March 31, 2021

The Psychology of Money by Morgan Housel | Book Notes

“A genius is the man who can do the average thing when everyone else around him is losing his mind.”
—Napoleon
  • “The world is full of obvious things which nobody by any chance ever observes.” —Sherlock Holmes
  • doing well with money has a little to do with how smart you are and a lot to do with how you behave.
  • A genius who loses control of their emotions can be a financial disaster. The opposite is also true. Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence.
  • One, financial outcomes are driven by luck, independent of intelligence and effort.
  • two (and I think more common), that financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.
  • Two topics impact everyone, whether you are interested in them or not: health and money.
  • Through collective trial and error over the years we learned how to become better farmers, skilled plumbers, and advanced chemists. But has trial and error taught us to become better with our personal finances? Are we less likely to bury ourselves in debt? More likely to save for a rainy day? Prepare for retirement? Have realistic views about what money does, and doesn’t do, to our happiness? I’ve seen no compelling evidence.
  • you could understand it better through the lenses of psychology and history, not finance.
  • I’d rather make 20 short points you finish than one long one you give up on.

1. No One’s Crazy

  • Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works.
  • Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.
  • We all think we know how the world works. But we’ve all only experienced a tiny sliver of it.
  • Michael Batnick says, “some lessons have to be experienced before they can be understood.”
  • a view about money that one group of people thinks is outrageous can make perfect sense to another.
  • Buying a lottery ticket is the only time in our lives we can hold a tangible dream of getting the good stuff that you already have and take for granted. We are paying for a dream, and you may not understand that because you are already living a dream. That’s why we buy more tickets than you do.
  • “To rephrase an old saying: everyone talks about retirement, but apparently very few do anything about it.”6
  • many of us are bad at saving and investing for retirement. We’re not crazy. We’re all just newbies.
  • Yet here we are, with between 20 and 50 years of experience in the modern financial system, hoping to be perfectly acclimated.
  • We all do crazy stuff with money, because we’re all relatively new to this game and what looks crazy to you might make sense to me.

2. Luck & Risk

  • Luck and Risk are siblings.
  • NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others’: “Nothing is as good or as bad as it seems.”
  • Bill Gates went to one of the only high schools in the world that had a computer.
  • Gates is not shy about what this meant. “If there had been no Lakeside, there would have been no Microsoft,” he told the school’s graduating class in 2005.
  • Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes. They are driven by the same thing: You are one person in a game with seven billion other people and infinite moving parts. The accidental impact of actions outside of your control can be more consequential than the ones you consciously take.
  • When judging others, attributing success to luck makes you look jealous and mean, even if we know it exists. And when judging yourself, attributing success to luck can be too demoralizing to accept.
  • Everything worth pursuing has less than 100% odds of succeeding, and risk is just what happens when you end up on the unfortunate side of that equation.
  • someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk.
  • The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side.
  • But when does the narrative shift from, “You didn’t let outdated laws get in the way of innovation,” to “You committed a crime?”
  • Risk and luck are so hard to pin down.
  • There are so many examples of this.
  • Countless fortunes (and failures) owe their outcome to leverage.
  • The best (and worst) managers drive their employees as hard as they can.
  • “The customer is always right” and “customers don’t know what they want” are both accepted business wisdom.
  • Risk and luck are doppelgangers.
  • Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.
  • just be careful when assuming that 100% of outcomes can be attributed to effort and decisions.
  • Therefore, focus less on specific individuals and case studies and more on broad patterns.
  • Studying a specific person can be dangerous because we tend to study extreme examples—the billionaires, the CEOs, or the massive failures that dominate the news—
  • You’ll get closer to actionable takeaways by looking for broad patterns of success and failure.
  • Bill Gates once said, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.”
  • The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.

