies, video games, music, sporting events, and books combined.
And who buys them? Mostly poor people.
The lowest-income households in the U.S. on average spend $412 a year on lotto tickets, four times the amount of those in the highest income groups. Forty percent of Americans cannot come up with $400 in an emergency. Which is to say: Those buying $400 in lottery tickets are by and large the same people who say they couldn’t come up with $400 in an emergency. They are blowing their safety nets on something with a one-in-millions chance of hitting it big.
That seems crazy to me. It probably seems crazy to you, too. But I’m not in the lowest income group. You’re likely not, either. So it’s hard for many of us to intuitively grasp the subconscious reasoning of low-income lottery ticket buyers.
But strain a little, and you can imagine it going something like this:
We live paycheck-to-paycheck and saving seems out of reach. Our prospects for much higher wages seem out of reach. We can’t afford nice vacations, new cars, health insurance, or homes in safe neighborhoods. We can’t put our kids through college without crippling debt. Much of the stuff you people who read finance books either have now, or have a good chance of getting, we don’t. Buying a lottery ticket is the only time in our lives we can hold a tangible dream of getting the good stuff that you already have and take for granted. We are paying for a dream, and you may not understand that because you are already living a dream. That’s why we buy more tickets than you do.
You don’t have to agree with this reasoning. Buying lotto tickets when you’re broke is still a bad idea. But I can kind of understand why lotto ticket sales persist.
And that idea—“What you’re doing seems crazy but I kind of understand why you’re doing it.”—uncovers the root of many of our financial decisions.
Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.
- Bill Gates went to one of the only high schools in the world that had a computer.
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.
Gates is not shy about what this meant. “If there had been no Lakeside, there would have been no Microsoft,” he told the school’s graduating class in 2005.
Gates is staggeringly smart, even more hardworking, and as a teenager had a vision for computers that even most seasoned computer executives couldn’t grasp. He also had a one in a million head start by going to school at Lakeside.
- When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.
- 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.
- Crime committed by those living on the edge of survival is one thing. A Nigerian scam artist once told The New York Times that he felt guilty for hurting others, but “poverty will not make you feel the pain.”
What Gupta and Madoff did is something different. They already had everything: unimaginable wealth, prestige, power, freedom. And they threw it all away because they wanted more.
They had no sense of enough.
- There is no reason to risk what you have and need for what you don’t have and don’t need.
- The ceiling of social comparison is so high that virtually no one will ever hit it. 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.
- None of the 2,000 books picking apart Buffett’s success are titled This Guy Has Been Investing Consistently for Three-Quarters of a Century. But we know that’s the key to the majority of his success. It’s just hard to wrap your head around that math because it’s not intuitive.
There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called Shut Up And Wait. It’s just one page with a long-term chart of economic growth.
- Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.
- Getting money requires taking risks, being optimistic, and putting yourself out there.
But keeping money requires the opposite of taking risk. 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.
- You’ve likely heard of the investing duo of Warren Buffett and Charlie Munger. But 40 years ago there was a third member of the group, Rick Guerin.
Warren, Charlie, and Rick made investments together and interviewed business managers together. Then Rick kind of disappeared, at least relative to Buffett and Munger’s success. Investor Mohnish Pabrai once asked Buffett what happened to Rick. Mohnish recalled:
[Warren said] “Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry.”
What happened was that in the 1973–1974 downturn, Rick was levered with margin loans. And the stock market went down almost 70% in those two years, so he got margin calls. He sold his Berkshire stock to Warren—Warren actually said “I bought Rick’s Berkshire stock”—at under $40 a piece. Rick was forced to sell because he was levered.
Charlie, Warren, and Rick were equally skilled at getting wealthy. But Warren and Charlie had the added skill of staying wealthy. Which, over time, is the skill that matters most.
- No one wants to hold cash during a bull market. They want to own assets that go up a lot. You look and feel conservative holding cash during a bull market, because you become acutely aware of how much return you’re giving up by not owning the good stuff. Say cash earns 1% and stocks return 10% a year. That 9% gap will gnaw at you every day.
But if that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year—it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.
- “The great investors bought vast quantities of art,” the firm writes. “A subset of the collections turned out to be great investments, and they were held for a sufficiently long period of time to allow the portfolio return to converge upon the return of the best elements in the portfolio. That’s all that happens.”
The great art dealers operated like index funds. They bought everything they could. And they bought it in portfolios, not individual pieces they happened to like. Then they sat and waited for a few winners to emerge.
That’s all that happens.
Perhaps 99% of the works someone like Berggruen acquired in his life turned out to be of little value. But that doesn’t particularly matter if the other 1% turn out to be the work of someone like Picasso. Berggruen could be wrong most of the time and still end up stupendously right.
- Part of why this isn’t intuitive is because in most fields we only see the finished product, not the losses incurred that led to the tail-success product.
The Chris Rock I see on TV is hilarious, flawless. The Chris Rock that performs in dozens of small clubs each year is just OK. That is by design. No comedic genius is smart enough to preemptively know what jokes will land well. Every big comedian tests their material in small clubs before using it in big venues. Rock was once asked if he missed small clubs. He responded:
When I start a tour, it’s not like I start out in arenas. Before this last tour I performed in this place in New Brunswick called the Stress Factory. I did about 40 or 50 shows getting ready for the tour.
One newspaper profiled these small-club sessions. It described Rock thumbing through pages of notes and fumbling with material. “I’m going to have to cut some of these jokes,” he says mid-skit. The good jokes I see on Netflix are the tails that stuck out of a universe of hundreds of attempts.
- 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. It is the highest dividend money pays.
- Doing something you love on a schedule you can’t control can feel the same as doing something you hate.
