The Psychology of Money

Books · Investing

(I had finished reading this in December 2020, but added it to Notion in Feb 2021)

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The Psychology of Money

Summary

  1. Few people make financial decisions purely based on a spreadsheet. They make them on the dinner table or in meetings where emotions and egos are a significant concern
  2. Risk and luck are siblings. The more extreme an outcome, the less likely that you can apply it to your own life because it is likely influenced by the extreme ends of luck or risk
  3. The key to dealing with failure is arranging your financial life in a way that a bad investment here or a missed financial goal there won’t wipe you out, so you can keep playing until the odds rule in your favor (eliminate the risk of ruin)
  4. If you have enough wealth/income to satisfy your needs, remember that the hardest financial skill is getting the goalposts to stop moving
  5. Good investing is not necessarily about earning the highest returns. Because highest returns tend to be one-offs that cannot be repeated. Instead, you should try to get pretty good returns over a long period of time
  6. There are a million ways to get wealthy, but only one to stay wealthy. Some combination of frugality and paranoia
  7. Always have a margin of safety and leave some room for error. The purpose of a margin of safety is to render the forecast unnecessary
  8. Buffet’s fortune is not just due to being a good investor, but being a good investor since he was literally a child. Increase you time horizon to let compounding happen
  9. Be okay with a lot of things going wrong in a small way. Most of the returns come from something going right in a big way

Highlights

Introduction

Doing well with money had little to do with how smart you are, and a lot to do with how you behave (the psychology of money)

A janitor had 8 million dollars when he died aged 92. He put his money in blue chip stocks, and waited as his savings compounded for years on end

To understand why investors sell at the bottom of a bear market, you need to look at your family and wonder if your investments are imperiling their future

Chapter 1: No One’s Crazy

  • Different people learn very different lessons
  • What you’ve experienced is much more salient than what you learn second hand
  • Someone who grew up poor things about risk and reward in ways that are very different from the son of a wealthy banker
  • My aunt worked several years in what Americans call “sweat shops.” It was hard work. Long hours, “small” wage, “poor” working conditions. Do you know what my aunt did before she worked in one of these factories? She was a prostitute. The idea of working in a “sweat shop” compared to that old lifestyle is an improvement, in my opinion. I know that my aunt would rather be “exploited” by an evil capitalist boss for a couple of dollars than have her body be exploited by several men for pennies. That is why I am upset by many Americans’ thinking. We do not have the same opportunities as the West. Our governmental infrastructure is different. The country is different. Yes, factory is hard labor. Could it be better? Yes, but only when you compare such to American jobs. If Americans truly care about Asian welfare, they would know that shutting down “sweat shops” would force many of us to return to rural regions and return to truly despicable “jobs.” And I fear that forcing factories to pay higher wages would mean they hire FEWER workers, not more.
  • If you are not in a particular group and haven’t had their life experiences, it’s difficult for you to understand how they think
  • Few people make financial decisions purely based on a spreadsheet. They make them on the dinner table or in meetings where emotions and egos are a significant concern

Chapter 2: Luck & Risk

  • Risk and Luck are siblings
  • Bill Gates happened to be one of the few students who were in a school that could afford to buy computers
  • Kent Evans, who was a friend of Bill Gates and also really good at computers, died of a mountaineering accident when he was young. He was on the opposite site of luck as Bill Gates
  • Incomes among brothers are more correlated than height and weight
  • Someone else’s failure is usually attributed to bad decisions, while your failure is generally attributed to bad luck/risk
  • The more extreme an outcome, the less likely that you can apply it to your own life. Because it is likely influenced by the extreme ends of luck or risk
  • You’re closer to actionable takeaways by looking at broad patterns/trends of success and failure. The more common the pattern, the more it may be likely to apply to your life
  • The key to dealing with failure is arranging your financial life in a way that a bad investment here or a missed financial goal there won’t wipe you out, so you can keep playing until the odds rule in your favor

