Book Notes: The Psychology of Money
No One's Crazy
- Your personal experiences with money make up maybe 0.000000001% of what's happened in the world, but maybe 80% of how you think the world works.
- People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons.
- If you were born in 1970, the S&P 500 increased almost 10-fold, adjusted for inflation, during your teens and 20s. That's an amazing return. If you were born in 1950, the market went literally nowhere in your teens and 20s adjusted for inflation. Two groups of people, separated by chance of their birth year, go through life with a completely different view on how the stock market works.
- A Foxconn worker said "We do not have the same opportunities as the West. Our governmental infrastructure is different. The country is different. Yes, factory is hard labor. Could it be better? Yes, but only when you compare such to American jobs."
- No one should expect them to agree on what matters, what's worth it, what's likely to happen next, and what's the best path forward is. Their view of money was formed in different worlds. And when that's the case, a view about money that one group of people thinks is outrageous can make perfect sense to another.
Luck & Risk
- In 1968, there are roughly 303 million high-school-age people in the world. About 18 million of them lived in the US. About 270,000 of them lived in Washington state. A little over 100,000 of them lived in the Seattle area. And only about 300 of them attended Lakeside School. One in a million high-school-age students attended the high school that had the combination of cash and foresight to buy a computer. Bill Gates happened to be one of them. Gates is not shy about what this meant. "If there had been no Lakeside, there would have been no Microsoft."
- Now let me tell you about Gates' friend Kent Evans. He experienced an equally powerful dose of luck's close sibling, risk. Kent Evans and Bill Gates became best friends in eighth grade. Evans was, by Gates' own account, the best student in the class. Kent could have been a founding partner of Microsoft with Gates and Allen. But it would never happen. Kent died in a mountaineering accident before he graduated high school. The odds of being killed on a mountain in high school are roughly one in a million.
- The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on different side.
- The dangerous part is that we're all trying to learn about what works and what doesn't with money. What investing strategies work? Which ones don't? What business strategies work? Which ones don't? How do you get rich? How do you avoid being poor? We tend to seek out these lessons by observing successes and failures and saying, "Do what she did, avoid what he did." We have brains that prefer easy answers without much appetite for nuance. So identifying the traits we should emulate and avoid can be agonizingly hard.
- Facebook not selling to Yahoo was genius. Yahoo not selling to Microsoft was a mistake. Countless fortunes (and mistakes) owe their outcomes to leverage. The best (and worst) managers drive their employees as hard as they can. "The customers are always right" and "customers don't know what they want" are both accepted business wisdom. The line between "inspiringly bold" and "foolishly reckless" can be a millimeter thick and only visible with hindsight. Risk and luck are doppelgängers.
- Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming. Therefore, 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. On the other hand, we should forgive ourselves and leave room for understanding when judging failures.
- At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day over its whole history. Heller responds, "Yes, but I have something he will never have ... enough."
- The hardest financial skill is getting the goalpost to stop moving. It gets dangerous when the taste of having more -- more money, more power, more prestige -- increases ambition faster than satisfaction.
- Social comparison is the problem here. A rookie baseball players who earns $500k a year envies Mike Trout who has a 12-year, $430 million contract envies a hedge fund manager who makes $340 million a year envies Warren Buffett who had a $3.5 billion increase in fortune in 2018.
- Enough is not too little. The idea of having "enough" may look like conservatism, leaving opportunities and potential on the table. No, "enough" is realizing the opposite -- an insatiable appetite for more -- will push you to the point of regret.
- There are many things never worth risking, no matter the potential gain. Reputation is invaluable. Freedom and independence are invaluable. Friends and family 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.
- $81.5 billion of Warren Buffet's $84.5 billion net worth came after his 65th birthday. Our minds are not built to handle such absurdities.
- Jim Simons, head of the hedge fund Renaissance Technologies, has compounded money at 66% annually since 1988. Simon's net worth is $21 billion, 75% less rich than Buffet, because Simons did not find his investment stride until he was 50 years old, whereas Buffet seriously started investing at age 10, even though his annual return is only 22%.
