Book Summary of The Psychology of Money

In this chapter-by-chapter book summary of The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness by Morgan Housel, we will cover key lessons from each of the 20 chapters.

Introduction: The Greatest Show on Earth

This chapter sets the stage for the book. The book opens with a Wikipedia entry: “Ronald James Read was an American philanthropist, investor, janitor, and gas station attendant.” There “wasn’t much worth mentioning” about Ronald. He lived as low-key a life as one could. He worked at a gas station for 25 years, and before that he swept the floors at JCPenney for 17 years. He lived in a $12,000 two-bedroom house for the entirety of his adult life. His main hobby was chopping firewood. He was one of 2,8 million Americans that died in 2014. Only 4,000 of them had a net worth of more than $8 million – Ronald was one of them. Those who knew him were baffled. Where did he get all that money?

It wasn’t due to a lottery jackpot or a big inheritance. He saved what little he could and invested it in bue chip stocks. Then, he waited for decades and left compounding to work its magic. That’s it. From janitor to philanthropist who donated $6 million to his local hospital and library.

We then meet another character, Richard Fuscone. He was the former vice chairmen of Merrill Lynch and once part of the Forbes’ “40 under 40” list. He retired at age 40 in 2000 to pursue personal and charitable interests. Despite his massive success and wealth, he was destroyed by the 2007-2008 crisis. He was living well beyond his means and invested on margin to such a degree that he filed for personal bankruptcy in 2010.

The author concludes: “The fact that Ronald Read can coexist with Richard Fuscone has two explanations. One, financial outcomes are driven by luck, independent of intelligence and effort. That’s true to some extent, and this book will discuss it in further detail. Or, two (and I think more common), that financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know. I call this soft skill the psychology of money.”

Morgan wraps up the introduction by saying that the book aims to convince readers that soft skills are more important than the technical side of money. Each of the book’s 20 chapters uses short stories and discussions to describe what are “the most important and often counterintuitive features of the psychology of money.”

Chapter 1 – No One’s Crazy

This chapter stresses that we shouldn’t be judgmental about what other people do with their money. What might seem crazy to one person, can be completely reasonable to another. Morgan says: “People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons. […] We see the world through a different lens.”

Morgan argues that while spreadsheets can model e.g. big stock market declines, they can’t model the feeling of having made investment decisions that can negatively impact your family’s life. Until you’ve personally felt the consequences, you may not understand it enough. As investor Michael Batnick says: “Some lessons have to be experienced before they can be understood.”

In length, those who grew up in a high-inflationary environment consider bonds to be more ‘scary’ than those who grew up when inflation was low. If you happened to grow up when the stock market was strong, you invested more of your money in stocks later in life compared to those who grew up when stocks were weak. Investors’ willingness to bear risk thus depends on personal history. “Not intelligence, or education, or sophistication. Just the dumb luck of when and where you were born”, as Morgan states.

He continues to argue that we can’t expect the members of these different groups to think the same about inflation, stocks, bonds, unemployment or how they respond to financial information. “Their view of money was formed in different worlds. And when that’s the case, a view about money that one group of people thinks is outrageous can make perfect sense to another. […] Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works. […] But 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.”

Chapter 2 – Luck & Risk

The chapter opens with this statement: “Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort.” Namely, the world is too complex to allow 100% of your actions to dictate 100% of your outcome. You are playing a game with (or against, if you will) billions of people and moving parts. The actions you take likely means less than what’s outside of your control.

You can’t believe in the role of luck without respecting risk. However, the role of luck/risk in a decision is too hard, messy and complex to assess. How much of an outcome was conscious versus a risk? If, for instance, you buy a stock and it’s gone nowhere for five years, have you made a bad decision by buying it in the first place? Or was it a good decision that had an 80% chance of making money, and you just so happened to end up on the side of the unfortunate 20%? Did you make a mistake, or did you just experience the reality of risk? It’s (mostly) impossible to know. Therefore, Morgan concludes the chapter by saying: “More important is that as much as we recognize the role of luck in success, the role of risk means we should forgive ourselves and leave room for understanding when judging failures.”

