My Learnings from a Book that Changed My Life

Psychology of Money by Morgan Housel

This is one of the very few books that have had a great impact on my life. I am thankful to my sister who brought this book in my life in a form of a gift.

The book has a fairly simple structure. There are 20 lessons divided into 20 chapters, last 2 being summarization and author’s psychology of his own money.

The book starts with an example of a tech executive, a genius, who had designed and patented a key part inside of a WIFI router. He was an exceptionally successful who had started and sold multiple companies. His relationship with money was utterly stupid though. He once bought a 1000 $ gold coins for skipping them across ocean as fun. Eventually he went on to get bankrupt.

There was also a guy called Ronald Read. An investor, philanthropist, a janitor and a gas station attendant. It’s hard to imagine all these professions to be of a single person. He died in 2014 along with around 2.8 Million other Americans that year. And he was one of the 4000 others among them who had a net worth of greater than 8 Million.

Author also talks about a Merrill Lynch executive, a Harvard MBA who was once on Crain’s ‘40 under 40’ most successful businessman’s list went bankrupt during 2008’s economics crises and his several lavish homes had to be seized and auctioned.

The key highlight here is finance works unlike other technical domains like Physics, Engineering, medical sciences. A good heart surgeon will accomplish a heart surgery which cannot be even imagined to have performed by a janitor who has no medical knowledge. But same is not true for making correct financial decisions when it comes to a finance professional and a janitor as is evident from the earlier examples. Financial outcomes are influenced by luck to some extent but are majorly influenced by our psychology and behavior.

And this aspect is what the book is about.

• The first chapter has an interesting title. ‘No one’s crazy’:

The financial strategies of one person might look crazy to some and perfectly fine to many others. This is because what we think of money is highly influenced the the unique experience we have had while growing up, how the economy performed in our region or country and how was the inflation and stock market returns during that period. For example if you were born in 1950 in the US you would have experienced almost no real returns from market and it was stagnant for almost 2 decades. But your son might invest in the market heavily post 1970 as market grew almost 10 fold in the next 10 years. You might think your son is crazy and vice versa.

The bottom line is we all make crazy decisions when it comes to money because we are new to this game and our decisions are based upon our unique personal life experiences.

• The Role of Luck and Risk:

In 1968, out of 303 Million high school students in the world 300 were studying at Lakeside school in the US, which was the only one school with a Teletype model 30 computer, one of the most advanced machines at the time. Bill Gates was one of those 300 students. One in a million! He was smart and hardworking who got the opportunity to play and explore the device. He is not shy about this and says that had there been no Lakeside, there would have been no Microsoft. Bill Gates and Paul Allen went ahead to found Microsoft. There was one other guy with them named Kent Evans, equally genius and Bill Gates’ best friend. Unfortunately he died in one mountaineering accident. The probability of something like this happening is one in a Million.

There is always some role of luck and risk in any financial outcome. How much? We do not know. And we can never know. The financial decision we took five years ago could be good. There was 80% chance of success. But may be you ended up on the 20% side. The Forbes magazine always shares successful investing stories and never the failed investors. Mark Zuckerberg is applauded for turning down 1 Billion $ offer by Yahoo! in 2006 but Yahoo! is criticized for turning down a buyout offer by Microsoft. The important takeaway from this is that we should focus on broad trends rather than hyper successful individuals or firms. Because we do not know how much role the risk or luck played for that individual or the organization to reach where it is today.

• The Power of Compounding

81.5 Billion net worth of Warren Buffet’s 84.5 Billion came after his 65th birthday. This is mind boggling but underlies the hidden power of compounding. If you look at the average annual returns of Buffet’s portfolio, it comes to be around 22%. But the sheer amount of time that he is investing for is crazy. He’s been investing since last 7 decades!

One of the most successful investor Jim Simons who is also a hedge fund manager earned on average 66% returns from the market. 3 times that of what Buffet earned. And Jim’s net worth is 22 Billion. The reason being Jim Simons started investing during his 50s. Had he been investing for as much time as Buffet has, his net worth would have been 63 Quintillion!! To create wealth, you do not need high returns but a consistent moderate returns over a long period of time.

• Getting Wealthy vs Staying Wealthy

Getting wealthy and staying wealthy are two different things which require different skill sets. For getting wealthy you need to take risks, stay optimistic about future and put yourself out there. For staying wealthy you require fear, humility, frugality.

While having an optimistic view point about future you also need to acknowledge that things might go south as well. You need to have a plan. The best part of the plan is to have a plan on the plan not going according to the plan. A margin of safety helps us here.

• Tails

Tails drive everything. A German art dealer started collecting art pieces of artists from all across the world. And he was a very successful art dealer. It is amazing to note that 99% of the art pieces he acquired in his lifetime turned out to be of a very little value. But those 1% ones, one of which was sold for 100 Million $ in 2000, was responsible for his success. Walt Disney had created more than 400s of cartoons since 1930s but ‘Snow White and the Seven Dwarfs’ changed everything. Out of 100s of investments a VC firm does, 65 may lose all the money. 4-5 may give you 5x-10x returns. 2-3 may give you 20x and hardly 1 may give you more than 50x returns. The large part of the Amazon’s success is driven by Prime and AWS. They have tried and failed launching many other products such as Fire Phone. In 2013 annual meeting of Berkshire Hathaway, Warren Buffet said that out of 400-500 stocks he invested in, he made most of his money on 10 of them. But the rest of them were a big part of his journey. So it is not about right or wrong. You could be wrong half of the times and still you can make fortune. Tails come to your rescue here.