3. Never Enough

  • There is no reason to risk what you have and need for what you don’t have and don’t need.
  • Remember a few things.
  • 1. The hardest financial skill is getting the goalpost to stop moving.
  • It gets dangerous when the taste of having more—more money, more power, more prestige— increases ambition faster than satisfaction.
  • Happiness, as it’s said, is just results minus expectations.
  • 2. Social comparison is the problem here.
  • the ceiling of social comparison is so high that virtually no one will ever hit it.
  • accept that you might have enough, even if it’s less than those around you.
  • 3. “Enough” is not too little.
  • many will only stop reaching for more when they break and are forced to. This can be as innocent as burning out at work or a risky investment allocation you can’t maintain.
  • 4. There are many things never worth risking, no matter the potential gain.
  • Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable.
  • Being loved by those who you want to love you is invaluable.
  • Happiness is invaluable.
  • Your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.

4. Confounding – Compounding

  • $81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday. Our minds are not built to handle such absurdities.
  • amazing thing here is how big something can grow from a relatively small change in conditions.
  • “It is not necessarily the amount of snow that causes ice sheets but the fact that snow, however little, lasts.”
  • The big takeaway from ice ages is that you don’t need tremendous force to create tremendous results.
  • Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child.
  • The real key to his success is that he’s been a phenomenal investor for three quarters of a century.
  • His skill is investing, but his secret is time.
  • when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider compounding potential.
  • good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.

5. Getting Wealthy vs. Staying Wealthy

  • Good investing is not necessarily about making good decisions. It’s about consistently not screwing up.
  • THERE ARE a million ways to get wealthy, and plenty of books on how to do so. But there’s only one way to stay wealthy: some combination of frugality and paranoia.
  • Getting money is one thing. Keeping it is another.
  • Capitalism is hard. But part of the reason this happens is because getting money and keeping money are two different skills.
  • Getting money requires taking risks, being optimistic, and putting yourself out there.
  • But keeping money requires the opposite of taking risk. It requires humility, and fear that what you’ve made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
  • There are two reasons why a survival mentality is so key with money. One is the obvious: few gains are so great that they’re worth wiping yourself out over. The other, as we saw in chapter 4, is the counterintuitive math of compounding.
  • Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.”
  • Applying the survival mindset to the real world comes down to appreciating three things.
  • 1. More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.
    - Compounding doesn’t rely on earning big returns. Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.
  • 2. Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
    - But few plans of any kind survive their first encounter with the real world.
    - The more you need specific elements of a plan to be true, the more fragile your financial life becomes. If there’s enough room for error in your savings rate that you can say, “It’d be great if the market returns 8% a year over the next 30 years, but if it only does 4% a year I’ll still be OK,” the more valuable your plan becomes.
    - Room for error—often called margin of safety—is one of the most underappreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline— anything that lets you live happily with a range of outcomes.
  • 3. A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
    - Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery.
    - Economies, markets, and careers often follow a similar path— growth amid loss.

6. Tails, You Win

  • You can be wrong half the time and still make a fortune.
  • 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.
  • Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. And most of our attention goes to things that are huge, profitable, famous, or influential. When most of what we pay attention to is the result of a tail, it’s easy to underestimate how rare and powerful they are.
  • In 2018, Amazon drove 6% of the S&P 500’s returns. And Amazon’s growth is almost entirely due to Prime and Amazon Web Services, which itself are tail events in a company that has experimented with hundreds of products, from the Fire Phone to travel agencies.
  • Apple was responsible for almost 7% of the index’s returns in 2018. And it is driven overwhelmingly by the iPhone, which in the world of tech products is as tail-y as tails get.
  • How you behaved as an investor during a few months in late 2008 and early 2009 will likely have more impact on your lifetime returns than everything you did from 2000 to 2008.
  • Your success as an investor will be determined by how you respond to punctuated moments of terror, not the years spent on cruise control.
  • A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy. Tails drive everything.
  • When you accept that tails drive everything in business, investing, and finance you realize that it’s normal for lots of things to go wrong, break, fail, and fall.
  • If you’re a good stock picker you’ll be right maybe half the time.
  • If you’re a good business leader maybe half of your product and strategy ideas will work.
  • If you’re a good investor most years will be just OK, and plenty will be bad.
  • If you’re a good worker you’ll find the right company in the right field after several attempts and trials.
  • But CEO Jeff Bezos said shortly after the disastrous launch of the company’s Fire Phone: If you think that’s a big failure, we’re working on much bigger failures right now. I am not kidding. Some of them are going to make the Fire Phone look like a tiny little blip. It’s OK for Amazon to lose a lot of money on the Fire Phone because it will be offset by something like Amazon Web Services that earns tens of billions of dollars. Tails to the rescue.
  • in most fields we only see the finished product, not the losses incurred that led to the tail-success product.
  • 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.

