The Psychology of Money || Notes from the book

“The line between bold and reckless can be thin. When we dont give risk and luck their proper billing its often invisible”

Our ignorance of chance is dangerous because many people try to gain wealth by imitating the most exceptionally successful people—but thanks to chance, copying what they did often doesn’t lead to success.

“Focus less on specific individuals and case studies and more on broad patterns”

“When things are going extremely well, realize it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly.”

“But the same is true in the other direction. Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk. The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.”

We confuse being wealthy with being rich. He explains that if you’re wealthy, you have a lot of money in the bank. In other words, wealth is money you’re not using but could use if you wanted to.

It’s easy to see and imitate people who are rich—and if you don’t understand they might not also be wealthy, you may assume being wealthy means you can spend money as you wish. But behaving this way will impoverish you. When you understand the difference between being rich and being wealthy, you avoid this trap and prevent yourself from draining your money away.

“To make money they didn’t have and didn’t need, they risked what they did have and did need. And that’s foolish. It is just plain foolish. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.”

The hardest financial skill is getting the goalpost to stop moving. Reputation is invaluable. Freedom and independence are invaluable. Family and friends are invaluable. Being loved by those who you want to love you is invaluable. Happiness is invaluable. And your best shot at keeping these things is knowing when it’s time to stop taking risks that might harm them. Knowing when you have enough.

“The hardest thing about this was that I loved the work. And I wanted to work hard. But doing something you love on a schedule you can’t control can feel the same as doing something you hate.”

The flexibility and control over your time is an unseen return on wealth

In a world where intelligence is hyper-competitive and many previous technical skills have become automated, competitive advantages tilt toward nuanced and soft skills—like communication, empathy, and, perhaps most of all, flexibility.

Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, for as long as you want to, pays the highest dividend that exists in finance.

In his book 30 Lessons for Living, gerontologist Karl Pillemer interviewed a thousand elderly Americans looking for the most important lessons they learned from decades of life experience. He wrote:

• No one—not a single person out of a thousand—said that to be happy you should try to work as hard as you can to make money to buy the things you want.

• No one—not a single person—said it’s important to be at least as wealthy as the people around you, and if you have more than they do it’s real success.

• No one—not a single person—said you should choose your work based on your desired future earning power.

• What they did value were things like quality friendships, being part of something bigger than themselves, and spending quality, unstructured time with their children.

• “Your kids don’t want your money (or what your money buys) anywhere near as much as they want you. Specifically, they want you with them,” Pillemer writes.

• Take it from those who have lived through everything: Controlling your time is the highest dividend money pays. Now, a short chapter on one of the lowest dividends money pays.

95% of Warren Buffett’s net worth came after his 65th birthday

The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong.

Charlie Munger says the first rule of compounding is to never interrupt it unnecessarily.

The S&P 500 increased 119-fold in the 50 years ending 2018. All you had to do was sit back and let your money compound. But, of course, successful investing looks easy when you’re not the one doing it. “Hold stocks for the long run,” you’ll hear. It’s good advice. But do you know how hard it is to maintain a long-term outlook when stocks are collapsing? Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.

Market returns are never free and never will be. They demand you pay a price, like any other product. You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can go to the local county fair where tickets might be $10, or stay home for free. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee—the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.

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.

The ability to stick around for a long time, without wiping out or being forced to give up, is what makes the biggest difference.

What Buffett didn’t do:

• He didn’t get carried away with debt.

• He didn’t panic and sell during the 14 recessions he’s lived through. He didn’t sully his business reputation.

• He didn’t attach himself to one strategy, one world view, or one passing trend.

• He didn’t rely on others’ money (managing investments through a public company meant investors couldn’t withdraw their capital).

• He didn’t burn himself out and quit or retire.

• He survived. Survival gave him longevity. And longevity—investing consistently from age 10 to at least age 89—is what made compounding work wonders. That single point is what matters most when describing his success.

