What I Learned From "The Psychology of Money"
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What I Learned From "The Psychology of Money"
Like the rest of the personal finance world, I finally took the plunge and purchase Morgan Housel's stream of consciousness. I, like many, have been a long time Housel fan due to his early work at The Motely Fool, and I always found his writing style to be Ted Lasso-esque: curious, but not judgemental.
When I dove into the book several months ago, I knew that this was the book for me. It took high-minded concepts and broke them down into bite-sized chunks, as well as taking some concepts I hadn't considered and fleshed them out into something I actually wanted to start considering.
It is, however, quite long for the way it's written. So, with that, here are my top five takeaways from The Psychology of Money:
Wealth is What You Don't See
To understand this concept, we must first delineate the distinction between wealth and income. Income is what you bring in – it's your paycheck. Wealth, on the other hand, is the sum of your assets, minus your liabilities – essentially, what you own. However, the key lesson in Housel's book is that real wealth is about the money you've saved and invested, not the money you spend. It's a measure of your financial resilience, your security, not your image.
Think of wealth as an iceberg. What you see above the water – the flashy cars, the designer clothes, the extravagant vacations – are merely the visible tip. The true measure of wealth lies beneath the surface – in the frugality, the years of steady saving and investing, the sound financial decisions that are often not seen, or even appreciated by others. The stealth-wealth lifestyle isn't glamorous, but it provides stability, peace of mind, and yes, even freedom.
The Roles of Luck and Risk
Understanding the roles of luck and risk in financial success is key to maintaining a balanced perspective on wealth. There's a danger in attributing success solely to one's hard work, talent, or intelligence. This narrative can fuel an overly optimistic outlook, leading individuals to take unnecessary risks, assuming that their skills alone will lead to success.
Conversely, acknowledging the role of luck allows for humility in success, and empathy in the face of others' failures. A downturn in the market, a global pandemic, a sudden illness – these are risks that can impact even the most skilled and hardworking individuals. In acknowledging this, we not only adjust our expectations but also make more informed decisions, such as diversifying investments or setting up emergency funds.
Reasonable > Rational
At first glance, it might seem odd to suggest that being perfectly rational is not always the best strategy when it comes to personal finance. After all, aren't numbers and data supposed to be devoid of emotions?
The problem arises when we fail to consider that we are not purely rational beings. We are also driven by our emotions, our experiences, our biases. Trying to force a purely rational approach can lead to decisions that might look good on paper but leave us unhappy or stressed.
Consider the decision to buy a home. A purely rational approach might suggest renting is better in some high-cost areas, but that fails to take into account the emotional satisfaction and sense of security many people derive from homeownership. The key is to strike a balance – to make financial decisions that are reasonable, taking into account not only the hard numbers but also our emotional well-being.
Compounding Interest Is Your Best Friend
Albert Einstein reportedly called compounding the "eighth wonder of the world." It's a simple concept: the earnings from an investment are reinvested, and over time, they begin to earn returns of their own. It's not just your money that's working for you, but the returns on that money as well.
But for compounding to work its magic, two ingredients are needed: time and patience. Time allows the compounding process to unfold, and patience keeps you from interrupting the process. This could mean resisting the temptation to pull out your investment at the first sign of a market downturn, or not getting discouraged when progress seems slow at first.
Compounding, in its slow and steady nature, is a powerful testament to the merits of long-term investing. It’s not about timing the market or landing the next big thing, it's about time IN the market, consistently and patiently letting your money grow.
Flexibility Is More Important Than Precision
This is one I truly wish I understood about 10 years ago. Housel underscores the importance of flexibility over precision. Many people approach financial planning as a mathematical exercise, seeking to predict future returns with surgical precision. But life, much like the market, is unpredictable.
This is not to say that planning is futile. On the contrary, planning is essential. But a good financial plan is one that's built to adapt – to the ups and downs of the market, to life's curveballs, to the evolving goals and needs of the individual. This might mean maintaining a healthy emergency fund, diversifying your investments, or reviewing and adjusting your financial plan annually.
In summary, Housel’s “The Psychology of Money” offers profound insights into how we think about, handle, and grow wealth. It's not just about making money, but also about understanding the psychological traps, misconceptions, and behaviors that can lead us astray. By applying these lessons, we can make better financial decisions, and ultimately, enjoy a healthier relationship with money.