A quick search on Amazon reveals no fewer than 416 entries on Investor Psychology. These titles cover the range – everything from how to day trade for a living to academically focused studies of investor behavior. Morgan Housel’s just released book, The Psychology of Money, is a welcome change from most books on the subject.
Housel, a former columnist at The Motley Fool and The Wall Street Journal is a gifted writer. His narrative on how we cope with financial decisions, organized into 20 short chapters, is an easy and entertaining read. Like many books on the subject, this one delves into the behavioral problems people face when trying to accumulate and retain wealth. But it also challenges us to shift our thinking on some fundamental concepts. Housel starts by reminding us that the point of making money is to be happy. But, ironically for most people, control over their time – who they spend it with and how much they have – rather than accumulation of money and things, is what makes them happy. Our inability to understand how much is “enough” also works against achieving happiness. By continually reaching for more, we put the things that really do make us happy like freedom and independence at risk.
The role that risk and more specifically “tail” risk plays in life and investing is a concept that recurs throughout the book. Tail risks are associated with rare events that can’t be foreseen. In finance, risk generally refers to the degree of uncertainty and/or potential loss inherent in a decision or outcome. Things that are known can be anticipated and the results, therefore, avoided or mitigated. Because tail risks cannot be anticipated, they tend to have a big impact on results. Housel also makes the somewhat uncomfortable observation that tail risks actually occur all the time. The most recent pandemic is a painful reminder of this fact. Once you embrace this idea, it is easy to see that luck (being born in the right decade, for example) has more to do with success than skill or ability. A humbling thought to be sure.
Several constructive investment lessons fall out of this conclusion. While the benefits of compound interest are clear, if you take excessive risk you will not be able to stay invested long enough to benefit from this powerful force. The concept of “Margin of Safety,” first coined by famed value investor Benjamin Graham, also comes into play. Since you cannot avoid tail risks, you better proceed with a cushion that protects you from unanticipated loss. Saving, which produces guaranteed outcomes, is a better way to build this cushion than expecting consistent, outsized returns.
The book explores a range of flaws and biases that contribute to poor financial choices. It ends with a historical review of American consumerism and some observations on how this experience has contributed to our current economic and political conditions. While he offers no outright prescriptions to the challenges we face, this travel back in time provides a useful framework for thinking about how to move forward.
The Psychology of Money is not a “how-to” guide as much as a helpful set of insights into why we behave the way we do around money. Some of Housel’s observations are simple reminders of things you probably know but need to hear again. But the book’s real value lies in how it challenges us to recalibrate our thinking about money and change our behavior. While useful for all, it is a book I wish I had read 40 years ago and one I plan to give this holiday season to those starting out their financial journey.