Chapter 3: Never Enough

  • Rajat Gupta was really rich (Mckinsey MD, Goldman BoD), but he always wanted more. He indulged in insider trading and was prisoned, and his reputation was forever ruined. Similar story for Bernie Madoff
  • If you have enough wealth/income to satisfy your needs, remember the following
    • 1) the hardest financial skill is getting the goalposts to stop moving. It gets when the taste of having more increases ambition faster than satisfaction
      1. social comparison is a problem. Never compare to your social circles, always compare to your needs
    • 3) enough is not too little. It’s realising that the insatiable appetite for more hurts more than it helps. It can lead to burnout, too much risk, and unethical decisions
      1. there are many things that are never worth risking – no matter what the potential gain. Reputation, freedom & independence, love, happiness, and family & friends are invaluable

Chapter 4: Confounding Compounding

  • Buffet’s fortune is not just due to being a good investor, but being a good investor since he was literally a child
  • Buffet’s net worth is $84.5B. Of that, $84.2B was accumulated after his 50th birthday. $81.5B came after he qualified for social security in his mid sixties
  • He began investing when he was 10. When he was 30, he had a net worth of $1M (or $9M in today’s money)
  • Buffet’s skill is investing. But his secret is time
  • Simons of Renaissance is a much better investor. His CAGR is 3x Buffet’s. But he only started investing when he was in his 50s
  • The counter intuitive nature of exponential growth leads even the smartest people to ignore it
  • Good investing is not necessarily about earning the highest returns. Because highest returns tend to be one offs that cannot be repeated. Instead, you should try to get pretty good returns over a long period of time

Chapter 5: Getting Wealthy vs Staying Wealthy

  • There are a million ways to get wealthy, but only one to stay wealthy. Some combination of frugality and paranoia
  • Jesse Livermore was worth today’s equivalent of $100M as a stock trader. When the market crashed in 1929, he had shorted it. On that one day, he made the equivalent of $3B. But 4 years later, he made larger and larger bets and went bankrupt, eventually killing himself
  • To get wealth, consolidate. To stay wealthy, diversify and just survive
  • The ability to stick around for a long time without being wiped out (avoiding risk of ruin) is key to staying wealthy
    1. more than immediate big returns, I want to be in breakable. If I’m unbreakable, I’ll get big returns in the long term because I’ll be able to stick around long enough to get the benefits of compounding. 2) planning is important but the most important thing is to plan for contingencies — what happens if things don’t go to plan, what is your margin of safety? 3) A barbelled mindset — optimism about the future and paranoia about what happens if your future doesn’t play out well — is critical

Chapter 6: Tails, You Win

  • in the art market, the great investors bought large quantities of the art. And held on to them for long enough such that they benefited when the superstars arrived
  • Having a portfolio of bets is really important
  • Because of long tails, you can be wrong most of the time and still end up stupendously right
  • Anything that returns outside returns is a tail event. If you want to get rich without getting lucky, have enough volume
  • Even in the public markets, a few companies that outperform by a lot lead to the most returns
  • Napoleon’s definition of a militarily genius was someone who could do the average thing while all around him are going crazy. It’s the same for investing
  • Invest cash when the economy is in a recession to have the best returns (buy low)
  • How you behaved as an investor in late 2008/early 2009 or during March/April 2020 will have more of an impact on your investments than almost everything else you did
  • Long tails drive everything. Accept failure
  • Bezos after fire phone launch: “if you think that’s a big failure, be ready for more. We’ll have more failures that make this one look like a blip”

Chapter 7: Freedom

  • The highest form of wealth is the ability to wake up every morning and say “I can do whatever I want today”. Freedom is the highest dividend that money pays
  • A small amount of wealth means the ability to take a few days off work when you’re sick without breaking the bank. A bit more means waiting for a good job to come around after you’ve been laid off rather than taking the first thing that’s on offer. 6 months emergency expenses means not being terrified of your boss, because you know you won’t have to be worried if you can’t find a job immediately. More still means being able to take a job with lower pay but with a lifestyle that fits yours. Then there’s retiring when you want to, instead of when you need to
  • Keep your expenses in line with your income, have enough funds in the bank for emergencies, and then you’re rich

