Joseph Heller and I were at a party given by a billionaire
on Shelter Island.
I said, “How does it make you feel to know that our host only yesterday may have made more money than your novel ‘Catch-22’ has earned in its entire history?”
And Joe said, “I’ve got something he can never have.”
And I said, “What on earth could that be, Joe?”
And Joe said, “Enough.”
— Chapter 3: Never Enough
I've just completed the audiobook version of Morgan Housel's The Psychology of Money (affiliate link here). This is the sort of book that will hit differently depending on the kind of money management experience you have.
I won't bury the lede: I thought it was excellent. I'm going to set some personal context (which you can skip) and then mark out the three (related) themes of the book which particularly stood out to me:
- Getting Wealthy
- Staying Wealthy
I'll also link chapters I reference with publicly available versions of stuff that Morgan has written in the past (like this), but of course if you want the most concise/polished version you'll have to get the book.
My background is a longish story but in short: I accumulated all the paper qualifications during my finance career. BSc from Wharton, MSc from Chicago, CFA, CAIA. Some years of sell- and buy-side experience.
It took me a lot of time in the markets (and some family financial mismanagement) to understand that the paper stuff doesn't matter. Have you spent years at the world's best universities only to be completely trounced by someone who didn't even graduate high school? I have. Reality is extremely humbling to people who were brought up in ivory towers.
In particular I reflect a lot on my hedge fund days. We did all sorts of terrible trades. We failed to be sufficiently long on big tech because it was "consensus". We lost money shorting the Taiwanese display industry because we got squeezed - in a year when the sector eventually went down >50%. I spread myself thin "covering" 300 names when a normal workload should be like 30 (it was, however, a ridiculously mind-expanding time with unparalleled access - highlights include visiting Dentsu's glittering HQ in Tokyo, Mobile World Congress in Barcelona, LINE in Seoul, the MAGIC trade show in Vegas, and touring the Tesla Fremont Factory with their CFO). Our boss made mid-seven figures as our PM, yet mostly rode the coattails of G, the real star on our team.
I think what we neglected was, for lack of a better word, our "Psychology of Money". It's no surprise to me that a psychiatrist is a central character of the hedge fund drama Billions. I wish we had one. I quit the industry because I couldn't handle the stress from our high risk, earnings day whipsaw positions. We habitually lied that we were looking for 18-24 month investment theses when the reality was that we'd be out after the next earnings. We chased after >50% win-rates but cut winners short at the first sign of trouble. We attributed luck to skill. Our boss often spent money as fast as he could make it - fancy sports car, fancy seaview condo, fancy everything. He had everything but I don't think he ever had enough. It rubbed off on me - despite making perhaps $250k after taxes, I saved almost none of it.
Save Money (Chapter 10). Seems obvious, but many people don't do it, so it is worth mentioning. You can't control what you make. But you can control what you save.
Stay in the Game. You need Room for Error (Chapter 13) to let compounding work (Chapter 4). If Warren Buffett had only been an investor for 30 years (ages 30–60 like most people), you would not have heard of him.
"Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday... [If he started at age 30 and] generated 22% annual returns, and retired at 60 to play golf, his net worth would only be $11.9 million (99.9% less than current)."
It's compounding for 70 years – not 30 – that made the difference.
There's a flip side to this too: Most people don't know that Rick Guerin was the third member of Warren Buffett and Charlie Munger's investing group when they started out in the 1960s.
Warren and Charlie survived 14 recessions. Rick got caught out levered with margin loans. Today — you've already forgotten his name.
"The trick when dealing with failure is arranging your financial life in a way that a bad investment here or missed financial goal there won't wipe you out so you can keep playing until the odds fall in your favor." (Chapter 2)
Time Horizons Matter. The historical odds of making money in U.S. markets are 50/50 over one-day periods, 68% in one-year periods, 88% in 10-year periods, and (so far) 100% in 20-year periods. (Chapter 11)
Fight Overoptimism AND Overpessimism.
Your bias is based on your context and personal experience (Chapter 1). "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".
Beware taking financial cues from people that are playing a different game than you are. Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term. (Chapter 16)
Pessimism is extremely seductive (Chapter 17). Optimism is the best bet for most people because the world tends to get better for most people most of the time. Pessimism isn’t just more common than optimism. It also sounds smarter. It’s intellectually captivating, and it’s paid more attention than optimism, which is often viewed as being oblivious to risk.
