The psychology of money

  

The psychology of Money –Morgan Housel

 

How much money is enough?

Well this depends on a person. Anna Hazare is happy with Rs.5000 per month whereas our friend Adani  isn’t happy with Rs.2 lks per second. Happiness, as it’s said, is just results minus expectations. Apart from our needs to meet a good life style, we need enough money to buy Freedom.

 Freedom: 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 numerator 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.

If your job is to build cars, there is little you can do when you’re not on the assembly line. You detach from work and leave your tools in the factory. But if your job is to create a marketing campaign a thought-based and decision job your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you’re making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning. You might be on the clock for fewer hours than you would in 1950. But it feels like you’re working 24/7.

Morgan in this book talks less about the technical part and more about the behavioural part of earning money that we need to enjoy the freedom to manage our desires

 Behaviour: To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism. To get why investors sell out at the bottom of a bear market you don’t need to study the math of expected future returns; you need to think about the agony of looking at your family and wondering if your investments are imperilling their future.

Although money has been around a long time. King Alyattes of Lydia, now part of Turkey, is thought to have created the first official currency in 600 BC. But the modern foundation of money decisions—saving and investing—is based around concepts that are practically infants.

 Confounding Compounding

$81.5bn of $84.5 bn of Warren buffet came after his 65th birthday. The results with bigger impacts come later. Do 8 + 8 + 8…9 ten times. We get 72. Now do 8 x8 x 8 …9 times, the result will explode your head. It’s 13,42,17,728 (say 13.5 cr) and the next multiple? 107,37,41,824 (107 cr +)

The challenge is in Maintaining the compounding discipline and consistency in the initial few years. Later on each new day has a huge impact over the previous. Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships. Endurance is key.

 Frugality and Paranoia:

There are a million ways to get wealthy, and plenty of books on how to do so.

But there’s only one way to stay wealthy: some combination of frugality and paranoia. A degree of Paranoia avoids complacency. Being optimistic about the future lifts the confidence, but paranoid about what will prevent you from getting to the future is vital. A typical way to bring it in practicality is by bringing in mind the different ways a plan can go wrong. That’s good enough to be planned for the unplanned.

A mind-set 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.

 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. Tails drive everything. Peter Lynch is one of the best investors of our time. “If you’re terrific in this business, you’re right six times out of 10,” he once said.

There are fields where you must be perfect every time. Flying a plane, for example. Then there are fields where you want to be at least pretty good nearly all the time. A restaurant chef, let’s say.

Investing, business, and finance are just not like these fields.

Something to learn from both investors and entrepreneurs is that no one makes good decisions all the time. The most impressive people are packed full of horrendous ideas that are often acted upon.

 Misunderstood Role models

For most of us Role models are great in their acts all the time and we as followers are worst most of the times. Understanding the fact that the role models make as common mistakes as we make, gives lot of confidence. 

It’s much harder to piece together every investment he’s made over his career. No one talks about the dud picks, the ugly businesses, the poor acquisitions. But they’re a big part of Buffett’s story. They are the other side of tail-driven returns. 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. 

 Wealth Paradox:

Though not very convincing, Morgan finds a paradox in wealth assimilation: 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.

Someone driving a $100,000 car might be wealthy. But the only data point you have about their wealth is that they have $100,000 less than they did before they bought the car (or $100,000 more in debt). That’s all you know about them.

We tend to judge wealth by what we see, because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars, Homes, Instagram photos, Modern capitalism makes helping people fake it until they make it a cherished industry.

But the truth is that wealth is what you don’t see. Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.

That’s not how we think about wealth, because you can’t contextualize what you can’t see.

But wealth is hidden. It’s income not spent. Wealth is an option not yet taken to buy something later. Its value lies in offering you options, flexibility, and growth to one day purchase more stuff than you could right now.

If wealth is what you don’t spend, what good is it?  Spend money on the merit of your needs, (Maslow’s hierarchy) without intentionally letting the others know about it. That’s sense.

 Don’t rely on History all the time:

Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next. You’ll likely miss the outlier events that move the needle the most. The correct lesson to learn from surprises is that the world is surprising. Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next. The most important economic events of the future things that will move the needle the most are things that history gives us little to no guide about. They will be unprecedented events. Their unprecedented nature means we won’t be prepared for them, which is part of what makes them so impactful. This is true for both scary events like recessions and wars, and great events like innovation.

And

History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.

 Recession is cycling slowly:

The average time between recessions has grown from about two years in the late 1800s to five years in the early 20th century to eight years over the last half-century.

There are plenty of theories on why recessions have become less frequent. One of them is that heavy industry is more prone to boom-and-bust overproduction than the service industries that dominated the last 50 years.

 Room for error:

Although card counting is statistically proven to work, it does not guarantee you will win every hand let alone every trip you make to the casino. We must make sure that we have enough money to withstand any swings of bad luck. The answer to those what ifs is, “You won’t be able to retire like you once predicted.” Which can be a disaster.

The solution is simple: Use room for error when estimating your future returns. This is more art than science. For his own investments, Morgan assumes the future returns he’ll earn in my lifetime will be 1⁄3 lower than the historic average. So he saves more than I would if I assumed the future will resemble the past. It’s my margin of safety. The future may be worse than 1⁄3 lower than the past, but no margin of safety offers a 100% guarantee. A one-third buffer is enough to allow him to sleep well at night. And if the future does resemble the past, Morgan will be pleasantly surprised.

