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  /  Investing   /  The Psychology of Money by Morgan Housel- Book Review

The Psychology of Money by Morgan Housel- Book Review

“All money is imaginary,” answered the Calcatrix simply. “Money is magic everyone agrees to pretend is not magic.”
                                                                    -Catherynne M. Valente

Personal finance books have exploded in popularity over the past two decades, and with fine reason. Human beings live longer than ever, are richer than ever, and have more avenues for entertainment than ever. But while our formal education system is well equipped to teach us how to attain wealth, they are remarkably poor in teaching us how to manage the same. None of the subjects in our core curriculum focus on investment, risk management, or savings. Lack of information on such a crucial component of our professional lives means that good, credible advice on personal finance can be incredibly important for a successful career.

All personal finance books are not the same. While some give you valuable advice on managing your money, others embellish shallow advice under the guise of witty remarks and ‘get rich quick’ schemes. Fortunately, this book lies in the former category – an excellent look into why human beings are motivated by money, and how to make it work for you.

Source – Rupiko

The book begins with a simple premise: earning money, and managing money smartly are two vastly different areas. Expertise in one subject does not necessitate expertise in another. This point is well illustrated by the opening anecdote; a story about a wildly successful technology executive. He patented key components of WiFi routers in his 20s, evidently a smart man, but eventually went bankrupt. This forms the bedrock of the book – doing well with money has little to do with innate smartness and everything to do with human behavior, i.e, our psychology.

Context is important in personal finance. As much as we hail the human race as smart, rational people, our worldview is fundamentally shaped by the context of our childhood and family (both economic and social). There is a simple intuitive example for this: an individual who grew up in poverty will have a vastly different appetite for risk in his portfolio compared to a wealthy banker who inherited his family business. All of us go through life using vastly different tenets. This is not due to one person being smarter than another, it is because every person has lived a different life, and each experience is as persuasive as the last.

Luck also plays a very important role in wealth creation. The fact that you are reading this article on The Economic Transcript website signals two things: you can speak and read English fluently, and you have access to high-speed Internet. The former characteristic means that you likely received your education in an English-speaking school, and the latter means that you are within 45% of India’s population (and 60% of the global population) with access to the Internet. This is due to sheer luck and will give you access to opportunities far beyond those of your peers who do not understand English or use the Internet.

Source – Statista

One of the most important lessons in the book reads is to get the goalpost to stop moving. If you do not have an understanding of how much is ‘enough, you will keep desiring more – more money, more power, and more prestige – and never be truly happy. The author uses famed insider trading convict Rajat Gupta as an example. Born to a middle-class family in India, he reached unimaginable heights in his professional career (as the first foreign-born MD of McKinsey & Co.) but he never had enough. Being a millionaire was not enough, he wanted to be a billionaire. He staked his reputation and his credibility (both invaluable) and did not know when to stop. His subsequent downfall, and conviction, were both products of his own folly.

There is no secret trick to becoming wealthy; one needs time and the requisite skill sets to do so – the golden rule of compounding. We rarely stop to understand the potential of compounding interest or the value of time when both are essential drivers of success. Used by legendary investors like Charlie Munger or Warren Buffett, starting with a small base and allowing it to compound over decades can yield very, very lucrative results. Over 2000 books have been written about Buffett’s investment strategy but none are titled ‘Shut Up and Wait’, the aptest description for his outlook on money.

The power of compounding can also be applied to saving money. The financial equation is composed of two factors: things within your control, and things outside your control. Investments and trading on the stock markets are largely beyond your control. There is no guarantee that an investment strategy will work, the stock market may not cooperate with your interests, and a freak accident tomorrow can wipe out your investments. Savings, and financial frugality, are completely within your control. Controlling for inflation, your savings rate can be 100% as effective today as it was tomorrow.

Source – @ESIRInvestors on Medium

While the intrinsic value of money cannot be overstated, there is something more important that earning wealth enables us to do; control our time. Rather than focusing on the more physical aspects of wealth, the latest car or the biggest house, wealth creation enables individuals to spend money as they wish – the most essential component of happiness.

As noted earlier; the context of wealth creation and flexibility of your final goal are important factors. Additionally, it is important to note that long-term planning can never be fully accurate. People change over time, their desires change over time, and this has consequences for how people plan their lives financially. People underestimate how much they change over the course of their lifetime.

One of the main reasons why people like Buffett become successful is due to doing the same thing for years at a time, and not quitting when the going gets tough. Compounding only works when a plan is nurtured over several decades at a time.

The book ends with a personal story: what the author does with his own money, i.e, putting his money where his mouth is. He, along with his wife, began their careers at entry-level jobs with entry-level incomes and gradually progressed upwards the career ladder. Their lifestyles have remained virtually the same, the higher income funneled into a higher savings rate, giving them independence over their lifestyles and future changes in career. His strategy is simple: he relies on a high savings rate, patience, and optimism that the global economy will create value over the next few decades (the former two are directly in his own control).

If you are someone with no background in investing and wish to get started on understanding personal finance, I cannot recommend this book enough. It is deeply insightful, does not rely on exotic investment strategies, and is easy to read. While the book will not give you an in-depth understanding of money, it will give you an excellent introduction for the same and prime you for further education on this subject.

Written by- Anusha Paul Choudhury

Edited by- Heeral Dattwani

The post The Psychology of Money by Morgan Housel- Book Review appeared first on The Economic Transcript.

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