The Psychology of Money

My review of The Psychology of Money by Morgan Housel. Gems of wisdom from someone part-way along his path to financial freedom for people just starting out.

A financial journalist turned investor and writer, Morgan Housel has a wise head on young shoulders. In The Psychology of Money he collects together 20 ‘timeless lessons on wealth, greed and happiness.’ He’s learned by his mid-thirties what it takes many people several decades more to learn, if they ever do.

The book is a collection of independent essays, articles and blogs written by Housel over the years. It can be read in order, out of order, dipped into and out of. As such, it’s a great candidate for ‘bathroom reading’, although the insights go much deeper than that term suggests.

It’s such an eclectic mix that it’s tough to summarise. Broadly, there are four main themes:

  • Happiness requires you to put money in its proper perspective: as a vehicle for greater freedom.
  • Keep your financial life simple: save plenty and then let compound interest be your friend over the long term in simple, cheap funds.
  • Expect the unexpected: set up your finances to deal with potentially unpredictable changes to you, your circumstances and the world.
  • Take account of your psychology: an investment approach you can stick to and that lets you sleep at night is better than an ‘optimal’ strategy that you can’t and doesn’t.

I’ll illustrate using three of the lessons that are perhaps most important for professionals at the inflexion point of career success.

Never enough

When rich people do crazy things.

Housel is (as am I) a big fan of the concept of ‘enough’ when it comes to money. He warms the reader up with cautionary tales about how Rajat Gupta and Bernie Madoff snatched defeat from the jaws of victory, driven by greed. Paraphrasing Warren Buffett, Housel cautions: there is no reason to risk what you have and need for what you don’t have and don’t need. But the problem is we lose perspective on what we need.

Housel identifies the hardest financial skill as getting the goalposts to stop moving. Too often we’re driven by social comparison into ever higher levels of spending. If you’re a successful professional you’ll hang out with other successful professionals at work and it will seem only natural to eat out regularly at the smartest restaurants. If you send your kids to a private school, your own friends will become people who will ski, holiday in the Carribean, take a villa in Tuscany and shop in New York — all in the same year. Your sense of what is normal and what is enough can become distorted.

If we allow ourselves to get sucked into financial social comparisons and one-upmanship we’re joining in a battle we can’t win — the only way to win is not to fight to begin with, to accept that you might have enough, even if it’s less than some of those around you.

And let’s not fool ourselves into thinking that enough is too little, that it’s somehow settling for mediocrity. There’s never enough learning, there’s never enough depth to your relationships, but with money there is a point where it’s enough. And those that don’t believe this, who get hooked into social comparisons, can get driven to deprioritise important dimensions of their lives, take too much investment risk, or in the case of the Guptas and Madoffs of this world, get driven to even worse.

Housel’s final point on the topic is that there are many things never worth risking, no matter the potential gain: your relationships, your humanity, your reputation. But getting hooked on the money treadmill of ‘never enough’ can cause previously sensible people to risk what’s in reality most valuable.

You’ll change

Long-term planning is harder than it seems because people’s goals and desires change over time.

A few of Housel’s lessons refer to the unpredictability of the world. Stuff happens that we don’t expect. And sometimes that is what happens inside ourselves.

Let’s say you’ve just made partner in a professional firm. You’re pumped. The career is humming, you’re loving the challenge, the sense of having influence. And, yes admit it, the status is invigorating. You can’t imagine wanting to do this for anything less than 20 years. So why not leverage up on a massive mortgage for an amazing house? Why not relax the purse strings and enjoy the full fruits of your hard work now?

You may always feel this way about your career. But you may not. And at some point, your career may not feel the same way about you. So options are important. That big house and high spending lifestyle may not feel so great if can’t stand it anymore in a decade’s time and you’re wanting to change your life in the middle of a housing market crash.

The reality is that we are terrible at predicting what we’ll want next week, let alone in a decade’s time. We also don’t know what the world will throw at us. So creating options, having a margin for error are important. Any financial plan that’s based on a linear extrapolation of today’s circumstances into the future is likely to be based on a massive risk that you’re not fully aware of.

Of course, enjoy your success. No need to live like a monk. But you’d be wise to plan for the possibility that the person you are tomorrow is quite different from who you are today. By the same token, living on beans today so you can be financially free tomorrow is equally no recipe for success in life. Postponing happiness into a future utopia is not the way to go. So, in general, financial planning needs to avoid the extremes.

Reasonable > rational

Aiming to be mostly reasonable works better than trying to be coldly rational.

The financial world is full of ‘optimal’ strategies that make no sense in the real world. Yes, leveraging yourself up to invest in the stock market delivers better outcomes on average. But it requires you to be prepared to withstand being wiped out on several occasions along the way. Few people can live with the consequences of that strategy.

Once you’ve got the mindset of ‘enough’ you’ll recognise that you can do well enough by investing in a low-cost and broadly diversified way across markets for the long term. So do what it takes to stick that course, even if it means doing something that’s a bit suboptimal.

So if you need to hold a bit more in cash to make you feel comfortable about your equity investments, that’s fine. If the comfort you get from paying off your mortgage enables you to stress less, tilt a bit more towards that objective. If you feel more comfortable investing in companies you know, and understand, then by all means skew your investments a bit towards your home market. You need to be able to sleep at night and to stick the course so that while you’re asleep, the miracle of compounding is working on your behalf.

If Housel’s book has a single unifying message it’s this: do what it takes to get yourself in the frame of mind where money enables your freedom, rather than imprisoning you.

The Psychology of Money by Morgan Housel is a great read for successful professionals starting out on their journey to financial freedom.