Do you allow personal finance stories to change how you use your money? Do finance stories scare you away from making certain decisions or inspire you to invest in certain things?
According to Morgan Housel, the author of The Psychology of Money, falling for financial success stories can cause you to make poor financial decisions. Listening to the personal finance stories of others can influence you to risk your financial health based on hope, or even make you think that you have more control than you actually do.
Here’s why you should be careful what stories you believe about money.
Be Careful What Stories You Believe About Money
Maintaining your financial success isn’t just about understanding what information matters to you; it’s also about understanding the power of information in general. Morgan Housel posits that personal finance stories drive our decisions more effectively than statistics—so if you fall for an incorrect story, you’re prone to making poor financial decisions. Therefore, Housel warns, you must be careful what stories you believe about money.
To illustrate how stories affect our financial decisions more than objective factors—like our ability to grow wealth—Housel points to how the United States’ economic situation differed between 2007 and 2009. Many of the seemingly objective factors were better in 2009 than in 2007: We had and were capable of more thanks to things like advancements in technology. But 2009’s economy was far worse than 2007’s because, according to Housel, we were reacting to a different story. In 2007, we believed that housing prices would keep rising; by 2009, we were experiencing the fallout that occurred when people stopped believing that story.
|How Stories Affect the Objective Factors That Matter
Housel uses the same story about the difference between the United States’ economic situation in 2009 and 2007 to begin a 2017 report that describes the power stories have to affect our financial decisions. Many sections of the report are practically identical to sections of his book. However, Housel makes one key claim in this report that he doesn’t mention in his book: He argues that every economic asset, like a career or a company’s value, depends on both its actual ability to deliver value and how much people believe in that ability—and that the second factor influences the first. For example, he notes, people believe that Amazon will drive technological change, so top engineers flock to Amazon—and so, Amazon has the talent it needs to drive technological change. In other words, stories may affect our financial decisions more than objective factors, but the stories can change those objective factors, too.
How Stories Influence Your Decisions
How, exactly, does falling for an incorrect story worsen your financial decisions? Housel posits that there are two main reasons.
#1: The more you want something to be true, the more likely you are to make financial decisions as if that thing is true—and the more you’ll risk your financial health.
Housel argues that in any high-stakes situation where you have little control, like investing, your desire for a story to be true often drives you to behave as if that story is true—no matter how improbable. But if the story isn’t true, acting on it can have detrimental financial effects. For example, in 2021, many people lost their life savings in the volatile cryptocurrency market: They wanted cryptocurrency to make them money, so they believed it definitely would make them money.
(Shortform note: If you’re desperate for something to be true, you might also increase your belief in it by surrounding yourself with people who believe the same thing you do—which is easier than ever thanks to the ability to connect to various niche groups online. And if everybody around you is doing something, it’s far easier for you to convince yourself to do it too.)
Housel contends that when you’re planning for the future, you’re emotionally invested, and that makes you highly susceptible to attractive stories. The more you want something to be true, the more evidence you’ll find to support your opinion—so the more likely you are to become too convinced that an improbable financial future will definitely occur. And if you do, the margin of safety you build into your financial plan might not encompass what happens at all.
(Shortform note: To avoid such a fate, consider following Taleb’s strategy in The Black Swan of “negative empiricism”: the process of seeking out information that disproves your original belief. By doing so, the less likely you may be to become too convinced of an improbable financial future, and the more margin of safety you’ll build into your financial plan.)
#2: Stories make you confident that you have control when you don’t.
According to Housel, we often don’t realize we don’t understand a situation we’re in. This is because, as Housel notes, we create a reasonable explanation that makes sense to us, and we never think to question it. For example, you may see an old man sitting alone on your commute every day, assume he’s on his way to his job, and feel bad that he’s unable to retire. However, he might actually be financially independent and on his way to yoga at his gym—but you never question the story you created, so you never realize it’s wrong.
Housel posits that we make up explanations because it makes us feel like our chaotic world is more predictable and controllable than it is. For example, Housel notes, we continue to pay attention to market forecasts—even though investors generally agree they’re useless—because it’s comforting to believe that the smart person on TV knows what’s going to happen to your money.
(Shortform note: In The Black Swan, Taleb suggests a biological reason we narrativize situations: Interpreting information makes it easier for our brains to store. For example, whereas retaining 100 randomly ordered numbers would be near impossible, retaining 100 numbers that were ordered according to a specific rule would be much easier. So when we interpret—or narrativize—we’re attempting to impose our own organizing rule on the random facts of the world.)
Unfortunately, finance isn’t as predictable or controllable as we want it to be. Since it’s subject to the whims of human emotions, it doesn’t follow easy, logical rules like science does—and so you don’t have as much control as you want over what happens to your money. When you overestimate how much control you have, you’re likely to ignore factors like chance or others’ decisions and may make poor financial decisions as a result.
For example, Housel cites how entrepreneurs are overwhelmingly—and incorrectly—confident that their success depends at least 80% on factors within their control. They underestimate critical external factors they’re not intimately aware of, like their competitors’ plans, and instead create a story of success based mostly on their own knowledge. Although Housel doesn’t explicitly state that this mistaken belief drives these entrepreneurs to make poor decisions, we can infer that it might: If you don’t think your competitors’ plans will greatly impact your ability to succeed, for example, you likely won’t pay as much attention to them as you should.
(Shortform note: Entrepreneurs may be especially prone to overestimating how much they control their success—and consequently, how likely they are to succeed—because, as one psychologist suggests, the people who become entrepreneurs tend to be more optimistic in general. After all, 96% of US businesses fail within 10 years, so to become an entrepreneur to begin with suggests that you’re more optimistic than most people—and may mean that you think you have more control over your life than the average person.)
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Here's what you'll find in our full The Psychology of Money summary :
- Why the key to financial success lies in understanding human behavior
- How to make better financial decisions
- How chance plays a bigger role in our financial lives than we think