Chapter 3 – Never Enough

The chapter opens with a story from John Bogle about money: “At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.”

Enough. It’s a powerful statement in today’s society where the wealthiest and most powerful can’t seem to grasp what enough entails. Morgan provides two examples of how the strive for more can lead to terrible outcomes and drive people to do reckless and criminal acts.

In the wake of those examples, he provides a few pointers for those who “at some point in their life, earn a salary or have a sum of money sufficient to cover every reasonable thing they need and a lot of what they want”:

  • The hardest financial skill is getting the goalpost to stop moving: “If expectations rise with results there is no logic in striving for more because you’ll feel the same after putting in the extra effort. It gets dangerous when the taste of having more – more money, more power, more prestige – increases ambition faster than satisfaction.”
  • Social comparison is the problem: “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.
  • “Enough” is not too little: “The idea of having “enough” might look like conservatism, leaving opportunity and potential on the table. I don’t think that’s right. “Enough” is realizing that the opposite—an insatiable appetite for more—will push you to the point of regret.”
  • There are many things never worth risking, no matter the potential gain: “Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable. Being loved by those who you want to love you is invaluable. Happiness is invaluable. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.”

Chapter 4 – Confounding Compounding

Warren Buffett is considered the best investor in the world. He is certainly the one who build the largest fortune solely by investing. Many, however, miss a key point about his success. Many famed investors have outpaced Warren’s 22% annual return, but none of them have been doing it for more than 80 years, like the Oracle of Omaha has.

Morgan writes: “Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. Consider a little thought experiment. Buffett began serious investing when he was 10 years old. By the time he was 30 he had a net worth of $1 million, or $9.3 million adjusted for inflation.What if he was a more normal person, spending his teens and 20s exploring the world and finding his passion, and by age 30 his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22% annually), but quit investing and retired at age 60 to play golf and spend time with his grandkids. What would a rough estimate of his net worth be today? Not $84.5 billion. $11.9 million. 99.9% less than his actual net worth. Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, but his secret is time. That’s how compounding works.”

He concludes the chapter with an amusing comment: “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.”

Chapter 5 – Getting Wealthy vs. Staying Wealthy

According to Morgan, there are a million ways to get wealthy, but only one way to stay wealthy: “Some combination of frugality and paranoia.”

He continues: “Getting money and keeping money are two different skills. 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. […] Few gains are so great that they’re worth wiping yourself out over.”

There are three ‘secrets’ behind the survival mindset that is needed to maintain wealth:

  • More than I want big returns, I want to be financially unbreakable: Here, Morgan argues that you must ensure not to interrupt compounding in the chase of ever-higher returns: “Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time – especially in times of chaos and havoc – will always win.” In length, if holding 20% cash in a roaring bull-market is what makes you feel comfortable holding on to your, say, 80% stocks, the seemingly 1% return on that cash is is not actually 1%: “Because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.”
  • Planning is important, but the most important part of every plan is to plan on the plan not going according to plan: “A plan is only useful if it can survive reality. And a future filled with unknowns is everyone’s reality.” Hence, you need to devise financial plans thar embraces and emphasises room for error. The more you need a plan to be true, the more fragile your financial life becomes.
  • A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital: “Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And in fact you know it will be filled with misery. You can be optimistic that the long-term growth trajectory is up and to the right, but equally sure that the road between now and then is filled with landmines, and always will be. Those two things are not mutually exclusive.”

