The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness

Author: Morgan Housel

My favorite Wikipedia entry begins: “Ronald James Read was an American philanthropist, investor, janitor, and gas station attendant.”
In his will the former janitor left $2 mi ll i o n t o hi ss t e p ki d s an d m ore t han$ 6 million to his local hospital and library.
Those who knew Read were baffled. Where did he get all that money?
Read saved what little he could and invested it in blue chip stocks. Then he waited, for decades on end, as tiny savings compounded into more than $8 million.
In what other industry does someone with no college degree, no training, no background, no formal experience, and no connections massively outperform someone with the best education, the best training, and the best connections?
The fact that Ronald Read can coexist with Richard Fuscone has two explanations.
One, financial outcomes are driven by luck, independent of intelligence and effort. That’s
Or, two (and I think more common), that financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.
The aim of this book is to use short stories to convince you that soft skills are more important than the technical side of money.
Two topics impact everyone, whether you are interested in them or not: health and money.
Most of the reason why, I believe, is that 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).
Few topics offer a more powerful magnifying glass that helps explain why people behave the way they do than money.
But the first thing I learned after the financial crisis was that no one could accurately explain what happened, or why it happened, let alone what should be done about it. For every good explanation there was an equally convincing rebuttal.
The more I studied and wrote about the financial crisis, the more I realized that you could understand it better through the lenses of psychology and history, not finance.
I love Voltaire’s observation that “History never repeats itself; man always does
I love Voltaire’s observation that “History never repeats itself; man always does.” It applies so well to how we behave with money.
It’s not a long book. You’re welcome. Most readers don’t finish the books they begin because most single topics don’t require 300 pages of explanation. I’d rather make 20 short points you finish than one long one you give up on.
People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons.
So all of us—you, me, everyone—go through life anchored to a set of views about how money works that vary wildly from person to person.
Your personal experiences with money make up maybe 0.00000001% of what’s happened in the world, but maybe 80% of how you think the world works.
Twenty-five years later, as he was running for president, John F. Kennedy was asked by a reporter what he remembered from the Depression. He remarked: I have no first-hand knowledge of the Depression. My family had one of the great fortunes of the world and it was worth more than ever then. We had bigger houses, more servants, we traveled more. About the only thing that I saw directly was when my father hired some extra gardeners just to give them a job so they could eat. I really did not learn about the Depression until I read about it at Harvard.
The challenge for us is that no amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.
Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior.
The economists wrote: “Our findings suggest that individual investors’ willingness to bear risk depends on personal history.” Not intelligence, or education, or sophistication. Just the dumb luck of when and where you were born.
A few years ago, The New York Times did a story on the working conditions of Foxconn, the massive Taiwanese electronics manufacturer.
But a fascinating response to the story came from the nephew of a Chinese worker, who wrote in the comment section: My aunt worked several years in what Americans call “sweat shops.” It was hard work. Long hours, “small” wage, “poor” working conditions. Do you know what my aunt did before she worked in one of these factories? She was a prostitute.
I don’t know what to make of this. Part of me wants to argue, fiercely. Part of me wants to understand. But mostly it’s an example of how different experiences can lead to vastly different views within topics that one side intuitively thinks should be black and white. Every
I don’t know what to make of this. Part of me wants to argue, fiercely. Part of me wants to understand. But mostly it’s an example of how different experiences can lead to vastly different views within topics that one side intuitively thinks should be black and white.
But every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check.
But every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences.
And that idea—“What you’re doing seems crazy but I kind of understand why you’re doing it.”—uncovers the root of many of our financial decisions.
It was not until the 1980s that the idea that everyone deserves, and should have, a dignified retirement took hold.
There is not decades of accumulated experience to even attempt to learn from. We’re winging it.
Even widespread use of consumer debt—mortgages, credit cards, and car loans—did not take off until after World War II, when the GI Bill made it easier for millions of Americans to borrow.
We all do crazy stuff with money, because we’re all relatively new to this game and what looks crazy to you might make sense to
We all do crazy stuff with money, because we’re all relatively new to this game and what looks crazy to you might make sense to me.
NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others’: “Nothing is as good or as bad as it seems.” Bill Gates went to one of the only high schools in the world that had a computer.
NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others’: “Nothing is as good or as bad as it seems.”
Most university graduate schools did not have a computer anywhere near as advanced as Bill Gates had access to in eighth grade.
One in a million high-school-age students attended the high school that had the combination of cash and foresight to buy a computer. Bill Gates happened to be one of them.
Bill Gates experienced one in a million luck by ending up at Lakeside. Kent Evans experienced one in a million risk by never getting to finish what he and Gates set out to achieve.
Bill Gates experienced one in a million luck by ending up at Lakeside. Kent Evans experienced one in a million risk by never getting to finish what he and Gates set out to achieve. The same force, the same magnitude, working in opposite directions.
