Psychology of Money


Two topics affect your life whether you are interested or not: money and health. Financial outcomes are driven in large part by luck, which is independent of talent, effort and behavior. How you behave matters more than what you do.

It is possible for someone with no college degree, no training, no formal experience or connections to outperform someone with a the best college degree and best training in finance.

Why is managing our finances hard? Concepts like 401(k) are only ~40 years old which makes it new to us.

Each person has gone through different experiences, which influence how they make their financial descision. For example, one might have grew up through poverty, lived in age of inflation, or may not have seen inflation, been through the Great Depression or the housing crisis and it all influences their financial decisions in different ways. What may make perfect sense someone can seem wrong or incorrect to other. No one is crazy - everyone makes decision which are sensible to them.

Luck and risk plays a huge role on the returns of your investment. They influence our outcome way beyond our indivdidual effort. The extreme examples highlighted by the media are cases of luck/risk playing huge roles. The dangerous part of this is trying to learn from the extreme examples. What investing strategies work? What doesn't? What business strategis work? What doesn't? A CEO who pushes his employees hard and a CEO who gives freedom to his employees - both make good business stories of management depending on the story. Customer is always right and customer doesn't know what he wants are both accepted business wisdoms. Instead, look at broad general patterns.

When we fail, we blame it on risk. When someone else fails, we look for a cause and effect. We say to ourselves convincing stories. Failure can be due to a good decision turning wrong.

Enough is realizing that an insatiable appetite for more will push you to the point of regret. When you have enough to cover every reasonable thing, stop moving the goalpost in search of more. Don't risk what you have and need for what you don't have and don't need. Some of the greatest things are reputation, freedom, independence, friends and family are invaluable. Don't risk them for something you don't want. A rookie baseball player who earns compares his $500,000 to top baseball earns who earns $300 million. The top baseball player compares himself to the top hedge fund managers, who make $700 million. The top hedge fund manager compares them to the billionaires. Social comparison is an endless game. The only way to win the game is not to play it.

Warren Buffets's net worth is $84.5 billion. Of that, $84.2 billion accumulated after his 50th birthday, $81.5 billion after he became qualified for social security. Compounding confounds. Because it is too hard to imagine how small consistent growth, when accumulated over time, leads to enormous results. Good investing is not about achieving the highest one-time returns because the highest-returns tend to be outliers. It is about earning pretty good returns and sticking around with them for long time to allow compounding to show it's effects.

Getting wealthy requires taking risks and being optimistic. Staying wealthy requires humility and fear, the fear that things could go wrong and success may not repeat indefinitely. Things won't be like yesterday and you can't afford to stay complacent. You must plan on the plan not going according to the plan. Your plan should allow room for error - that even if things does not happen as expected, you will be able to survive so that the odds turn in your favor in long run. A room for error allows you to live with a range of outcomes and increases your chances of survival. If your plan depends too much on edge cases and conditions to be satisfied for the plan to succeed, then you have too much room for error as a single failure point can cause the entire plan to derail.

Every thing that can break will eventually break. You should be financially unbreakable, so that you can stick around for long. Survival requires fear of things going awry. Survival gives longevity, and longevity allows compounding to do wonders. Nobody wants to hold cash in a bull market but if that cash allows you to survive a bad bear market without selling your stocks, then the returns on the cash is invaluable. Have a survival mentality. Be optimistic about the future, but also be paranoid on what can prevent you from getting to the future. Sensible optimism is the belife that odds will be in your favor and over time, things will balance out even if the path in between is filled with misery. Economies, careers, and markets follow the path of growth amid loss.

Walt disney made several hundreds hours of films, despite which Disney was in debt. The 83 minute Snow White and Seven Dwarf earned $8 million, compensating for all the other losses and earning Disney a fortune. Take venture captialism - out of 50 investments, about half will fail, 10 will do pretty well and one or two will be bonanza, driving most of the fund returns. Amazon drove 6% of S&P 500's returns in 2018. In Amazon, the primary growth was due to Prime Video and Amazon Web Services, which itself are tail events in a company that has experimented with hundreds of product. The people working in these companies have tail careers - Google's hiring acceptance rate is 0.2%. The big winners which we see are tail events - they are rare and powerful. It is normal for things to fail. An investor can be wrong half the time but he can still make a fortune because it is the tails which drive the results. If you are a good investor, most years will be okay and plenty will be bad. If you are a good worker, you will find the right company in the right field after several attempts and trial. If you are a good business leader, maybe half of your ideas and products will succeed. When we look at our own failures, setbacks and losses, we feel did we have done something wrong. But it's possible that it is how things are.