“The best way to achieve felicity is to aim low,” says Charlie Munger.

An important cousin of room for error is what Morgan calls optimism bias in risk-taking.

 Luck and Risk:

 We would’ve talked more about Kent Evans than Bill Gates. Kent died in a mountaineering accident before he graduated high school. Couple of years elder to Bill, Kent had an extra edge over Bill in the dream they shared together.

Every year there are around three dozen mountaineering deaths in the United States. The odds of being killed on a mountain in high school are roughly one in a million.

Bill Gates experienced one in a million luck by ending up at Lakeside school and then meet Kent Evans who experienced one in a million risk by never getting to finish what he and Gates set out to achieve. The same force, the same magnitude, working in opposite directions.

Although fortune is not in our hand, somethings are surely in our hands. There is no reason to risk what you have and need for what you don’t have and don’t need. There are many things never worth risking, no matter the potential gain

 Planning on your plan:

The most important part of every plan is planning on your plan not going according to plan.

An underpinning of psychology is that people are poor forecasters of their future selves.

Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life stresses that grow with competitive pursuits is something entirely different.

Many of us wind through life on a similar trajectory. Only 27% of college grads have a job related to their major, according to the Federal Reserve. Twenty-nine percent of stay-at-home parents have a college degree. Few likely regret their education, of course. But we should acknowledge that a new parent in their 30s may think about life goals in a way their 18-year-old self-making career goals would never imagine.

At every stage of our lives we make decisions that will profoundly influence the lives of the people we’re going to become, and then when we become those people, we’re not always thrilled with the decisions we made. So young people pay good money to get tattoos removed that teenagers paid good money to get. Middle-aged people rushed to divorce people who young adults rushed to marry. Older adults work hard to lose what middle-aged adults worked hard to gain. On and on and on. We should also come to accept the reality of changing our minds. The trick is to accept the reality of change and move on as soon as possible.

 When it is easy to find others mistake but tough to do yourself flawlessly:

The 2008 financial crisis sent GE’s financing division which supplied more than half the company’s profits into chaos. It was eventually sold for scrap. Subsequent bets in oil and energy were disasters, resulting in billions in write offs. GE stock fell from $40 in 2007 to $7 by 2018.

Blame placed on CEO Jeff Immelt who ran the company since 2001 was immediate and harsh. He was criticized for his leadership, his acquisitions, cutting the dividend, laying off workers and of course the plunging stock price. Rightly so: those rewarded with dynastic wealth when times are good hold the burden of responsibility when the tide goes out. He stepped down in 2017.

Every job looks easy when you’re not the one doing it because the challenges faced by someone in the arena are often invisible to those in the crowd.

 How are Bubbles formed in economy?

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. The formation of bubbles isn’t so much about people irrationally participating in long-term investing. They’re about people somewhat rationally moving toward short- term trading to capture momentum that had been feeding on itself.

 These two investors rarely even know that each other exist. But they’re on the same field, running toward each other. When their paths blindly collide, someone gets hurt. Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them. But when you don’t know why someone behaves like they do you won’t know how long they’ll continue acting that way, what will make them change their mind, or whether they’ll ever learn their lesson.

When a commentator on CNBC says, “You should buy this stock,” keep in mind that they do not know who you are. Are you a teenager trading for fun? The main thing I can recommend is going out of your way to identify what game you’re playing.

It’s surprising how few of us do. We call everyone investing money “investors” like they’re basketball players, all playing the same game with the same rules. When you realize how wrong that notion is you see how vital it is to simply identify what game you’re playing. 

We live in Copy Cat economy. If something clicks for someone, most others are desperate to follow the footsteps. Remember that the early birds get the bigger pie often.

 The seduction of Pessimism:

Optimism talks about sales pitch. Pessimism sounds like someone trying to help you.

Expecting things to be great means a best-case scenario that feels flat. Pessimism reduces expectations, narrowing the gap between possible outcomes and outcomes you feel great about.

Maybe that’s why it’s so seductive. Expecting things to be bad is the best way to be pleasantly surprised when they’re not.

Which, ironically, is something to be optimistic about.

Just like a baby, we at times don’t know what we don’t know. So we just are as susceptible to explaining the world through the limited set of mental models we have at our disposal.

Like the baby, we look for the most understandable causes in everything we come across. And, like her, we are wrong about a lot of them, because we know a lot less about how the world works than we think we do. Risk is what’s left over when you think you’ve thought of everything.”

 The alien circling over Earth?

Imagine an alien who drops down before the year 2000 and leaves the earth around 2019, just before covid pandemic. Ask him about dot com bubble, Lehman bro crises..etc. His reaction will be. “When people are the same, financial systems are the same, tools are the same, policies majorly are the same what is causing the change?

The one who’s confident he knows what’s happening based on what he sees but turns out to be completely wrong because he can’t know the stories going on inside everyone else’s head?

The alien is all of us.

  

Disclaimer: This write up is just an attempt to preserve the good points stated by Morgan Housel. In the process, I have used my knowledge, experience, forecasts and discretion to settle on a point.