21Sep04 | Book Highlights: The Psychology of Money

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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.
Ordinary folks with no financial education can be wealthy if they have a handful of behavioral skills that have nothing to do with formal measures of intelligence.
Ronald read was patient; richard fuscone was greedy. that’s all it took to eclipse the massive education and experience gap between the two.
Two topics impact everyone, whether you are interested in them or not: health and money.
The more I studied and wrote about the financial crisis, the more i realized that you could understand it better through the lenses of psychology and history, not finance.

Here’s the thing: people from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons.
Everyone has their own unique experience with how the world works. and what you’ve experienced is more compelling than what you learn second-hand. so all of us—you, me, everyone—go through life anchored to a set of views about how money works that vary wildly from person to person. what seems crazy to you might make sense to me.
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. so equally smart people can disagree about how and why recessions happen, how you should invest your money, what you should prioritize, how much risk you should take, and so on.
The challenge for us is that no amount of studying or openmindedness can genuinely recreate the power of fear and uncertainty.
Studying history makes you feel like you understand something. but until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior. we all think we know how the world works. but we’ve all only experienced a tiny sliver of it.
The economists found that people’s lifetime investment decisions are heavily anchored to the experiences those investors had in their own generation—especially experiences early in their adult life.
If you grew up when inflation was high, you invested less of your money in bonds later in life compared to those who grew up when inflation was low. if you happened to grow up when the stock market was strong, you invested more of your money in stocks later in life compared to those who grew up when stocks were weak.
The economists wrote: “our findings suggest that individual investors’ willingness to bear risk depends on personal history.” not intelligence, or education, or sophistication. just the dumb luck of when and where you were born.
Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works.
Those people can be misinformed. they can have incomplete information. they can be bad at math. they can be persuaded by rotten marketing. they can have no idea what they’re doing. they can misjudge the consequences of their actions. oh, can they ever.
Few people make financial decisions purely with a spreadsheet. they make them at the dinner table, or in a company meeting. places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.

The big takeaway from ice ages is that you don’t need tremendous force to create tremendous results. if something compounds—if a little growth serves as the fuel for future growth—a small starting base can lead to results so extraordinary they seem to defy logic. it can be so logicdefying that you underestimate what’s possible, where growth comes from, and what it can lead to. and so it is with money.
"His skill is investing, but his secret is time."
I have heard many people say the first time they saw a compound interest table—or one of those stories about how much more you’d have for retirement if you began saving in your 20s versus your 30s—changed their life. but it probably didn’t. what it likely did was surprise them, because the results intuitively didn’t seem right.
Linear thinking is so much more intuitive than exponential thinking. if i ask you to calculate 8+8+8+8+8+8+8+8+8 in your head, you can do it in a few seconds (it’s 72). if i ask you to calculate 8×8×8×8×8×8×8×8×8, your head will explode (it’s 134,217,728).
The counterintuitive nature of compounding leads even the smartest of us to overlook its power. in 2004 bill gates criticized the new gmail, wondering why anyone would need a gigabyte of storage. author steven levy wrote, “despite his currency with cutting-edge technologies, his mentality was anchored in the old paradigm of storage being a commodity that must be conserved.” you never get accustomed to how quickly things can grow.
The danger here is that when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. not because we’re overthinking, but because we rarely stop to consider compounding potential.
But good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. it’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. that’s when compounding runs wild.

Getting money is one thing. keeping it is another.
Capitalism is hard. but part of the reason this happens is because getting money and keeping money are two different skills. getting money requires taking risks, being optimistic, and putting yourself out there.
But keeping money requires the opposite of taking risk. it requires humility, and fear that what you’ve made can be taken away from you just as fast. it requires frugality and an acceptance that at least some of what you’ve made is attributable to luck, so past success can’t be relied upon to repeat indefinitely.
Moritz: there’s a lot of truth to that … we assume that tomorrow won’t be like yesterday. we can’t afford to rest on our laurels. we can’t be complacent. we can’t assume that yesterday’s success translates into tomorrow’s good fortune.
Nassim taleb put it this way: “having an ‘edge’ and surviving are two different things: the first requires the second. you need to avoid ruin. at all costs.”
Applying the survival mindset to the real world comes down to appreciating three things.
1. more than i want big returns, i want to be financially unbreakable. and if i’m unbreakable i actually think i’ll get the biggest returns, because i’ll be able to stick around long enough for compounding to work wonders.
2. planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
What’s the saying? you plan, god laughs. financial and investment planning are critical, because they let you know whether your current actions are within the realm of reasonable. but few plans of any kind survive their first encounter with the real world.
A plan is only useful if it can survive reality. and a future filled with unknowns is everyone’s reality.
Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right. room for error—often called margin of safety—is one of the most underappreciated forces in finance. it comes in many forms: a frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes.
It’s different from being conservative. conservative is avoiding a certain level of risk. margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.
3. a barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future —is vital.
Our standard of living increased 20-fold in these 170 years, but barely a day went by that lacked tangible reasons for pessimism. a mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. but you need short-term paranoia to keep you alive long enough to exploit long-term optimism.