- From 1950 to 1990, we gained 296 megabytes in terms of hard drive space. From 1990 through today, we gained 100 million megabytes. If you were a technology optimist in the 1950s you may have predicted that practical storage would become 1,000 times larger. Few would have said "30 million times larger within my lifetime." But that's what happened.
Getting Wealthy vs. Staying Wealthy
- 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. It requires frugality and an acceptance that at least some of what you've made is attributable to luck, so past success can't be relied upon to repeat indefinitely.
- More than I want big returns, I want to be financially unbreakable. And if I'm unbreakable I actually think I'll get the biggest returns, because I'll be able to stick around long enough for compounding to work wonders. Good returns sustained uninterrupted for the longest period of time will always win.
- Planning is important, but the most important part of every plan is to plan on the plan not going according to plan. Many bets failed not because they were wrong, but because they were mostly right in a situation that required things to be exactly right.
- A barbelled personality -- optimistic about the future, but paranoid about what will prevent you from getting to the future -- is vital. During the past 200 years, the stock market feel more than 10% from a recent high at least 102 times and lost a third of the value at least 12 times, even though GDP rose 30x in the time span.
Tails, You Win
- In 2018, Amazon drove 6% of the S&P 500's returns. And AMazon's growth is almost entirely due to Prime and Amazon Web Services, which itself are tail events in a company that has experimented with hundreds of products, from the Fire Phone to travel agencies.
- Apple was responsible for almost 7% of the index's returns in 2018. And it is driven overwhelmingly by the iPhone, which in the world of tech products is as tail--y as tails get.
- And who's working at these companies? Google's hiring acceptance rate if 0.2%. Facebook's is 0.1%. Apple's is about 2%. So the people working on these tail projects that drive tail returns have tail careers.
- When you accept that tails drive everything is business, investing and finance you will realize that it's normal for lots of things to go wrong, break, fail and fall. If you are a good stock picker you'll be right maybe half the time. If you're a good business leader maybe half of your product and strategy ideas will work. If you're a good investor most years will be just OK, and plenty will be bad. If you're a good worker you'll find the right company in the right field after several attempts and trials. And that's if you're good.
- At the Berkshire Hathaway shareholder meeting in 2013 Warren Buffet said he's owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger followed up: "If you remove just a few of Berkshire's top investments, its long-term track record is pretty average.
- When we pay special attention to a role model's successes we overlook that their gains came from a small percent of their actions. That makes our own failures, losses, and setbacks feel like we're doing something wrong.
- There are 100 billion planets in our galaxy and only one, as far as we know, with intelligent life.
- The highest form of wealth is the ability to wake up every morning and say "I can do whatever I want today." The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.
- Research has shown having a strong sense of controlling one's life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.
- People like to feel like they're in control -- in the drivers' seat. When we try to get them to do something, they feel disempowered. Rather than feeling like they made the choice, they feel like we made it for them. So they say no or do something else, even when they might have originally been happy to go along.
- The author realized why investment bankers make a lot of money: They work longer and more controlled hours than he knew humans could handle. The job was intellectually stimulating, paid well, and made him feel important. But every waking second of his time became a slave to his boss's demands, which was enough to turn it into one of the most miserable experiences of his life.
- If your job is a thought-based and decision job, your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you're making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning. You might be on the clock for fewer hours than you would in 1050. But it feels like you're working 24/7.
Man in the Car Paradox
- When you see someone driving a nice car, you rarely think, "Wow, the guy driving that car is cool." Instead, you think, "Wow, if I had that car people would think I'm cool." There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. But in reality, those other people often bypass admiring you, not because they don't think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.
- People generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine. If respect and admiration are your goal, be careful how you see it. Humility, kindness, and empathy will being you more respect than horsepower ever will.
Wealth is What You Don't See
- We tend to judge wealthy by what we see, because that's the information we have in front of us. We can't see people's bank accounts or brokerage statements. So we rely on outward appearances to gauge financial successes. Cars. Homes. Instagram photos.
- Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes forgone and the first-class upgrade declined. Wealth is the financial assets that you haven't yet been converted into the stuff you see.
