Listened to The Psychology of Money audiobook on Libby app while driving to Florida recently. For those who want to buy the book here (affiliate link). The thesis is simple and powerful. You don’t need to be a MBA to make good money decisions. A lot of this is not the head, but it’s the heart and the hand. Being sensible and consistent is WAY more important that coming up with genius candlestick trading algorithms.
Ronald Read – janitor and philanthropist
Starts off with the story of Ronald Read, who was a car mechanic and janitor, who left $8M to this children and charity at the age of 92. Without formal “financial education”, Ronald did the smart and basic things well. He put his money in large growth-cap stocks and didn’t touch them. This is better than what most of us do.
To some, lottery tickets make sense
It’s easy to judge other people’s financial decisions. (confession, I do that all the time). Yet, we can also say that everyone’s biases are influenced by their upbringing, education, and values. Basically, don’t judge. Yes, lottery makes no statistical sense. And yes, people do it all the time. And yes, lower income people buy them at 4x the rate of higher income folks. Lots of education and work needed on this, and no, don’t blindly judge people.
Luck is real, risk is real
It’s easy to pick out winners and extrapolate from there. Sadly, we do that in business school all the time – look too much at the winners. Yet, we know that luck exists. Housel notes that Bill Gates had the good fortune of going to a high school that had one of the first computers. (1 in a million chance). At the same time, one of Bill Gates good friends (Kent Evans), someone who could have been a co-founder of Microsoft with Bill and Paul died in a high school hiking accident (also 1 in a million chance).
Limit the FOMO
Housel says, “The hardest financial skill is to get the goal post to stop moving.” This is so deep. You get some money and want X. Then you get more money and you want Y. Then you get more money and you want Z. Dude, make the ladder of expectation stop. Super wealthy people do stupid things too. Everyone is in an inane search for MORE. Bernie Madoff had a legitimate market-making business which ran 9% of NYSE volume. The firm made plenty of money, but alas, it was not enough to feed the FOMO machine.
Compounding return = magic
This is not how the author described it, but you get the point. Putting your money to work takes time, patience, and leverage. You don’t get financially free after 1 great year of stock picking (or lottery). Wealth is about compounding. The majority of Warren Buffett’s wealth came after he turned 85 years old. If you look at a exponential scale, it sure doesn’t move a lot a the beginning. . .then later, it looks like a rocket.
Making money and keeping money are different
This one surprised me. The nut of it is that getting wealthy requires risk, while staying wealthy requires humility and fear. Capitalism is difficult and you need to be around to ‘play another round.’ Need to let compounding work. To me, this means that the brainpower you use in your 30-50s to gain wealth, might look different from the brainpower you use in your 60-80s to keep the wealthy. Deep.
Non-linear returns; the long tail matters
This is also something I intuitively know, but am continually surprised by. Averages have no meaning. There is a reason you have a portfolio of investments – because you don’t know which one will be an APPL or GOOGL. JP Morgan showed that over a 35 year period of the Russell 3000, 7% of the stocks drove all the return. Basically, if you missed some of the whale investment returns from a few winners, you’re bumming. Charlie Munger essentially said the same thing about BRK-A returns. George Soros said, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” Basically, you can be wrong a LOT, and still be massively successful.
Money’s value = control of your time
Housel talks about “doing what you want, with who you want, when you want, for as long as you want.” Money affords you flexibility, security, agility, creativity. Money frees up your time. BOOM.
Wealth is what you don’t see
This is incredibly counter-intuitive. Being rich is visible = a fancy German car, French handbag, a second home. Being wealthy is invisible = liquidity, available credit, marginable securities, dividend payments, rental income.
Savings = income – ego
We can’t control the future, stock volatility, interest rates, or the business cycle. However, we can control our savings. Housel poetically describes savings as the difference between “ego and income.” BOOM. If you can control your ego (new laptop, new car, new house, new clothes) under your income, that’s savings rate.
Plans don’t go according to plan
We live in a crazy, unpredictable world. Your plans will not be perfect. Humans are beautiful and messy. It’s impossible to forecast with accuracy. Ergo, it’s important to expect some of your plans will go awry. You need a margin of safety or room for error. If your plan has to be perfect to work (like a Mission Impossible movie), it’s not a very good plan. In contrast, if X can go wrong, and Y can go wrong, and you’re still okay = that’s a good plan.
“End of history” illusion
I have never heard of this heuristic, but it rings true. We are hyper-aware of how much we’ve changed in the past, but “underestimate how much their personalities, desires, and goals are likely to change in the future.” Basically, we THINK we know what we want, but really don’t. We should we wary of over-planning. We should stay flexible. Show ourselves some grace; it’s okay to change our mind. We change, we fall in love, we fail, we get bored.
Markets are efficient
The author says that “nothing is free” and I would probably rephrase this to say that risk and return are correlated. If you’re aiming for alpha (above average rate of return), then you need to be willing to accept some volatility. There is no free lunch; return comes with risk
What’s your time frame?
If you’re in your 50s, you might have 100% of your assets in growth stocks. It’s aggressive, but I can see that. If you’re in your 80s, that probably doesn’t make sense. The 50 year-old and the 80 year-old have different investing time horizons. As with strategy, you need to play your own game.
Sleep better at night
I love this idea. Money is a tool – not a goal, not an idol. It serves us. So, make money decisions that help you to sleep at night and live the life you want.
Extend your time horizon
Housel emphasizes that time is the biggest tailwind in your wealth creation. Remember, Warren Buffett has been investing for 75 years. Start early, stay in the game, celebrate the wins, forgive mistakes, keep going.
Key takeaways
For me, John, it looks like this. . over your 20s, 30s, 40s, 50s. . .
Revenues = price x quantity
- Get really good at something that the world wants, (think: Cal Newport)
- Do a LOT of it; work harder than most
- Get better and better at it; raise your prices, get a promotion; raise your bill rate
Expenses = live below your means
- Save like crazy; pay yourself first; ignore FOMO
- Be bourgeois and cheap (anyone can pay full price, after all)
- Spend on things that give you value (safety, comfort, confidence, fulfilment)
Assets = get things that accrue in value
- Assets come in all shapes, flavors, and sizes. Get assets that go up in value
- Get assets that play to your advantage (you know what to do with them)
- Get assets that last (e.g., not things that depreciate quickly)
- Use debt well (low interest rates; sufficient interest coverage) get a higher ROE
- Dupont is your friend; higher margin x higher efficiency x reasonable leverage