7. Freedom

  • Controlling your time is the highest dividend money pays.
  • THE HIGHEST FORM of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”
  • 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.
  • Six months’ emergency expenses means not being terrified of your boss, because you know you won’t be ruined if you have to take some time off to find a new job.
  • 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.
  • In 1870, 46% of jobs were in agriculture, and 35% were in crafts or manufacturing, according to economist Robert Gordon. Few professions relied on a worker’s brain. You didn’t think; you labored, without interruption, and your work was visible and tangible.
  • our days don’t end when we clock out and leave the factory. We’re constantly working in our heads, which means it feels like work never ends.
  • If your job is to build cars, there is little you can do when you’re not on the assembly line. You detach from work and leave your tools in the factory. But if your job is to create a marketing campaign—a thought-based and decision job—your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you’re making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning.
  • Controlling your time is the highest dividend money pays.

8. Man in the Car Paradox

  • No one is impressed with your possessions as much as you are.
  • There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.
  • Humility, kindness, and empathy will bring you more respect than horsepower ever will.

9. Wealth is What You Don’t See

  • Spending money to show people how much money you have is the fastest way to have less money.
  • We tend to judge wealth by what we see, because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Instagram photos.
  • 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.
  • When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.
  • We should be careful to define the difference between wealthy and rich. It is more than semantics.
  • 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.
  • 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.
  • Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.” Wealth is turning down that treat meal and actually burning net calories.
  • People are good at learning by imitation. But the hidden nature of wealth makes it hard to imitate others and learn from their ways.
  • 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.

10. Save Money

  • Past a certain level of income people fall into three groups: Those who save, those who don’t think they can save, and those who don’t think they need to save.
  • 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.
  • Investment returns can make you rich. But whether an investing strategy will work, and how long it will work for, and whether markets will cooperate, is always in doubt. Results are shrouded in uncertainty.
  • Personal savings and frugality—finance’s conservation and efficiency—are parts of the money equation that are more in your control and have a 100% chance of being as effective in the future as they are today.
  • 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.
  • Learning to be happy with less money creates a gap between what you have and what you want—similar to the gap you get from growing your paycheck, but easier and more in your control.
  • one of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.
  • Savings can be created by spending less. You can spend less if you desire less. And you will desire less if you care less about what others think of you. As I argue often in this book, money relies more on psychology than finance.
  • Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.
  • 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.
  • Intelligence is not a reliable advantage in a world that’s become as connected as ours has. But flexibility is.
  • In a world where intelligence is hyper-competitive and many previous technical skills have become automated, competitive advantages tilt toward nuanced and soft skills—like communication, empathy, and, perhaps most of all, flexibility.
  • 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.
  • 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.

