Book Summary: The Psychology of Money by Morgan Housel

The Book in Three Sentences

In this summary of The Psychology of Money, you’ll learn that doing well with money isn’t about intelligence or education, it’s about behavior. The problem with behavior is that it’s hard to teach even if you’re highly educated. In the book, author Morgan Housel shares nineteen stories about how people think about money.

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The Psychology of Money Summary

Introduction: The Greatest Show on Earth

Doing well with money isn’t about being smart, it’s about how you behave. You can be successful and highly educated, but still be financially illiterate. You can be unremarkable and make a fortune. Financial success is a soft skill that doesn’t depend on luck but on your behavior. This skill is what the author calls the psychology of money.

Chapter 1: No One’s Crazy

When it comes to money, people do crazy things yet no one is crazy. There are thousands of variations that come into play when we talk about money: the generation you belong to, the parents that raised you, the income you have, the values you were taught, the country you were born in, and so on. This explains why everyone sees money differently. This has nothing to do with intelligence and education, it’s about experiences. What’s outrageous to some, makes complete sense to others. Money decisions are difficult, the topic is relatively new and everyone has their own perspective on it. In most cases, people make poor decisions because there aren’t decades of experience to learn from.

Chapter 2: Luck and Risk

Luck and risk are strongly related. Back in the 1960s, Bill Gates attended one of the only high schools in the world that had a computer. Bill Gates and Paul Allen were obsessed with the machine and toyed around with it incessantly. This obsession eventually led to the foundation of Microsoft, a trillion-dollar company. Apart from Allen, Gates had a close friend called Kent Evans who died in a mountaineering accident. Where Gates experienced luck, Evans experienced risk. Apart from individual effort, life is guided by luck and risk. One of the most difficult problems we face when it comes to money is identifying luck, risk, and skill.

Chapter 3: Never Enough

For most people, there’s no limit to accumulating money, but never having enough is dangerous. Some people worth hundreds of millions of dollars risk their entire fortunes only to have more. Never risk what you have and need for what you don’t have and don’t need.

If you ever find yourself in a similar financial situation remember:

Getting the goalpost to stop moving is the hardest financial skill to learn.
Don’t compare your salary to people who earn more than you because you’ll never win.
Enough is realizing that if you keep pushing, you’ll regret it.
Some things aren’t worth risking, despite the potential gain. You can’t put a price on certain virtues or values, such as reputation, freedom, family, love, and happiness.

Chapter 4: Confounding Compounding

Small changes can lead to big results, this is called compounding. The secret of compounding is time because the earlier you start, the sooner you’ll see the results. Compounding isn’t intuitive, so we ignore its potential which is dangerous in investing. Good investing isn’t about earning the highest returns because it can’t be repeated. Good investing is about earning good returns that can be repeated for a long time.

Chapter 5: Getting Wealthy vs Staying Wealthy

Staying wealthy is a mixture of frugality and paranoia. You can be good at getting wealthy, but bad at staying wealthy. One thing is to get money and another thing is to keep it. Money success is about survival. While getting money is about taking risks and being optimistic, keeping money is about not taking risks, it’s about being humble, and it’s about being afraid that you might lose it. Compounding only works when you give an asset a long time to grow even when there are some unpredictable factors that affect it.

The survival mindset can help in the real world:

More than getting big returns, aim to be financially unbreakable. By being unbreakable, you’ll get the biggest returns because you’ll be around long enough for compounding to work. Compounding is about uninterrupted good returns that happen over time.
Planning is important, but plan for the unexpected too. Your financial plan, whatever it is, should have room for error.
Be optimistic and paranoid at the same time. You’ll make more money over time, but there will be many problems along the way too.

Chapter 6: Tails, You Win

You can be wrong 99% of the time and still be right 1% of the time. That 1% can make you rich. Something that’s big, profitable, famous, or influential is the result of a series of small events, that 1%. These are called tail events. Likewise, the opposite can happen: you can have a series of huge successes, then a single flop, and go bankrupt. Some companies can afford failures thanks to tail events.