Chapter 8: Man In The Car Paradox

  • People tend to want signals of wealth (like expensive cars) to signal to others that they have a lot of wealth and should be admired. But people generally look past admiring you and focus on admiring the object you bought
  • Humility, kindness, and empathy will bring you far more respect than horsepower

Chapter 9: Wealth is what you don’t see

  • Many people with expensive cars don’t have much wealth — they just spend a large percentage of their wealth on these things
  • The way to be rich is to not spend the money that you do have
  • Rich is current income, wealth is your net assets. Wealth is income not spent. It’s value lies in giving you the options and flexibility to have gratification in the long run
  • Don’t let your current bank balance fall by too much

Chapter 10: Save Money

  • Building wealth is directly correlated to how much you save. Wealth is just the accumulated leftovers of what you’ve spent after you’ve taken in
  • Don’t let your lifestyle compound as fast as your assets
  • Spending beyond a certain comfortable level of materialism is a sign that your ego is growing in line with your income
  • Don’t give a damn what others think about you. You can spend less if you desire less, and you’ll desire less if you don’t care what others think of you
  • Savings are a hedge for the inevitability for what life throws are you in the most unexpected ways
  • Flexibility and optionality are really worth it. They let you control your time and your options. Savings enable these

Chapter 11: Reasonable > Rational

  • You’re an irrational person. Don’t aim to be coldly rational, just try to be reasonable
  • Owning diversified index funds is rational. But owning a smattering of individual stocks that you have high conviction in, in addition to diversified index funds, is a lot more reasonable and will help you scratch your itch

Chapter 12: Surprise!

  • History helps us calibrate our expectations, but it’s not in any way a map of the future
  • An over-reliance on historical data as a signal for future change is a bad idea
  • Experiencing significant events doesn’t necessarily qualify you for what happens next. In fact, it may make you more overconfident
  • If you look mostly at history, you may miss outliers
  • The Intelligent Investor (the book) is full of wisdom, but terrible as a howto guide. Because it’s out of date

Chapter 13: Room for Error

  • Always have a margin of safety and leave some room for error. The purpose of a margin of safety is to render the forecast unnecessary
  • Always hold enough cash so you can pounce once the opportunity strikes
  • Assume that your future returns will be one third lower than what they have been in the past
  • You can be risk loving and yet completely averse to ruin. Don’t play Russian roulette
  • Think of your money as a barbell. Take risks with one portion, and leave the other untouched
  • Everything that can break will eventually break. Avoid single points of failure

Chapter 14: You’ll Change

  • Your preferences will change over time. Keep this in mind when planning for the future. And when they do change, don’t regret it. Just move on as soon as possible
  • Ignore sunk costs

Chapter 15: Nothing’s Free

  • Things that give big returns can take them away just as fast (high risk is the price of high returns)

Chapter 16: You & Me

  • Bubbles form when short term traders trade much more than long term ones
  • Long term investors should not take their cues from short term traders
  • There’s no rational price. What a long term investor values something at is very different from what a “momentum trader” does

Chapter 17: The Seduction of Pessimism

Chapter 18: When You’ll Believe Anything

  • What you want to be true is not unequivocally true. The higher the stakes, the greater should be your room for error
  • Everything has an incomplete view of the world, but we fill it with complete narratives to make sense of it for us
  • Even if you know little, you tell yourself a coherent story to match the world with what you do know

Chapter 19: All Together Now

  • Go out of your way to find humility when things are going right, and forgiveness and compassion when they are going wrong
  • Respect the power of luck and risk
  • Less ego, more wealth. Go for delayed gratification
  • Increase your time horizon to let compounding happen
  • Be okay with a lot of things going wrong in a small way. Most of the returns come from something going right in a big way
  • Use money to gain control over your time
  • Be nicer and less flashy
  • Save more
  • Worship room for error
  • Avoid the extreme ends of financial decisions
  • Define the game you’re playing, and make sure your actions are not influenced by people playing a different game