The distribution of success among large public stocks over time is not much different than it is in venture capital. Most public companies are duds, a few do well, and a handful become extraordinary winners that account for the majority of the stock market’s returns.

One of my deeply held investing beliefs is that there is little correlation between investment effort and investment results. The reason is because the world is driven by tails—a few variables account for the majority of returns. No matter how hard you try at investing you won’t do well if you miss the two or three things that move the needle in your strategy. The reverse is true. Simple investment strategies can work great as long as they capture the few things that are important to that strategy’s success.

Building wealth has little to do with your income or investment returns and lots to do with your savings rate

Past a certain level of income, what you need is just what sits below your ego

Less ego, more wealth. Saving money is the gap between your ego and your income, and wealth is what you don’t see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today.

Save. Just save. You don’t need a specific reason to save. It’s great to save for a car, or a downpayment, or a medical emergency. But saving for things that are impossible to predict or define is one of the best reasons to save. Everyone’s life is a continuous chain of surprises. Savings that aren’t earmarked for anything in particular is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.

Investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing, which can make even smart people nervous, greedy and paranoid.

The most important driver of anything tied to money is the stories people tell themselves and the preferences they have for goods and services. Those things don’t tend to sit still. They change with culture and generation. They’re always changing and always will.

Realizing the future might not look anything like the past is a special kind of skill that is not generally looked highly upon by the financial forecasting community.

There is never a moment when you’re so right that you can bet every chip in front of you. The world isn’t that kind to anyone—not consistently, anyways. You have to give yourself room for error. You have to plan on your plan not going according to plan.

There are a few specific places for investors to think about room for error. One is volatility. Can you survive your assets declining by 30%? On a spreadsheet, maybe yes—in terms of actually paying your bills and staying cash-flow positive. But what about mentally? It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest.

Nassim Taleb says, “You can be risk loving and yet completely averse to ruin.” And indeed, you should. The idea is that you have to take risk to get ahead, but no risk that can wipe you out is ever worth taking. The odds are in your favor when playing Russian roulette. But the downside is not worth the potential upside. There is no margin of safety that can compensate for the risk.

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. It’s surprising how few of us do.

We call everyone investing money “investors” like they’re basketball players, all playing the same game with the same rules. When you realize how wrong that notion is you see how vital it is to simply identify what game you’re playing. How I invest my own money is detailed in chapter 20, but years ago I wrote out “I am a passive investor optimistic in the world’s ability to generate real economic growth and I’m confident that over the next 30 years that growth will accrue to my investments.” This might seem quaint, but once you write that mission statement down you realize everything that’s unrelated to it—what the market did this year, or whether we’ll have a recession next year—is part of a game I’m not playing. So I don’t pay attention to it, and am in no danger of being persuaded by it.

There is an iron law in economics: extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways.

Assuming that something ugly will stay ugly is an easy forecast to make. And it’s persuasive, because it doesn’t require imagining the world changing. But problems correct and people adapt. Threats incentivize solutions in equal magnitude. That’s a common plot of economic history that is too easily forgotten by pessimists who forecast in straight lines.

At the personal level, there are two things to keep in mind about a story-driven world when managing your money. 1. 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.

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. The world is big and complex. Luck and risk are both real and hard to identify. Do so when judging both yourself and others. Respect the power of luck and risk and you’ll have a better chance of focusing on things you can actually control. You’ll also have a better chance of finding the right role models.

Manage your money in a way that helps you sleep at night. That’s different from saying you should aim to earn the highest returns or save a specific percentage of your income. Some people won’t sleep well unless they’re earning the highest returns; others will only get a good rest if they’re conservatively invested. To each their own. But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions.

If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve. Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune, because a small minority of things account for the majority of outcomes. No matter what you’re doing with your money you should be comfortable with a lot of stuff not working. That’s just how the world is. So you should always measure how you’ve done by looking at your full portfolio, rather than individual investments. It is fine to have a large chunk of poor investments and a few outstanding ones. That’s usually the best-case scenario.