The core theme of the book is the fact that how we deal with money is rooted in our psychological thought processes, rather than in cold, hard logical thought as we would be so eager to believe. It thus follows that maintaining control of our emotions is the root behind making the most sound financial choices. This is a sound premise that after reading this book I wholeheartedly believe to be accurate.
I split this review into the following sections in accordance to my main takeaways:
- Finances and Emotions
- Keeping Your Cool
- Historians as Prophets?
- Understand Your Game
- The Power of Compounding
Let’s get started.
Finances and Emotions
Housel puts forward the idea that a random person in an unrelated profession can outperform (in his investing portfolio) a seasoned investor. This is a dynamic we rarely see otherwise. It is near impossible, for example, for a career economist to understand marine biology better than someone experienced and actively working in the field. However the premise of this book is that if one’s emotions can be controlled, understood and maintained, then such an outcome is not only possible, but probable.
Conversely, in almost all facets of financial education, we are taught only the hard, cold math aspect of business. This undoubtedly forms the core of the industry and has its place, but as the Author mentions, financial decisions are rarely ever made by looking at the cold, raw data on a spreadsheet, but they are made at dinner tables and boardrooms, where emotions, ego and human biases reign supreme. Humans are emotionally driven at the most fundamental level, therefore ignoring the effects our psychological attitudes to money have on our effectiveness as investors is a recipe for failure. Soft skills are more important than is commonly stated, and once you have a reasonable amount of control over yourself and your emotions, then your chances of being an effective investor increase exponentially.
Keeping Your Cool
A key part of maintaining control of your emotions is when you keep your cool during times of general hysteria. Housel demonstrates this idea through a few examples, some of which I will mention.
Understanding the key concept that earning money and keeping it require two different psychological understandings mean that we can mentally separate the two and learn how to have both sets of skills. By default we may be inclined to keep both skills united under the idea of being able to “make money”, but we hardly question how see even the extremely wealthy and financially privileged witness their fortunes dwindle and even declare bankruptcy. Confusion drawn from hearing of such a situation stems from our lack of seeing personal finances from such a lens. Once we learn the skills required to make good decisions with our money, we can truly take advantage of any income we do earn.
Keeping a balanced outlook and maintaining your cool with money means that we are able to draw boundaries with our ventures. While others may deal with the burdensome effects of the ‘Sunk Cost Fallacy’, anyone smart and experienced with money knows that there is no requirement to sink with the ship on a bad investment. While it may seem unbearably painful to give up on something that you have invested so much into, ultimately, staying with it is the more painful decision. In times of necessity, be prepared to accept the change happening in the markets and move on quickly. Adaptability is key to understanding the needs and patterns of the market.
The ubiquitous nature of social/mass media means that we can sit in the comfort of our homes and have beamed to us the escapades, luxuries and riches of wealthy individuals, celebrities and elites instantly. Naturally desiring to be in a similar state, we are prone to taken to an imitation of their choices and decisions in the hopes that we may join their rank. While taking (positive, healthy) role models is a praiseworthy act, we fail to realise that the people we look up to (on the more extreme end of the spectrum) are likely extreme outliers. The circumstances of their apparent success and fortune are so unique to their individual situation and story, that it cannot possibly be emulated by anyone else. Ultimately we come to the conclusion that such outliers are by definition inimitable.
Historians as Prophets?
Outliers also come in many forms. Their most impactful one is in the form of world events such as World Wars, Financial Market crashes and like we have seen in recent times, the Coronavirus Pandemic. Such events have rippling effects on the rest of the world, with repercussions trickling down the economic hierarchy to affect different sections of society in different ways.
One side effect of this is that we may look back at human history and overuse its events and lessons in order to predict the future. Such precaution is praiseworthy, but then it crosses the line into attempting to foresee possible events into believing that they will happen without a doubt, then it becomes a blameworthy action which no man of sense should indulge in. Housel says it best here when he says that ‘Historians aren’t Prophets’. Look to history for patterns, but do not be fooled into thinking the future’s story is exactly written in the pages of the past.
