The Psychology of Money

When thinking about saving, finances and accumulating wealth there are plenty of books available (most of them are a snooze). There are some that are enjoyable and digestible, but most importantly USEFUL! One of those books is The Psychology of Money by Morgan Housel. The main reason we like this book is because it is centered around the idea that financial success is not about how smart you are with money, but more about how you behave.

The author smartly points out that the way we think and are taught about finances is very scientific and very constrained by laws and rules, almost as if it is physics. While we should teach money management more as psychology—replacing the rules with emotions and nuances, as finance is driven by people’s behaviors not by laws.

The book has 18 lessons that everyone should consider regarding finance. If you are not a reader here are School of Whales’ favorite excerpts. You’re welcome!

Lesson 1. No One’s Crazy

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.

Basically, each person’s experience with money (dictated by your birthplace, the decade you grew up in and your family’s socio-economic status) will influence your decision-making regarding money.

Decisions are justified by a mix between the information you have available and your own beliefs of how money works, so some people make crazy decisions with money, but no one’s crazy. In theory people should make investment decisions based on their goals and the characteristics of the investment options available to them at the time. But that’s not what people do. They do it based on their personal experiences.


Lesson 2. Luck & Risk

 Luck and risk are grounding reminders that every outcome in life is guided by forces other than individual effort.

 Nothing is as good or as bad as it seems.

They are so similar that you can’t believe in one without equally respecting the other. They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes.

Go out of your way to find humility when things are going right and forgiveness / compassion when they go wrong. Because it’s never as good or as bad as it looks. You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time.


Lesson 3. Never enough

The most difficult, but also one of the most important financial skill to develop is getting the goalpost to stop moving. If expectations rise with results, there is no logic in striving for more because you’ll feel the same after putting in extra effort. It gets dangerous when the taste of having more—more money, more power, more prestige—increases ambition faster than satisfaction.

Social comparison is the problem. The point is that the ceiling of social comparison is so high that virtually no one will ever hit it. Which means it’s a battle that can never be won, or that the only way to win is to not fight to begin with—to accept that you might have enough, even if it’s less than those around you.


Lesson 4. Confounding Compounding

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.

$81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday.


Our minds are not built to handle such absurdities. He is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him. His skill is investing, but his secret is time. That’s how compounding works.


Lesson 5. Getting Wealthy vs. Staying Wealthy


Good investing is not necessarily about making good decisions. It’s about consistently not screwing up. 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.

The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest difference. This should be the cornerstone of your strategy, whether it’s in investing or your career or a business you own. There are two reasons why a survival mentality is so key with money. One is the obvious: few gains are so great that they’re worth wiping yourself out over. The other is the counterintuitive math of compounding. Compounding only works if you can give an asset years and years to grow.

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.


Lesson 6. Tails, You Win

An investor can be wrong half the time and still make a fortune.

A lot of things in business and investing work this way. Long tails—the farthest ends of a distribution of outcomes—have tremendous influence in finance, where a small number of events can account for the majority of outcomes.

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.

The idea that a few things account for most results is not just true for companies in your investment portfolio. It’s also an important part of your behavior as an investor.

Napoleon’s definition of a military genius was, “The man who can do the average thing when all around him are going crazy.

It’s the same in investing.


Lesson 7. Freedom

Controlling your time is the highest dividend money pays.

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.

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.

Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.

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.

Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.


Lesson 8. Man in the Car Paradox

No one is impressed with your possessions as much as you are.

There is a paradox, 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.

It’s a subtle recognition that people generally aspire to be respected and admired by others, but using money to buy fancy things may bring less of it than you imagine. If respect and admiration are your goal, be careful how you seek it. Humility, kindness, and empathy will bring you more respect than horsepower ever will.


Lesson 9. Wealth is What you Don’t See

Spending money to show people how much money you have is the fastest way to have less money.

Money has many ironies. Here’s an important one: Wealth is what you don’t see.

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.

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.

The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth. We should be careful to define the difference between wealthy and rich. It is more than semantics. Not knowing the difference is a source of countless poor money decisions.

Rich is a current income. Someone driving a $100,000 car is almost certainly rich, because even if they purchased the car with debt, you need a certain level of income to afford the monthly payment. Same with those who live in big homes. It’s not hard to spot rich people. They often go out of their way to make themselves known.

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.


Lesson 10. Save Money

The only factor you can control generates one of the only things that matters—how wonderful. Personal savings and frugality—finance’s conservation and efficiency—are parts of the money equation that are more in your control and have a 100% chance of being as effective in the future as they are today.

Building wealth has little to do with your income or investment returns, and lots to do with your savings rate. Independence, at any income level, is driven by your savings rate.

Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income but have no chance of building wealth without a high savings rate, it’s clear which one matters more.

