Book Note - The Psychology of Money

The book, The Psychology of Money, contains 20 lessons about money that are both inspirational and educational to read.

I started Dollar Cost Averaging last year and the returns were good. This year, however, I lost some money and became anxious. After reading the examples in Chapter 6 of Tails, You Win, I feel more confident to stick with it.

Assuming Sue, Jim, and Tom each had $1 every month to invest from 1900 to 2019. Sue invested $1 in stocks every month without fail. Jim sold all stocks and saved $1 each month during recessions, and reinvested all of it after the recession. Tom only invested in stocks when there was no recession, sold all stocks six months after the recession started, and reinvested six months after the recession ended. These three individuals ended up earning $435,551, $257,386, and $234,476 respectively. Out of the 1428 months from 1900 to 2019, only 300 months, or 22%, were in a recession. So if I can stay cool like Sue 22% of the time, I may end up with almost three-quarters more money.

I had originally planned to just pick my top 5 lessons from the book, but after going through my notes, I realized it was difficult to narrow it down. That's why I chose to include all the chapter summaries I wrote while reading.

Ali Abdaal's Youtube video categorized the 20 lessons into four types:

• Attitudes towards Money
• Getting Money
• Spending Money
• Protecting Money If you plan to read the book yourself, then watch his video after you finish the book.

1. No One's Crazy

People's investment decisions, attitudes toward money, educational background, intelligence level, etc. are not as related as we think they are. Instead, they are related to personal experience, especially the socio-economic environment during the teenage and twenties. For example, if the stock market was flourishing at that stage, people are more likely to invest in stocks; if the economy was not good, people are more likely to save money. It is mentioned in another book that when people are more likely to vote for Democrats if Democrats won the election when that person was eight years old, and vice versa.

Therefore, sometimes we may think someone's investment behavior is "crazy", but there is often some rationale behind it. There is no one-size-fits-all logic.

2. Luck & Risk

When we think of successful investors, we often attribute their success to their skills and judgment. However, luck also plays a big part, but it is often overlooked because it is difficult to quantify.

3. Never Enough

It is important to know when to stop, otherwise, a pursuit of numbers can lead one to criminal activities. Enjoy the present.

4. Confounding Compounding

Compounding is a powerful tool. Most of Warren Buffett's wealth was earned after he was 60 years old.

5. Getting Wealthy vs. Staying Wealthy

Different mindsets are needed for getting wealthy and stay wealthy. To stay wealthy, one must remain optimistic about the future, but also think about what could hinder them from continuing to be optimistic.

6. Tails, you win

The Long Tail Theory. Art collections, large tech companies, etc. are not about making money, but rather about investing in numerous projects, even if 90% of them fail, the remaining 10% can make up for these losses due to their success. This concept is also applicable to individuals, who should strive to try new things.

7. Freedom

The significance of wealth is the freedom of choice; the ability to choose when to do or not do something.

8. Man in the Car Paradox

We purchase luxury cars in order to gain respect from others, but often people pay attention to the car itself and not the person driving it. We want luxury cars not for the car itself, but in order to gain admiration and respect for ourselves.

9. Wealth is What you don't see

We often assume that people who drive expensive cars are wealthy, but a car that costs $100,000 only tells us that the person who bought it has $100,000 less than they did before the purchase. The amount of money in the bank is something that no one else can see.

10. Save Money

Everyone should save money. Instead of setting specific goals like "saving for a bike" or "saving for a vacation", you can save without having a detailed plan in mind.

11. Reasonable > Rational

It may seem "correct" to approach investing with a cold and calculating attitude, but this does not take into account human nature. A strategy that is cold and calculating may have higher chances of success in theory, but it does not consider the psychological burden of failure. Reasonable approaches are better than rational ones when investing.

12. Surprise!

Studying history can help us anticipate the future, but what ultimately becomes history are the outliers; the surprises that no one could have predicted, such as the impact of the Covid-19 pandemic. On the other hand, financial markets are constantly changing and evolving, with new concepts, such as retirement savings, and technological advances making strategies that were once effective obsolete within a few years. Therefore, the further back we look into the past, the more essential it is to identify general patterns and lessons.