11. Reasonable > 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.

12. Surprise!

  • “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.
  • Richard Feynman, the great physicist, once said, “Imagine how much harder physics would be if electrons had feelings.”
  • The cornerstone of economics is that things change over time,
  • Few things stay the same for very long, which means we can’t treat historians as prophets.
  • Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.
  • 1. You’ll likely miss the outlier events that move the needle the most.
  • 0.00000000004% of people were responsible for perhaps the majority of the world’s direction over the last century.
  • The majority of what’s happening at any given moment in the global economy can be tied back to a handful of past events that were nearly impossible to predict.
  • Realizing the future might not look anything like the past is a special kind of skill that is not generally looked highly upon by the financial forecasting community.
  • The most important economic events of the future—things that will move the needle the most—are things that history gives us little to no guide about. They will be unprecedented events.
  • 2. 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.
  • What this means, in effect, is that all historical data going back just a few decades about how startups are financed is out of date. What we know about investment cycles and startup failure rates is not a deep base of history to learn from, because the way companies are funded today is such a new historical paradigm.
  • The S&P 500 did not include financial stocks until 1976; today, financials make up 16% of the index. Technology stocks were virtually nonexistent 50 years ago. Today, they’re more than a fifth of the index. Accounting rules have changed over time.
  • The average time between recessions has grown from about two years in the late 1800s to five years in the early 20th century to eight years over the last half-century.
  • As I write this it looks like we’re going into recession—12 years since the last recession began in December 2007. That’s the longest gap between recessions since before the Civil War.
  • The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff.
  • But specific trends, specific trades, specific sectors, specific causal relationships about markets, and what people should do with their money are always an example of evolution in progress. Historians are not prophets.

13. Room for Error

  • The most important part of every plan is planning on your plan not going according to plan.
  • You have to give yourself room for error. You have to plan on your plan not going according to plan.
  • History is littered with good ideas taken too far, which are indistinguishable from bad ideas. The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—“unknowns”—are an ever-present part of life. The only way to deal with them is by increasing the gap between what you think will happen and what can happen while still leaving you capable of fighting another day.
  • Benjamin Graham is known for his concept of margin of safety.
  • “the purpose of the margin of safety is to render the forecast unnecessary.”
  • Graham’s margin of safety is a simple suggestion that we don’t need to view the world in front of us as black or white, predictable or a crapshoot. The grey area—pursuing things where a range of potential outcomes are acceptable—is the smart way to proceed.
  • Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor.
  • So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong.
  • Having a gap between what you can technically endure versus what’s emotionally possible is an overlooked version of room for error.
  • Use room for error when estimating your future returns.
  • “The best way to achieve felicity is to aim low,” says Charlie Munger.
  • The idea is that you have to take risk to get ahead, but no risk that can wipe you out is ever worth taking.
  • But if something has 95% odds of being right, the 5% odds of being wrong means you will almost certainly experience the downside at some point in your life. And if the cost of the downside is ruin, the upside the other 95% of the time likely isn’t worth the risk, no matter how appealing it looks.
  • The ability to do what you want, when you want, for as long as you want, has an infinite ROI.
  • You can plan for every risk except the things that are too crazy to cross your mind. And those crazy things can do the most harm, because they happen more often than you think and you have no plan for how to deal with them.
  • A good rule of thumb for a lot of things in life is that everything that can break will eventually break.
  • if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe. That’s a single point of failure.
  • Most critical systems on airplanes have backups, and the backups often have backups.
  • Suspension bridges can similarly lose many of their cables without falling.
  • The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.

14. You’ll Change

  • An underpinning of psychology is that people are poor forecasters of their future selves.
  • The End of History Illusion is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.
  • Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily.
  • We should avoid the extreme ends of financial planning.
  • 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.
  • We should also come to accept the reality of changing our minds.
  • Sunk costs—anchoring decisions to past efforts that can’t be refunded—are a devil in a world where people change over time. They make our future selves prisoners to our past, different, selves. It’s the equivalent of a stranger making major life decisions for you.

15. Nothing’s Free

  • Every job looks easy when you’re not the one doing it because the challenges faced by someone in the arena are often invisible to those in the crowd.
  • Most things are harder in practice than they are in theory. Sometimes this is because we’re overconfident. More often it’s because we’re not good at identifying what the price of success is, which prevents us from being able to pay it.
  • Same with investing, where volatility is almost always a fee, not a fine.
  • The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.

