Morgan Housel presents the most gratifying outcome of habits about wealth creation in his book – The Psychology of Money. The premise of his book is that the secret to building a solid financial background is more to do with your behavior than your intellect. The author in his book insists on long-term saving strategies over any short-term investing formulas. He cites how a successful Wall Street hedge fund manager goes bankrupt in few years with his spending habits compared to a janitor who died at the age of 81 with a bank balance of 8 million dollars. The janitor happened to be the 4000th richest person to die in the US in 2014 among the millions of American citizens who passed away that year. Morgan’s narrative comes from his personal experiences in finance and the backdrop of the US economy in the last one hundred years.
Getting rich or creating wealth?
He explains the difference between getting rich and getting wealthy by studying mindsets of ‘live by the day individuals’ vs. value investors. We often chase money to buy stuff to look rich and impress others to the extent of piling on debt or eroding our savings. These materials at the first glance hardly tells a story about your hard work to onlookers. People often look to your possessions as something they would like to own. Consider when you stare at a massive house with a lawn, pool, state-of-the-art gym, and a lineup of impressive cars. You would first wish, if you could own all of these, then think of the person who owns it. For you, it doesn’t matter who does. You are concerned with what you would like for yourself.
The author warns us to avoid case studies and instead focus on historical trends. Case studies concentrate on the outliers, offering no insights on a real scenario. The success of Bill Gates is a one-in-a-million hit as he got lucky in hacking his school servers while establishing Microsoft. Not everyone back then could get such an opportunity. Bill Gates happened to be there at the right time. Not everyone can be Bill Gates. Likewise, the death of his best friend and likely partner in Microsoft Kent Evans was one-in-a-million failure who died in a hiking excursion. Not many teens die such a death. Kent Evans would have otherwise been the third founding member of the tech behemoth with Bill Gates and Paul Allen. He just went for a hike at the wrong time.
He adds that in investments or business, there are no bad ideas. No one intentionally invests in failing vision. Everyone wants the best for themselves. It just depends on where you happen to be. A person born during a stock market boom will vouch for investments in shares. A person born during rising inflation would believe more in bonds. Someone who has seen a real estate boom as a kid will want to invest more in a property. It is just timing that drives success. Bill Gates or any other billionaire would have had many opportunities in their favor. It might not be for all. We are therefor better off studying these long-term trends than the life of a billionaire.
Good or bad luck does have a role, and you must factor both when it concerns your investments. For this, the author explains the margin of safety you should consider before going all out, especially with high-risk investment options. You should expect the worst and plan for the worst while wanting the best. Always be prepared for a 30% dip in your investments for a random crash in the market. Where will this land you? If it does not bother you, then that’s your margin of safety. If it does, then you need to realign your investment strategies to your risk appetite.
The wisdom of compounding returns
Housel has quoted plenty of real-life examples to explain how people have generated long-term wealth on the wisdom of compounding. He has inferred on the human psychology of linear thinking that isolates us from understanding the compounding effect. We are quick to answer that 8+8+8+8+8 is 40. But cannot fathom that 8x8x8x8x8 computes to 32768. This simple example denotes how compounding works, and by design, why your mind does not think exponentially. The understanding of compounding returns is central to know about long term returns for your hard-earned savings.
To elaborate this, Morgan narrates a real-life example. The author shares the investment strategy of Warren Buffet. At eighty-five, Warren Buffet’s portfolio neared 85 billion USD. But his folio generated almost 84 billion USD after the investing giant turned fifty. This level of compounding is after Mr. Buffet started investing at the age of ten and has been doing it religiously for three-quarters of a century.
Buffet’s folio has earned him an annual YoY average return of 22%. These returns look low compared to the jaw-dropping YoY average returns of 66% James Simons has accumulated since 1988. Yet, you probably never heard of the mathematician James Simons. His net worth today is roughly around 27 billion USD as compared to Buffet’s 85. The difference is the seventy years that Buffet has been compounding his wealth that puts him right on top, even though the returns are standard. In this period, Buffet has seen more recessions than most of us. This market aberration has not deterred his investment strategy, and he has stayed put instead of cashing out. Hence you too, must hold on to your savings and allow it to compound as much as possible than withdraw to meet your expenses.
Create tails in your portfolio
The author enlightens on the age-old wisdom of diversifying your assets with the concept of tail investments. Expect some of your investments to fail, but it would be those 2-3 stocks or strategies in your folio that would earn you exponential returns and not just cover for your losses. The ideology is true for Private Equity (PE) firms who invest in multiple business ideas, knowing most will fail, but it would be the one or two ventures that will take off and get them the returns they need.
You see this ratio in every walk of life. We tend to measure success in terms of what we see than what the person has endured to achieve the success. Going back to Buffet and his folio, the world knows about which stocks earned him exceedingly high returns. But you would never know the wrong investment decisions or bad stocks he picked up and suffered losses.
Rational vs. Reasonable
The author also cautions on investment advice from fund managers. He quotes a study from the investment journal Morning Star claiming 85% of fund managers do not invest in their funds. Investors should have insights into the markets, weighing the options of what is rational vs. what are reasonable investments. A reasonable investment is where you deeply believe in a firm’s vision and are not deterred even if it takes a dip. This reason will help you stay invested as compared to a rational investment which dips and makes you question your investment. Here it’s more likely you would move out with the slightest blip on the firm.
I might find it reasonable to invest in technology even if the market says otherwise. However, my reasoning will help me stick with the industry even if it tumbles. This attachment does not stay in the case of rational decision-based investments, where I would find it difficult to stay longer in a downturn.
Control over your life
The author shares his investment strategy of moving into low index funds and holding them for years than focusing on high return funds that might be risky. He drives an essential point that investment strategy must match your short and long-term goals. To each his own. Our situations, needs, culture, geopolitical demographics all differ from one another. Investments are the same. What worked for me might not work for you or even for my family members. When you hear someone on the news on where to invest, do they have your interests in mind? Rarely. The author explains how having low basic needs provides him with an essential element for happiness – control over his life. His disposition to finance right from the teenage years has been to avoid unnecessary spending to boost egos. We must be conscious of such impulsive expenditure.
Eventually, the author narrates a detailed study of the American consumer since the second world war. He explains what growth and debt meant to the affluent, average, and low-income families back then in the fifty’s and how that story has altered in the current times. The gap in the lifestyle of these groups has widened considerably, not just through capitalism but through perceptions that led to overspending, causing the mortgage crisis and recession of 2008.
The Psychology of Money is a highly recommended book for the times we are in to make sense of the complexities and volatility around us. It equips us for the unseen times, which are pretty standard in the financial world. The author’s narration is simple and to the point, with enough examples that generate relatability. It will help you to devise better risk mitigation plans that you never fathomed. To put it in the author’s own words, ‘in the financial world things that have never happened before, happens all the time.’
About the writer
Roshan Shetty is an author, corporate coach, and consultant. He trains corporates on Leadership, Emotional Intelligence, Change Management, and Wellness.
His book Shift Left on Emotional Intelligence and skills required for the future is available on Amazon worldwide.
Learn more about his work at www.roshanshetty.com. Subscribe to his YouTube Channel, Cult Curator, for life hacks on well-being.
Very interesting post – thanks for sharing. I’m definitely interested in reading The Psychology of Money.