Dear Readers,
I recently completed reading “The Psychology of Money” by Morgan Housel. This has to be one of the best personal finance books that I have read in the recent past. I posted a twitter thread detailing my top 10 takeaways from this book. I am re-posting it here with some added notes for you to read and enjoy.
PS: I got a “like” from Morgan Housel on this twitter thread. It just made my day, knowing the author of this book liked my post about his book. 🙂
Takeaway 1: Different perspectives
Two smart people can disagree about how to invest, their definition of risk, how and why recessions happen etc. simply because of their upbringing, their life experiences and when they were born.
Personal finance is called “personal” for a reason. We each have our own risk tolerances, our own investing objectives and our preferences about when and how to go about our financial independence journey. But I did not appreciate this philosophy as much until I read through the evidences Morgan Housel provided in support of this argument. Indeed, I don’t think anybody reading this article would have gone through the economic turmoil resulting due to the Great Depression. It is hard for any of us to imagine what it would be like to live through World Wars. It was a different world, and therefore my definition of risk, and what could go wrong in this world is very very different from someone from that era.
Takeaway 2: Luck and Risk
Luck and risk impact every outcome in life. They are hard to measure, hard to accept and are often overlooked.
We cannot understate the importance of sheer luck in life. It is something that we take for granted quite often. Even with the most celebrated success stories, there are so many instances of how luck played a significant part in each of stories. The same is true with investing. We celebrate the most successful investors comparing how they were able to beat the market through their investments, but underplay the importance of luck in some of their decisions. For. eg. the most celebrated investor of our time, Warren Buffett also states how lucky he got with his investments. One such example is as follows: During the 60s and early 70s, Buffett was finding it hard to find good value opportunities because of the booming stock market. He decided to dissolve his investment partnerships in 1969. Come 1973-74, US was in an economic recession and Buffett, now managing Berkshire Hathaway full-time, was able to invest again into securities at much depressed valuations. His partner, Charlie Munger, stated the following:
“You can argue it worked out wonderfully for Warren to quit in ’69. And then have ’73-4 to come into with his powder dry. I don’t think we’re likely to be that quite that fortunate again.”
Risk happens to be another side of the same coin as luck. Once again, in a discussion about returns generated by famous investors, there is rarely a note on the amount of risk they are taking on to generate those returns.
Takeaway 3: The Power of Compounding
The power of compounding isn’t intuitive. It is easy to ignore its potential and get distracted. Compounding doesn’t rely on big returns. Instead, it depends on good returns kept *uninterrupted* for the longest period of time – amidst times of chaos and havoc.
I have written about the wonders of compound interest on this blog previously. Nobody can dispute it since it is math. It is therefore very surprising that investors stray away from just a simple “buy and hold” strategy and try and deviate towards other means of making a quick profit. Morgan Housel argues that while the math makes sense on paper, it is hard for the human mind to come to terms with the enormity of these numbers.
Takeaway 4: Room for Error aka Margin of Safety
Margin of Safety raises the odds of success at a given level of risk. It lets you live happily and safeguards you against *a range of possible outcomes*
Nothing much to add on this one. As the godfather of value investing, Benjamin Graham, has stated himself: Investing with a margin of safety helps in safeguarding the investor from poor investment decisions.
Takeaway 5: Rich vs Wealthy
It is not that hard to spot rich people. They go out of their way to make themselves known. In contrast, wealth is hidden. It’s income that is not spent. Its value lies in giving you options later in the future.
I absolutely loved this chapter in the book. The difference between being rich and being wealthy is perhaps one of the first lessons that ought to be taught in personal finance studies. Far too often, it is easy to get enamored by folks who trot around in their fancy cars, their designer clothes leading a lavish lifestyle. One can wonder how cool it would be to live life like that. But is that really a smart way to live life? Whom is this really benefiting? Isn’t this just short-term gratification?
Contrast this those who are wealthy, they make enough money to live life comfortably, but pay specific attention to living well below their means and save for a rainy day. This lifestyle choice gives them plenty of options to overcome situations when life throws a curveball at them.
Takeaway 6: Savings Rate
Building wealth has little to do with your income and investment returns, but lots to do with your *savings rate*.
I have written previously on this blog about the importance of Savings Rate and how this is such an under-appreciated concept in investing. Morgan Housel emphasizes the same concept in this chapter through some great examples.
Takeaway 7: The cost of successful investment returns
“As with everything, successful investing demands a price. But its currency is not dollars. It’s volatility, fear, doubt, uncertainty, and regret – all of which are easy to overlook until you’re dealing with them in real time.”
So while there is no denying that compounding is the easiest way to generate massive returns from our investments, the biggest impediment to compounding is our own mindset. It is very easy to get distracted by the next “easiest way to make a quick profit” or the “new hot investment vehicle that is guaranteed to triple your money in a few months”. It is also very very hard to look at your investment returns during a bear market and believe that everything will be alright.
Takeaway 8: The Lure of Pessimism
It is hard not to ignore pessimism, it sounds smart and seems more plausible.
It is very hard to ignore negative news, be it in investing or even generally: it is in our face almost everywhere we go, especially in today’s world which is dominated by social media. And when the news is regarding the market, everyone is keen to pay particular attention to it. There is no news that heightens our anxiety like the news on money and our investment.
However, Morgan argues how this pessimism is often times overblown:
“The investing industry is filled with prophets of doom, despite the fact that the stock market has grown 17000-fold in the last century (including dividends).“
Takeaway 9: Different rules for Different players
Investors have different goals and time horizons. Thus prices for assets that look ridiculous to one person can make sense to another, because each investor is paying attention to a different set of factors.
A day-trader can look at the price of an asset and not care about its intrinsic value, especially if he/she is only interested in selling that asset within the same day in order to make a quick profit. But should a long-term investor have the same outlook? If yes, then the long-term investor is bound to have a disappointing return on his/her investment into that very asset. Thus a wise investor should have an ability to think for themselves and independently judge whether a particular investment makes sense for them rather than rely on someone else’s stock picks or analysis.
Takeaway 10: Reasonable > Rational
The rational investor can rely on academic finance to come up with a mathematically optimal investing strategy. The reasonable investor, however, wants to rely on a strategy that will help him/her sleep better at night.
This was another brilliant chapter in this book, one that I re-read a couple of times. Morgan Housel cites several examples to show how investors will choose to be reasonable instead of “cold-hard” rational when it comes to investment choices and decisions. This is what separates humans from analytical robots, because we all have emotions that can impact our thinking and objectivity.
Summary
This book has remained on my to-read shelf for a while now, and I am glad I picked it up to read at the start of this year. It has truly been motivational and eye-opening in some of its insights it has given me. Long-term investing is much about the right mindset as it is about picking good businesses to invest in. I think this book will help me stay grounded and remain objective in my investing journey.
Have you read this book? What were your takeaways from this book? Please let me know in the comments below!
Cheers!
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