PDF Summary:The Psychology of Money, by Morgan Housel

Most of us assume financial success depends on education and intelligence. But in The Psychology of Money, finance expert Morgan Housel presents an alternate hypothesis: The key to financial success lies in understanding human behavior. Housel posits that when you understand how emotions and beliefs influence your financial decisions, you’ll make better financial decisions.

In this guide, we compare Housel’s advice with that of other finance experts and supplement his ideas with concrete recommendations. You’ll learn why people fail to achieve financial success and what’s behind your desire for money. You’ll also learn what to include in a financial strategy, how to create one you can follow for decades, how to follow it through those decades—and how to pay attention to the information you need to do so.

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(Shortform note: Not all thought leaders distinguish between saving and investing: In The Success Principles, Jack Canfield suggests maximizing your savings by investing them. But by Housel’s definition, investing isn’t the same as saving: You can’t rely on your investments because you could lose them at any moment.)

To ensure you save money, Housel recommends, stop caring about others' opinions. Housel argues we overspend because we care too much about others’ opinions of us. Once you exceed the level of spending needed to purchase luxurious basics, he contends, you’re no longer spending for yourself: You’re now spending to prove to others how much money you have. (Shortform note: Housel recommends only spending enough to purchase luxurious basics, which are “comfortable, entertaining and enlightening.” But this is subjective, so it’s hard to tell if you’re overspending. One way to assess whether you’re spending for your ego is to define what’s “enough”—as we saw in Lesson #4—and see if you spend more than that.)

By learning to be humble and ignore others’ opinions, you’ll naturally want less. When you want less, you’ll spend less, and you’ll save more. (Shortform note: In How to Stop Worrying and Start Living, Dale Carnegie recommends several strategies for ignoring others’ opinions, like becoming your own worst critic.)

Lesson #7: Plan for Things to Go Wrong

The final essential element of any financial strategy, according to Housel, is to plan for things to go wrong. Doing so protects your financial future and keeps you in the game long enough to reap the benefits of compounding.

Housel warns that people are often too optimistic with their finances, which leads them to put too much of their wealth at risk at any one time on a strategy that can be taken down by any one factor of bad luck. But the future is uncertain: You don’t know what bad luck or risks you will experience. So if your financial plan only works in a narrow range of possible futures, you’re placing yourself in a precarious position.

Planning for things to go wrong protects you: In doing so, you plan for a wide range of possible futures—and increase the likelihood you’ll become financially successful even if a lot of things don’t go your way. (Shortform note: Having broad competence in many fields, as Epstein recommends, is one way to protect yourself: You’ll survive even if your industry disappears.)

Additionally, planning for setbacks allows you to endure losses long enough to be positioned to take advantage of opportunities when they arise. When you can weather occasional losses, you’ll still be in the game to reap the occasional windfall—which can earn you significant money if you’re able to grab it. This applies to many types of investments, like the housing market: If a downturn wipes your savings out, you won’t be able to take advantage of low housing prices, which could lead to high future returns.

(Shortform note: Housel’s warning about the housing market implies that he thinks buying a house is an investment. But other financial experts warn that a house is not an investment : A house’s value depends on the economic opportunities of where it is, so if your local economic opportunities decline, your house will decline in value and may become a liability.)

How, exactly, can you plan for things to go wrong? Housel recommends the following methods:

Never put your entire fortune at risk. Instead, risk only a small portion at a time. Keep enough invested in safe investments so you can cover any losses incurred by your riskier investments. (Shortform note: In Antifragile, Taleb also warns against risking your entire fortune. But he emphasizes the extreme options over the average ones—specifically, the barbell model: Keep one end extremely safe (like in the bank), and one end high-risk and high-reward. This way, you can only ever lose the small portion of your money you’ve risked—but could earn a lot more.)

Don’t create strategies that hinge on one single factor because if that factor goes wrong, the entire strategy fails. Instead, have backup systems in place that protect you when a particular factor fails. (Shortform note: A single factor many of us base our financial lives on is our ability to keep working. But you could suffer a medical condition that prevents you from working. That’s why financial experts recommend purchasing disability insurance.)

How to Create a Financial Strategy You Can Stick To

Now that you know what to put in your financial strategy, how do you make sure it’s one you’ll stick to? Housel names two principles to keep in mind: Expect your future goals to change, and prioritize sense over logic.

Lesson #8: Expect Your Future Goals to Change

To develop a long-term strategy you can follow over decades, Housel recommends, expect your future goals to change. As we’ve seen, the longer you leave your money alone, the more compound interest it can accumulate. But, he posits, people struggle to leave their money alone because they change—and since they can’t predict how they’ll change, they don’t invest their money in ways that will work for their future selves.

