Book review: The Psychology of Money

Two topics impact everyone, whether you are interested in them or not: health and money.

The Psychology of Money

I found my first salaried job in 2006 through my friend, who was interning at the startup. He was excited about something called a Roth IRA. Research led me to an introduction to compound interest, which led to the finite and boring world of personal finance.

Personal finance is very old and well understood. Everyone repeats the same advice, or gives advice from personal experience as if it were universal. Best practices can be boiled down to a notecard or flowchart.

The tactics of personal finance are very simple, yet very few people put them into practice. In The Psychology of Money, Morgan Housel mostly ignores the tactical aspects of personal finance. Instead, he dives into the “soft skills” that most people lack as a prerequisite for succeeding at the tactics.

The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is hard to teach, even to really smart people. […] The aim of this book is to use short stories to convince you that soft skills are more important than the technical side of money. I’ll do this in a way that will help everyone […] make better financial decisions.

I recommend ignoring all other personal finance material and read/re-read this book. If you do not read books, you can read a large sample from his blog post1. Having a firm grasp of these concepts will serve you better than any personal finance content on the internet.

Each chapter’s relevance will depend on the individual. Here are the chapters and subtitles in order of importance or impact to me.

  1. You & Me: Beware taking financial cues from people playing a different game than you are.
  2. Nothing’s Free: Everything has a price, but not all prices appear on labels.
  3. 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.
  4. Luck & Risk: Nothing is as good or bad as it seems.
  5. Freedom: Controlling your time is the highest dividend money pays.
  6. Surprise!: History is the study of change, ironically used as a map of the future.
  7. You’ll Change: Long-term planning is harder than it seems because people’s goals and desires change over time.
  8. Confounding Compounding: $81.5 billion of Warren Buffet’s $84.5 billion net worth came after his 65th birthday. Our minds are not built to handle such absurdities.
  9. Room for Error: The most important part of every plan is planning on your plan not going according to plan.
  10. Reasonable > Rational: Aiming to be mostly reasonable works better than trying to be coldly rational.
  11. Getting Wealthy vs. Staying Wealthy: Good investing is not necessarily about making good decisions. It’s about consistently not screwing up.
  12. Tails, You Win: You can be wrong half the time and still make a fortune.
  13. Never Enough: When rich people do crazy things.
  14. Save Money: The only factor you can control generates one of the only things that matters. How wonderful.
  15. Man in the Car Paradox: No one is impressed with your possessions as much as you are.
  16. 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.
  17. When You’ll Believe Anything: Appealing fictions, and why stories are more powerful than statistics.
  18. The Seduction of Pessimism: Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you.

The last two chapters (19 & 20) are different in that one is a summary of the book and how it all works together and the other is on Housel’s own finances. The postscript, a short history of how the American psychology of money came to be, was more interesting to me as it went into how Americans became comfortable with debt and what drove our economy and aspirations over time.

All the chapters are good, but I’ll give an overview of my personal top three.

You & Me

The main thing I can recommend is going out of your way to identify what game you’re playing. It’s surprising how few of us do. We call everyone investing money “investors” like they’re basketball players, all playing the same game with the same rules. When you realize how wrong that notion is you see how vital it is to simply identify what game you’re playing.

You can broadly apply this advice to almost every aspect of life. Consequently, it’s also the unifying theme of the book: play your game, not theirs. Figure out your risk tolerance, goals, and values, don’t base it on other’s. Moreover, you likely can’t tell who is “winning” or “losing” based on your rules, so be careful who you listen to, admire, or dismiss.

My favorite example was how the creator of the Modern Portfolio theory doesn’t follow the results of his Nobel Prize⁠–winning research. He knows the theoretical best approach to balancing his portfolio would include a specific mix of asset classes (small business, emerging markets, etc.), but he also knows himself.

I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down and I was completely in it. My intention was to minimize my future regret. So I split my contributions 50/50 between bonds and equities.

Harry Markowitz

But then, Housel writes about flip side of the same coin in No One’s Crazy.

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.

Knowing yourself is important to figure out your goals and how to get there, but it doesn’t work well when you try to apply what you “know” about the world to… the world. Your experience with the economy depends on when you were born or started working and investing.

This resonated with me. I started investing all the money I could spare starting in 2006. In 2008, my net worth dropped 50% and the stock market took 6 years to get back to 2006 levels. In 2020, when the market dipped sharply due to a once-in-a-lifetime pandemic, I thought the market would take a while to recover, but it took less than a year.

John Templeton famously said, “The four most dangerous words in investing are: ‘It’s different this time.”

Michael Batnick says, “The 12 most dangerous words in investing are, ‘The four most dangerous words in investing are: it’s different this time.’”

Both are right.

The Psychology of Money (Blog post)

In short, look inward to figure out your goals, risk tolerances, and path. Don’t look inward to figure out what the rest of the world should or will do.

Nothing is free

Alpha doesn’t exist. Ok, he never actually says alpha does not exist, but that was my takeaway. Alpha is above average gains. Buying an index fund that tracks the market as a whole is the average, the only bet you are making is that the entire economy will grow over time (yay capitalism). In return for money, time, and volatility, you will usually get more money.

To beat the market, there is always a price. The price may be emotional or psychological, financial or temporal. If you beat the market, you must have paid the price. If you paid the price, did you really beat the market2?

Every money reward has a price beyond the financial fee you can see and count. Accepting that is critical. Scott Adams once wrote: “One of the best pieces of advice I’ve ever heard goes something like this: If you want success, figure out the price, then pay it. It sounds trivial and obvious, but if you unpack the idea it has extraordinary power.”

The Psychology of Money (Blog post)

Like many, Warren Buffet spent countless hours working. He traded time and health of his relationships for money. Whether or not he regrets it depends on what he values (see You & Me).

Read it

All the chapters are worth reading. Even if you already understand the concepts, the writing is well done and stories are interesting. This is the only personal finance book I found to be useful, fun to read, and mercifully short. I highly recommend it.

  1. The book is still worth reading, it is significantly better than the blog post.

  2. That is, adjusting for the price: risk, time, work, and money. Granted, the lucky do get more than what they pay for, but that's another chapter.