In this article, we’ll be delving into 12 vital lessons about money, all sourced from this exceptional book by Morgan Housel, “The Psychology of Money.”
We’re going to discuss these lessons, extracted from some of my preferred reading material, across four sections. These will cover our perceptions about money, the process of earning money, how we spend money, and ultimately, protecting our financial resources.
Lesson 1: Understanding our Perceptions of Money.
Our first topic revolves around understanding that people’s attitudes towards money can greatly differ.
This variance can influence how people earn, save, and spend, and it’s essential not to judge too hastily based on what they choose to do with their money.
For instance, consider the way people engage with real estate as an investment.
If you were born in a bustling city during the 1980s where property values skyrocketed, you might see real estate as an almost sure-fire investment.
You’ve seen, first-hand, the value of properties multiply many times over, making property owners wealthy in the process.
However, for those born in a rural area or a place where real estate prices have remained stagnant or even fallen over time, property doesn’t represent the same “golden goose.”
They may view real estate as a risky or even poor investment.
It’s easy for a city-dweller, who has seen real estate work wonders, to question why more people don’t invest heavily in it.
They might even wonder why people hesitate to dive into newer investment arenas like cryptocurrency.
But the wisdom gained from Housel’s book reminds us to empathize.
Everyone’s attitude towards money is shaped by their unique experiences, and we need to respect these differing perspectives, rather than dismiss them.
Lesson 2 – Recognizing the Role of Fortune.
The second principle underscores the significance of acknowledging the element of luck in financial success.
Essentially, any outcome, be it financial prosperity or any other facet of life, is a concoction of luck, talent, and unique advantages.
Consider the story of Jane Yolen, the celebrated author, as an illustration.
Without a doubt, she possesses an extraordinary talent for storytelling.
However, it was also a stroke of good fortune that she attended a school with a robust emphasis on creative writing, nurturing her unique gift from an early age.
This exposure fuelled her passion and ultimately led to her becoming a successful author of children’s books.
So, the underlying lesson of chapter 2, drawn from Morgan Housel’s ideas, is that it’s not always constructive to zoom in on individuals’ success stories – be it the tale of Jeff Bezos or Jane Yolen.
Instead, we should shift our focus to broader patterns, that account for these variations in luck.
This way, we could comprehend the bigger picture, and develop a more profound understanding of the forces, at play in our journey to financial success.
We need to remember that while hard work and talent are crucial, sometimes, being in the right place at the right time, can make all the difference.
Lesson 3 – Understanding the Value of “Enough”.
Our next key insight from the book underscores the importance of, learning to appreciate the concept of “enough.”
It’s inherent in our nature as humans to perpetually shift our goalposts.
As we attain one goal – whether it’s related to finances, career, physical fitness, or relationships.
we instinctively set our sights on the next one.
This perpetual cycle is often fuelled by our propensity, to compare ourselves with those, who we perceive as being higher up on this figurative ladder of success.
This idea resonated with me deeply because I’ve been pursuing the entrepreneurial path since my early teens, trying to generate income online.
Starting from virtually zero earnings, my income gradually accumulated over the years, to a point where most would consider it to be more than satisfactory.
Yet, I found my point of comparison continually shifting.
This lesson reminds us that it’s essential to understand when we’ve reached “enough,” and to refrain from chasing growth for growth’s sake.
The book cites various instances of wealthy individuals who, in their pursuit of more wealth, engaged in questionable activities.
A case in point is Bernie Madoff, who, despite already being exceedingly wealthy, he masterminds the largest Ponzi scheme in history, worth about $64.8 billion to accumulate even more wealth, which ultimately landed him in prison.
The crucial question here is – when is enough truly enough?
Do we genuinely need more? There’s a poignant quote in the book which encapsulates this –
“There is no reason to risk what you have, and need for what you don’t have, and don’t need.”
Moving onto the next segment, while this isn’t a article on building wealth from scratch, there are excellent chapters on wealth accumulation, which we’ll delve into for our next lesson.
Lesson 4 – Grasp the Power of Compounding Interest.
One should always marvel at the enchanting potency of compound interest.
To illustrate this, imagine that you decided to invest $1000 in an S&P 500 index fund.
Assuming an annual return of about 10%, by the end of the first year, your total amount would be $1100.
When the next year comes, you’re not just earning a 10% return on your initial investment, but also on the $100 that grew from it.
Consequently, by the start of the third year, you’ll possess $1210.