Housel explains that when making financial plans, most people fall victim to the end-of-history illusion, a psychological phenomenon where you recognize that you’ve changed a lot, but you don’t expect to change a lot in the future. However, you’ll probably change just as much in the future as you did in the past. (Shortform note: Why do people fall for the end-of-history illusion? The psychologists who discovered the end-of-history illusion (or the end-of-history effect) suggest that believing you don’t change is comforting: It’s terrifying to imagine a future self drastically different from your current self.)

To protect yourself from the end-of-history illusion, Housel recommends that you don’t make extreme financial plans. In other words, avoid any plan that involves extremes in your commute, savings, or personal time. (Shortform note: What counts as extreme in each area will likely depend on your age and location. So instead of comparing yourself to others not in your situation, consider avoiding the options that feel extreme to you, even if they statistically aren’t.)

Why? Housel explains, if you make an extreme financial plan, you may regret your choices. For example, your single-minded focus on your career may lead to wealth but no loved ones to share it with. (Shortform note: If you do regret an extreme financial plan, ease the pain by finding the silver lining: Learn something from the regret and apply it to your future.)

Second, Housel states, if you make an extreme financial plan and change it later, you won’t be able to take full advantage of compound returns. For example, if you think you’ll never want to settle in one place, you may take jobs that pay just enough to let you travel the world cheaply. But if you eventually want to settle down, you may not be able to retire where you want. Had you taken slightly better-paying jobs and invested that money, you would have more compound returns—but you can’t get that money now. (Shortform note: Remember that you may change your financial plan not because you want to but because you have to. If this happens, you’ll be more exposed to financial ruin if you’ve followed an extreme financial plan, which can help you achieve one goal but might leave you vulnerable to things going wrong in other areas of your finances.)

Lesson #9: Be Sensible, Not Logical

Another key to creating a long-term financial strategy you can follow for decades is to develop a strategy that’s sensible, not logical. Housel implies that most people mistakenly think they want a logical strategy (which focuses exclusively on maximizing your earnings) because that will make them the most money. But what people really want is a sensible strategy, which prioritizes your peace of mind, and that following a sensible strategy will maximize your earnings in the long run.

(Shortform note: The more complicated something is, the smarter it seems. So a sensible strategy, which prioritizes your peace of mind over complicated math, may seem too simple to work. But in a 2015 article, Housel explains you don’t need to understand the math behind why your strategy works—only its real-world consequences.)

Housel explains that following a sensible strategy will ultimately make you more money, even if it doesn’t perfectly maximize your earnings, because it accounts for the important non-financial elements logical strategies ignore—like your desire to prevent regret or the ease of following a strategy. (Shortform note: Why do we follow logical strategies that ignore such important elements? We may be overly impressed with the academic credentials of the experts who recommend them, and so follow their advice blindly.)

How does this work, exactly? As Housel repeatedly states, the longer you have money in the market, the more likely you are to increase it. So the best long-term financial strategy is to pick a strategy and commit to it long-term. Since you’re more likely to stray from a strictly logical strategy if it drives you to feel regret or if it’s unreasonably difficult to follow, a sensible strategy—which is easier to stick to—will ultimately make you more money. (Shortform note: One way to make a strategy easy to follow long-term and thus sensible is to automate your investments, as financial expert Ramit Sethi suggests in I Will Teach You to Be Rich.)

To create a sensible strategy, Housel recommends, invest in companies you love. This is illogical: How you feel about a company doesn’t affect its earning potential. But, if a company you love does poorly, you won’t abandon your investment as easily because you care about the company. By investing in companies you love, you’ll stay in the market longer, which will ultimately lead to more wealth. (Shortform note: Just don’t invest in the company you work for, experts warn: If the company fails, you’ll lose your investments and your income.)

How to Counter Negative Thinking

You now know the keys to creating a financial strategy you can stick to long-term. But in an ever-fluctuating market, how do you handle the inevitable bad times? Housel shares two lessons to help you evaluate bad news appropriately: Don’t be put off by uncertainty, and remember that even if you fail frequently, you can still succeed.

Lesson #10: Don’t Be Put Off by Uncertainty

Housel shares one key to reacting well to bad news: Don’t be put off by uncertainty. He argues that to achieve long-term investing success, you must accept that you’ll feel uncertainty as the market fluctuates. Otherwise, you won’t be able to endure the uncertainty long enough to let your returns compound.