16. You & Me

  • Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.
  • flipping the home
  • Note: Explore meaning of this
  • number of houses in America that sold more than once in a 12-month period—they were flipped
  • The formation of bubbles isn’t so much about people irrationally participating in long-term investing. They’re about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself.
  • What do you expect people to do when momentum creates a big short-term return potential? Sit and watch patiently? Never. That’s not how the world works. Profits will always be chased.
  • Sixty dollars a share was a reasonable price for the traders, because they planned on selling the stock before the end of the day, when its price would probably be higher. But sixty dollars was a disaster in the making for you, because you planned on holding shares for the long run.
  • Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them. But when you don’t know why someone behaves like they do you won’t know how long they’ll continue acting that way, what will make them change their mind, or whether they’ll ever learn their lesson.
  • It’s hard to grasp that other investors have different goals than we do, because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own.
  • So much consumer spending, particularly in developed countries, is socially driven: subtly influenced by people you admire, and done because you subtly want people to admire you.
  • A young lawyer aiming to be a partner at a prestigious law firm might need to maintain an appearance that I, a writer who can work in sweatpants, have no need for. But when his purchases set my own expectations, I’m wandering down a path of potential disappointment because I’m spending the money without the career boost he’s getting.

17. The Seduction of Pessimism

  • Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.
  • Pessimism isn’t just more common than optimism. It also sounds smarter. It’s intellectually captivating, and it’s paid more attention than optimism, which is often viewed as being oblivious to risk.
  • Real optimists don’t believe that everything will be great. That’s complacency.
  • Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.
  • Pessimism just sounds smarter and more plausible than optimism.
  • Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention.
  • The intellectual allure of pessimism has been known for ages. John Stuart Mill wrote in the 1840s: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.”
  • Part of it is instinctual and unavoidable. Kahneman says the asymmetric aversion to loss is an evolutionary shield. He writes: 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.
  • And while few question or try to explain why the market went up—isn’t it supposed to go up?—there is almost always an attempt to explain why it went down.
  • 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.
  • 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.
  • A third is that progress happens too slowly to notice, but setbacks happen too quickly to ignore.
  • There are lots of overnight tragedies. There are rarely overnight miracles.
  • If you had to make a list of the most important inventions of the 20th century, the airplane would be at least top five, if not number one. The airplane changed everything. It started world wars, it ended world wars. It connected the world, bridging gaps between cities and rural communities; oceans and countries.
  • The Washington Post wrote in 1909: “There will never be such a thing as commercial aerial freighters. Freight will continue to drag its slow weight across the patient earth.” The first cargo plane took off five months later.
  • 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.
  • It’s easier to create a narrative around pessimism because the story pieces tend to be fresher and more recent. Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together.
  • And in careers, where reputations take a lifetime to build and a single email to destroy.
  • In investing you must identify the price of success— volatility and loss amid the long backdrop of growth—and be willing to pay it.
  • Expecting things to be great means a best-case scenario that feels flat. Pessimism reduces expectations, narrowing the gap between possible outcomes and outcomes you feel great about. Maybe that’s why it’s so seductive. Expecting things to be bad is the best way to be pleasantly surprised when they’re not. Which, ironically, is something to be optimistic about.

18. When You’ll Believe Anything

  • In 2007, we told a story about the stability of housing prices, the prudence of bankers, and the ability of financial markets to accurately price risk. In 2009 we stopped believing that story.
  • At the personal level, there are two things to keep in mind about a story-driven world when managing your money.
  • 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.
  • Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
  • Daniel Kahneman once told me about the stories people tell themselves to make sense of the past. He said: Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense. That’s a big deal in producing mistakes in many fields.
  • Part of the reason forecasting the stock market and the economy is so hard is because you are the only person in the world who thinks the world operates the way you do. When you make decisions for reasons that I can’t even comprehend, I might follow you blindly into a decision that’s right for you and disastrous to me.
  • Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is out of your control. And that can be hard to accept.
  • Carl Richards writes: “Risk is what’s left over when you think you’ve thought of everything.”
  • Psychologist Philip Tetlock once wrote: “We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”
  • Wanting to believe we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated and solved. The illusion of control is more persuasive than the reality of uncertainty. So we cling to stories about outcomes being in our control.
  • Business, economics, and investing, are fields of uncertainty, overwhelmingly driven by decisions that can’t easily be explained with clean formulas,
  • We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.