- The letter I wrote after my son was born said, “You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does—especially from the people you want to respect and admire you.”
- We tend to judge wealth by what we see, because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Instagram photos.
Modern capitalism makes helping people fake it until they make it a cherished industry.
But the truth is that 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.
- In a world where intelligence is hyper-competitive and many previous technical skills have become automated, competitive advantages tilt toward nuanced and soft skills—like communication, empathy, and, perhaps most of all, flexibility.
If you have flexibility you can wait for good opportunities, both in your career and for your investments. You’ll have a better chance of being able to learn a new skill when it’s necessary. You’ll feel less urgency to chase competitors who can do things you can’t, and have more leeway to find your passion and your niche at your own pace. You can find a new routine, a slower pace, and think about life with a different set of assumptions. The ability to do those things when most others can’t is one of the few things that will set you apart in a world where intelligence is no longer a sustainable advantage.
Having more control over your time and options is becoming one of the most valuable currencies in the world.
- The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound. How, for example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans, but that’s what happens in a world driven by a few outlier tail events.
- Although card counting is statistically proven to work, it does not guarantee you will win every hand—let alone every trip you make to the casino. We must make sure that we have enough money to withstand any swings of bad luck.
Let’s assume you have roughly a 2 percent edge over the casino. That still means the casino will win 49 percent of the time. Therefore, you need to have enough money to withstand any variant swings against you. A rule of thumb is that you should have at least a hundred basic units. Assuming you start with ten thousand dollars, you could comfortably play a hundred-dollar unit.
- Nassim Taleb says, “You can be risk loving and yet completely averse to ruin.” And indeed, you should.
The idea is that you have to take risk to get ahead, but no risk that can wipe you out is ever worth taking. The odds are in your favor when playing Russian roulette. But the downside is not worth the potential upside. There is no margin of safety that can compensate for the risk.
Same with money. The odds of many lucrative things are in your favor. Real estate prices go up most years, and during most years you’ll get a paycheck every other week. But if something has 95% odds of being right, the 5% odds of being wrong means you will almost certainly experience the downside at some point in your life. And if the cost of the downside is ruin, the upside the other 95% of the time likely isn’t worth the risk, no matter how appealing it looks.
Leverage is the devil here. Leverage—taking on debt to make your money go further—pushes routine risks into something capable of producing ruin. The danger is that rational optimism most of the time masks the odds of ruin some of the time. The result is we systematically underestimate risk. Housing prices fell 30% last decade. A few companies defaulted on their debt. That’s capitalism. It happens. But those with high leverage had a double wipeout: Not only were they left broke, but being wiped out erased every opportunity to get back in the game at the very moment opportunity was ripe. A homeowner wiped out in 2009 had no chance of taking advantage of cheap mortgage rates in 2010. Lehman Brothers had no chance of investing in cheap debt in 2009. They were done.
To get around this, I think of my own money as barbelled. I take risks with one portion and am terrified with the other. This is not inconsistent, but the psychology of money would lead you to believe that it is. I just want to ensure I can remain standing long enough for my risks to pay off. You have to survive to succeed. To repeat a point we’ve made a few times in this book: The ability to do what you want, when you want, for as long as you want, has an infinite ROI.
- Every five-year-old boy wants to drive a tractor when they grow up. Few jobs look better in the eyes of a young boy whose idea of a good job begins and ends with “Vroom vroom, beep beep, big tractor, here I come!”
Then many grow up and realize that driving a tractor maybe isn’t the best career. Maybe they want something more prestigious or lucrative.
So as a teenager they dream of being a lawyer. Now they think—they know—their plan is set. Law school and its costs, here we come.
Then, as a lawyer, they face such long working hours that they rarely see their families.
So perhaps they take a lower-paying job with flexible hours. Then they realize that childcare is so expensive that it consumes most of their paycheck, and they opt to be a stay-at-home parent. This, they conclude, is finally the right choice.
Then, at age 70, they realize that a lifetime of staying home means they’re unprepared to afford retirement.
Many of us wind through life on a similar trajectory. Only 27% of college grads have a job related to their major, according to the Federal Reserve. Twenty-nine percent of stay-at-home parents have a college degree. Few likely regret their education, of course. But we should acknowledge that a new parent in their 30s may think about life goals in a way their 18-year-old self making career goals would never imagine.
- “All of us,” he said, “are walking around with an illusion—an illusion that history, our personal history, has just come to an end, that we have just recently become the people that we were always meant to be and will be for the rest of our lives.” We tend to never learn this lesson. Gilbert’s research shows people from age 18 to 68 underestimate how much they will change in the future.
- We should avoid the extreme ends of financial planning. Assuming you’ll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you’ll one day find yourself at a point of regret. The fuel of the End of History Illusion is that people adapt to most circumstances, so the benefits of an extreme plan—the simplicity of having hardly anything, or the thrill of having almost everything—wear off. But the downsides of those extremes—not being able to afford retirement, or looking back at a life spent devoted to chasing dollars—become enduring regrets. Regrets are especially painful when you abandon a previous plan and feel like you have to run in the other direction twice as fast to make up for lost time.
- 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.
- When I’m blind to parts of how the world works I might completely misunderstand why the stock market is behaving like it is, in a way that gives me too much confidence in my ability to know what it might do next. Part of the reason forecasting the stock market and the economy is so hard is because you are the only person in the world who thinks the world operates the way you do. When you make decisions for reasons that I can’t even comprehend, I might follow you blindly into a decision that’s right for you and disastrous to me. This is how bubbles form.
- Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions.
- Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.
If you liked the above content, I’d definitely recommend reading the whole book. 💯
Until We Meet Again…