Doing well with money isn’t necessarily about what you know. It’s about how you behave. And behavior is hard to teach, even to really smart people. Money—investing, personal finance, and business decisions—is typically taught as a math-based field, where data and formulas tell us exactly what to do.
The Psychology of Money Summary
We think we know how the world works, but our worldview is actually very limited. Each of our personal experiences reflect just a tiny fraction of the collective human experience over the generations.
Our worldview is shaped by our life experiences. So, people from different generations, background and life experiences perceive money differently. Someone who grew up with poverty/ starvation will interpret “risks” and “rewards” differently from someone from a wealthy family who never had to worry about money.
Someone who survived WWII or lived through a recession would see money in a different light from someone who grew up in a stable economy. Others’ financial decisions may seem crazy to you, but it makes perfect sense to them. You’ll never understand someone’s financial insecurities just by reading about it; you must experience it personally to fully grasp it. The Psychology of Money !
In fact, most of our modern investment/financial tools are actually very new. For example, USA’s 401(k)—the backbone of their retirement planning—was introduced in 1978, and the Roth IRA was added only in 1998. Even index funds were developed only in the 1970s. We’ve only had <50 years to master these new tools/concepts, making us collectively inexperienced in the modern money game.
No success/failure is purely due to hard work or sound decisions. Your circumstances define the opportunities available to you. Every action you take also has unintentional ripple effects. Take Microsoft for example. Bill Gates was smart, hardworking, and had a rare affinity with computers. However, he was also lucky to attend one of the only high schools in his time with a computer (which Housel estimates to be a 1 in a million chance). The Psychology of Money!
Gates eventually co-founded Microsoft with his classmate Paul Allen. They had a close friend, Kent Evans, who shared their skills and passion with computers. Yet, Evans wasn’t a part of Microsoft because he died on a mountaineering accident, another rare event. Both Gates and Evans were smart and loved computers, but they fell on 2 extreme ends of luck and risk.
Warren Buffett may be a brilliant investor, but his biggest secret isn’t his investment strategy or formula; it’s time. Unlike most people, he started investing when he was 10 years old, so by the time he was 30 (when most people start investing), he already had a net worth of $1million. The Psychology of Money !
Even then, $81.5 billion of his $84.5 billion net worth came after his 65th birthday. That’s the power of compounding and time.
Scientists now estimate that there were 5 ice ages in Earth’s history (not just one). They theorize that a small sliver of ice left over from a cool summer is enough to trigger compounded changes in global temperatures to cause an ice age. The Psychology of Money !
Basically, the ideas above center around 3 main themes:
(i) we’re overconfident of our knowledge of and control over the market,
(ii) the surest way to make money from investments is through compounding (with consistent returns over a long period of time), and
(iii) stick to your financial goals instead of trying to impress others. Know when you have enough, and realize that the biggest value of money isn’t to buy luxury goods but to gain control over your time and life.
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About the Author
Morgan Housel is a partner at The Collaborative Fund and a former columnist at The Motley Fool and The Wall Street Journal. The Psychology of Money !