Chapter 7: Freedom

Wealth is about waking up and being able to do whatever you want. People want to be wealthy and happy, but to get there, you first need to be in control of your life. Although we’re richer than ever, most people aren’t in control of their lives due to the nature of their jobs. Happiness isn’t about working more to buy more expensive things. Happiness is about friendships and spending quality time with loved ones.

Chapter 8: Man in the Car Paradox

You never notice the people driving luxury cars. You want an expensive car in order to feel important and admired, but you only care about the object and not the person who owns it. In other words, the important thing is the car, you don’t see the person in the driver’s seat as someone important and worth admiring. The same happens with big houses, jewelry, clothes, and other luxury items. The best way to look for respect and admiration is through kindness, humility, and empathy.

Chapter 9: Wealth Is What You Don’t See

If you see an expensive car, don’t assume the driver is rich. They spent a lot of money on an expensive car after all. Don’t judge wealth by what you see, wealth is about the expensive things you don’t buy. The opposite of being a millionaire is spending millions of dollars. Spend the money you have, not the money you don’t have. Rich is what you see, wealth is what you don’t. The author defines wealth as income not spent. While rich is cars, houses, and private schools, wealth is savings, retirements, and investment portfolios.

Chapter 10: Save Money

There are three kinds of people: the ones who save, the ones who don’t think they can save, and the ones who don’t think they need to save.

Building wealth isn’t about your income or investments, it’s about your savings rate. Focus on what you can control (savings and frugality), not on what you can’t. Learn to be happy with less. To save more money, don’t raise your income, raise your humility. Your ego is making you spend money so that you can show others what you bought. Save by spending less, spend less by wanting less, and want less by not caring about what other people will think of you. You don’t need a specific goal to save money. Life will surprise you and you can be prepared by having some money. Money has tangible benefits (the things you can buy with it) and intangible benefits (flexibility, control over time, and security).

To stand out in the hyper-connected world we live in, you don’t have to be intelligent, but you have to be flexible. This means waiting for opportunities in business and your investments, feeling less urgency to chase others, and having the time to pursue your passions.

Chapter 11: Reasonable > Rational

Don’t try to be rational when making financial decisions, try to be reasonable. You’re a person and people are emotional by nature.

Chapter 12: Surprise!

Investors and economies use history as a guide to the future, but there’s a problem with that. Economy and investing are fields where innovation and change are paramount, so history can’t predict what will happen. Investing is hard to predict because investors have feelings and emotions which makes them hard to predict too. Experiencing certain events doesn’t make you an expert. If anything, it clouds your judgment and makes you overconfident.

When you rely on history as a guide to the future:

You miss outlier events. The most important events in history are called outlier events and these are the ones that affect the economy the most. Some examples include the Great Depression, World War II, the dot-com bubble, and September 11th. The world is surprising, so the most important events that will happen in the future will be unprecedented and we won’t be prepared.
History can be misleading because it doesn’t take structural changes relevant to today’s world into account. Rules change over time.

Chapter 13: Room for Error

Give yourself room for error. The plan that you have might fail and you have to take that into consideration. Uncertainty, randomness, and chance are part of life. Room for error (also known as redundancy or margin of safety) is controlled by odds, not certainty. When trying to predict the future, no one can talk with certainties, they can talk in probabilities.

Never take a risk that can wipe you out. If there’s a slight probability of losing, don’t take the risk. Although the probabilities might be low, you’ll lose at some point in your life and you won’t be able to recover from that. The goal is to survive at all costs. If things can go wrong, they will go wrong. Avoid single points of failure. When it comes to money, never rely on a paycheck to fund short-term needs without savings. What your expenses are right now might change in the future.

