The Psychology of Money: Book Review & Lessons Learned

I love to read, and particularly enjoy reading nonfiction personal finance and health books. Every once in a while, I read a book that’s a bit different and worth sharing. Morgan Housel’s book, “The Psychology of Money: Timeless lessons on wealth, greed, and happiness” is one of those books.

Unlike most finance books, this one is not full of numbers and statistics. Rather, the Psychology of Money is about our emotional biases and the psychology behind the way we think about money and the financial decisions we make.

In the Psychology of Money, Housel shares 19 short stories exploring these concepts so that we can be more mindful as to what’s driving us, and change course (if we so choose). He also shares his own financial strategy at the end, for those interested.

Overall, I found this book to be well-written, concise, and an interesting read. Although not a technical investing resource, the book is chocked full of life lessons and quotable quotes.

I recommend this book if you’re interested in behavioral studies, have ever struggled with making bad financial decisions, or are pursuing financial independence.

Check out your library first to see if they carry the book (FREE). Or if they don’t, feel free to use my Amazon affiliate link below (and thank you).

MY FAVORITE TAKAWAYS FROM THE PSYCHOLOGY OF MONEY

Our financial decisions are heavily biased by our personal experiences.

Our viewpoints of the World, including money, are both fueled and limited by what we’ve personally experienced, particularly during our formative young adult years. When we make decisions about how to invest, or how much risk to take on, our mind uses these guideposts as our basis of what’s “normal”.

People who grew up during the great depression are more likely to view bonds favorably. Whereas, those who grew up during periods of high inflation are less likely to invest heavily in bonds. This bias is the reason why equally smart people can vehemently disagree about investment strategies, such whether to pay down the mortgage or invest excess cash or whether it’s better to invest lump sums or dollar-cost average.  

Nothing is as good or as bad as it seems.

Luck and risk go hand and hand, but how we view them is incredibly biased. If you’re not careful, these biases can lead you to make poor financial (or life) decisions in the future.

What does this mean? We are hard-wired to defend our own failings, attributing them to external factors (i.e. bad luck). For example, if I didn’t get a promotion I’m seeking, I’m more likely to believe that I was unfairly passed over for [fill in the blank] reason. However, if you didn’t get a promotion, I’d revert back to internal factors, such as a lack of skills or effort. The reverse is also true. We minimize the impact of luck in evaluating our own successes, but will view luck as a much more significant factor in someone else’s.

It also means that our failings and successes won’t make us as sad or as happy as we expect they will… or for as long as we expect they will.

Learning to have “enough” is the key to wealth.

Morgan Housel points out that, “Modern Capitalism is a pro at two things: generating wealth & generating envy.”

While there are many people who are good a generating wealth, few of these people are also good at keeping it. Getting wealthy and staying wealthy are two separate skill sets. One requires taking risks and optimism, while the other requires frugality, fear, and humility.

Staying wealthy is made harder by the fact that we live in a society that emphasizes achieving that next level of everything, and where social comparison is as easy as opening up your phone.

Although we typically define wealth by a number, such as net worth, that’s not really the best measure for of its value. An investment banker who makes $500,000 a year but spends it all on his large house, luxury cars, and other things, is living with much less abundance and more financial stress than someone making $80,000 who is content with a life that costs just $40,000 a year. Building wealth has more to do with your savings rate than your income or investment returns.

How wealthy we feel is driven almost entirely by how close we are to having “enough”. If you can stop lifestyle inflation, your income will keep growing, but what it costs to maintain your quality of life will not. Eventually, you’ll reach a level of wealth where you have “enough” … and that is where you’ll find financial freedom.

Wealth is what you don’t see.

Wealth is the money you don’t spend. It’s the fancy car or watch that you didn’t buy. Once you spend money, it’s no longer wealth…it’s an object or experience.  

This message is very similar to that from The Millionaire Next Door, but I always find it powerful. We tend to look around at our neighbors and friends, seeing all the stuff they’ve accumulated and view it as normal. It makes us feel like we should have those things too.

The reality is that people who have achieved financial freedom live within their means. They don’t spend as much of their wealth on things. Trying to keep up with the Jones’s will only slow down your journey to financial independence.   

Slow and steady wins the race

Small changes add up over time, whether you’re talking about climate change or investing. That’s the power of compounding.

You don’t need to earn the highest returns to make a killing in the market. Warren Buffet didn’t and he’s one of the most famous investors of our time. What Buffett did do was start investing wisely at a young age, let his money grow in the market, and continue to earn and invest well into his 80’s. As if you needed another excuse to start investing as early as you can!

Good investing is about consistently earning good returns that you can repeat over the longest period of time. Beating the market once or twice may feel nice, but no one can do it consistently. As the saying goes: “Time in the market, beats timing the market.”

Expect the Unexpected

The most important part of the best laid plans is the contingency for when things don’t go as planned. This is especially true when it comes to our finances.

While history can guide our expectations, it cannot predict the future. There are always at least a few known unknowns that we can try build into our plans. But what about the things we can’t even comprehend yet?

These can be financial or other events that have never occurred (or occurred to that severity), or an unexpected change in our wants, needs or goals down the road. Because there are so many unknowns, it’s wise to include room for error in your forecasts when estimating future costs or market returns, and to always have a back-up plan.    

You are not a spreadsheet; You are a person.

Okay, this one isn’t new… I say it a lot on this blog. Math up a situation all you want. I love a good nerdy analysis. But at the end of the day, the right decision for you is the one that helps you sleep at night. It’s not worth worrying about money to gain an extra percent or two. The whole point of trying to build up wealth is for the freedom it can provide… and that includes freedom from worry.  

If you’ve read the Psychology of Money, what was your favorite takeaway?

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