At the end of the chapter, Morgan raises an interesting point. He says: “Our standard of living increased 20-fold in [the past] 170 years, but barely a day went by that lacked tangible reasons for pessimism.” This comment comes in the wake of a chart that shows how real GDP per capita has ‘rocketed’ since 1850 to 2020. But, throughout the period, there was always a reason to be pessimistic about the future and events that caused turmoil, such as …

  • 1.3 million Americans died while fighting nine major wars.
  • Roughly 99.9% of all companies that were created went out of business.
  • Four U.S. presidents were assassinated.
  • 33 recessions lasted a cumulative 48 years.
  • The stock market fell more than 10% from a recent high at least 102 times.
  • Stocks lost a third of their value at least 12 times.
  • Annual inflation exceeded 7% in 20 separate years.

As I am writing this, we are in the midst of yet another financial storm. The S&P500 is down 25% year-to-date; inflation is the highest its been in 40 years; Europe is in the midst of an energy crisis, courtesy of Russia’s invasion of Ukraine. Looking at charts such as the one described above makes you convinced that “this too shall pass”.

Chapter 6 – Tails, You Win

The chapter opens with a message: Tails drive everything. Morgan continues: ” Most public companies are duds, a few do well, and a handful become extraordinary winners that account for the majority of the stock market’s returns.” This insight is backed up by a study of the Russell 3000. In the study of this index – consisting of 3000 companies – 40% lost at least 70% of the value and never recovered. Practically all of the index’s overall returns (which is a 7,300% since 1980) came from just 7% of the companies.

Between 1900 and 2019, there were 1,428 months. Around 300 – or 22% – of them were during a recession. To partake in the sort of return outlined before (e.g. Russel 3000’s 73-fold return), you will need to keep your cool through those 22% recessions and turmoil: “Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control. 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. Tails drive everything.”

To further stress the point, Morgan takes readers back to the 2013 Berkshire Hathaway meeting in which Buffett said most of his profits came from just 10 investments (from a pool of 400-500). Charlie Munger said: “If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.”

Morgan concludes: “When we pay special attention to a role model’s successes we overlook that their gains came from a small percent of their actions. That makes our own failures, losses, and setbacks feel like we’re doing something wrong. But it’s possible we are wrong, or just sort of right, just as often as the masters are. They may have been more right when they were right, but they could have been wrong just as often as you. “It’s not whether you’re right or wrong that’s important,” George Soros once said, “but how much money you make when you’re right and how much you lose when you’re wrong.” You can be wrong half the time and still make a fortune.

Chapter 7 – Freedom

Morgan describes the highest form of wealth to be the ability to wake up in the morning and say, “I can do whatever I want today.” He writes: “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.”

The author thus suggest one uses his/her money to buy time and options rather than luxury goods. In length, the United States is the richest nation, but its citizens are not happier today than they were in the 1950s when wealth and income were much lower. 45% of Americans feels “a lot of worry” and 55% “a lot of stress” (the global average is 39% and 35%, respectively). Part of the explanation is that people have used the greater wealth to buy more, bigger and better ‘stuff’. As a consequence, people have given up more control.

Morgan’s recommendation is clear: Use your money to buy control – freedom – rather than pretentious goods.

Chapter 8 – Man in the Car Paradox

If you see someone driving an expensive car, you likely won’t think “the guy driving that car is cool”. Instead, you think, “if I had that car, people would think I’m cool.” The paradox is evident. People buy expensive products to be admired. But people don’t think about you, but rather regard “your wealth as a benchmark for their own desire to be liked and admired. […] It’s a subtle recognition that people generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine.”

Chapter 9 – Wealth is What You Don’t See

Morgan describes wealth as such: “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. That’s not how we think about wealth, because you can’t contextualize what you can’t see. […] When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.”

In length, becoming wealthy requires restraint. You need to not spend: “The danger here is that I think most people, deep down, want to be wealthy. They want freedom and flexibility, which is what financial assets not yet spent can give you. But it is so ingrained in us that to have money is to spend money that we don’t get to see the restraint it takes to actually be wealthy.”

