My 6 Top Learnings from Psychology of Money
I’ve read many books about investing, personal finance, and money. Some focus on creating valuable businesses (The Millionaire Fastlane, Million Dollar Weekend) others focus on automating your job (The 4-Hour Workweek) and others focus on the investment side (The Intelligent Investor, Psychology of Money).
As I outlined in this article, one of the best books about the topic is Psychology of Money by Morgan Housel. In this article, I want to share my top 6 learnings from the book.
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| Photo by Alexander Grey on Unsplash |
1. Luck and risk
Luck and risk are closely intertwined and one cannot exist without the other. The price for investments and their profit is volatile.
This is not a new learning at all, but a confirmation of common knowledge.
The fact that there can also be large extremes in normally distributed environments is emphasized very well in Calling Bullshit. A good example is the success story of Bill Gates as outlined in the book Outliers - he was in the right place at the right time.
2. There is no goal
Money has no goal - if you reach a certain level of wealth, the default mode is to strive for even more.
However, it is important not to take any risks that threaten your existence, or to paraphrase Warren Buffet: you should never risk something you need to gain something you don’t need.
3. Room for error
You shouldn’t threaten your existence with your investments.
You also shouldn’t calculate with over-optimistic assumptions. If you plan on relying on your future capital returns there should be a buffer.
You should have room for errors. A personal strategy of the author, Morgan Housel, is the following: he starts from historical returns and deducts 1/3 of the return as “room for error”.
4. Compound interest
Compound interest is the eighth wonder of the world. He who understands it earns it. He who doesn’t pays it.” - Albert Einstein
Compound interest is powerful and can - at a certain point - outweigh the gains from your initial capital.
However, the compound interest effect is challenging to understand for us humans. We usually think in a linear way and not in exponential relationships. We humans are just bad intuitive statistics, as Daniel Kahneman puts it (Thinking, Fast and Slow).
To visualize the potential of the compound interest effect, calculations as well as tables and visualizations are good tools.
5. Tails (or black swans)
The extreme values (“tails”) bring the greatest success.
How can you take advantage of this?
If you invest during a recession, you can outshine 10 “normal” investment years or, to put it another way, a quote from Napoleon: “In war, those who do ordinary things are the most successful, while the majority go crazy.”
6. Freedom
On the subject of freedom: in a work context, it is important to create an environment in which people can control their actions (or at least believe they can). Because even if you do something that you enjoy doing under someone else’s instructions or schedule, it can feel like something you hate.
Freedom, or let’s call it independence is the ultimate goal for investments!
As studies show, it is our independence that makes us happiest. Morgan Housel defines independence as doing what you want to do, with whom you want to do it, and for as long as you want to do it.