The Psychology of Money

History never repeats itself, man does.

People do crazy things, but no one is crazy.

• No amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.

• Some lessons have to be experienced before they can be understood.

Nothing is as good or as bad as it seems.

• Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming. 

• Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.

• Therefore, focus less on specific individuals and case studies and more on broad patterns.

• You’ll get closer to actionable takeaways by looking for broad patterns of success and failure. The more common the pattern, the more applicable it might be to your life.

• There is no reason to risk what you have and need for what you don’t have and don’t need.It’s one of those things that’s as obvious as it is overlooked.

Building enough - Compounding

• Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.

Getting Wealthy vs. Staying Wealthy

• There's only one way to stay wealthy: some combination of frugality and paranoia.

• A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.

You can be wrong half of the time and still make a fortune

• A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.

• Tails drive everything.

• When you accept that tails drive everything in business, investing, and finance you realize that it’s normal for lots of things to go wrong, break, fail, and fall.

• If you’re 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.

Freedom - Controlling your time is the highest dividend money pays.

A wise old owl lived in an oak,

The more he saw the less he spoke,

The less he spoke, the more he heard,

Why aren’t we all like that wise old bird?

No one is impressed by your possessions except you are.

• You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does—especially from the people you want to respect and admire you.

• Humility, kindness, and empathy will bring you more respect than horsepower ever will.

Wealth is what you don’t see

• The only way to be wealthy is to not spend the money that you do have. It’s not just the only way to accumulate wealth; it’s the very definition of wealth.

Save Money

• If you have flexibility you can wait for good opportunities, both in your career and for your investments. You’ll have a better chance of being able to learn a new skill when it’s necessary. You’ll feel less urgency to chase competitors who can do things you can’t, and have more leeway to find your passion and your niche at your own pace. You can find a new routine, a slower pace, and think about life with a different set of assumptions. The ability to do those things when most others can’t is one of the few things that will set you apart in a world where intelligence is no longer a sustainable advantage.

• Having more control over your time and options is becoming one of the most valuable currencies in the world.

Reasonable vs. 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 for the long run, which is what matters most when managing money.

The world is surprising

• Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make that mistake again.’ But, in fact, what you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. 

• The correct lesson to learn from surprises is that the world is surprising. Not that we should use past surprises as a guide to future boundaries; that we should use past surprises as an admission that we have no idea what might happen next.

• The four most dangerous words in investing are, ‘it’s different this time.’

• 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

• You have to plan on your plan not going according to plan.

• Warren Buffett expressed a similar idea when he told Berkshire Hathaway shareholders in 2008: “I have pledged—to you, the rating agencies and myself—to always run Berkshire with more than ample cash ... When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.”

• Use room for error when estimating your future returns. This is more art than science. For my own investments, I assume the future returns I’ll earn in my lifetime will be ⅓ lower than the historic average. So I save more than I would if I assumed the future will resemble the past. It’s my margin of safety. The future may be worse than ⅓ lower than the past, but no margin of safety offers a 100% guarantee. A one-third buffer is enough to allow me to sleep well at night. And if the future does resemble the past, I’ll be pleasantly surprised. 

• “The best way to achieve felicity is to aim low,” says Charlie Munger.

You will change

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

• 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 quicker it’s done, the sooner you can get back to compounding.

You and Me

• Investors have different goals and time horizons.Ask yourself: How much should you pay for Google stock today? The answer depends on who “you” are.

• Do you have a 30-year time horizon? Then the smart price to pay involves a sober analysis of Google’s discounted cash flows over the next 30 years.

• Are you looking to cash out within 10 years? Then the price to pay can be figured out by an analysis of the tech industry’s potential over the next decade and whether Google management can execute on its vision.

• Are you looking to sell within a year? Then pay attention to Google’s current product sales cycles and whether we’ll have a bear market.

• Are you a day trader? Then the smart price to pay is “who cares?” because you’re just trying to squeeze a few bucks out of whatever happens between now and lunchtime, which can be accomplished at any price.

• When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.

Pessimism is seductive

• Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.

When you will believe everything

• If you desperately need a solution and a good one isn’t known or readily available to you, you are willing to believe anything. Not just try anything, but believe it. (When you have no money and your son is sick, you believe everything)

• History cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art. Those who read history tend to look for what proves them right and confirms their personal opinions. They defend loyalties. They read with a purpose to affirm or to attack. They resist inconvenient truth since everyone wants to be on the side of the angels. Just as we start wars to end all wars.

• Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.

• Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense. That’s a big deal in producing mistakes in many fields.

• 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 past 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.

Putting all together

• 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.

• 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.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. Judging how you’ve done by focusing on individual investments makes winners look more brilliant than they were, and losers appear more regrettable than they should.

• 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.

• Be nicer and less flashy. No one is impressed with your possessions as much as you are. You might think you want a fancy car or a nice watch. But what you probably want is respect and admiration. And you’re more likely to gain those things through kindness and humility than horsepower and chrome.

• 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.

• Define the cost of success and be ready to pay it. Because nothing worthwhile is free. And remember that most financial costs don’t have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid).

• Worship room for error. A gap between what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time. Room for error often looks like a conservative hedge, but if it keeps you in the game it can pay for itself many times over.

• Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the more you may regret them as you evolve.You should like risk because it pays off over time. But you should be paranoid of ruinous risk because it prevents you from taking future risks that will pay off over time.

• Define the game you’re playing, and make sure your actions are not being influenced by people playing a different game.

• Respect the mess. Smart, informed, and reasonable people can disagree in finance, because people have vastly different goals and desires. There is no single right answer; just the answer that works for you.

• There’s a mile-wide gap between what makes sense - which is what people suggest you do - and what feels right to them - which is what they actually do.

How I think of investing

• If I had to summarize my views on investing, it’s this: Every investor should pick a strategy that has the highest odds of successfully meeting their goals. And I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.T

• Beating the market should be hard; the odds of success should be low. If they weren’t, everyone would do it, and if everyone did it there would be no opportunity. So no one should be surprised that the majority of those trying to beat the market fail to do so. (The statistics show 85% of large-cap active managers didn’t beat the S&P 500 over the decade ending 2019.)

• I know people who think it’s insane to try to beat the market but encourage their kids to reach for the stars and try to become professional athletes. To each their own. Life is about playing the odds, and we all think about odds a little differently.

• Over the years I came around to the view that we’ll have a high chance of meeting all of our family’s financial goals if we consistently invest money into a low-cost index fund for decades on end, leaving the money alone to compound. A lot of this view comes from our lifestyle of frugal spending. If you can meet all your goals without having to take the added risk that comes from trying to outperform the market, then what’s the point of even trying? 

• I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us. I know not everyone will agree with that logic, especially my friends whose job it is to beat the market. I respect what they do. But this is what works for us.

• We invest money from every paycheck into these index funds—a combination of U.S. and international stocks. There’s no set goal—it’s just whatever is leftover after we spend. We max out retirement accounts in the same funds, and contribute to our kids’ 529 college savings plans.And that’s about it. Effectively all of our net worth is a house, a checking account, and some Vanguard index funds.It doesn’t need to be more complicated than that for us. 

• I like it simple. 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.