Chapter 10 – Save Money

Morgan opens the chapter with a discussion on ego. He argues that beyond a certain level of basics, comfort, entertainment and enlightening, all spending is a reflection of ego; a way to show people that you have money. Hence, he says: “One of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility. When you define savings as the gap between your ego and your income you realize why many people with decent incomes save so little. It’s a daily struggle against instincts to extend your peacock feathers.” The lesson is, of course, to “not give a damn” about what others think and thus save more.

Chapter 11 – Reasonable > Rational

The author argues that one shouldn’t try to be coldly rational when making financial decisions. Instead, aim at being “pretty reasonable”, as you’ll have a better change of sticking with your decisions for the long run. He uses an example to drive home the point: “Harry Markowitz won the Nobel Prize for exploring the mathematical tradeoff between risk and return. He was once asked how he invested his own money, and described his portfolio allocation in the 1950s, when his models were first developed: I visualised my grief if the stock market went way up and I wasn’t in it—or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities. Markowitz eventually changed his investment strategy, diversifying the mix. But two things here are important. One is that “minimising future regret” is hard to rationalise on paper but easy to justify in real life.”

Chapte 12 – Surprise!

History is important, as it helps investors calibrate expectations and gives us a rough guide of what tends to work. However, history is mostly the study of surprising events; “things that have never happened before happen all the time”, as it’s phrased in the book. Morgan cautions readers to not be overly reliant on past data as a signal for the future, as “innovation and change are the lifeblood of progress”.

The author continues: “The most common plot of economic history is the role of surprises. […] This is not a failure of analysis. It’s a failure of imagination. Realising the future might not look anything like the past is a special kind of skill that is not generally looked highly upon by the financial forecasting community. […] What you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising. […] We should use past surprises as an admission that we have no idea what might happen next.”

Chapter 13 – Room for Error

In this chapter, Morgan compares investing with blackjack card counting. When you’re card counting, you track which cards have been dealt already. You bet more when the odds of getting a favorable card is in your favor, and less when they’re against you. It’s a strategy that hinges on odds – not certainties – and humility: “Humility that they don’t know, and cannot know exactly what’s going to happen next, so play their hand accordingly. […] Bet too heavily even when the odds seem in your favor and, if you’re wrong, you might lose so much that you don’t have enough money to keep playing. The lesson, he says, is to give yourself room for error. You have to plan on your plan not going according to plan.

Later in the chapter, the author uses a war story to drive home this point:

The Battle of Stalingrad during World War II was the largest battle in history. […] In late 1942, when a German tank unit sat in reserve on grasslands outside the city. When tanks were desperately needed on the front lines, something happened that surprised everyone: Almost none of them worked. Out of 104 tanks in the unit, fewer than 20 were operable. Engineers quickly found the issue. Historian William Craig writes: “During the weeks of inactivity behind the front lines, field mice had nested inside the vehicles and eaten away insulation covering the electrical systems.” The Germans had the most sophisticated equipment in the world. Yet there they were, defeated by mice. You can imagine their disbelief. This almost certainly never crossed their minds. What kind of tank designer thinks about mouse protection? Not a reasonable one. And not one who studied tank history. But these kinds of things happen all the time. You can plan for every risk except the things that are too crazy to cross your mind. And those crazy things can do the most harm, because they happen more often than you think and you have no plan for how to deal with them.”

“Good ideas” are often indistinguishable from “bad ideas”. An outcome that ended out in your favor might as well have ended badly. We need to acknowledge the role of uncertainty, randomness and chance. These “unknowns” should be dealt with by ensuring a margin of safety: “The purpose of the margin of safety is to render the forecast unnecessary.”

“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.” The point being: Don’t take foolish risks in the pursuit of profits, as you risk being wiped out thus not being able to stay in the game.

