The Psychology of Money

by Morgan Housel

The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people.

Finance is overwhelmingly taught as a math-based field, where you put data into a formula and the formula tells you what to do, and it’s assumed that you’ll just go do it. This is true in personal finance, where you’re told to have a six-month emergency fund and save 10% of your salary. It’s true in investing, where we know the exact historical correlations between interest rates and valuations. And it’s true in corporate finance, where CFOs can measure the precise cost of capital. It’s not that any of these things are bad or wrong. It’s that knowing what to do tells you nothing about what happens in your head when you try to do it.

I love Voltaire’s observation that “History never repeats itself; man always does.” It applies so well to how we behave with money.

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.

lottery tickets. Americans spend more on them than movies, video games, music, sporting events, and books combined. And who buys them? Mostly poor people.

Forty percent of Americans cannot come up with $400 in an emergency. Which is to say: Those buying $400 in lottery tickets are by and large the same people who say they couldn’t come up with $400 in an emergency. They are blowing their safety nets on something with a one-in-millions chance of hitting it big.

Cornelius Vanderbilt had just finished a series of business deals to expand his railroad empire. One of his business advisors leaned in to tell Vanderbilt that every transaction he agreed to broke the law. “My God, John,” said Vanderbilt, “You don’t suppose you can run a railroad in accordance with the statutes of the State of New York, do you?”10 My first thought when reading this was: “That attitude is why he was so successful.” Laws didn’t accommodate railroads during Vanderbilt’s day. So he said “to hell with it” and went ahead anyway.

Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.

Or, just be careful when assuming that 100% of outcomes can be attributed to effort and decisions. After my son was born, I wrote him a letter that said, in part: Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging of entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself. Therefore, focus less on specific individuals and case studies and more on broad patterns.

My favorite historian, Frederick Lewis Allen, spent his career depicting the life of the average, median American—how they lived, how they changed, what they did for work, what they ate for dinner, etc. There are more relevant lessons to take away from this kind of broad observation than there are in studying the extreme characters that tend to dominate the news.

There is no reason to risk what you have and need for what you don’t have and don’t need.

The hardest financial skill is getting the goalpost to stop moving.

Modern capitalism is a pro at two things: generating wealth and generating envy. Perhaps they go hand in hand; wanting to surpass your peers can be the fuel of hard work. But life isn’t any fun without a sense of enough. Happiness, as it’s said, is just results minus expectations.

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.

1. More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.

Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.

More than your salary. More than the size of your house. More than the prestige of your job. Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.

In his book 30 Lessons for Living, gerontologist Karl Pillemer interviewed a thousand elderly Americans looking for the most important lessons they learned from decades of life experience. He wrote: No one—not a single person out of a thousand—said that to be happy you should try to work as hard as you can to make money to buy the things you want. No one—not a single person—said it’s important to be at least as wealthy as the people around you, and if you have more than they do it’s real success. No one—not a single person—said you should choose your work based on your desired future earning power. What they did value were things like quality friendships, being part of something bigger than themselves, and spending quality, unstructured time with their children. “Your kids don’t want your money (or what your money buys) anywhere near as much as they want you. Specifically, they want you with them,” Pillemer writes.

Past a certain level of income, what you need is just what sits below your ego. Everyone needs the basics. Once they’re covered there’s another level of comfortable basics, and past that there’s basics that are both comfortable, entertaining, and enlightening. But spending beyond a pretty low level of materialism is mostly a reflection of ego approaching income, a way to spend money to show people that you have (or had) money. Think of it like this, and one of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.

It is smart to have a deep appreciation for economic and investing history. History helps us calibrate our expectations, study where people tend to go wrong, and offers a rough guide of what tends to work. But it is not, in any way, a map of the future.

Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next. 1. You’ll likely miss the outlier events that move the needle the most.

In Pharaonic Egypt … scribes tracked the high-water mark of the Nile and used it as an estimate for a future worst-case scenario. The same can be seen in the Fukushima nuclear reactor, which experienced a catastrophic failure in 2011 when a tsunami struck. It had been built to withstand the worst past historical earthquake, with the builders not imagining much worse—and not thinking that the worst past event had to be a surprise, as it had no precedent.

Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make

that mistake again.’ But, in fact, 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.

2. History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.

That doesn’t mean we should ignore history when thinking about money. But there’s an important nuance: The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff. But specific trends, specific trades, specific sectors, specific causal relationships about markets, and what people should do with their money are always an example of evolution in progress. Historians are not prophets.

Although card counting is statistically proven to work, it does not guarantee you will win every hand—let alone every trip you make to the casino. We must make sure that we have enough money to withstand any swings of bad luck.

History is littered with good ideas taken too far, which are indistinguishable from bad ideas. The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—“unknowns”—are an ever-present part of life. The only way to deal with them is by increasing the gap between what you think will happen and what can happen while still leaving you capable of fighting another day.

Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor. The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong.

Can you survive your assets declining by 30%? On a spreadsheet, maybe yes—in terms of

actually paying your bills and staying cash-flow positive. But what about mentally? It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest. You—or your spouse—may decide it’s time for a new plan, or new career. I know several investors who quit after losses because they were exhausted. Physically exhausted. Spreadsheets are good at telling you when the numbers do or don’t add up. They’re not good at modeling how you’ll feel when you tuck your kids in at night wondering if the investment decisions you’ve made were a mistake that will hurt their future. Having a gap between what you can technically endure versus what’s emotionally possible is an overlooked version of room for error.

In 2006 Warren Buffett announced a search for his eventual replacement. He said he needed someone “genetically programmed to recognize and avoid serious risks, including those never before encountered.”45

Embracing the idea that financial goals made when you were a different person should be abandoned without mercy versus put on life support and dragged on can be a good strategy to minimize future regret. The quicker it’s done, the sooner you can get back to compounding.

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.

“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.”

Pessimism just sounds smarter and more plausible than optimism. Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention. If a smart person tells me they have a stock pick that’s going to rise 10-fold in the next year, I will immediately write them off as full of nonsense. If someone who’s full of nonsense tells me that a stock I own is about to collapse because it’s an accounting fraud, I will clear my calendar and listen to their every word.

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.

Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong.

Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see.

Manage your money in a way that helps you sleep at night.

If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon.

Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune,

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.

Save. Just save. You don’t need a specific reason to save.

palliative care

Charlie Munger once said “I did not intend to get rich. I just wanted to get independent.”

Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.

If there’s a part of our household financial plan I’m proud of it’s that we got the goalpost of lifestyle desires to stop moving at a young age. Our savings rate is fairly high, but we rarely feel like we’re repressively frugal because our aspirations for more stuff haven’t moved much. It’s not that our aspirations are nonexistent—we like nice stuff and live comfortably. We just got the goalpost to stop moving. This would not work for everyone, and it only works for us because we both agree to it equally—neither of us are compromising for the other. Most of what we get pleasure from—going for walks, reading, podcasts—costs little, so we rarely feel like we’re missing out. On the rare occasion when I question our savings rate I think of the independence my parents earned from years of high savings, and I quickly come back. Independence is our top goal. A secondary benefit of maintaining a lifestyle below what you can afford is avoiding the psychological treadmill of keeping up with the Joneses.