You don’t need a specific reason to save. Savings without a spending goal gives you options and flexibility. The ability to wait and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms.


Lesson 11. Reasonable > Rational

Aiming to be mostly reasonable works better than trying to be coldly rational.

You are not a spreadsheet. You are a person. A screwed up, emotional person. Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money. What’s often overlooked in finance is that something can be technically true, but contextually nonsense.

A rational investor makes decisions based on numeric facts. A reasonable investor makes them in a conference room surrounded by co-workers whom you want to think highly of you, or in the kitchen with a spouse whom you don’t want to let down, or judged against the silly, but realistic competitors that are your brother-in-law, your neighbor, and your own personal doubts. Investing has a social component that is often ignored when viewed through a strictly financial lens.

Fever is almost universally seen as a bad thing. They’re treated with drugs like Tylenol to reduce them as quickly as they appear. Despite millions of years of evolution as a defense mechanism, no parent, no patient, few doctors, and certainly no drug company views fever as anything but a misfortune that should be eliminated.

Why does this happen? If fevers are beneficial, why do we fight them so universally? Because the doctor’s goal is not just to cure the disease. It’s to cure the disease within the confines of what’s reasonable and tolerable for the patient.

It may be rational to want a fever if you have an infection. But it’s not reasonable. That philosophy – aiming to be reasonable instead of rational— is one more people should consider when making decisions with their money.


Lesson 12. Surprise!

History is the study of change, ironically used as a map of the future. It is smart to have a deep appreciation for economic and investing history. History helps us calibrate our expectations, study where people tend to go wrong, and offers a rough guide of what tends to work. But it is not, in any way, a map of the future.

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.

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

The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives, tend to be stable in time. The history of money is useful for that kind of stuff. But specific trends, specific trades, specific sectors, specific causal relationships of markets, and what people should do with their money are always an example of evolution in progress. Historians are not prophets.


Lesson 13. Room for Error

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

Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time.

The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.


Lesson 14. You’ll Change

Long-term planning is harder than it seems because people’s goals and desires change over time.

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. This has a big impact on our ability to plan for future financial goals.

The End of History Illusion is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.


Lesson 15. Nothing’s Free

Everything has a price, but not all prices appear on labels.

Everything has a price, and the key to a lot of things with money is just figuring out what that price is and being willing to pay it. The problem is that the price of a lot of things is not obvious until you’ve experienced them firsthand, when the bill is overdue.

The question is: Why do so many people who are willing to pay the price of cars, houses, food, and vacations try so hard to avoid paying the price of good investment returns? The answer is simple: The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good. It feels like a fine for doing something wrong. And while people are generally fine with paying fees, fines are supposed to be avoided. You’re supposed to make decisions that preempt and avoid fines.

Define the cost of success and be ready to pay for it. Because nothing worthwhile is free.

Lesson 16. You & Me

Beware taking financial cues from people playing a different game than you are.

An idea exists in finance that seems innocent, but has done incalculable damage: Is the notion that assets have one rational price in a world where investors have different goals and time horizons.

It’s hard to grasp that other investors have different goals than we do, because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own. Rising prices persuade all investors in ways the best marketers envy. They are a drug that can turn value-conscious investors into dewy-eyed optimists, detached from their own reality by the actions of someone playing a different game than they are.

A takeaway here is that few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are. The main thing I can recommend is going out of your way to identify what game you’re playing.

Smart, informed, and reasonable people can disagree in finance, because people have vastly different goals and desires. There is no single right answer; just the answer that works for you.


Lesson 17. The Seduction of Pessimism

Optimism sounds like a sales pitch. Pessimism sounds like someone trying to help you. Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.

Pessimists often extrapolate present trends without accounting for how markets adapt. Progress happens too slowly to notice, but setbacks happen too quickly to ignore.

It’s easier to create a narrative around pessimism because the story pieces tend to be fresher and more recent. Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together.


Lesson 18. When You’ll Believe Anything

Appealing fiction—Why stories are more powerful than statistics: Stories are, by far, the most powerful force in the economy. They are the fuel that can let the tangible parts of the economy work, or the brake that holds our capabilities back. The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.

An appealing fiction happens when you are smart, you want to find solutions, but face a combination of limited control and high stakes. They are extremely powerful. They can make you believe just about anything. Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

Wanting to believe that we are in control is an emotional itch that needs to be scratched, rather than an analytical problem to be calculated and solved. The illusion of control is more persuasive than the reality of uncertainty. So, we cling to stories about outcomes being in our control.


Key Takeaways

We hope that these 18 rules about money management and investment help you create a better financial and personal future. These excerpts cover a lot of the wisdom of the book; however, it leaves out the fantastic storytelling of Morgan Housel.  Do yourself a favor and buy the book. We promise you will not be disappointed.