The Psychology of Money by Morgan Housel covers personal finance from the perspective of a middle aged American value investor. It offers some interesting insights into long-term investing mindsets and the psychology of why we make investment decisions.
- Evolution of Personal Finance
- Financial Planning
- Reasonable Frugality
- Financial Bubbles
- Psychology Of Money Conclusion
Evolution of Personal Finance
Western economies have seen a transition in the way we work from manual labour to more thought-based work, such as marketing and services. This shift is largely due to the changing needs of the economy, as well as the increasing availability of technology and automation.
In the past, most jobs were focused on manual production, such as manufacturing and farming. At the end of the day a worker would clock out and there was little they could do to take their work home. As technology and automation began to take over these roles, new jobs began to emerge, such as those in marketing and services. These thought based jobs mean that we are much more likely to continue thinking about our work beyond the bounds of our work environment and work times. A digital marketing manager for example might be thinking about his next campaign after he comes home and is spending time with his family.
Personal finance has shifted too and the lessons and mathematical formulas from early value investors such as Graham and Dodd are no longer relevant in todays markets.
People from different backgrounds will have different outlooks to their financial planning and different appetites for risk based on their previous experiences. For example, an individual who has previously experienced a financial crisis may be more cautious when it comes to investing and taking risks. On the other hand, someone with a more optimistic outlook may take more risks in order to generate higher returns.
The book discusses how investment and trading decisions by 3rd parties may not be understood but to the individual it makes sense. No market participant is crazy and the decisions they make are logical to them given the information available at the time.
Financial Planning
Something I’ve been guilty of in the past is adjusting goals as I’ve reached previous milestones. Moving financial goal posts causes an endless struggle because when you set a financial goal, you work hard to achieve it, but as soon as you reach it, you reset the goal to a higher one. This means that you never really achieve what you set out to achieve, and instead are always striving to reach the next level.
When making any kind of financial plan the most important thing is to stick to the plan, especially in the lean years. Take a financial plan to buy a little bit of Bitcoin every month, the most important time to throughout this strategy is during the crashes when your funds go much further and allocate capital more efficiently. These are also the times where it’s easiest to question your strategy and to give up on it. I started purchasing cryptocurrency in 2017 and my entire portfolio was down after the crash in 2018. This was the opportunity of a lifetime but it didn’t feel like it at the time.
Plan on the plan not going to plan
Stock markets, crypto, real estate and just about every other investment follows market cycles and this brings challenges and opportunities. Having a solid plan and sticking to it is key to reaching financial goals.
Warren Buffett is successful not only because of his method but because he has stuck to it since 1941. The compounding effect of staying the course and executing well on a financial plan can create great wealth over the long-term.
Reasonable Frugality
The author is an advocate for saving and frugality which I think is a good lesson in todays climate of debt and degenerate investing. He talks about the paradox of fast cars in that no one cares who is driving.
There is a differentiation between reasonable and rational financial decisions. On paper investing in your younger years with 2:1 leverage always works out better even if you get wiped out in your 20’s and lose everything on a 50% market drop. For most people though this type of financial plan and volatility isn’t reasonable. While it might make sense on paper it doesn’t make sense on a psychological level which makes it very hard to stick to over multiple decades of ups and downs.
Our approach to financial planning must work for us and it is worth losing some upside for a more psychologically reasonable strategy.
Financial Bubbles
Financial bubbles form when investors become overly optimistic about a particular asset or investment, bidding its price up to unsustainable levels. The phenomenon has been seen over and over in markets ranging from stocks to housing to crypto. While the causes of bubbles vary, one of the most common is momentum trading: when short-term traders become more influential than long-term investors.
Momentum trading is when investors buy assets that are rising in value with the idea that recent performance is a reliable indicator of its future potential. Momentum investors are generally not concerned with the underlying fundamentals of the security, such as the company’s balance sheet or its competitive position in the market.
When momentum investing becomes widespread, it can lead to a bubble. Short-term traders become more influential than long-term investors in driving prices higher, as they are more likely to buy into an asset that has recently been performing well. This buying pressure can drive prices to unsustainable levels, creating a bubble.
Financial bubbles are a consistent result of different investors, having different financial goals and carrying out different market behaviours. When the bubble bursts, the prices of the asset often fall sharply. Long term investors who were counting on the security to continue to rise suffer heavy losses. Their timeframe was not aligned with those of the short-term traders who were influencing the markets.
Psychology Of Money Conclusion
The author advocates that the end goal of financial planning and investing is to free up time and buy independence to do what you want to do.
By creating a financial plan and investing wisely, you can increase your wealth and have more control over your life. You can use your newfound wealth and freedom to pursue hobbies, travel, and build meaningful relationships.
Morgan Housel ends The Psychology of Money with his own personal investment strategy which is to dollar cost average into index funds over long time frames and live well within his means. He doesn’t have a mortgage despite understanding it would likely be financially beneficial to use that low cost leverage because there is value in psychology of being debt free. He strives to optimise his and his families finances around what is reasonable for him even if on paper it might not be fully rational.
