Richard Gill, CFA, reviews The Psychology of Money, a book by Morgan Housel, which delves deeper into the personal element of finance and wealth.
Finance is a funny business. What other professions are there where someone with no formal training whatsoever can do better the professionals? The average person on the street will never be able to run a marathon faster than Eliud Kipchoge, contribute a revolutionary physics paper like Einstein or create a deliciously bizarre, three-star culinary treat like Heston Blumenthal.
Yet when it comes to money, time and time again it has been shown that the average Joe can do better than those considered to be “financial geniuses”. What this comes down to, according to a new book from author Morgan Housel, is not how clever you are but how you behave. Or in other words, it’s not what you know, it’s what you do.
In The Psychology of Money, Housel delves deeper into the personal element of finance and wealth, providing a score of short stories looking at the ways people think about their money. As the book shows, a conservative penny pincher with no financial education can turn out to be wealthier than a stubborn, emotive, mathematical genius.
The author is an award winning financial journalist, being a two-time winner of the Best in Business Award from the Society of American Business Editors and Writers and winner of the New York Times Sidney Award. He is also a partner at The Collaborative Fund, a venture capital firm focused on providing seed and early stage funding to technology companies.
Patience vs Greed
The “psychology of money” referred to in the title is defined by the author as a soft skill, where how you behave is more important than what you can learn from an investment book full of ratios and formulas. Through 20 short stories, the core of the book goes on to show how these soft skills can help you to make better financial decisions and be wealthier in the long run. Following on from a 2018 report outlining some of the most important causes of bad behaviour, the author goes more deeply into the topic, describing what he believes to be the most important features of the psychology of money.
The introductory chapter kicks off with the story of two contrasting individuals. Ronald Read was a janitor and gas station attendant all his working life and Richard Fuscone was a Harvard educated finance executive with an MBA. But can you guess which one ended up leaving a seven figure sum to charity and who ended up bust? That’s right, the lowly janitor shared an $8 million fortune between his relatives and charity when he died at the ripe old age of 92 after frugally saving and investing his money in blue-chips stocks over the decades. Fuscone meanwhile went bankrupt following the financial crisis of 2008/9 after taking on huge amounts of debt to buy lavish but illiquid luxury properties.
One of my favourite sections is Chapter 4, which expands on one of the wider themes of Read’s success – that is the importance of long-term compounding of wealth. Titled Confounding Compounding, Housel gives the analogy of how global ice ages work to reflect how money can build up over time. Scientists have found that cool summers, not colder winters, lead to more ice building up as less of it is melted during the hotter months. This bigger base allows more ice to accumulate over time – just like with money. He also discusses how Warren Buffett’s fortune has not been built up solely due to good investing but because he’s been doing it consistently for around 75 years. The point here is not to try to live until you’re 100 years old but to have an appreciation of the power of long-term compounding. Staring to invest earlier on in life will help too – Buffett started when he was just 10 – as will not chasing large but short lived returns.
Wealth is often thought to be demonstrated via possessions. A fast car, big house, shiny jewellery and so on. But in another favourite of mine, Chapter 9, Housel dismisses this idea and instead argues that Wealth is What You Don’t See. Here he makes the distinction between being wealthy and being rich, two words often used synonymously but in fact having a subtle difference. “Rich” refers to current income, which might be used to buy and show off luxury items. But in contrast, “wealth” is hidden and unspent, instead squirreled away in pension plans, investment funds, ISAs and the like. Its value lies its ability to offer you the option to buy more stuff in the future. Therefore, just because someone doesn’t spend money on possessions doesn’t necessarily mean they aren’t wealthy. And just because someone drives a fast car doesn’t mean they are wealthy either – they might have borrowed it or stretched themselves to the financial limit by taking out a crippling loan.
The Psychology of Money is a refreshing and interesting addition to the behavioural finance literature, packed full of wise advice and investment tips without a financial formula in sight. Perhaps the main theme in the book is that humans rarely act like the rational homo economicus, instead basing their financial behaviour on a range of desires and feelings rather than cold and emotionless spreadsheets and equations alone.
And sometimes there’s nothing wrong with that. For example, deciding to pay down your mortgage rather than investing in bonds with a higher interest rate might make you less wealthy according to the numbers. But having the peace of mind of being mortgage free sooner than planned might be priceless. Equally, buying a flashy car to show off your riches might bring you untold happiness and attention from strangers – but according to Chapter 8, Man in the Car Paradox, this is unlikely.
Whatever your desires, The Psychology of Money will help readers to better understand the thinking behind the financial decisions we make and how to become better, not just at investing, but at managing all aspects of your financial life.