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Notes from "The Psychology of Money"

These are my notes from "The Psychology of Money" by Morgan Housel. This book explains important ways to think about finance and investing. They are governed by human psychology and the right answers differ depending on your personal situation and time horizon. I'd highly recommend this book for everyone, especially young people, since money affects everyone in a big way.

Financial success is not a hard science. It's a soft skill, where how you behave is more important than what you know.

Knowing what to do tells you nothing about what happens in your head when you try to do it.

2 topics impact everyone whether you're interested in them or not: health and money.

Physics is uncontroversial. It's guided by laws. Finance is different. It's guided by people's behaviors.

Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort.

If you risk something that is important to you for something that is unimportant to you, it just doesn't make any sense.

Modern capitalism is great at two things: generating wealth and generating envy.

Getting money and keeping money are two different skills. Getting money requires taking risks, being optimistic, and putting yourself out there. But keeping money requires the opposite of taking risks. It requires humility and fear that what you've made can be taken away from you just as fast. It requires frugality and an acceptance that at least some of what you've made is attributable to luck, so some of your past success can't be relied upon to continue indefinitely.

Compounding doesn't rely on huge returns. Merely good returns, sustained uninterrupted for long periods of time, especially times of chaos and havoc, will always win. Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.

Financial and investment planning are critical because they let you know whether your current actions are within the realm of reasonable. But few plans of any kind survive their first encounter with the real world.

Many bets fail, not because they were wrong, but because they were mostly right in a situation that required things to be exactly right. Room for error, often called margin of safety, is one of the most under appreciated forces in finance. Being conservative is avoiding a certain level of risk. Having a margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. Its magic is that the higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.

There are a million ways to get wealthy. There is only one way to stay wealthy: some combination of frugality and paranoia.

Your success as an investor will depend on how you respond to punctuated moments of terror, not the years spent on cruise control. A good definition of an investing genius is the man or woman who can do the average thing when all those around them are going crazy.

The highest form of wealth is the ability to wake up every morning and say "I can do whatever I want today". People want to be wealthier to make themselves happier. Happiness is a complicated subject because everyone is different. But if there's a common denominator in happiness, a universal fuel of joy, it's that people want to control their lives. The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.

Doing something you love on a schedule you can't control can feel the same as doing something you hate.

The only way to be wealthy is to not spend the money that you do have. It's not just the only way to build wealth, it's the very definition of wealth.

Wealth is just the accumulated leftovers after you spend what you take in.

Experiencing specific events does not necessarily qualify you to know what will happen next, in fact it rarely does. Because experience leads to overconfidence more than forecasting ability.

The majority of what's happening in the global economy can be tied back to a handful of past events that were nearly impossible to predict. The most common plot of economic history is the role of surprises.

What you should learn when you make a mistake because you did not anticipate something, is that the world is difficult to anticipate. The correct lesson to learn from surprises is that the world is surprising, not that we should use past surprises as a guide to future boundaries. We should use past surprises as an admission that we have no idea what might happen next.

Leverage, taking on debt to make your money go further, turns routine risks into something capable of producing ruin. The danger is that rational optimism most of the time masks the dangers of ruin some of the time. The result is that we systematically underestimate risk.

Thinking of market volatility as a fee, rather than a fine, is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

The formation of bubbles isn't so much about people irrationally participating in long term investing. They're about people somewhat rationally moving towards short term trading to capture momentum that had been feeding on itself. Short term traders operate in an area where the rules governing long term investing, particularly around valuation, are ignored because they're irrelevant to the game being played. That's where things get interesting and where the problems begin. Bubbles do their damage when long term investors playing one game start taking their cues from those short term traders playing another.

Many finance decisions are rooted in either copying what other people do, or betting against them. But when you don't know why people do what they do, you don't know how long they'll continue acting that way, what will make them change their mind, or what will ever make them learn their lesson.

Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are. The main thing I can recommend is to go out of your way to identify what game you're playing.

The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.

Appealing fictions happen when you are smart, you want to find solutions, but face a combination of limited control and high stakes. They are extremely powerful and can make you believe just about anything.

History cannot be interpreted without the aid of imagination and intuition. The sheer quantity of information is so immense that selection is inevitable. Where there is selection, there is art. Those who read history tend to look for what proves them right and confirms their personal opinions.

Most people, when confronted with something they don't understand, do not realize that they don't understand it because they're able to come up with an explanation that makes sense based on their own unique perspective and experiences in the world. However limited those experiences are, we all want the complicated world we live in to make sense, so we tell ourselves stories to fill in the gaps of what are effectively blind spots. What these stories do to us financially can be both fascinating and terrifying.

Part of the reason forecasting the stock market and the economy is so hard is because you are the only person in the world who thinks the world operates the way you do. When you make decisions for reasons that I can't even comprehend, I might follow you blindly into a decision that's right for you and disastrous for me. This is how bubbles form. Coming to terms with how much you don't know is coming to terms with how much of what happens in the world is out of your control.

Saving money is the gap between your ego and your income, and wealth is what you don't see. So wealth is created by suppressing what you could buy today in order to have more stuff or more options in the future. No matter how much you earn, you can never build wealth unless you can put a lid on how much fun you can have with your money right now.

Manage your money in a way that helps you sleep well at night, not in a way that might give you the highest return.

If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big, and big mistakes fade away.

Become okay with a lot of things going wrong. You can be okay with a lot of things going wrong and still make a fortune, because a small minority of things account for the majority of outcomes.

Define the cost of success and be ready to pay it, because nothing worthwhile is free. And remember that most financial costs don't have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world. They're often worth paying, but you have to view them as fees.

Every investor should pick a strategy that has the highest odds of meeting their goals. And I think for most investors, dollar cost averaging into low-cost index funds will set you up for the most success.

Expectations always move slower than facts.

You can scoff at linking the rise of Donald Trump to income inequality alone, and you should. These things are always layers of complexity deep, but it's a key part of what drive people to think: "I don't live in the world I expected. That pisses me off, so screw this, and screw you, I'm gonna fight for something totally different because this (whatever it is) isn't working." Take that mentality and raise it to the power of Facebook, Instagram, and cable to news, where people are more keenly aware of how other people live than ever before. It's gasoline on a flame. The more the internet exposes people to different points of view, the angrier people get that different points of view exist.


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