“For reasons I have never understood, people like to hear that the world is going to hell.” — Historian Deirdre McCloskey
To square the two, learn to be comfortably bipolar: Save like a Pessimist, Invest like an Optimist.
"Things that have never happened before happen all the time."
— Scott Sagan
Morgan notes in Chapter 12, Surprise: "History is mostly the study of surprising events, but is used by economists as an unassailable guide to the future." The "Historians as Prophets" fallacy was always my biggest problem in the quantitative aspects of finance.
Put aside the unsolvable problem of hilariously small sample sizes and lack of controlled experiments in finance. The simple assumption that what has happened before sets the upper and lower bounds for what can happen in future is laughable — considering how much technology, society, and even geography change within a single human lifespan. John Templeton is known for saying that "This Time Is Different" are the four most dangerous words in investing, but even he concedes that 20% of the time it really is different.
We adopt this because of some combination of physics envy and politician's syllogism. We want to believe something so we'll believe anything (Chapter 18). It works well enough for 95% of days, and then is completely useless (or worse than useless) for the 5% of the time things are new. (It's even more frustrating when regulators encode this arrogance into law, but that's a huge tangent...)
“We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.” — Philip Tetlock
5% is a small number; we'd be able to live with it if this other fact weren't true — investment returns are strongly determined by fat tails (Chapter 6), created by outside forces rather than individual effort (Chapter 2), with forcing out weak hands with no Room for Error (Chapter 13). Meaning that 5% of the time things are new can determine 95% of total return, especially when taking investor response into account.
This is an argument for diversifying by indexing (as Morgan notes, this even works for art markets), and simply sticking it out long enough for it to work. Also means not pursuing the biggest short term returns - merely good returns for the longest possible amount of time.
This approach to luck and risk also applies to forgiveness and social judgment. Not all success is due to hard work, and not all poverty is due to laziness.
“Risk is what’s left over when you think you’ve thought of everything.” — Carl Richards
This book taught me that Wealth is What You Don't Spend (chapter 9). We spend on flashy things mostly to impress other impressive people. This is a never ending pit of emptiness because there will always be someone who can outspend you, and in the end all you are left with is the empty joys of the stuff you bought and a smaller net worth than when you started.
We need to fight the urge that we can Never have Enough (chapter 3). This is the sort of greed that lead Rajat Gupta, a widely well respected former CEO of McKinsey, to commit insider trading to save less than $3 million in losses. He was already worth ~$100 million. He wanted to be a billionaire. He ended up going to jail instead.
"The hardest financial skill is **getting the goalpost to stop moving."
It takes a very different skillset and mindset to Stay Wealthy after Getting Wealthy (chapter 5). The annals of finance are riddled with famous investors who knew the latter but not the former. Jesse Livermore made the equivalent of $3 billion in one day after shorting Black Monday in 1929 - then proceeded to lose it all, file for bankruptcy by 1934 and kill himself in 1940.
"There are a million ways to get wealthy... but there is only one way to **stay* wealthy - some combination of frugality and paranoia. Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined.*"
Instead of pursuing the image of wealth (being the Man in the Car nobody cares about - chapter 8), you can use wealth to buy Freedom (chapter 7 - can't find anything close but this is a nice ladder to think about).
"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."
Morgan is one of the best financial writers of our generation. This was honed over a decade of writing about finance for the Motley Fool and WSJ. It's not easy to make these "soft", non-technical points to someone as technically inclined as myself. But perhaps I just happen to be in the right mental space to receive this message.
I think, above all, Morgan makes an extremely compelling case that Pyschology, not math, governs our personal relationship with money and finances.
"Important financial decisions are not made in spreadsheets or in textbooks. **They are made at the dinner table. They often aren’t made with the intention of maximizing returns, but minimizing the chance of disappointing a spouse or child." - Chapter 20
Of course, he isn't the first to observe this. But he is the first, in my mind, to do it well, more cogently than Charlie Munger, who is the inspiration for this book. Academic behavioral finance studies this in isolated cases, but Morgan makes it relatable by setting these in real life contexts.
For those interested in the audiobook version (you can get your first free here), I found Chris Hill's narration pleasant and undistracting. I wondered if he was a professional narrator, but it turns out he is a friend and ex-colleague of the author.