Chapter 14 – You’ll Change

The End of History Illusion is a psychological theory regarding people’s tendency to be aware of much they’ve changed in the past, but underestimating how much their personalities, desires and goals are likely to change in the future. In other words: We’re poor forecasters of our future selfs. Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life stresses that grow with competitive pursuits is something entirely different. This has a big impact on our ability to plan for future financial goals. We should realize this shortcoming about ourselves, and take it into consideration when making long-term decisions, especially around financial planning. In short, his advice is to avoid the extreme ends of the spectrum:

“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.”

Chapter 15 – Nothing’s Free

Morgan opens the chapter with a great quote: “Every job looks easy when you’re not the one doing it. Every job looks easy when you’re not the one doing it because the challenges faced by someone in the arena are often invisible to those in the crowd.” For the past 50 years, the S&P 500 increased 119-fold. All you had to do was sit back and let your money compound. Easy, right? But throughout that period, you would have experienced grueling drawbacks that would be very hard to endure and ‘stay put’.

He uses Netflix and Monster Beverage as an example of the ‘price’ investors need to pay for outsized gains alongside a lesson.

Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of days. Monster Beverage returned 319,000% from 1995 to 2018—among the highest returns in history—but traded below its previous high 95% of the time during that period. Now here’s the important part. Like the car, you have a few options: You can pay this price, accepting volatility and upheaval. Or you can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand-theft auto: Try to get the return while avoiding the volatility that comes along with it. Many people in investing choose the third option. […] They form tricks and strategies to get the return without paying the price. They trade in and out. They attempt to sell before the next recession and buy before the next boom. Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step: trying to avoid it. But the Money Gods do not look highly upon those who seek a reward without paying the price.”

Morgan reasons: “The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good. […] It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.”

Chapter 16 – You & Me

This chapter revolves around the differences in investment goals and time horizons. What is ‘prudent’ to you might not be for others. Are you a teenager trading for fun? A widow on a limited budget dependent on fixed income? A hedge fund manager who aims at maximising returns for the current quarter? The author asks: “Are we supposed to think those three people have the same priorities, and that whatever level a particular stock is trading at is right for all three of them? It’s crazy. It’s hard to grasp that other investors have different goals than we do, because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own.” Earlier in the chapter, Morgan says:

Competition for investment returns is fierce, and someone has to own every asset at every point in time. That means the mere idea of bubbles will always be controversial, because no one wants to think they own an overvalued asset. […] Let me propose one reason [bubbles] happen that both goes overlooked and applies to you personally: Investors often innocently take cues from other investors who are playing a different game than they are. […] Ask yourself: How much should you pay for Google stock today? The answer depends on who “you” are. […] When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.

Towards the end of the chapter, Morgan advises investors to form a statement about oneself that can act as an anchor to keep you rational. The author’s own sounds like this: “I am a passive investor optimistic in the world’s ability to generate real economic growth and I’m confident that over the next 30 years that growth will accrue to my investments.” He says that this mission statement will allow him to keep his eye on the ball; what the market did this year or next year are factors irrelevant to the game he’s playing.

Chapter 17 – The Seduction of Pessimism

The chapter opens with a quote from historian Deirdre McCloskey: “For reasons I have never understood, people like to hear that the world is going to hell.” Morgan goes on to say pessimism holds a “special place in our hearts” because it sounds smarter, is intellectually captivating and is paid more attention to than optimism.

He says optimism is often being viewed as being oblivious to risk. But that’s not true. Real opportunists don’t believing everything will be great. Rather, “optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way. The simple idea that most people wake up in the morning trying to make things a little better and more productive than wake up looking to cause trouble is the foundation of optimism. […] A constant drumbeat of pessimism usually drowns out any triumphalist song … If you say the world has been getting better you may get away with being called naïve and insensitive. If you say the world is going to go on getting better, you are considered embarrassingly mad.”

In finance, the ‘allure’ of pessimism might be explained by the asymmetry between the joy of gains vs. the pain of losses: “Kahneman says the asymmetric aversion to loss is an evolutionary shield. He writes: When directly compared or weighted against each other, losses loom larger than gains. This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history.”