13. Room for Error

Making plans is important, but it is also important to leave room for error. For example, although counting cards can increase the chances of winning, good players should leave room for losing a few hands before winning. Generally, the bet size should be 1/100 of the original capital.

Similarly, when making long-term plans such as retirement plans, one should lower their expectations and save more money. For example, if you expect to earn three times your current salary in a few years, you should plan as if you can only earn two times your salary.

This gives your a chance to start over if things don't go as expected.

14. You'll Change

People are often aware of their past changes, but tend to think that they won't change in the future. This leads to money plans made in the present that may no longer be applicable in the future. Therefore, when making plans it is important to leave some room for error, instead of believing that you'll "never have material desires" or that you will "always prioritize money".

15. Nothing's Free

Nothing is truly "free" when it comes to investments. While losses are a normal part of investing, without the upfront cost of losing money being clearly labeled, it can feel as though you are being punished for making a mistake and thus many people try to avoid the cost. It's like going to Disney World and paying $100 for a day of fun; there is an inherent cost to the enjoyment.

16. You & Me

People with different goals view stock prices differently. For high-frequency traders, it doesn't matter how high the current price is as long as they think it will rise a little in a short time, so they can buy it. However, for those who want to hold stocks for a long time, holding stocks that are overvalued is not a good option.

It is easy to get confused when people with different goals do the same thing. For instance, people who want to hold stocks for the long term may be swayed to follow the trend of high-frequency trading, which may lead to a bubble.

Therefore, it is important to recognize our own goals and not follow the crowd just because everyone around us is doing something. As our goals may be different from others, following the crowd may lead to counterproductive results.

17. The Seduction of Pessimism

Why is it that pessimistic views tend to draw more attention and be taken more seriously than optimistic views?

In 2008, a Russian scholar proposed a theory that the US would split up into five parts by 2030 due to an economic crisis. This theory was published in the Times and generated a great deal of discussion and serious consideration.

Pessimistic predictions lower expectations, so if the outcome is better than expected, it can be met with great joy. Additionally, the emotional impact of losing $100 is greater than the happiness of gaining $100. Therefore, people generally prefer to be pessimistic.

There are several reasons why pessimism is so prevalent in the economic sphere:

1. Money is relevant to everyone, so it garners everyone's attention. For example, if a hurricane floods Florida, it only affects certain people, but everyone can relate to a financial crisis.
2. People often forget that the market is constantly adjusting, and without a long-term perspective, it is easy to think that "if this continues, resources will be depleted and the economy will collapse".
3. Success is a long-term, gradual process of compounding, while failure can happen in an instant. For example, medical progress may not seem significant each year, but compared to 50 years ago, the number of Americans dying of heart disease has decreased by millions each year.

18. When You'll Believe Anything

The more we desire something to be true, the more likely we are to believe stories and narratives that suggest it is true. For example, in times when medical knowledge was less advanced, many operations that seem absurd now, were believed by many people, because if they didn't, there would be no hope.

Everyone's understanding is limited, and often when we don't understand something, we use our existing knowledge to explain and imagine, and believe that is the truth. For example, a child may not understand what it means to work for money, so they may use their own life experiences to try and make sense of it, and may not realize they don't fully understand what it means to go to work.

19. All Together Now

A summary of the previous lessons. Read this chapter if you don't have time for the whole book. However, the content will make more sense if you read the entire book.

20. Confessions

A chapter where the author shares his financial strategies. While some of his practices may not be considered "best practices," they work for him and his family.

A Brief History of Why the US Consumer Thinks the Way they do

What happened after WWII? Why do Americans take loans? Before the 80s, people were happy because even the richest people in the country live similar lives as the poor ones. There were 3 TV stations, so the whole nation was basically in sync. As the wealth gap widened, the richest family started to have lifestyles unimaginable for common people.