The allure of compounding is that you’re not merely gaining interest or returns on your original investment, but you’re also generating profit on your previous profits.
When you visualize this concept with larger numbers, the outcome is truly extraordinary.
Instead of referring to Morgan’s example of Warren Buffett from the book, let’s consider a different billionaire investor: Charlie Munger.
Munger, who’s Buffett’s longtime business partner, also utilized the power of compound interest to amass a significant fortune.
When the book was penned, Munger’s net worth hovered around $2 billion.
Intriguingly, nearly all of it – $1.96 billion – was earned after he celebrated his 50th birthday.
Furthermore, $1.8 billion of this amount was amassed after he turned 60.
The secret behind Munger’s incredible wealth accumulation wasn’t a miraculous one-time investment,
but rather the decision to start investing at a young age, and continuing consistently over many decades.
In fact, he started investing when he was merely 20 years old.
By the time he was 30, he had already garnered a million dollars in investments.
Notably, he didn’t stop there and kept at it.
The math in the book further elucidates, that approximately 99.9% of Munger’s wealth is a result of compounding, credited to his early start, and persistent investing over a considerable period.
To quote the book, none of the many analyses of Munger’s success are titled, “This Man Has Been Investing Steadily for More Than Half a Century.”
But we understand that this consistency, is the fundamental cornerstone of his wealth creation.
It may be challenging to comprehend the math, because it seems counterintuitive, but that’s what makes the power of compounding so magical.
As we progress to Lesson 5, we’ll explore the importance of saving as much as you can.
Lesson 5 – Harness the Power of Saving.
While you might not have a definitive aim to save, it’s important to understand, that the path to financial abundance isn’t solely about your salary, or investment gains, but rather significantly hinged on your saving habits.
This idea, articulated by Morgan, presents a shift in our conventional perception about saving.
Instead of viewing it as the mere residual of your income after expenses, consider savings as the difference between your income and your self-importance.
This thought-provoking perspective, encourages us to scrutinize our expenditures.
How much of it is truly essential, versus how much is propelled by vanity?
Now, when you break it down, the savings rate is the only factor within this financial equation, that we wield absolute control over.
We may not have total control over our earnings, and certainly, we can’t dictate the fluctuations in the stock market, cryptocurrency or the property market.
However, we have complete autonomy over, how much we decide to save from our earnings.
A related concept, shared by a biologist during an interview on Tim Ferriss’s podcast, amplifies the power of maintaining a high savings rate, and modest personal expenses.
Living minimally, requiring less money to lead a fulfilling life, affords you greater freedom.
Unfortunately, many are tethered to jobs they find unfulfilling, due to a lifestyle that necessitates a hefty income.
The question arises, is it worth spending approximately 80,000 hours of your life, the majority of your waking hours, unhappy in a job merely to sustain an extravagant lifestyle?
Hence, by curbing our personal expenses, and boosting our savings rate, we augment our financial resilience, freedom, and autonomy.
It empowers us to spend more time doing what we truly love.
To sum up this lesson, remember, saving isn’t just about money; it’s about giving yourself the freedom to live a more fulfilled life.
Lesson 6 – Prioritize Avoiding Mistakes | Psychology of Money
The sixth principle from the book, emphasizes the importance of avoiding mistakes, over seeking significant returns.
To illustrate this, let’s consider the investment strategies of two fictional individuals, Molly and Dan.
Molly invests a dollar into a diversified mutual fund every single month, regardless of market conditions.
On the other hand, Dan tries to outsmart the market.
He buys when the market seems to be on a rise and sells when it appears to be on a downturn, hoping to leverage the market cycles.
Over the years, Molly’s portfolio steadily grows, while Dan’s portfolio, unfortunately, experiences more fluctuations.
The key difference between Molly and Dan is not about who made the larger profits, but who avoided making the larger losses.
Molly succeeded by not selling her investments during market downturns, thus avoiding panic-based decisions.
Instead of trying to time the market, a more commonly recommended approach is to focus on a long-term investment strategy based on your financial goals, risk tolerance, and time horizon.
This strategy often involves diversifying your portfolio by investing in a mix of different assets and holding them for the long term.
This way, you can potentially benefit from the overall growth of the market over time while reducing the impact of short-term market fluctuations.
The fascinating observation here is that when it comes to managing our money, the consequences of a wrong decision are far more detrimental than the benefits of a right one.