• The Ultimate Goal behind Investing - Freedom!

The ultimate goal of investing should be this : To be able to do what you want, when you want, with whom you want and for as long as you want. Getting control over your time is the highest dividend that money pays.

• Man in the Car Paradox and the Difference between Rich and Wealthy

Someone might feel that owning a luxury car, big house earns one respect in the society. But it never works like that. When you see a Ferrari passing by, you hardly notice who is in the driving seat. Our mind goes into imagining ourself in that Ferrari and we never think of any kind of respect or admiration of the person owning that Ferrari, although he might expect that it is what is happening. If respect and admiration is your goal, be careful how you seek it. Kindness, humility, empathy will bring you more respect than any amount of Horsepower.

There is a difference between rich and wealthy. By looking at someone’s possessions like car, house, watches, you might conclude he/she is rich. But wealth is what you don’t see. That’s why it is difficult to contextualize. Wealth is the nice cars and nice diamonds not bought. Wealth is financial assets that have not been converted into stuff you see yet.

• The Golden Mantra: Save Save Save!

Building wealth has little to do with your income and more with your save rate. You got to build a habit of saving money. And there need not be any reason to save. Savings offer you options and flexibility. Saving money in the bank and getting 0% interest on it also has a silver lining to it. 

If you are facing some difficulties in your job, you are not satisfied with the kind of work you do, a six months of savings will give you enough time to explore new opportunities. A good amount of savings might provide you with ability to wait for the investment opportunity rather than someone who might turn desperate and make unreasonable decision.

• Reasonable >>> Rational

Being reasonable is always better than being rational. You cannot execute all your financial decisions made rationally, purely based on excel calculations. We are emotional beings. We are emotional about our investments. And it turns out to be beneficial also.

An excel calculation might recommend us to sell a stock which is 20% down its bought value. But its our reasoning and emotions that let us stick around with our strategy and make bets for longer horizons. A rational decision might make us walk away over a small turmoil in the market.

• Surprise

The most important events in the future that move the needle the most are the ones that history gives no guide about. The Great Depression, WW2, Vaccines, Antibiotics, ARPANET, 9/11, Fall of Soviet Union.

But nothing among all the major historical events is sufficient enough to model the future uncertainties in the market. That’s why a margin of safety is important.

• Margin of Safety (Room For Error)

For the plan not going according to the plan, we need margin of safety. It is a highly underappreciated and misunderstood concept. It is often viewed as conservative hedge used by those who do not want to take much risk and are not confident of their views. The markets are uncertain and as we know there are going to be surprises. If there is something that will endure us for the range of possibilities and help us stick around longer than those who will run away with small fluctuations, then it is this margin of safety.

• You Will Change

The way you have planed your life may change over time. You may be extremely ambitious and career oriented and work 80 hours a week throughout your life. But in the process, you may leave behind your family, friends and hobbies. And the regrets could trouble you day in and out. Or in other case you might enjoy your life to the fullest, spend on what you like, party with family and friends only to end up with insufficient retirement money when you turn 60. You should avoid both such extreme ends of financial planning. Your goals in life will change. And so your financial plans. But you have to acknowledge and incorporate the change as early as possible because remember, power of compounding lies in the time you hold your investments.

• Nothing’s Free

Successful investing is not free. It comes with fear, uncertainty, risk, doubt and regret. This is the cost you pay against your returns.

And there are people who try short cuts. A tactical mutual fund with intentions to maximize returns by buying and selling stocks within short period of time became popular during last 2 decades. During 2010-11, out of 112 such funds, only 9 had better returns than a simple 60-40 stock bond fund. More than half had lesser returns than index.

• You and Me

It is a notion that an asset has a rational price in the market where investors have different goals and time horizons. How much should you pay for a Google stock depends on who you are and how much time you are ready to dedicate. For 30 years, we might look at the 30 year cash flow cycle. For 10 years, we might look at industry’s vision over next 10 years. For 1 year, we might look at product cycle and economy. For a day trader, who cares. When multiple type of investors with different goals, risk appetites and different time horizons play in the same field they might collide and get hurt. When the momentum of short term returns attracts enough money, it changes the dynamics of market from mostly long term to mostly short term investors. This gives rise to bubble in the market.

Dot com bubble was the era of ultra optimism about future, but it was also an era of record amount of volumes being traded. Those setting the prices were not there for 20 years but for a few months. During housing bubble, the number of times the house was being flipped more than once became 5 fold. You need to identify yourself and stick to it to avoid unnecessary regrets and risks.

• The Seduction of Pessimism

Optimism sounds like a sales pitch. Pessimism sounds like someone is trying to help you. Money is ubiquitous. If we hear something bad about it, it tends to affect everyone and captures everyone’s attention. Also a lot of time pessimists tend to extrapolate the current trends without accounting for adapting nature of humans. A pessimist may suggest we may run out of fossil fuels within next 10 years. But what he/she tends to miss is how rapidly we are adapting to the new renewable technology trends through innovations. But there is a silver lining here. Expecting things will be very bad could be relieving when then are not that bad, which is ironically optimistic.

These are my major learnings from this incredible book.

Thank you! Hope you enjoyed the read!