- The problem for many of us is that it is easy to find rich role models. It's harder to find wealthy ones because by definition their success is more hidden.
- The first idea -- simple, but easy to overlook -- is that building wealth has little to do with your income or investment returns, and lots to do with your savings rate.
- The value of wealth is relative to what you need. Past a certain level of income, what you need is just what sits below your ego. So people's ability to save is more in their control than they might think. And you don't need a specific reason to save. One of the most powerful ways to income your savings isn't to raise your income. It's to raise your humility.
- Flexibility and control over your time is an unseen return on wealth. And that hidden return is becoming more important. 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. Having more control over your time and options is becoming one of the most valuable currencies in the world.
Reasonable > Rational
- You're not a spreadsheet. You're a person. A screwed up, emotional person. Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it in the long run, which is what matters most when managing money.
- "Minimizing future regret" is hard to rationalize on paper but easy to justify in real life. A rational investor makes decisions based on numeric facts. A reasonable investor makes them in a conference room surrounded by co-workers you want to think highly of you, with a purpose you don't want to let down, or judged against the silly but realistic competitors that are your brother-in-law, your neighbor, and your own personal doublets. Investing has a social component that's often ignored when viewed through a strictly financial lens.
- Day trading and picking individual stocks is not rational for most investors -- the odds are heavily against your success. But they're both reasonable in small amounts if they scratch an itch hard enough to leave the rest of your more diversified investments alone.
- History is mostly the study of surprising events. But it is often used by investors and economists as an unassailable guide to the future. Do you see the irony? Do you see the problem?
- You'll likely miss the outlier events that move the needles the most. The Great Depression, World War II, The Manhattan Project, Vaccines, Antibiotics, ARPANET, September 11th, The fall of the Soviet Union. How many projects and events occurred in the 20th century? Billions, trillions -- who knows. But those eight alone impacted the world orders upon orders of magnitude more than others. The thing that makes tail events easy to under appreciate is how easy it is to underestimate how things compound. For example, 9/11 actually led to $1.6 trillion in student loans with a 1.8% default rate.
- History can be a misleading guide to the future of the economy and stock market because it doesn't account for structural changes that are relevant to today's world. The 401k is 42 years old. The Roth IRA is younger. Venture capital barely existed 25 years ago. The S&P did not include financial stocks until 1976; today, financials make up 16% of the index. Technology stocks were virtually nonexistent 50 years ago. Today, they're more than a fifth of the index.
- The further back in history you look, the more general your takeaways should be. General things like people's relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff. But specific trends, specific trades, specific sectors, specific causal relationships about markets, and what people should do with their money are always an example of evolution in progress. Historians are not prophets.
Room for Error
- History is littered with good ideas taken too far, which are indistinguishable from bad ideas. The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance -- "unknowns" -- are an ever-present part of life. The only way to deal with them is by increasing the gap between what you think will happen and what can happen while still leaving you capable of fighting another day.
- 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 and mentally? Another is saving for retirement. What if future returns are lower? What if you need to cash out your retirement accounts in your 30s to pay for a medical mishap?
- You have to take risk to get ahead, but no risk that can wipe you out is ever worth taking. A homeowner wiped out in 2009 had no chance of taking advantage of cheap mortgage rates in 2010. Lehman Brothers had no chance of investing in cheap debt in 2009.
- A good rule of thumb for a lot of things in life is that everything that can break will eventually break. If there's one way to guard against damage, it's avoiding single points of failure.
- Long-term planning is harder than it seems because people's goals and desires change over time.
- The End of History Illusion is what psychologists call the tendency for people to be keenly aware of how much they've changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.
- We should avoid the extreme ends of financial planning. Assuming you'll be happy with a very low income, or choosing to work endless hours in pursuit of a high one, increases the odds that you'll one day find yourself at a point of regrets. Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increase the odds of being able to stick with a plan and avoid regret than if any one of those thinning fall to the extreme sides of the spectrum.
- We should also accept the reality of changing our minds. Some of the most miserable workers I've met are people who stay loyal to a career only because it's the field they picked when deciding on a college major at age 18.