19. All Together Now

  • In the last 50 years medical schools subtly shifted teaching away from treating disease and toward treating patients. That meant laying out the options of treatment plans, and then letting the patient decide the best path forward.
  • Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong. Because it’s never as good or as bad as it looks. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control. You’ll also have a better chance of finding the right role models.
  • Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today.
  • Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “…
  • If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and…
  • Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune, because a small minority of things account for the majority of outcomes. No matter what you’re doing with your money you should be comfortable with a lot of stuff not working. That’s just how the world is. So you should always measure how you’ve done by looking at your full portfolio, rather than individual investments. It is fine to have a large chunk of poor investments and a few outstanding ones. That’s usually the best-case scenario. Judging how you’ve…
  • Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you…
  • Be nicer and less flashy. No one is impressed with your possessions as much as you are. You might think you want a fancy car or a nice watch. But what you probably want is respect and admiration. And you’re more likely to gain those…
  • Save. Just save. You don’t need a specific reason to save. It’s great to save for a car, or a downpayment, or a medical emergency. But saving for things that are impossible to predict or define is one of the best reasons to save. Everyone’s life is a continuous chain of surprises. Savings that aren’t earmarked for anything in particular is a hedge…
  • Define the cost of success and be ready to pay it. Because nothing worthwhile is free. And remember that most financial costs don’t have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to…
  • Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge,…
  • Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the…
  • You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future…
  • Define the game you’re playing, and make sure your actions are not being influenced by people…
  • Respect the mess. Smart, informed, and reasonable people can disagree in finance, because people have vastly different goals and desires. There is no single right…

20 Confessions

  • How my family thinks about savings
  • Charlie Munger once said “I did not intend to get rich. I just wanted to get independent.”
  • Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.
  • Independence, at any income level, is driven by your savings rate. And past a certain level of income your savings rate is driven by your ability to keep your lifestyle expectations from running away.
  • How my family thinks about investing
  • Here’s how the modern consumer got here.
  • August, 1945. World War II ends.
  • Three forces had built up during the war:
    - Housing construction ground to a halt, as virtually all production capacity was shifted to building war supplies. Fewer than 12,000 homes per month were built in 1943, equivalent to less than one new home per American city. Returning soldiers faced a severe housing shortage.
    - The specific jobs created during the war—building ships, tanks, and planes—were very suddenly not necessary after it, stopping with a speed and magnitude rarely seen in private business. It was unclear where soldiers could work.
    - The marriage rate spiked during and immediately after the war. Soldiers didn’t want to return to their mother’s basement. They wanted to start a family, in their own home, with a good job, right away.
  • Low interest rates and the intentional birth of the American consumer.
  • The explicit reason for keeping rates down was to keep the cost of financing the equivalent of the $6 trillion we spent on the war low.
  • Pent-up demand for stuff fed by a credit boom and a hidden 1930s productivity boom led to an economic boom.
  • The 1930s were the hardest economic decade in American history. But there was a silver lining that took two decades to notice: By necessity, the Great Depression had supercharged resourcefulness, productivity, and innovation.
  • Gains are shared more equally than ever before.
  • The defining characteristic of economics in the 1950s is that the country got rich by making the poor less poor.
  • Debt rose tremendously. But so did incomes, so the impact wasn’t a big deal.
  • Things start cracking.
  • The boom resumes, but it’s different than before.
  • The big stretch.
  • Once a paradigm is in place it is very hard to turn it around.
  • The economy works better for some people than others.
  • The Tea Party, Occupy Wall Street, Brexit, and Donald Trump each represents a group shouting, “Stop the ride, I want off.”
Benedict Evans says, “The more the Internet exposes people to new points of view, the angrier people get that different views exist.”

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