The Psychology of Money by Morgan Housel
In this post, I will be discussing about investing and managing your finances that I hope is different from the standard you have been receiving. To illustrate, when you are researching about investing and financial management, I am sure most blogs, financial websites and financial consultants rattle off numbers, stats, market sentiment and market conditions. Recommendations are dispersed based on some advanced calculus to weigh all these factors to give you a customized suggestion.
If you go to CNBC and you see analysts spewing off stocks to buy and predicting the next Amazon. You have to think to yourself, is he applying these stocks for my particular investment style and risk tolerance? If so, is everyone’s style and tolerance the same for the analyst to give such blanket recommendation to the general audience?
Most likely not. All these blogs, website and “professional analysts” throw numbers, charts and acronyms which does have a place in making investment choices but it does not take in to account your investment style and your psychological tendencies when it comes to money. I think your psychology and your thought process is a big factor on how you should invest because everyone has a different view when it comes to money. For example, your appetite for risk, your social status and your subconscious tendencies can all influence how you invest and manage money. This is a factor all these financial website and blogs tend to miss and just try to give the next hot stock (most likely they own it and want to push their price up).
So, I want to dive deep in to this aspect. I recently read a book called The Psychology of Money by Morgan Housel. The book dives deep in to the human psyche and how it is developed from their surroundings and general conditions overall. This is key in how one views their relationships with money and is a big contributing factor in the way you handle your finances.
It lays out how people behave in certain ways and how risks are seen very differently by their upbringing, generational differences and social/economic factors. If there is mass tipping point, this can lead to exuberant or irrational markets. Tech bubble of 1999, housing bubble of 2008, current Bitcoin and Gamestop mania are probably good examples of this. If you take this to a global scale, you can never predict the market or outsmart the market. The book highlights what the general consensus is – that financial analysts and economists are just fancy job titles.
Some interesting points mentioned is how our financial goalpost keeps moving. We can not settle on enough and social comparison is one of the biggest fault (“keeping up with the Jones” or watching too much Bling Empire). Not knowing when enough is enough is comparable to not knowing when to walk away from a winning streak at a casino. This is very important and you need to gauge your risk appetite. Sometimes, it is just not worth it for the wrong reasons.
His discussion of history, outlier events and room for error in planning are relayed very well to support many of his hypothesis. His thoughts on End of History Illusion was an interesting point as well. Finally, his quick run through American history and its impact on people’s view of financial planning that resulted in drastic, different way of investing and planning, was a great way to end the book.
One very specific topic he focused on is loss aversion. This topic is something to highlight because we experience this all the time and can hamper in you making a sound decision and not investing in stocks. Basically, it means we feel the psychological and emotional impact of a loss more than that of a gain. The estimate is that we feel the impact of the pain twice as much as that of the gain.
To highlight this, let’s say you are gambling at a casino. You are in a losing streak and in a big hole (hopefully nothing on collateral). All of a sudden you are in a great winning streak and break even. What a sensation of relief.
Now picture another scenario where you are on a winning streak and breaking the house (may be a down payment on a Ferrari). Unfortunately, you go on a losing streak but still up.
Now which feels better, the fact that you were down a lot and broke even or you still ended up winning in the second scenario? This is oversimplification, but loss aversion is very much at work in a lot of people’s portfolios. We all know that savings, interest bearing accounts and even time deposits hardly give us any yield; and yet a lot of people just keep their hard earned money in these accounts. Because of the possibility of losing money in stock investment, only less than 1% of our population invests in this asset class.
If you are interested in human behavior and how the mind relates to money and wealth, I do urge to read this book. If you learn and understand human tendencies and how our brain is wired, then I think you can better understand yourself and be better prepared on how you approach anything you plan. Also if you are starting to invest, this book is also a good start. You need to be mentally ready to invest and not just be proficient in stats and acronyms.
If you have read the book, let me know what you think and leave a comment. Healthy debate and insights are always welcome.