- Sunk costs are a devil in a world where people change over time. Embracing the idea that financial goals made when you were a different person should be abandoned without mercy versus put on life support and dragged on can be a good strategy to minimize future regret.
- 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 do you know how hard it is to maintain a long-term outlook when stocks are collapsing?
- Netflix stock returned more than 35,000% from 2002 to 2018, but traded below its previous all-time high on 94% of the days.
- Here's the important part. Like the car, you have a few options: You can buy this price, accepting volatility and upheaval. Or you can find an asset with less uncertainty and a lower payout, the equivalent of a used var. Or you can attempt the equivalent of grand-theft auto: Try to get the return while avoiding the volatility that comes with it. You attempt to use before the next recession and buy before the next boom.But the Money Gods do not look highly upon those who seek reward without paying the price. Some var thieves will get away with it. Many more will be caught and punished.
- It sounds trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.
You & Me
- AN idea exists in finance that seems innocent but has done incalculable damage. It's the notion that assets have one rational price in a world where investors have different goals and time horizons.
- An iron rule of finance is that money chases returns to the greatest extent that it can. If an asset has momentum -- it's been moving consistently up for a period of time -- it's not crazy for a group of short-term traders to assume it will keep moving up. Not indefinitely; just for a short period of time they need it to. Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.
- When a commentator on CNBC says, "You should buy this stock," keep in mind that they do not know who you are. Are you a teenager trading for fun? An elderly window on a limited budget? A hedge fund manager trying to shore up your books before the quarter ends? Are we supposed to think those three people have the same priorities, and that whatever level a particular stock is trading at is right for all three of them?
- 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 Seduction of Pessimism
- If a smart person tells me they have a stock pick that's going to rise 10-fold in the next year, I will immediately write them off as full of nonsense. If someone who's full of nonsense tells me that a stock I own is about to collapse because it's an accounting fraud, I will clear my calendar and listen to their every word.
- Money is ubiquitous, so something bad happening tends to affect everyone and captures everyone's attention. Stock rising 1% might be briefly mentioned in the evening news. But a 1% fall will be reported in bold, all-caps letters usually written in blood red.
- Pessimists often extrapolate present trends without accounting for how markets adapt. 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.
- Progress happens too slowly to notice, but setbacks happen too quickly to ignore. There are lots of overnight tragedies. There are rarely overnight miracles. A 40% decline in the stock market that takes place in six months will draw congressional investigations, but a 140% gain that takes place over six years can go virtually unnoticed.
When You'll Believe Anything
- 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. Consider that 85% of active mutual funds underperformed their benchmark over the 10 years ending 2018. That figure has been fairly stable for generations. You would think an industry with such poor performance would be a niche service and have a hard time staying in business. But there's almost give trillion dollars invested in these funds. Give someone the chance of investing alongside "the next Warren Buffett" and they'll believe with such faith that millions of people will put their life savings behind it.
- Everyone has an incomplete view of the world. But we form a complete narratives to fill in the gaps. We all want the complicated world we live in to make sense. So we tell ourselves stories to fill in the gaps of what are effectively blind spots.
- When planning we focus on what we want to do and can do, neglecting the plans and skills of others whose decisions might affect our outcomes. Both in explaining the pst and in predicting the future, we focus on the causal role of skill and neglect the role of luck. We focus on what we know and neglect what we do not know, which makes us overly confident in our beliefs.
All Together Now
- There are universal truths in money, even if people come to different conclusions about how they want to apply those truths to their own finances.
- Go out of your way to find humility when things are going right and forgiveness/compassion when they go wrong.
- Less ego, more wealth.
- Manage your money in a way that helps you sleep at night.
- If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon.
- Become OK with a lot of things going wrong. You can be wrong half the time and still make a fortune.
- Use money to gain control over your time.
- Be nicer and less flashy.
- Save. Just save. You don't need a specific reason to save.
- Define the cost of success and be ready to pay it.
- Worship room for error.
- Avoid the extreme ends of financial decisions.
- You should like risk because it pays off over time.
- Define the game you're playing.
- Respect the mess.