The future is inherently unknown, and while many may forecast either optimistic or dire years ahead of us, we simply will never be able to know the reality of what lies ahead. Planning and analysis will only allow us into taking the best decisions we can according to the information we have at the time, nothing more. It is in fact due to this same inherently unknown feature of the future that we should always leave room in our plans for flexibility and quite simply, the unknown.
Accounting for the unknown via use of flexibility allows you to be humble enough to not know what is going to happen and reasonably account for it anyway. Looking at our current times, many despair for example, that it is too late to tackle Climate Change or any of the other main concerns of our times. However we fail to account for the fact that a solution in the form of technology or biological development may allow us to leapfrog the issue entirely, or at the very least give us a way out. Wilder things have happened, and as long as there are some working towards a solution, we should never condemn our future selves and give up on thing entirely.
This mindset will help to mitigate impending, irrational senses of both blind doom and unfounded optimism, allowing us to make wiser and more reasonable financial decisions.
It also helps us to understand the underlying principle that it is always the historical outliers that cause the most change to our world. Things and events that no one could have otherwise predicted end up changing our lives in the biggest ways. Once you understand this, we then open ourselves to understanding why companies such as Google or Netflix seem to be known for making products (either services or shows) that are then either cancelled down the line or written off entirely, much to the chagrin of its loyal users or avid viewers. I must admit, I never saw the logic behind it before I read this book either. Why cancel a TV Series which many people love? Why does Google start so many new projects and products only to scrap them en-masse?
Morgan Housel teaches us that the underlying principle regarding outliers also works in reverse. If it is often the outliers that cause the most change and are the most successful, then the best way to take advantage of the situation is to produce and finance many things in order to find the one that sticks. This is known as the principle of chasing ‘Tails’. By no coincidence, this is also the method that Venture Capitalist Firms also utilise in their search for products that will bring them the most return on investment. Even the most richest men in the world today have made most of their money on a few stocks out of a large pool.
The business world runs on Tails.
Another big perspective changer from this book was the realisation that the whole idea of retirement is at most only 2-3 generations old. Before that time, people simply worked until they reach old age and died. This idea may sound harsh to us, but conversely it is our expectations which are new and contrary to the historical norm. Couple this fact with the fact that the average age of many developed nations is increasing, meaning that people are having less children and therefore the number of workers required to support a burgeoning elderly population are insufficient and you have some questions questions to ask. The underlying message here is that we should not necessarily mentally rely on an institution that is so new and whose underpinning is faltering to take care of us in our old age.
The solution to this is to return to the good old method of relying upon yourself. To save some of your own money and invest it yourself to do your best to ensure that you have something for yourself in your older years. A healthy amount of savings do not only help you in your future, but also hedge you against any sudden happenings in the present and near-future. Financial savings pay dividends on the most important of any currency, time. Having money saved allows you to regain control of your time and freedom. It allows you to not be at the whim of your boss and it means you can wait out the right job without feeling pressured to take the first one that comes your way.
For many, this mental barrier against external compulsion brings a sense of freedom that has more value than any financial return can give, and is often overlooked by people who only see hard figures and therefore any money sitting in the bank as inherently wasted as ‘not doing anything’. This once again plays into the idea that money management is as much to do with psychology as it is anything else, a point well made by the Author in this book and one that will stick with me.
Understand Your Game
One of the unwritten rules of investing is the concept that one should understand what game he is playing. We tend to see ‘investing’ like the word ‘sports’, yet understand there is a clear difference between the one who plays football versus the one who plays table tennis. While both are capable in their chosen fields, the skills and acuteness required are vastly different for each type of game.
The same applies with the Day-Trader and the Long-Term Investor. We may lump them both under the mental concept of someone investing their money to increase their wealth, but if one were to copy to habits and skills of another while ignoring the nuances of their own chosen game, they would crash and burn very hard. Understanding which game you are playing is the first step towards setting your boundaries and laying the groundwork for the task you set out to achieve. It allows you to take onboard what you need and to discard what you don’t. It is the filter by which you know what to do and what not to do, and as we all know, the person with the most defined and curated game-plan usually performs as expected.
