The Psychology of Money

by Morgan Housel

Spending money to show people how much money you have is the fastest way to have less money.

But the truth is that 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.

“There is no faster way to feel rich than to spend lots of money on really nice things. But the way to be rich is to spend money you have, and to not spend money you don’t have. It’s really that simple.”31 It is excellent advice, but it may not go far enough. The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth.

wealth is hidden. It’s income not spent. Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.

The world is filled with people who look modest but are actually wealthy and people who look rich who live at the razor’s edge of insolvency. Keep this in mind when quickly judging others’ success and setting your own goals.

Save Money The only factor you can control generates one of the only things that matters. How wonderful.

The first idea—simple, but easy to overlook—is that building wealth has little to do with your income or investment returns, and lots to do with your savings rate.

More importantly, the value of wealth is relative to what you need.

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. 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 to their outermost limits and keep up with others doing the same.

People with enduring personal finance success—not necessarily those with high incomes—tend to have a propensity to not give a...

people’s ability to save is more in their control than...

Savings can be created by spending less. You can spend less if you desire less. And you will desire less if you care le...

And you don’t need a specific reason to save.

Savings without a spending goal gives you options and flexibility, the ability to wait and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms.

When you don’t have control over your time, you’re forced to accept whatever bad luck is thrown your way. But if you have flexibility you have the time to wait for no-brainer opportunities to fall in your lap. This is a hidden return on your savings.

Savings in the bank that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate.

If you have flexibility you can wait for good opportunities, both in your career and for your investments. You’ll have a better chance of being able to learn a new skill when it’s necessary. You’ll feel less urgency to chase competitors who can do things you can’t, and have more leeway to find your passion and your niche at your own pace. You can find a new routine, a slower pace, and think about life with a different set of assumptions. 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. Having more control over your time and options is becoming one of the most valuable currencies in the world. That’s why more people can, and more people should, save money.

Reasonable > Rational Aiming to be mostly reasonable works better than trying to be coldly 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.

Invest in a promising company you don’t care about, and you might enjoy it when everything’s going well. But when the tide inevitably turns you’re suddenly losing money on something you’re not interested in. It’s a double burden, and the path of least resistance is to move onto something else. If you’re passionate about the company to begin with—you love the mission, the product, the team, the science, whatever—the inevitable down times when you’re losing money or the company needs help are blunted by the fact that at least you feel like you’re part of something meaningful. That can be the necessary motivation that prevents you from giving up and moving on.

History is the study of change, ironically used as a map of the future.

“Things that have never happened before happen all the time.”

investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing, which can make even smart people nervous, greedy and paranoid.

You’ll likely miss the outlier events that move the needle the most.

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.

Room for Error The most important part of every plan is planning on your plan not going according to plan.

“The best way to achieve felicity is to aim low,”

Long-term planning is harder than it seems because people’s goals and desires change over time.

At every stage of our lives we make decisions that will profoundly influence the lives of the people we’re going to become, and then when we become those people, we’re not always thrilled with the decisions we made. So young people pay good money to get tattoos removed that teenagers paid good money to get. Middle-aged people rushed to divorce people who young adults rushed to marry. Older adults work hard to lose what middle-aged adults worked hard to gain. On and on and on.

We should avoid the extreme ends of financial planning. 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. Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key. And when you consider our tendency to change who we are over time, balance at every point in your life becomes a strategy to avoid future regret and encourage endurance. Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.

We should also come to accept the reality of changing our minds.

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.

Nothing’s Free Everything has a price, but not all prices appear on labels.

You & Me Beware taking financial cues from people playing a different game than you are.

Investors often innocently take cues from other investors who are playing a different game than they are.

Seduction of Pessimism Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.

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. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.

One is that money is ubiquitous, so something bad happening tends to affect everyone and captures everyone’s attention.

There are two topics that will affect your life whether you are interested in them or not: money and health. While health issues tend to be individual, money issues are more systemic. In a connected system where one person’s decisions can affect everyone else, it’s understandable why financial risks gain a spotlight and capture attention in a way few other topics can.

There is an iron law in economics: extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways.

Assuming that something ugly will stay ugly is an easy forecast to make. And it’s persuasive, because it doesn’t require imagining the world changing. But problems correct and people adapt. Threats incentivize solutions in equal magnitude. That’s a common plot of economic history that is too easily forgotten by pessimists who forecast in straight lines.

A third is that progress happens too slowly to notice, but setbacks happen too quickly to ignore.

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.

In investing you must identify the price of success— volatility and loss amid the long backdrop of growth—and be willing to pay it.

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.

It can’t be overstated: there is no greater force in finance than room for error, and the higher the stakes, the wider it should be.

Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

[History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art. Those who read history tend to look for what proves them right and confirms their personal opinions. They defend loyalties. They read with a purpose to affirm or to attack. They resist inconvenient truth since everyone wants to be on the side of the angels. Just as we start wars to end all wars.

Most people, when confronted with something they don’t understand, do not realize they don’t understand it because they’re able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world, however limited those experiences are. We all want the complicated world we live in to make sense. So we tell ourselves stories to fill in the gaps of what are effectively blind spots.