Wednesday, January 20, 2021

The Psychology of Money

Morgan Housel is an excellent writer.  No matter the topic, any article of his is a compelling read, as is his book The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness.  It may seem bold to declare the lessons you teach to be “timeless,” but Housel delivers on this promise.  Thoughtful readers will learn about themselves in reading this book.

The format of the book is 20 independent essays, with just a few threads linking them together.  Collectively, though, they provide useful insight into the way we all think about money.

The introduction observes that we’ve collectively “become better farmers, skilled plumbers, and advanced chemists,” but Housel has “seen no compelling evidence” that we’re getting better at handling our money.  He believes this is because “we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance).”  I’d like to add another reason.  Finances are a competitive business pitting consumers against sellers and everyone against banks.  Expecting collective improvement is a little like bemoaning the fact that the 50% average win rate of tennis players hasn’t improved in decades.

My favourite essay is “The Seduction of Pessimism.”  Historian Deirdre McCloskey said “For reasons I have never understood, people like to hear that the world is going to hell.”  Housel explains why this is true, despite the fact that “Optimism is the best bet for most people because the world tends to get better for most people most of the time.”

Another good essay is “Wealth is What You Don’t See.”  Flashy spending signals wealth to us, but the only thing we can be sure of when we see an expensive car is that the owner has less money by the amount of the car.  True wealth is the money you haven’t spent.

One essay tries to make the case that it’s better to be reasonable than to be rational.  I was confused at first, but it seems Housel uses a different definition of “rational” than I use.  He gives a number of examples where a seemingly rational choice doesn’t work well because of factors it fails to take into account such as pain, worry, and regret.  However, I think of “rational” as making decisions taking into account all material factors, including the cost of the time spent making the decision.  For example, it is rational to take into account the possibility that investors might lose their nerve and sell at a terrible time.  

A concern I have about the belief that “reasonable” is better than “rational” is that it can be taken too far.  Housel gives some good examples where people’s feelings and tendencies are important to making a decision, but anyone could reject any rational choice asserting that a different choice is reasonable.  For example, “I won’t be able to live with myself unless I pile all my net worth into Tesla stock, so that’s reasonable for me.”  Sometimes it’s better to find a different way to deal with feelings than to put your finances at serious risk.

The essay “Surprise!” makes the case that the world is surprising, and that while a careful study of history may be a good idea, it won’t eliminate future surprise.  Housel says the failure of the Fukushima nuclear reactor (due to it only being able to “withstand the worst past historical earthquake”) was “not a failure of analysis.  It’s a failure of imagination.”  Having spent a career in engineering, I can imagine that it might have been a failure of management as well.  Even if engineers had made the case that a powerful future earthquake was too likely, higher costs and extended timelines might have been intolerable to management.

“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.”  I often see others believe things just because they want them to be true.  This makes me wonder what I believe just because I want it to be true.

The 20th essay includes an account of how Housel handles his own money.  “Effectively all our net worth is a house, a checking account, and some Vanguard index funds.”  For my own case, all I’d add is that I have a savings account as well.

Unlike most financial books that readers may struggle through, I found this book to be a page turner.  Even when I mildly disagreed with a few parts, it was consistently interesting and made me examine my own thoughts about money.

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