Book Note: The Psychology of Money
Intro: The greatest show on earth
Money is mostly human psychology and rarely finance as a subject. Voltaire: “History never repeats itself; man always does”
1. No one’s crazy
Every financial decision a person makes sense to them at that moment and checks the boxes they need to check. It is shaped by their own unique experiences and circumstances.
2. Luck & Risk
Both luck and risk are guided by forces other than individual effort. It is just a reality of our life. “Nothing is as good or as bad as it seems” because luck and risk do play a big role in success and failure. Success/failure can be influenced by luck and risk. Therefore, focus less on an individual (i.e. do not judge too hastily) and more on the broad pattern. Be careful studying extreme examples because the more extreme an event (extreme success and failure) the more likely it was influenced by luck or risk. Instead, try identifying a broad pattern. Then it can be turned into an actionable takeaway that can be applied in real life.
3. Never enough
Joseph Heller: “Yes, but I have something he (someone who made more money than him) will never have… enough” There is no reason to risk what you have and need for what you don’t have and don’t need. Keep the goalpost (your expectation) from moving all the time. Otherwise, you will never have enough. One step forward moves the goalpost two steps behind. To catch up, you end up taking incremental and unnecessary risks and even risk losing what you have for what you don’t have and don’t need. Life is no fun without the sense of enough. Happiness is just ‘results minus expectation’. Knowing when it is enough for you is important.
4. Confounding Compounding
The real key to his (Warren Buffett) success is that he’s been a phenomenal investor for three-quarters of a century. 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.
5. Getting wealthy VS staying wealthy
There are millions of ways to become wealthy but one way to stay wealthy: frugality and paranoia. It's about survival. Getting money (taking risk) and keeping money (opposite of taking risk → requires humility and fear) are two different skills. Past success/glory can’t be relied upon to repeat indefinitely. Often, the ability to stick around for a long time is the key. Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.” Build a plan in case the original plan doesn’t go as planned. In doing so, building in a margin of error is the best as it will reduce ‘edge/skill’ needed to have a favourable outcome. Have a barbell personality → optimistic about future but paranoid about what will prevent you to get to the future.
6. Tails, You Win
You can be wrong half the time and still make a fortune. Farthest ends of the distribution of outcomes have a tremendous influence on the final reward (Pareto Rule). Failure is more common and normal than success. Realising this will prevent you from overreacting to failure. Anything huge, profitable, famous, or influential is the result of a tail event and they get all the attention which blinds us from realising that those are actually extremely rare cases. A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy (i.e. market meltdown or a recession.) At the Berkshire Hathaway shareholder meeting in 2013, Warren Buffett said he’s owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger followed up: “If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.” George Soros: it's about how much you make when you are right and how much you lose when you are wrong.
Controlling your time is the highest dividend money pays. Be able to do whatever you want, whenever you want with whoever you want. This is the biggest thing money can give you.
8. Man in the Car Paradox
No one is impressed with your possession as much as you are. If respect and admiration are your goals, be careful how you seek it. Humility, kindness, and empathy will bring you more respect than horsepower ever will.
9. Wealth is what you don’t see
Wealth is 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.
10. Save Money
Building wealth has less to do with investment return or how much you make but more with your savings rate. Intelligence is not a reliable advantage in a world that’s become as connected as ours has. But flexibility is. 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 the flexibility you can wait for good opportunities, both in your career and for your investments. 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.
11. Reasonable > Rational
Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.
12. Room for error
“The best way to achieve felicity is to aim low,” says Charlie Munger. Wonderful. 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 the risk to get ahead, but no risk that can wipe you out is ever worth taking. The odds are in your favour 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.
13. You’ll change
Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily. But how do you not interrupt a money plan — careers, investments, spending, budgeting, whatever — when what you want out of life changes? It’s hard.
14. Nothing’s Free
Everything has a price but not all prices appear on labels. Most things are harder in practice than they are in theory. Price for successful investment is → volatility, fear, doubt, uncertainty and regret.
15. You & Me
Beware taking financial cues from people playing a different game than you are. Learn and identify what game you are playing (do you need a fancy suit?)
17. The seduction of pessimism
Optimism sounds like a sales pitch and pessimism sounds like someone trying to help you. Optimism shouldn’t be confused with complacency. Optimism is a belief that the odds of a good outcome is in your favour over time. Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.
17. When you will believe anything
Stories are more powerful than statistics. The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true. If you are desperate, you will believe anything. So don’t put yourself in such a situation or avoid making a decision when in one.