Another ‘allure’ of pessimism is the speed of which setbacks happen: “The short sting of pessimism prevails while the powerful pull of optimism goes unnoticed. […] 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. […] Progress happens too slowly to notice, but setbacks happen too quickly to ignore. There are lots of overnight tragedies. There are rarely overnight miracles.”

Chapter 18 – When You’ll Believe Anything

Imagine an alien visiting earth in 2007 and again in 2009. The economy is in the same shape, but U.S. households are $16 trillion poorer, 10 million more Americans are unemployed and the stock market is cut in half in two years. The alien says: “I don’t get it. […] I’ve seen the cities. I’ve looked at the factories. You guys have the same knowledge, the same tools, the same ideas. Nothing has changed! Why are you poorer? Why are you more pessimistic?” The author explains:

“There was one change the alien couldn’t see between 2007 and 2009: The stories we told ourselves about the economy. In 2007, we told a story about the stability of housing prices, the prudence of bankers, and the ability of financial markets to accurately price risk. In 2009 we stopped believing that story. That’s the only thing that changed. But it made all the difference in the world. Once the narrative that home prices will keep rising broke, mortgage defaults rose, then banks lost money, then they reduced lending to other businesses, which led to layoffs, which led to less spending, which led to more layoffs, and on and on. Other than clinging to a new narrative, we had an identical—if not greater—capacity for wealth and growth in 2009 as we did in 2007. Yet the economy suffered its worst hit in 80 years.”

The author states that there are two things to keep in mind about a story-driven world when managing your money:

  1. The more you want someting to be true, the more likely you are to believe a story that overestimates the odds of it being true. He calls the things in life you want to be true “appealing fictions”, and they have a big impact on how we think about investments and the economy.
  2. Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps. The author states that predicting stock market returns is notoriously difficult and ‘experts’ are wrong more often than not, but we turn to these authoritative-sounidng people to satisfy our need to live in a (perceived) predictable, controllable world. He writes: “Since big events come out of nowhere, forecasts may do more harm than good, giving the illusion of predictability in a world where unforeseen events control most outcomes. Carl Richards writes: “Risk is what’s left over when you think you’ve thought of everything.””

Chapter 19 – All Together Now

The chapter provides a few recommendations that can help readers make better decisions with one’s money, i.e.:

  • Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong. Because it’s never as good or as bad as it looks. The world is big and complex. Luck and risk are both real and hard to identify.
  • Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control.
  • No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today. Manage your money in a way that helps you sleep at night. “Does this help me sleep at night?” is the best universal guidepost for all financial decisions.
  • If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away.
  • Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance.
  • Be nicer and less flashy. No one is impressed with your possessions as much as you are.
  • Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge, but if it keeps you in the game it can pay for itself many times over.

Chapter 20 – Confessions

The book’s last chapter centers on the author’s approach to investing and money. Namely, Morgan’s primary financial goal has been independence: “Chasing the highest returns or leveraging my assets to live the most luxurious life has little interest to me. […] I mostly just want to wake up every day knowing my family and I can do whatever we want to do on our own terms. Every financial decision we make revolves around that goal.” He continues, saying that living below your means removes the amount of social pressure that comes with trying to keep up with the Joneses.

Morgan ‘confesses’ that owning his own house without a mortgage is a terrible financial decision, but his family’s best money decision: “The independent feeling I get from owning our house outright far exceeds the known financial gain I’d get from leveraging our assets with a cheap mortgage.”

He wraps-up the book by summarizing his view on investing as follows: “Every investor should pick a strategy that has the highest odds of successfully meeting their goals. And I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success. […] I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us. […] My investing strategy doesn’t rely on picking the right sector, or timing the next recession. It relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades.”

If you enjoyed this book summary of The Psychology of Money: Timeless Lessons on Wealth, Greed and Happiness, you would also enjoy this chapter-by-chapter book summary of Where the Money Is: Value Investing in the Digital Age.

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