Welcome Dear Readers, in this Blog Article we are excited to share with you the valuable insights of “The Psychology of Money”.
The story of Ronald Read serves as a testament to the power of good financial behavior. Despite his humble job as a janitor, he was able to amass a fortune of $8 million through consistent savings and wise investment decisions. This just goes to show that it is not necessarily intelligence or occupation that determines our financial success, but rather our behavior with money. By adopting smart financial habits and making sound decisions, anyone can achieve financial prosperity.
The story of Ronald Read is a prime example of how our behavior with money is a major factor in determining our financial success. In this blog, we will discuss key lessons that have real-life applications and can help us improve our financial well-being. We will summarize these important lessons and explore some good takeaways from renowned author Morgan Housel’s work on the psychology of money. Join us as we learn about The Psychology of Money and discover some innovative ideas for financial betterment.
Five Takeaways: The Psychology of Money
You can learn more about what it truly takes to build a financial fortune by reading the Top Five Takeaways summary (Prosperity).
Takeaway Number 1: Pay the price
What is Paying the Price?
- Imagine wanting to buy a new, fancy watch.
- You go to the store, pick one out, and pay for it.
- This is just like investing – you want to make more money, but it comes with a cost.
Volatility – The Cost of High Returns
- High returns from investing often come with a fee called volatility.
- Volatility means the stock price goes up and down a lot, making it hard to handle.
- But just like buying the watch, paying this cost is necessary for creating wealth.
Example – Investing in Netflix
- A real-life example is investing in Netflix 10 years ago.
- You would have become rich, but you would also have to handle the stock price falling 80%.
- This is why investing in the stock market has its challenges.
Diversification – A More Stable Option
- Even if you choose a more stable option, like an S&P 500 index fund, you will still face some ups and downs.
- From 1980 to 2020, there were 13 years when the investment portfolio was down 20% and 8 months when it was down 50%.
- The key is to be prepared for the cost and stick with it for a bright financial future.
Takeaway Number 2:- Never Enough
The Use of Comparisons Is Not Always Beneficial:
Sometimes, when we see others who have more than us, we can feel sad and like we are not good enough. This is called envy, and it is something that can happen because of capitalism.
Example: The Rich Doctor & the Richer CEO:
Let’s imagine you are a doctor who makes $500,000 per year, which is a very good salary. You might feel wealthy because that is a lot. But then you come across a CEO who makes $10 million annually! You can feel as though you suddenly don’t have enough money.
The Billionaire Neighbour:
And then, you hear about someone like Jeff Bezos, who’s worth billions of dollars ($). This can make us feel like we will never have enough.
The Risk of Comparing:
Comparing ourselves to others can make us do bad things, like spend too much money or break the law. It is important to be happy with what we have and not want more just because others have it.
How to Think Correctly:
If we focus on being successful investors and having financial freedom, we will get to a point where we are happy with what we have. We do not need to keep comparing ourselves to others.
Takeaway 3: Crazy is in the Eye of the Beholder
Different People, Different Viewpoints
It is okay to have different opinions (Schools of thought) and make different choices with your money. People have different backgrounds & experiences, so what seems crazy to one person might make perfect sense to another.
Example: Lottery Tickets
For example, some people might buy a lot of lottery tickets, even though they do not have a lot of money saved. It might seem silly, but when you understand that they live from paycheck to paycheck and don’t have much education, it makes sense that they’re trying to win the big prize to live their dream.
Advice on How to Make Smarter Investment Decisions:
- Know your own goals and values.
- Do not copy someone else’s investment portfolio or strategy just because it’s worked for them.
- If you are not familiar with an investment, it is okay to say no.
Conclusion:
Different people have different views and make different choices with their money. Understanding this will help you make sense of the world and find your own path (Track) to success.
Takeaway 4: Peek-A-Boo (Be Ready for Surprises)
Understanding Black Swans
Events like the Great Depression, World War II, financial crises, and Covid-19, the fifth-generation war, are all examples of things that no one saw coming but had a big impact on the financial market. These types of events are called Black Swans because they are rare and have a big impact, and we only understand why they happened after they occur.
The Importance of Preparation:
If you invested in the stock market 20 years ago, missing just the 4 best days could have meant a difference of nearly half in your return. This shows how important it is to be ready for events that you cannot predict. Instead of trying to guess what will happen in the future, it’s better to be prepared mentally and financially for disasters that can’t be foreseen.
Avoiding Macro Projections:
Do not pay too much attention to macro projections, because the events that will cause the most fear in the investment community are the ones that cannot be predicted.
Takeaway 5: The Seduction of Pessimism
The Power of Pessimism:
- We tend to listen to pessimists more carefully due to evolutionary reasons and because progress happens much slower than setbacks.
- Pessimism is more intriguing and persuasive because tragedies and setbacks happen during shorter time periods, while optimism requires a longer time horizon.
- Be aware of this bias and try to balance it with a long-term optimistic view.
Why Pessimism Sounds So Intelligent:
Setbacks and tragedies often happen during shorter time periods and thus, it is easier to create a compelling and intriguing story around them. On the other hand, progress happens much slower and to create an optimistic story, one must look at longer time horizons, which can become less dramatic and vague.
