The Psychology of Money

by Morgan Housel

A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.

A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.

I sometimes think that no price is too high for a speculator to pay to learn that which will keep him from getting the swelled head. A great many smashes by brilliant men can be traced directly to the swelled head.

A lot of things in business and investing work this way. Long tails—the farthest ends of a distribution of outcomes—have tremendous influence in finance, where a small number of events can account for the majority of outcomes.

Here’s the most important part of this story: The Russell 3000 has increased more than 73-fold since 1980. That is a spectacular return. That is success.

The idea that a few things account for most results is not just true for companies in your investment portfolio. It’s also an important part of your own behavior as an investor.

There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing. Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.

Investing, business, and finance are just not like these fields.

At the Berkshire Hathaway shareholder meeting in 2013 Warren Buffett said he’s owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger followed up: “If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.”

“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.

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.

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.

Money’s greatest intrinsic value—and this can’t be overstated— is its ability to give you control over your time. To obtain, bit by bit, a level of independence and autonomy that comes from unspent assets that give you g...

Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.

The hardest thing about this was that I loved the work. And I wanted to work hard. But doing something you love on a schedule you can’t control can feel the same as doing something you hate. There is a name for this feeling. Psychologists call it reactance.

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.

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. If respect and admiration are your goal, be careful how you seek it. Humility, kindness, and empathy will bring you more respect than horsepower ever will.

Rich is a current income. Someone driving a $100,000 car is almost certainly rich, because even if they purchased the car with debt you need a certain level of income to afford the monthly payment. Same with those who live in big homes. It’s not hard to spot rich people. They often go out of their way to make themselves known. But 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.

Imagine how hard it would be to learn how to write if you couldn’t read the works of great authors. Who would be your inspiration? Who would you admire? Whose nuanced tricks and tips would you follow? It would make something that is already hard even harder. It’s difficult to learn from what you can’t see. Which helps explain why it’s so hard for many to build wealth.

Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.

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.

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.

Only saving for a specific goal makes sense in a predictable world. But ours isn’t. Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.

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.

What is the return on cash in the bank that gives you the option of changing careers, or retiring early, or freedom from worry? I’d say it’s incalculable.

Intelligence is not a reliable advantage in a world that’s become as connected as ours has. But flexibility is.

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.

With it comes something that often goes overlooked: 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.

Wagner-Jauregg assumed this was due to a hunch that had been around for centuries but doctors didn’t understand well: fevers play a role in helping the body fight infection.

The organization today notes: “The main work that concerned Wagner-Jauregg throughout his working life was the endeavour to cure mental disease by inducing a fever.”

The Seattle Children’s Hospital includes a section on its website to educate parents who may panic at the slightest rise in their child’s temperature: “Fevers turn on the body’s immune system. They help the body fight infection. Normal fevers between 100° and 104° f are good for sick children.”

It may be rational to want a fever if you have an infection. But it’s not reasonable. That philosophy—aiming to be reasonable instead of rational—is one more people should consider when making decisions with their money.

the real world, people do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night.

I visualized 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.

A reasonable investor makes them in a conference room surrounded by co-workers you want to think highly of you, with a spouse you don’t want to let down, or judged against the silly but realistic competitors that are your brother-in-law, your neighbor, and your own personal doubts. Investing has a social component that’s often ignored when viewed through a strictly financial lens.

My own view is that people are neither rational nor irrational. We are human. We don’t like to think harder than we need to, and we have unceasing demands on our attention. Seen in that light, there’s nothing surprising about the fact that the pioneer of modern portfolio theory built his initial portfolio with so little regard for his own research. Nor is it surprising that he adjusted it later.

What’s often overlooked in finance is that something can be technically true but contextually nonsense.

No normal person could watch 100% of their retirement account evaporate and be so unphased that they carry on with the strategy undeterred. They’d quit, look for a different option, and perhaps sue their financial advisor.

But if lacking emotions about your strategy or the stocks you own increases the odds you’ll walk away from them when they become difficult, what looks like rational thinking becomes a liability.

The reasonable investors who love their technically imperfect strategies have an edge, because they’re more likely to stick with those strategies.

There are few financial variables more correlated to performance than commitment to a strategy during its lean years—both the amount of performance and the odds ...

providing the endurance necessary to put the quantifiable odds of success in your favor, you realize it should be the most important part of any financial strategy.

There’s a well-documented “home bias,” where people prefer to invest in companies from the country they live in while ignoring the other 95%+ of the planet. It’s not rational, until you consider that investing is effectively giving money to strangers. If familiarity helps you take the leap of faith required to remain backing those strangers, it’s reasonable.

“I’m not buying individual stocks because I think I’m going to generate alpha [outperformance]. I just love stocks and have ever since I was 20 years old. And it’s my money, I get to do whatever.”

“We do some things for family reasons,” Bogle told The Wall Street Journal. “If it’s not consistent, well, life isn’t always consistent.”

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

A trap many investors fall into is what I call “historians as prophets” fallacy: An overreliance on past data as a signal to future conditions in a field where innovation and change are the lifeblood of progress.