Today’s post is our first visit to a recent book – The Psychology of Money by Morgan Housel.
The psychology of money
Morgan Housel is a partner at the Collaborative Fund and a former columnist for The Motley Fool and The Wall Street Journal.
The book consists of 20 chapters, each covering a counterintuitive feature of the psychology of money.
Morgan begins the book with the story of a rich jerk who stayed at the hotel where Morgan worked as a valet during college.
- The money guy ended up losing.
The premise of this book is that managing money well has little to do with how smart you are and a lot to do with how you behave. And behavior is difficult to teach even really smart people.
A genius who loses control of his emotions can be a financial disaster. Ordinary people with no financial education can be rich if they have some behavioral skills.
The following story is about Ronald James Reed, a janitor and gas station attendant who died worth more than $8 million because of his blue chips in the stock market.
- In contrast, Merrill Lynch CEO Richard Fuscone spent all his money, borrowing excessively to expand his large house and throw lavish parties.
Morgan’s conclusion about finance is:
In what other industry does someone with no college degree, no training, no prior experience, no formal experience, and no connections vastly outperform someone with the best education, the best training, and the best connections?
Why is this?
Financial success is not a hard science. It’s a soft skill where how you behave is more important than what you know. I call this soft skill the psychology of money.
What is the book about.
Morgan plans to convince us with anecdotes, my least favorite form of book content.
- He’s not against math, but he thinks the problem with finance is that people don’t want/don’t do what they need to.
That’s true, but I doubt reading a lot of stories will change that.
Morgan believes that all the brainpower devoted to finance in recent decades has not made us better investors.
This is the golden age of do-it-yourself investing, with cheap and easy access to a wide range of products and tons of free information online.
- In the UK at least, the tax regime is rarely more favourable.
As for the widespread implementation of best practices, he is right.
- But the main reason here is easy credit and the desire of social networks to live in the present, instead of saving and planning for the future.
Finances are not to blame, and understanding the psychology of our most common flaws is unlikely to fix them for most people.
- Greed and fear will get you nowhere.
Nobody is crazy
People of different generations, raised by different parents, with different incomes and different values, in different parts of the world, born in different economies, experience different labor markets with different incentives and different degrees of luck, learn very different lessons.
It does, but I’m not sure it helps.
- There are objectively good and bad ways to invest, and people who were taught the wrong lessons as children should unlearn them – and replant with good lessons.
Morgan uses the example of a life of depression.
- Most of these people have been afraid to get out of the stock market their whole lives – but that’s not a good thing.
Ulrike Malmendier and Stefan Nagel of the National Bureau of Economic Research found that people’s investment decisions over the course of their lives are largely linked to the experiences those investors had early in their adult lives.
Inflation puts you out of bonds, and a stock market boom makes you fall for stocks.
Here is a chart of stock market experiences for those born in the 1950s and 1970s:
And here is the inflation for people born in the 1960s and 1990s:
Unemployment is a similar story.
Morgan points out that conditions in China’s sweatshops don’t seem that bad for the workers there, and notes that the poorest people buy most of the lottery tickets.
He also notes that the concept of retirement – and the need to save for it – is relatively new (people worked until they gave up).
- The same goes for extensive college attendance (and the accompanying debt).
I didn’t like this first chapter – Morgan’s description of how and why people make bad financial decisions rings true, but I don’t know what to make of it.
- Should readers accept their fate instead of educating and training themselves to be better?
I think a better title might be “we’re all crazy for different reasons, but we still have to fix it”.
Luck and risk
Chapter 2 is about luck.
Morgan begins with the story of how Bill Gates and Paul Allen were lucky enough to get access to a computer in high school.
- The odds were 1 million to 1 against.
Bill’s best friend at school was Kent Evans, not Paul Allen.
- But Kent died in a mountain climbing accident before he graduated, and Bill co-founded Microsoft with Paul Allen.
The odds of dying on the mountain in high school are also about 1 million to 1.
