Tag: The Psychology of Money

The power of compounding is surprising

Making versus saving money “To make money, you have to take risks, have faith, and stand up for yourself. But taking risks needs to be stopped if money is to be kept. It requires humility and the fear that everything you’ve worked for could be taken away from you just as quickly. You can’t always count on repeating past success, so you have to be thrifty and realise that at least some of what you’ve made is due to luck.

Money management is different from money management. To make money, you have to take risks, work hard, and keep a positive attitude. Keeping money is a different skill. It requires you to take less risk, not be greedy, and remember that things could be taken away from you at any time.

Money is not the enemy

A plan is only useful if it can stand up to the real world. The truth is that everyone has a future that is full of unknowns.

If you’re still young and have more income than expenses, the best way to get the most out of your long-term investments is to put most of your money into a diversified portfolio of low-cost index funds. Cash loses value over time, so it’s not smart to keep more than a small amount of your net worth in cash. Instead, you should invest in assets like stocks, which have historically grown at a rate of 10-11% per year.

Even though it might seem appealing to invest in ways that will give you the best returns, these ideas often don’t take your personality into account. Think about having 95% of your money in stocks and bonds and only 5% in cash. The market falls 20 to 25%. Having such a small amount of cash on hand may make you more likely to sell some of your stocks in a panic when the market goes down, depending on how that drop makes you feel. And if you sell in a panic, you can lose out on a lot more money than if you kept a bigger part of your portfolio in cash and didn’t sell because you felt safer.

Spreadsheets are not like people!

Even though the models say you should only keep 1% to 5% of your assets in cash, you may want to keep 10% to 20% to protect yourself from having a bad attitude when bad things happen. It can also be the best choice for your portfolio if having more cash on hand keeps you from making one big mistake.

Long Tail

In finance, a small number of events can be responsible for most of the outcomes. This is where long tails, or the ends of a distribution of outcomes, have a big effect.

Most of the time, your choices about investing don’t matter. What happens depends on the choices you make on a few days when something important happens, like a severe downturn, a frothy market, a speculative bubble, etc. Warren Buffet has held between 400 and 500 stocks over the course of his life. Most of his money came from just 10 of them.

Highest level of wealth

Having the freedom to do what you want, when you want, with who you want, and for as long as you want is very valuable. This is the best return that money can buy.

Being more flexible and in charge of your own time is much more useful than staying up late or making risky bets that keep you from sleeping just to boost your returns by 2%.

In The Psychology of Money, Morgan Housel shows you how to get along better with money and make better financial decisions. He doesn’t try to make people seem like machines that can maximise their return on investment. Instead, he shows how psychology can both help and hurt you.

Main Points

The real world isn’t a theory – the problem is that studying or having an open mind can’t really make us feel the same way that fear and uncertainty do.

We’re not like mathematical equations. Reading about historical events like stock market crashes or how stocks have gone up and to the right over time can teach us a lot, but it’s not the same as actually going through them. So be careful. You might think you can hold on to your stocks during a 30% drop in the market because you know that only fools sell at the bottom. However, you won’t know what to do until you actually go through a drop of that size.

Risk and reward

It’s easy to think that the quality of your decisions and actions is the only thing that affects your finances, but that’s not always the case. You can make smart decisions that lead to bad financial results. You could also make bad decisions that turn out to be good for your finances. You have to think about how chance and risk will play a role.

To make it less likely that people will stress how much individual effort affects results:

Be careful of the people you both look up to and look down on. Those at the top may have gotten lucky, while those at the bottom may have lost money because they took more risks.

Pay less attention to individual people and more attention to larger trends. It’s hard to copy what successful people have done, but you might be able to join larger patterns.

But what’s more important is that even if we agree that luck plays a role in success, we shouldn’t be too hard on ourselves when we fail because risk also plays a role.

Be kind to yourself when you make a mistake or find yourself in a dangerous situation. Since the world is unpredictable, if something goes wrong, it might not even be your fault.

What Buffett Says

According to legendary investor Warren Buffet, there’s no reason to put our needs and resources at risk for something you don’t need.

It’s easy to make a goalpost that can be moved. When you reach one of your goals, you move on to the next one. The cycle will never stop. Often, you do this because you’re comparing yourself to others, and most of the time, you’re comparing yourself to someone higher up on the ladder.

Someone else will always have more money than you do. Not a problem. It’s fine to look for ways to make more money, but don’t risk what you already have to get something you don’t need.

More lessons from the book follow on the next article.