In a survey of elderly men in America, no one said that to be happy you have to work hard to make money to buy things you want. No one said that to be happy, you have to be at least as wealthy as the people around you. What they did value was quality friendship, being part of something bigger than themselves and spending quality, unstructured time with their children. Having a strong sense of controlling one's life is a more dependable predictor of positive feelings of well-being. You have happiness when you have control over your time. Control over doing what you want to, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy. Use money to gain control over your time, thus having the ability to do what you want, when you want, for as long as you want which is the infinite returns on investment. You can wait for the right opportunity, you don't need to worry about your boss, you can quit when you wish to quit or take a break, you can take a medical emergency break. The biggest dividend which money pays is freedom.

You think that having a luxury car sends a strong signal that you made it but people don't admire the man in the luxury car, they admire the car and use it as a benchmark for their own desire to be liked and admired. Don't use money for gaining respect and admiration. There are other ways for it - humility, empathy, kindness and via a good character.

Wealth is what you don't see. A person who owns a Rolls-Royce is rich but he may not be wealthy. The only data-point which we have about a person who owns a $100, 000 car is that person has now less than $100, 000 than they did before they bough that car. Wealth is the money not spent - your assets, the money lying in your bank account, the savings, your investment portfolios.

Save. It gives you flexibility to wait for good opportunities, both in career and for your investments. You don't need a particular reason to save, like saving for a house or retirement. It is easier to increase the savings rate rather than to increase the returns of investment. Returns on investment are shrouded in uncertainity - it depends on the market and other factors. But if you are powered by frugality and efficiency by saving, you can accumulate more wealth. When you spend on things, you end up with things and not money.

Every person needs a basic requirements to live. Then, a set of requirement to live a comfortable life. After that, a set of requirement to live a comfortable and enjoyable life. Anything you spend after that is for your ego. Savings can be created by spending less. You will spend less if you desire less. You will desire less if you care about what others think of you.

Be reasonable over being rational. If the investment allows you to sleep peacefully over night, choose it instead of choosing formulas for portfolio allocation. By being reasonable, it gives you a reason to be committed to your investment strategy in the lean years.

Things that have never happened before happen all the time. The world is driven by tail events - World War 2, September 11th, etc. When you rely on worst-case scenarios based on the past to manage your investments, you are assuming that the future worst will be less worse than the historic worse. The world is surprising. Don't rely on history to manage your investments. The formulas which the famous investor and author Benjamin Graham advocated were updated five times between 1934 and 1972. Do you think the formulas will be relevant in 2020? Or 2050? Things change.

Assuming you will be happy with low income and not saving or working your tails-off for a high income may lead you to a point of regret as you'll change over time. Have things in moderation because it minimizes regret.

Markets will be volatile and consider the volatility as a fee which you pay for allowing the wealth to compound instead of thinking about them as fines or losses.

For day traders, it is important whether prices move in the rigt direction or not that day. Short term investors look for gains in short-time periods. For them, short term profits or earnings, like the quaterly earnings of a company are important. Medium term investores are looking for gains in the period of a decade. They look at the industry before judging to invest in a company. Long term investors wait patiently for 30 years. When the short-term investors drive the price high, other medium and long-term investors joins them. And as the process feeds on itself, it becomes a bubble. For a short-term investor, it is okay to buy a stock at high price because the short-term investor has planned to sell the stock before the end of a month, when the price would be even higher. But for the long-term investor, buying at a high price is a disaster.

Optimism is the belief that in the long run, odds will be in your favor, even when there is setbacks along the way. The foundation in optimism is that most people wake up in the morning, trying to make things a little better than wake up to cause trouble. Setbacks occur quickly but progress happens more slowly. A wrong email can destroy your career quickly but progress in career takes time. Pessimism is more eye-catching than optimism. The powerful pull of optimism tends to go unnoticed. In investing, you must be willing to pay the small prices - the market volatility, losses amid the long backdrop of growth.

People believe in stories as it give them the feeling that they understand the world and they are in control. Since the world of finance is messy, no narrative is complete. There is no answer that works for everyone because everyone is different. Hence, do what works for you.

Charlie Munger mentioned once said "I did not intend to get rich. I just wanted to get independent."