Chapter 14: You’ll Change

People can’t predict their own future. You might invest everything you have in a career that you won’t like a few years from now. This makes it difficult to plan for potential financial goals. The problem is that long-term financial planning is important. But you’ll change and your goals will change too. People underestimate how much they’ll change. This is something to bear in mind because according to Charlie Munger, “the first rule of compounding is to never interrupt it unnecessarily.”

For making long-term decisions:

Avoid the extremes of financial planning. Don’t assume you can live with a low income or work for hours on end to afford a life of luxury. Both of these can lead to a life of regret if you ever want to change your life. In compounding, endurance is key, so live a life of moderation.
Accept the fact that you might change your mind at some point. Don’t stick to a decision you took decades ago and no longer believe in.

Chapter 15: Nothing is Free

Everything has a price. When you want to buy something, figure out its price and whether or not you’re willing to pay for it. In investing, you have three options: pay the price, accept volatility, or look for an asset that’s less uncertain and with a lower payoff. Some people want the returns without paying the price first. This ends up costing investors double the price they avoided paying in the first place.

Chapter 16: You and Me

Bubbles don’t happen because people are greedy. The author believes bubbles happen because some investors take advantage of other investors who are playing a different game. Taking financial advice from people who are playing a different game than yours can become a problem.

Chapter 17: The Seduction of Pessimism

A lot of people are attracted to pessimism. Pessimism is more common than optimism and it sounds smarter. Optimism is based on the idea that the odds are in your favor, even when there are problems along the way. Pessimism, on the other hand, sounds smarter and more likely than optimism. So how does pessimism affect how we use money? For most people, losses make more impact than gains. Also, when something bad related to money happens, it captures the attention of everyone because money is ubiquitous. Finally, progress happens slowly and setbacks happen quickly. This is the case because growth depends on compounding which takes time. Destruction, on the other hand, depends on points of failure that happen in seconds.

Chapter 18: When You’ll Believe Anything

When we think about the growth of the economy, we think of tangible things, but stories are more important in the economy because they let the tangible parts work or hold our capabilities back. When thinking about such stories, keep in mind the following:

We believe some things are true because we want them to be true. The author calls them “appealing fictions” and they have an impact on how we view money, the economy, and investments.
You have an incomplete view of the world and we fill in the gaps with a story that makes sense even if it’s not true. The world is extremely complicated and we want to make sense of it somehow, so we tell ourselves stories. This is one of the reasons that might lead to bubbles.

Chapter 19: All Together Now

There are universal truths about money, but people reach different conclusions about how to apply those lessons. This makes finance a complicated subject. With that in mind, the author gives a series of suggestions in the form of a summary.

When everything is going according to plan, find humility. When everything isn’t, find forgiveness.
The world is a complex place.
Luck and risk are difficult to identify, so respect them and focus on what you can control instead.
Less ego means more wealth.
Rich is what you see, wealth is what you don’t.
Time is everything in investing. Given enough time, a small investment can become huge.
Things will go wrong and that’s OK. You can be wrong most of the time and still make a lot of money.
See your investment portfolio as a whole and not as a series of individual investments.
The ultimate goal of money is to let you control your time.
Don’t try to impress anyone with your possessions. To get the respect and admiration of others, use values such as kindness and humility.
Save money and don’t forget that you don’t need a reason to do so. Life is full of surprises and you don’t know what will happen.
Success has a price. Once you define success, you have to be willing to pay its price. Fees such as uncertainty, doubt, and regret are worth paying to get something nice in return.
There should always be room for error.
Endurance is what makes compounding work given enough time.
Your goals and desires will change over time, so avoid extreme financial decisions.
Risk pays off over time, but be paranoid about it too because it can ruin you.
Once you’ve defined the game you’re playing, avoid being influenced by those playing a different game.
When it comes to finances, there isn’t a definitive answer, just an answer that works for you.

Chapter 20: Confessions

There’s a difference between what makes sense and what you actually do. This is because there’s no definitive answer that works for everyone.