For every Bill Gates, there’s a Kent Evans who was just as skilled and focused, but ended up on the other side of life’s roulette wheel.
It’s a good story, but:
- Kent was killed on Mt.
- At my school we didn’t do mountain climbing – some risks can be avoided.
- Just because Kent and Bill were close in high school doesn’t mean they wouldn’t be the same 50 years later.
Of course, luck plays a role in everyone’s life, but the longer one lives, the less that role (for most people, away from extreme outcomes).
Bad decisions can lead to good results, and vice versa.
- But most often the opposite happens.
If you stick to a plan and trust your process, you can reduce the role of luck.
Morgan tells stories about Vanderbilt and Rockefeller (both of whom despised “antiquated” laws) and Ben Graham, whose investment success owes much to an outsized, rule-breaking position at GEICO. He said:
One lucky coincidence or one very insightful decision – can we tell the difference?
Another example is Zuckerberg. He was praised for rejecting Yahoo’s buyout offer, but Yahoo itself is now being criticized for rejecting Microsoft.
- One solution worked, and the other did not.
bill gates said
Success is a bad teacher. It tempts smart people to think they can’t lose.
Be careful who you praise and admire. Be careful who you look down on and don’t want to become.
He warns us not to focus on individuals, but on general patterns.
- Which brings me back to my dislike of jokes.
There is never enough
According to Morgan, Joseph Heller had enough money and Rajat Gupta (who is he?) didn’t.
- Gupta wanted to become a billionaire, turned to insider trading and ended up in prison.
A better version of the same story might involve Michael Milken or Bernie Madoff (whom Morgan does mention next).
The question we have to ask both Gupta and Madoff is why someone worth hundreds of millions of dollars was so desperate to get more money that he risked everything to get even more.
It’s a good question, but short of hundreds of millions and opportunity, I don’t feel qualified to answer.
- And since I’m unlikely to find myself in that situation, I wouldn’t get too much out of an answer if it were available.
I know my number and I quit when I dial it.
- Morgan says the hardest financial skill is to stop the goalpost from moving, but I don’t see that being the case.
- You just need to stop caring what the Joneses think.
Morgan also mentions the LTCM drop, but it’s a little different.
- These guys got their math wrong and took too much risk.
- They were not criminals.
Morgan’s first example composition these are the ice ages and the solar cycle.
It begins when the summer never gets warm enough to melt the previous winter’s snow. The remaining ice base facilitates snow accumulation the following winter, which increases the likelihood of snow accumulation the following summer, which attracts even more accumulation the following winter.
Permafrost reflects more sunlight, which increases cooling, which brings more snowfall, and so on.
And the same thing happens in reverse:
The inclination of the orbit, which lets in more sunlight, melts more winter snowpack, which reflects less light in subsequent years, which raises the temperature, which prevents more snow the following year, and so on.
The main takeaway is that you don’t need a huge amount of strength to get great results.
Buffett is another example:
As I write this, Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. The $81.5 billion came after he became eligible for Social Security, in his mid-60s.
Longevity is the key to his great success.
If he started investing in his 30s and retired in his 60s, few people would have heard of him. His skill is investing, but his secret is timing.
Morgan points out that Jim Simons has a higher one composition speed (three times better, in fact), but didn’t hit his stride until he was in his 50s.
But as Morgan points out:
Not one of the 2,000 books covering Buffett’s success is titled “This Guy Invested Consistently For Three Quarters of a Century.”
A good investment is not necessarily about getting the highest returns, because the highest returns are one-time hits that cannot be repeated. It’s about getting pretty good returns that you can stick with and repeat over the longest period of time.
Amen to that, and to avoid serious losses.
That’s all for today.
- We’re about 20% into the book, so there will be four more articles in this series.
I am disappointed by the anecdotal style of the book and I have no results as of today.
- But for the casual reader who is new to the psychological aspects of finance, I imagine it will be very interesting.
Until next time.