Understanding Asymmetry towards Loss:
It is important to understand that pessimism appeals to our survival instincts more than optimism does and this can affect our investment decisions. To avoid becoming asymmetric toward loss, it is helpful to be aware of this psychological tendency and make an effort to seek out more balanced and objective information.
Final Thoughts:
The world may be better than you think, but never risk what you have and need for what you do not have & do not need. Be careful when taking investment advice and understand that different perspectives can cause different courses of action to be reasonable or rational. Instead of trying to predict disasters, prepare yourself mentally and financially so that you can survive them.
Top Lessons From The Psychology of Money
Luck vs Risk in Investing:-
Investing in the stock market, for example, can often be a game of Luck & Risk. There are many factors beyond an individual’s control that can impact the outcome of an investment decision. While you may have conducted extensive research and made a well-informed decision, the market may still not perform as you expected. Similarly, you may have made a decision that appears to be a poor one, but due to luck, it turns out to be a success.
For Example, Bill Gates had the luck of being in one of the few schools or universities in his state with access to computers. This helped launch his career and eventually lead to his billions in wealth.
Compound Interest
Compound interest is a powerful concept in finance, where interest earned is reinvested, and the interest earned on the interest over time can add up to a significant amount.
This concept is often applied to investing, where a small investment made early on can grow significantly over time, due to the compounding of interest. It is important to keep in mind that wealth and success often take time and effort to achieve and it is important to start early, have a plan, and stick to it to reap the Advantages of compound interest over the long term (Duration).
Plan on the Plan
“Everybody has a plan until they get punched in the face.” -Mike Tyson
It is essential to plan for the unexpected when it comes to our financial lives. We should always aim to have an emergency fund, with enough money to cover 6 months to a year’s worth of living expenses (Annually Expenditures). This will help us weather any financial storms (Disasters) that may come our way, such as a recession or a housing crisis. By structuring our finances to be unbreakable, we can ensure that we are always in a stable financial position, no matter what happens.
Be a Pilot of Your Finances
Being a pilot of your finances means having control over your financial decisions and avoiding impulsive (Emotional) actions. Just like a pilot, you need to be aware of your surroundings and stay calm in chaotic situations.
Getting Wealthy vs Staying Wealthy
Getting rich is easy but staying rich is hard. This is why Morgan Housel emphasizes learning to stay wealthy first before getting rich. There are many ways to become wealthy, but there is only one way to stay wealthy, and that is by managing it properly.
Be Financially Unbreakable
The key to financial success is to aim to be financially unbreakable, meaning you should make sure to have a strong foundation both mentally and financially. This way, even if the market cycle fluctuates, you won’t be affected. Morgan Housel once said, “Learn to stay wealthy before becoming wealthy.” Focus on building a solid financial foundation so that you can weather any market storms and remain unbreakable.
Be Wealth, Not Flashy
True success and wealth is not measured by the amount of money you spend on flashy things, but by the freedom you have in your life. The goal should be to become truly wealthy, not just to spend a million dollars. People often mistake these two things, but being wealthy means having financial stability and independence, not just a high spending power.
Focus on Savings and Financial Independence
People can be categorized into three groups when it comes to savings:
- those who save,
- those who think they cannot save,
- and those who do not think they need to save.
It is important to save, regardless of one’s salary, as per the author of The Psychology of Money, Morgan Housel. According to him, people with lower salaries who manage to save will be better off than those who spend their salary on frivolous (Flippant) expenses or purchases. It is crucial to focus on savings in all circumstances, even if one has a low salary.
Tell Your Own Future
We often have limited foresight (Forward planning) into what the future holds and what career or job will be fulfilling for us in the long term. It is common or normal to stick with a job we chose when we were young, but this may not always lead to a fulfilling career.
It is important to regularly reevaluate our situation and make changes as needed to shape a future that brings happiness, satisfaction, and fulfillment. This could mean making a shift in your career or taking control of your finances to ensure financial stability. Do not get stuck in a job or career that does not bring you joy & fulfillment.
Avoid Appealing Fictions
Beware of your love for stories. If you dislike investing in the stock market or prefer investing in real estate or dislike starting a business, you will find a story that supports that narrative in your head. This is called appealing fiction. If you believe the stock market will go down next year, you will find plenty of evidence to support that idea, and the same goes if you think it will go up.
It is essential to approach researching, planning, and discussions with an open mind, rather than a pre-existing story that you are trying to fit the evidence into. This often happens in politics, where individuals surround themselves with those who agree with their mindset & never consider different perspectives or middle ground. We have a tendency (Habit) to love our stories.
Less Ego & More Wealth
Saving money is the key to bridging the gap between your ego and your income. Wealth is built by sacrificing the ability to buy what you want now, in order to have more options & resources in the future.
Regardless of your income, you cannot start building wealth until you practice the art of delayed gratification. It is important to keep in mind that true wealth is not just about what you can buy, but rather about what you do not see.
Invest with Peace of Mind
- Always prioritize being able to sleep at night over chasing the highest possible returns
- Consider the potential stress and anxiety a certain investment may bring into your life
- If an investment is causing too much stress, it may be worth looking into alternative options
- Remember, peace of mind is more important than a potentially higher return.
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