If we lose money, not only is it harder to get back in the game, but it also has direct implications on our lives. Conversely, while making more money is desirable, the incremental value decreases after a certain point.
Therefore, the underlying message here is that it’s important to think long-term, and prioritize not losing money over chasing the next big investment craze, be it the new hot cryptocurrency, or the next promising tech startup.
The key is to focus on consistent, disciplined investing over time, to truly leverage the power of compounding.
Now, let’s proceed to part three, where we’ll discuss the principles related to spending money. Stay tuned for the next lesson.
Lesson 7 – Investing Money for Liberty | Psychology of Money
The seventh chapter emphasizes the investment of money to gain freedom.
The core philosophy here is to value the independence, and opportunities money provides us, not merely considering it a tool, to acquire ostentatious belongings like high-end homes or luxury cars.
The crux of the matter is, money’s true essence, which is often undervalued, lies in its power to let you command your time.
Investing your wealth to liberate your time, and broaden your choices offers a quality of life that outshines any material luxury.
This concept stems from the universal pursuit of happiness, and a purposeful existence.
There is substantial research indicating that beyond a certain income level, which many experts peg around $75,000 annually in the US, the marginal increase in personal happiness or life satisfaction tapers off.
In essence, since time is the most precious resource we have—one that can’t be reproduced or replenished—it is wise to use money to purchase more time or freedom.
This is far more beneficial than squandering it on extravagant items, that offer momentary satisfaction but no real value.
The eighth chapter then moves onto discussing the pathways to wealth accumulation.
Lesson 8 – The Diverging Paths of Earning Wealth, and Preserving Wealth.
It’s critical to understand that accumulating wealth, and retaining it are two vastly different strategies.
In this lesson, the author points out a distinct contrast, accumulating wealth often demands taking risks, maintaining an optimistic outlook, and not being afraid to step out of your comfort zone.
On the other hand, retaining wealth calls for a more cautious approach, one that involves humility and an awareness that your fortunes could reverse rapidly.
For instance, how much should you retain in equities and real estate and how much you should venture into, let’s say, precious metals like gold, which are traditionally more stable but offer potentially lower returns?
Gold, while not as volatile as crypto, is subject to market forces that could cause it to either rise or fall dramatically.
Most people’s confidence in gold’s long-term value is fairly strong, yet a considerable portion of their assets remains in equities and real estate. This is due to the realization that their primary goal at this stage isn’t about aggressive wealth creation, but about conserving and steadily growing my existing wealth.
This brings us to the ninth lesson from the book, which we’ll delve into next.
Lesson 9 – Resist the Urge to Show Off.
In this lesson, we’re delving into a profound truth about personal finance, that everyone needs to understand.
It’s the notion of refraining from ostentatious displays of wealth, as eloquently described by a father to his son.
He states, “You may think you crave a luxury vehicle, a designer wristwatch, or an opulent mansion.
But trust me, what you genuinely desire is the esteem, and regard of others.
And contrary to popular belief, flaunting extravagant possessions hardly ever secures it, especially from those whose respect truly matters to you.”
This paradox can be further explained using what we’ll term the ‘Superyacht Dilemma’.
This dilemma reflects the misunderstanding, that underlies the purchase of luxury items like expensive cars or grandiose estates.
The belief that possessing such lavish possessions will earn you admiration, and respect is quite common.
For example, cruising the town in the latest Lamborghini, might create the impression that you are wealthy and successful.
However, what many fail to comprehend is that the admiration, is usually directed not towards the individual, but the item of luxury itself.
People aren’t necessarily in awe of the person driving the Lamborghini, or residing in the extravagant villa.
Instead, they marvel at the objects themselves, and picture themselves in possession of such luxurious items.
Therefore, trying to win respect by flaunting expensive items, is a flawed strategy since genuine admiration, and esteem can’t be purchased.
The second aspect to consider, is the need to resist the temptation to splurge on conspicuous consumption.
True wealth lies in the ability to refrain from spending, not in the amount you can display.
Moving onto the next segment, we’ll delve into strategies to safeguard your hard-earned wealth.
Regardless of the amount, every dollar of your money requires an adequate degree of protection, a critical aspect of managing personal finance, we’ll discuss this in the upcoming lesson. So stay tuned!
Lesson 10 – Incorporate a Margin of Safety.
Our tenth point delves into, the concept of creating a safety margin in your financial strategy.
This involves two key aspects.