That can be hard to deal with, even if you understand the math. it is not intuitive that an investor can be wrong half the time and still make a fortune. it means we underestimate how normal it is for a lot of things to fail. which causes us to overreact when they do.
Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event. and most of our attention goes to things that are huge, profitable, famous, or influential. when most of what we pay attention to is the result of a tail, it’s easy to underestimate how rare and powerful they are.
Most startups fail and the world is only kind enough to allow a few mega successes.
A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.
Part of why this isn’t intuitive is because in most fields we only see the finished product, not the losses incurred that led to the tailsuccess product.
When we pay special attention to a role model’s successes we overlook that their gains came from a small percent of their actions. that makes our own failures, losses, and setbacks feel like we’re doing something wrong. but it’s possible we are wrong, or just sort of right, just as often as the masters are. they may have been more right when they were right, but they could have been wrong just as often as you.

The highest form of wealth is the ability to wake up every morning and say, “i can do whatever i want today.”
People want to become wealthier to make them happier. happiness is a complicated subject because everyone’s different. but if there’s a common denominator in happiness— a universal fuel of joy—it’s that people want to control their lives. the ability to do what you want, when you want, with who you want, for as long as you want, is priceless. it is the highest dividend money pays.
More than your salary. more than the size of your house. more than the prestige of your job. control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.
Money’s greatest intrinsic value—and this can’t be overstated —is its ability to give you control over your time. to obtain, bit by bit, a level of independence and autonomy that comes from unspent assets that give you greater control over what you can do and when you can do it.
A small amount of wealth means the ability to take a few days off work when you’re sick without breaking the bank. gaining that ability is huge if you don’t have it. a bit more means waiting for a good job to come around after you get laid off, rather than having to take the first one you find. that can be life changing. six months’ emergency expenses means not being terrified of your boss, because you know you won’t be ruined if you have to take some time off to find a new job.
Then there’s retiring when you want to, instead of when you need to. using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.
Doing something you love on a schedule you can’t control can feel the same as doing something you hate.
People like to feel like they’re in control—in the drivers’ seat. when we try to get them to do something, they feel disempowered. rather than feeling like they made the choice, they feel like we made it for them. so they say no or do something else, even when they might have originally been happy to go along.²⁵
When you accept how true that statement is, you realize that aligning money towards a life that lets you do what you want, when you want, with who you want, where you want, for as long as you want, has incredible return.
Derek sivers, a successful entrepreneur, once wrote about a friend who asked him to tell the story about how he got rich: i had a day job in midtown manhattan paying $20 k per year—about minimum wage … i never ate out, and never took a taxi. my cost of living was about $1000/month, and i was earning $1800/month. i did this for two years, and saved up $12,000. i was 22 years old.
Once i had $12,000 i could quit my job and become a fulltime musician. i knew i could get a few gigs per month to pay my cost of living. so i was free. i quit my job a month later, and never had a job again.
When i finished telling my friend this story, he asked for more. i said no, that was it. he said, “no, what about when you sold your company?” i said no, that didn’t make a big difference in my life. that was just more money in the bank. the difference happened when i was 22.²⁶
Thirty-eight percent of jobs are now designated as “managers, officials, and professionals.” these are decision-making jobs. another 41% are service jobs that often rely on your thoughts as much as your actions.

When you see someone driving a nice car, you rarely think, “wow, the guy driving that car is cool.” instead, you think, “wow, if i had that car people would think i’m cool.” subconscious or not, this is how people think.
There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. but in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.