Housel explains that investing inherently includes some measure of uncertainty—and the higher the potential gain, the more uncertainty you feel. For example, the longer you let your stocks compound, the more money you can gain, but the longer you have to feel the uncertainty of not knowing exactly what will happen to your money. (Shortform note: Some discomfort may be inevitable when investing, but constant discomfort isn’t. Checking your investments only once a quarter may reduce your anxiety about your investments.)

According to Housel, most people try to limit the uncertainty they experience by timing the market—but since timing the market is impossible, they end up losing money. (Shortform note: Ironically, in The Intelligent Investor, Benjamin Graham suggests that some people time the market not due to fear of uncertainty but due to overconfidence: They think that if you’re smart enough, you can predict how the market will move.)

So, Housel recommends, instead of trying to avoid uncertainty, accept it’s inevitable when investing. Remind yourself you’re trading your short-term peace of mind for potential long-term investing success—and use that to endure the market long enough to let your returns compound. (Shortform note: In his book, Housel focuses exclusively on the toll investing can take. But in the blog post he based his book on, Housel argued every financial reward takes a toll on some aspect of your life, and you can only get the reward if you accept those tolls.)

Lesson #11: Even if You Fail Frequently, You Can Still Succeed

Another reason to remain optimistic in the face of bad news is that even if you fail frequently, you can still succeed.

Housel explains that nearly every successful financial venture you hear about owes its success to low-probability outlier events—luck. These events, when positive, are so powerful they compensate for a larger number of smaller setbacks a company might go through. For example, Nintendo owes its dominance in the American market to the massive success of Super Mario Bros., which did so well it made up for the losses from other products that failed in the United States. (Shortform note: Housel only discusses positive outliers, but they could be negative: A negative outlier event could drive the failure of an otherwise successful venture because it was so powerful it offset all the other successes.)

Since we only pay attention to these outlier events—and not to the failures the outlier events offset—we forget how rare outlier events are and conversely just how common failure is. As such, we overreact when failures inevitably happen to our own ventures. But when you realize how common failure is, you realize you can fail most of the time and still be successful—so you can react to your failures appropriately. (Shortform note: One area where we do pay attention to the failures offset by outliers is in careers: We often talk about how often successful people failed before achieving their (outlier) success.)

To do so, Housel recommends, pay attention not to the extent or frequency of individual failures but to the impact of your failures on your overall financial health. The outlier events in your life can offset the impact of many individual failures, Housel explains. So paying too much attention to how often you fail or the outcome of one investment paints an inaccurate picture of your financial health. Instead, pay attention to your overall financial health, since that’s what matters. (Shortform note: Instead of focusing on the negative impact of failure, consider viewing each failure as an opportunity to learn what not to do in the future.)

How to Pay Attention to the Right Financial Information

Sticking to a long-term financial strategy doesn’t just require you to understand the mindsets above—it also requires you to know how the information you encounter affects your decisions so you can make better decisions. One way to ensure you pay attention to the right information, according to Housel, is to know your personal financial goals.

Lesson #12: Know Your Personal Financial Goals

To pay attention to the right information, Housel suggests, know what financial goals matter to you personally so you don’t get caught up chasing the goals of other people. In other words, don’t get caught up in a herd mentality and chase investment opportunities just because lots of other people are chasing them.

When you know your financial goals, Housel contends, you can ignore irrelevant information that might lead you to make poor decisions, such as basing your financial moves on others’ actions and, for example, getting caught in an investment bubble (like housing or stocks), and so you’re able to make better decisions and protect your financial health.

(Shortform note: How does modern access to unlimited information affect our experience of bubbles? Experts contend that the Internet has made bubbles more dangerous for unsuspecting investors: Bubbles are bigger and faster now, partly because investing apps have made investing easier. But the Internet has also made us better at filtering out irrelevant information—so long-term investors may be better at ignoring what short-term investors do.)

To discover your personal financial goals, Housel recommends that you write a mission statement for your finances: How long will you invest your money? What do you expect or hope will happen over that time? (Shortform note: Housel’s financial mission statement focuses on your investments. Consider writing a financial mission statement that covers goals in other areas, like spending.)

Once you discover your financial goals, Housel contends, you’ll easily ignore irrelevant information. Instead, you’ll pay attention only to information relevant to your financial goals—and as such, you’ll make better decisions as you pursue them. (Shortform note: Paying attention to too much information may worsen your decisions, no matter how relevant: In Smarter Faster Better, productivity expert Charles Duhigg posits we may grow overwhelmed by the amount of data available and stop taking it in. He recommends preventing this overwhelm by acting on the data you encounter—like by handwriting it.)