The Psychology of Money-My learnings
I’m in my mid-20s and have been working for a few years now. Up until last year, I hadn’t really thought about investing and growing my money because I was focused on building the right skillsets for my career. Since I’m investing now, I decided to read ‘The Psychology of Money’ by Morgan Housel and see what the hype was about.
If you are someone who is looking to make good financial decisions, this blog is for you. To make good financial decisions, it’s important to understand how people think about money. This is not a technical guide on investments but it’s about the psychology of money about what money does to us, how we think about it and its impact on our lives.
This is not a technical guide on investments but it’s about the psychology of money about what money does to us, how we think about it and its impact on our lives.
Some of the concepts in the book are lessons we are already familiar with while some are refreshingly novel and make us reevaluate our attitudes towards money. While I’d recommend reading the book to get a holistic overview, I’m sharing the 6 most important learnings that I’m taking from this book
1. Control your Time with Money
Having control of our time is the ultimate luxury that comes along with having money.
This is an important lesson, that relates to my experience at my first startup. In a nutshell, I wasn’t able to continue with my startup as I didn’t have investments and savings from before. As a working professional in the early-mid 20s, I had not been able to grow my money before and hence, didn’t have the luxury of having control over my time and building my own business.
This aspect of having control over our time is extremely powerful. One of the most powerful quotes from this book is-
Doing something you love on a schedule you can’t control, can feel the same as doing something you hate
A good example of this is when one gets a job in a role/industry that one is passionate about, and gradually that motivation fades with time. Why? Typically in a job, one has limited control over their time and has to follow the employer’s schedule. That’s why we see a lot of companies adopting a flexible working hours culture, which can give this control of time back to the employee and lead to a more happy and productive outcome for the company.
2. Time is the best way to grow your money
Good Investing is not necessarily getting the highest returns as possible as these high returns are usually one-off events. Instead, it’s about getting pretty good returns over the longest period of time. This is where compounding gets wild.
So what is compounding?
The basic idea of compounding is that the interest earned is not just on the basic principal amount that is invested, but also on the interest that keeps getting added to it with time.
It’s hard to acknowledge that the interest earned on interest can lead to wild returns. So let us take an example of two individuals, one of them starts investing an amount of $500 monthly at the age of 25, but the other only begins at 35. Assuming a rate of return of 12% compounded annually for both of them, by the time they are 50, the former would have accumulated an amount of ~$800,000 (5.3x return) while the latter would have accumulated only ~$220,000 (2.4x return). So there’s an exponential growth of money with time. Therefore, the more time we give money to grow, the bigger the returns will be.
3. Role of luck in Investments
All good investments have a factor of luck involved. So when we make decisions that give us great financial success, it’s important to acknowledge the role of luck. Why? This will give us humility in success and prevent us from thinking we know everything.
I’ve seen traders, who made a lot of money initially but then lost it all and even more after that. Why? Success is a lousy teacher, it seduces us into thinking we know everything. In this case, it led them to believe that they can time the market and failed to appreciate the role of luck.
4. No One’s crazy
People have different attitudes towards money. This attitude is majorly driven by their unique experiences with money in their lives. Hence, this attitude can vary from person to person. For example, a person who has seen several bull runs of the stock market is much more inclined to invest in stocks than a person who was seen several bear runs.
So when we look at the way people earn and spend their money, we should not be quick to judge their financial decisions. For example, sometimes I think — Why don’t more people invest in crypto or invest in ETFs? Why do people spend loads of money on buying depreciating assets like fancy cars? So I should not be quick to judge their decisions but rather acknowledge and appreciate the differences in our attitudes towards money, which are shaped by our unique experiences.
5. Save as much as you can
Savings rate is an extremely powerful way to earn more money. And the good part is that we can control this unlike income or investment returns. The idea is to save as much as we can. To save effectively, we should change the way we think of savings.
We typically think of savings as whatever money is left from our income after spending on expenses.
Savings =Income - Expenses
We should rather redefine savings, specifically expenses. Everyone needs to spend on necessities but beyond a point, what we spend on becomes less of a need than more of an ego booster. Basically, we start spending on things that satisfy our egos, fulfill our desires and make us feel good about ourselves. So we should think of savings as the gap between our egos and our incomes.
Savings = Income - Ego
When we can adopt this mindset, it becomes easy to have a higher savings rate. The idea is when we raise our humility and reduce our egos, we will spend less on our desires, which will lead to a high savings rate.
6. Identify your game and filter out the noise
The idea is we should beware while taking financial cues from people as they might be playing a different game than us.
For example, let’s look at how some of the bubbles have formed in the past like the dot com bubble. A good indicator of bubbles is when the short term traders take over the long term investors in defining the asset price, which means that the price is no longer a good representation of the asset value rather it’s the price that short term traders are willing to pay as momentum is good and they think the price will continue to rise. This momentum then attracts other short term-traders who think since momentum is good, they can just trade and make some quick bucks. Now imagine, there’s a long-term investor during the dot cum bubble. When he sees that other investors are buying that asset, he might think ‘Wow, maybe these investors know something I don’t’ and then he buys it. What he doesn’t realize is that the traders who were largely responsible for the price of the stock were playing a different game. The traders’ game was to cash out within a day so they don’t care abt the fundamental value of the stock whereas as a long-term investor cares.
The important thing is to identify what game we are playing. Once we have identified, then other information that is not relevant to our game becomes redundant. For example, if I identify that I’m a long-term investor, then I would not care abt if the market is bullish or bearish in a particular year or if we will have a recession next year- all this information is irrelevant to the game that I’m playing.