Another interesting concept Housel introduced to me was the fact the path to success may often be filled with destruction complete failure along the way. Destruction is not the indicator of permanent failure for the one who understands this. An excellent example given was the difference in the number of braincells between a baby and a 20 year old adult. Unsurprisingly (or maybe surprisingly, depending on the 20 year olds you know), a 20 year old will have a vastly less number of braincells than the toddler, but no one will argue that the 20 year old is less intelligent as a result. Again, this may or may not be your position depending on the 20 year olds you know. The underlying principle makes itself known again. Sometimes the path toward progress involves destruction, failure and loss at some point. Just as the Adult loses braincells as he matures yet becomes wiser and more intelligent, the boxer also loses weight to become more lean and agile for a big fight.
Loss is not inherently the signal of absolute failure.
Another point the Author makes quite well is the fact that many people seem to have their financial goalposts expand enough when they make more money to the extent that it outpaces their income. Therefore they enter what is colloquially known as the ‘Rat Race’, the ever expanding race against themselves to support the lifestyle their new income brought. Once you withdraw from this game however (or better yet, never enter into it), you are able to reach a new level of freedom which means the ability to prioritise your family, friends and personal happiness over the monetary gains offered by a new job or promotion. Freedom is the ultimate expression of wealth.
Morgan Housel makes an interesting point about the origins of the Rat Race and how the idea of ‘Keeping Up with the Joneses’ entered into the (American) mind.
The first technology which worked as a mechanism to unify people’s mins was the Printing Press and thereby Newspapers. The second technology was the Radio. The third technology was an evolution of the two and eclipsed them in its ability to provide a rich experience to its users, this was the Television. From its inception, the Television had the power to unify the visions and sounds of the nation so that they collectively had a yearning for what was portrayed to be ‘normal’. where they may have been somewhat content with their situation before, the Television showed scenes of a house of a certain size and a car of a certain value to be ‘normal’. Thus the concept of ‘Keeping Up with the Joneses’ entered into the American Psyche, soon to take over the rest of the world.
An additional point Morgan Housel made which I found particularly interesting was the fact that we as human beings tend to see the world around us and indeed think of it according to mental models that work in a linear fashion. The brilliant yet simple example he gives is the fact that it is much easier for any of us to conceive of 8+8+8+8+8+8 compared to 8x8x8x8x8x8. Our minds cannot naturally comprehend without extra steps how quickly things expand and grow in an exponential fashion. The initial numbers are the same, but the exponential operators turn the answers into absolutely incomparable figures.
When it comes to investing, the same principle holds true. It is vital for the investor to understand that the small yet constant habit of saving and investing a little more every so often on a consistent basis may lead to much higher returns than erratic investing with much higher amounts. Like the seed which requires much water to sprout but then shoots up extremely fast when it does so, savings require consistent attention and most importantly the factor of time for the power of compounding takes effect.
All being said, this book taught me a lot more about psychology than about finance. I don’t find it hard to imagine that this was unintended, since the Author’s premise is that a healthy mindset is key to becoming a good investor. Upon finishing the book I find myself agreeing with him.
The book itself is very easily read and readers avoiding it for fear of it being a book of generic financial advice should take note from this review that this book is anything but. I get the impression that Housel is helping us to lay the foundations upon which hard, financial maxims concerning math and data should lay upon and in my opinion he has done an astounding job at it.
Not many talk about the psychological benefits of savings at the expense of investing every cent of it so that it is constantly ‘working for you’, and Morgan Housel even mentions that paying off his mortgage gave him the peace of mind that taking his time to pay it off (to benefit from the low interest rates) would have never given him otherwise. From these anecdotes dotted around the book, I got the impression of sincerity and practical advice which was miles away from the rabid advice that is so common today, imploring people to have every penny they have doing something for them financially. Sometimes there is a trade-off that people are not willing to make, and it is refreshing to see someone acknowledge it.
I wholly recommend this book for everyone to read, and it is a fascinating insight as to how we can make a practical difference to the way we approach finances by changing what is within our control.
Our emotions and psychology.