Firstly, it’s about developing a financial cushion, that ensures your financial resilience even if your projected returns fall short.
Suppose you’ve invested some capital, expecting an annual growth of seven percent.
It’s critical to devise a contingency plan if the growth rate falls to four, three, or even two percent, or if it dips into the negative.
The plan should be designed so that, your financial health can withstand these potential outcomes.
The second facet of this concept is not just about financial endurance, but emotional resilience too.
This links to whether the life you’d lead under these circumstances would be tolerable, or even desirable.
Consider this scenario, you’re employed in a conventional job but have managed to save an amount equivalent to two years’ worth of expenses.
Your plan is to resign and spend the next two years pursuing your dream, of being a professional artist, funded by your savings.
On paper, it seems like a solid plan – if your artistic endeavors don’t pan out, you can simply return to the workforce after two years.
But what isn’t factored into this equation is the emotional stress, associated with steadily depleting your hard-earned savings.
When you find yourself having spent half of your savings, you might experience substantial emotional distress.
This could result in you abandoning your artistic pursuits prematurely, and reverting to your previous job, unable to bear the emotional toll of dwindling savings, and a yet-to-be-successful artistic career.
So, the point being underscored here, as highlighted in the book, is the importance of making allowances for the emotional factors, that inevitably play a role in our financial decisions.
Our relationship with money, as explored in ‘The Psychology of Money’, is not strictly about rational and logical economic decisions.
It also involves accounting for our emotional reactions, and how they shape our financial decisions.
Moving on to lesson number 11, which is…
Lesson 11 – Evade Intense Financial Obligations for Your Future Self.
Steer clear of rigorous financial commitments for your future persona.
This primarily addresses those individuals who presume they have their future fully mapped out.
Let’s consider an example where someone assumes, they’re not going to embark on any grand entrepreneurial ventures, thereby justifying their current lavish expenditures.
Or perhaps someone who’s utterly convinced they won’t need a hefty retirement fund, thus allowing themselves a more extravagant lifestyle today.
However, this mindset can be problematic.
Even if you’re adamant about your life choices, there’s a high likelihood you’re mistaken and will change your mind further along your life journey.
Psychologists term this phenomenon as the ‘end of history illusion’.
Essentially, this suggests that while we can accurately reflect on how much we’ve evolved over the past decade, we tend to struggle when forecasting our future changes.
Indeed, if asked to envisage the transformations we’ll undergo in the next decade, we often fail to make accurate predictions.
We usually believe that our future selves will be much like our present selves.
Given our inability to accurately predict how our ambitions, principles, and cravings will shift with time, it’s vital to consider this uncertainty when making financial decisions.
As much as we dream of striking it rich with the next big thing, in AI, cryptocurrency or some other windfall, we’ll still need a reliable financial cushion for future decisions.
With that in mind, it’s imperative to avoid taking on severe financial commitments today.
Resist the temptation to spend your wealth recklessly, under the misguided belief of “live for today, forget about tomorrow”.
Because when the time comes, you might realize you have more years to live, and those years will be challenging if you’re penniless.
Lesson 12: Opt for Practicality over Pure Rationality.
The core argument here is that, our decisions may not always be the most logical ones, but they often satisfy our emotional needs.
Remember, we’re not just logic-driven beings; our emotions play a big role in our decision-making process.
For instance, Before this insight, the idea of paying off a car loan early may seemed illogical. The thinking goes something like this: borrowing money through a car loan is relatively inexpensive, and if you invest that money in mutual funds or other ventures, it would potentially yield more than the interest you’re paying on your loan.
Add inflation into the mix, and the value of your loan will decrease over time.
All of these are rational economic arguments, against paying off your car loan early.
However, what this perspective fails to consider, is the emotional comfort that comes with being free of debt.
The knowledge that you completely own your car, can give you a sense of security and peace of mind.
It can help you sleep better at night.
If you have the means and desire to pay off your car loan early, it may not be the most rational decision economically, but if it brings you peace of mind, then it’s the right decision for you.
We often face similar dilemmas when deciding how to invest.
Your friend may insist that investing all your savings into start-ups is the best strategy.
But if such a high-risk strategy causes you anxiety, it might be better to invest a portion you are comfortable with in start-ups, and the rest in more stable options.
Even if this decision doesn’t seem fully rational, it’s reasonable because it gives you peace of mind.
So, that’s our twelfth lesson on the psychology of money.