Years ago I asked economist Robert Shiller, who won the Nobel Prize in economics, “What do you want to know about investing that we can’t know?” “The exact role of luck in successful outcomes,” he answered.
Economist Bhashkar Mazumder has shown that incomes among brothers are more correlated than height or weight. If you are rich and tall, your brother is more likely to also be rich than he is tall.
But find me two rich brothers and I’ll show you two men who do not think this study’s findings apply to them.
Did failed businesses not try hard enough? Were bad investments not thought through well enough? Are wayward careers due to laziness? Sometimes, yes. Of course. But how much? It’s so hard to know.
It’s possible to statistically measure whether some decisions were wise. But in the real world, day to day, we simply don’t. It’s too hard. We prefer simple stories, which are easy but often devilishly misleading.
After spending years around investors and business leaders I’ve come to realize that someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk.
The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side. The dangerous part of this is that we’re all trying to learn about what works and what doesn’t with money. What
The cover of Forbes magazine does not celebrate poor investors who made good decisions but happened to experience the unfortunate side of risk. But it almost certainly celebrates rich investors who made OK or even reckless decisions and happened to get lucky. Both flipped the same coin that happened to land on a different side. The dangerous part of this is that we’re all trying to learn about what works and what doesn’t with money.
John D. Rockefeller is similar. His frequent circumventing of the law—a judge once called his company “no better than a common thief”—is often portrayed by historians as cunning business smarts. Maybe it was. But when does the narrative shift from, “You didn’t let outdated laws get in the way of innovation,” to “You committed a crime?”
Benjamin Graham is known as one of the greatest investors of all time, the father of value investing and the early mentor of Warren Buffett. But the majority of Benjamin Graham’s investing success was due to owning an enormous chunk of GEICO stock which, by his own admission, broke nearly every diversification rule that Graham himself laid out in his famous texts.
The line between “inspiringly bold” and “foolishly reckless” can be a millimeter thick and only visible with hindsight.
Risk and luck are doppelgangers.
problems we face when trying to learn about the best way to manage money. But two things can point you in a better direction. Be
Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming. Or, just be careful when assuming that 100% of outcomes can be attributed to effort and decisions.
Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.
Therefore, focus less on specific individuals and case studies and more on broad patterns.
The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was influenced
The more extreme the outcome, the less likely you can apply its lessons to your own life, because the more likely the outcome was influenced by extreme ends of luck or risk.
The more common the pattern, the more applicable it might be to your life. Trying
The more common the pattern, the more applicable it might be to your life.
My favorite historian, Frederick Lewis Allen, spent his career depicting the life of the average, median American—how they lived, how they changed, what they did for work, what they ate for dinner, etc. There are more relevant lessons to take away from this kind of broad observation than there are in studying the extreme characters that tend to dominate the news.
At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.” Enough.
At a party given by a billionaire on Shelter Island, Kurt Vonnegut informs his pal, Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch-22 over its whole history. Heller responds, “Yes, but I have something he will never have … enough.”
Madoff is the most notorious Ponzi schemer since Charles Ponzi himself. Madoff swindled investors for two decades before his crime was revealed—ironically just weeks after Gupta’s endeavor.
What Gupta and Madoff did is something different. They already had everything: unimaginable wealth, prestige, power, freedom. And they threw it all away because they wanted more.
There is no reason to risk what you have and need for what you don’t have and don’t need.
The hardest financial skill is getting the goalpost to stop moving.
Modern capitalism is a pro at two things: generating wealth and generating envy.
Happiness, as it’s said, is just results minus expectations.
Evidence became clear that there had not been one ice age, but five distinct ones we could measure.
The amount of energy needed to freeze the planet, melt it anew, and freeze it over yet again is staggering. What on Earth (literally) could be causing these cycles?
In the early 1900s a Serbian scientist named Milutin Milanković studied the Earth’s position relative to other planets and came up with the theory of ice ages that we now know is accurate: The gravitational pull of the sun and moon gently affect the Earth’s motion and tilt toward the sun. During parts of this cycle—which can last tens of thousands of years—each of the Earth’s hemispheres gets a little more, or a little less, solar radiation than they’re used to.
Moderately cool summers, not cold winters, were the icy culprit.
It begins when a summer never gets warm enough to melt the previous winter’s snow. The leftover ice base makes it easier for snow to accumulate the following winter, which increases the odds of snow sticking around in the following summer, which attracts even more accumulation the following winter. Perpetual snow reflects more of the sun’s rays, which exacerbates cooling, which brings more snowfall, and on and on. Within a few hundred years a seasonal snowpack grows into a continental ice sheet, and you’re off to the races.
The big takeaway from ice ages is that you don’t need tremendous force to create tremendous results.
Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years.
I have heard many people say the first time they saw a compound interest table—or one of those stories about how much more you’d have for retirement if you began saving in your 20s versus your 30s—changed their life. But it probably didn’t. What it likely did was surprise them, because the results intuitively didn’t seem right.
But good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.
Getting money is one thing. Keeping it is another. If I had to summarize money success in a single word it would be “survival.” As we’ll see in chapter 6, 40% of companies successful enough to become publicly traded lost effectively all of their value over time. The Forbes 400 list of richest Americans has, on average, roughly 20% turnover per decade for causes
Getting money is one thing. Keeping it is another.
As we’ll see in chapter 6, 40% of companies successful enough to become publicly traded lost effectively all of their value over time.
Getting money requires taking risks, being optimistic, and putting yourself out there.
But keeping money requires the opposite of taking risk. It requires humility, and fear that what you’ve made can be taken away from you just as fast.
Nassim Taleb put it this way: “Having an ‘edge’ and surviving are two different things: the first requires the second. You need to avoid ruin. At all costs.”
Applying the survival mindset to the real world comes down to appreciating three things.
1. More than I want big returns, I want to be financially unbreakable. And if I’m unbreakable I actually think I’ll get the biggest returns, because I’ll be able to stick around long enough for compounding to work wonders.
1. Planning is important, but the most important part of every plan is to plan on the plan not going according to plan.
Many bets fail not because they were wrong, but because they were mostly right in a situation that required things to be exactly right.
Conservative is avoiding a certain level of risk. Margin of safety is raising
It’s different from being conservative. Conservative is avoiding a certain level of risk. Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival.
1. A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital. Optimism is usually defined as a belief that things will go well. But that’s incomplete. Sensible optimism is a belief that the odds are in your favor, and over time things will balance out to a good outcome even if what happens in between is filled with misery. And
1. A barbelled personality—optimistic about the future, but paranoid about what will prevent you from getting to the future—is vital.
The idea that something can gain over the long run while being a basketcase in the short run is not intuitive, but it’s how a lot of things work in life.
A mindset that can be paranoid and optimistic at the same time is hard to maintain, because seeing things as black or white takes less effort than accepting nuance. But you need short-term paranoia to keep you alive long enough to exploit long-term optimism.
The great art dealers operated like index funds. They bought everything they could. And they bought it in portfolios, not individual pieces they happened to like. Then they sat and waited for a few winners to emerge.
A lot of things in business and investing work this way. Long tails—the farthest ends of a distribution of outcomes—have tremendous influence in finance, where a small number of events can account for the majority of outcomes.
Anything that is huge, profitable, famous, or influential is the result of a tail event—
Anything that is huge, profitable, famous, or influential is the result of a tail
Anything that is huge, profitable, famous, or influential is the result of a tail event—an outlying one-in-thousands or millions event.
The distribution of success among large public stocks over time is not much different than it is in venture capital.
Most public companies are duds, a few do well, and a handful become extraordinary winners that account for the majority of the stock market’s returns.
Napoleon’s definition of a military genius was, “The man who can do the average thing when all those around him are going crazy.”
There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.”
There is the old pilot quip that their jobs are “hours and hours of boredom punctuated by moments of sheer terror.” It’s the same in investing.
If you’re a good worker you’ll find the right company in the right field after several attempts and trials.
Part of why this isn’t intuitive is because in most fields we only see the finished product, not the losses incurred that led to the tail-success product.
When we pay special attention to a role model’s successes we overlook that their gains came from a small percent of their actions.
When we pay special attention to a role model’s successes we overlook that their gains came from a small percent of their actions. That makes our own failures, losses, and setbacks feel like we’re doing something wrong. But it’s possible we are wrong, or just sort of right, just as often as the masters are.
The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”
Happiness is a complicated subject because everyone’s different. But if there’s a common denominator in happiness—a universal fuel of joy—it’s that people want to control their lives.
Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.
Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time.
Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.
But doing something you love on a schedule you can’t control can feel the same as doing something you hate.
But doing something you love on a schedule you can’t control can feel the same as doing something you hate. There is a name for this feeling. Psychologists call it reactance.
The United States is the richest nation in the history of the world. But there is little evidence that its citizens are, on average, happier today than they were in the 1950s, when wealth and income were much lower—even at the median level and adjusted for inflation.
A 2019 Gallup poll of 150,000 people in 140 countries found that about 45% of Americans said they felt “a lot of worry” the previous day.²⁷ The global average was 39%.
Fifty-five percent of Americans said they felt “a lot of stress” the previous day. For the rest of the world, 35% said the same.
refinery worker who occasionally had Rockefeller’s ear once remarked: “He lets everybody else talk, while he sits back and says nothing.”
A refinery worker who occasionally had Rockefeller’s ear once remarked: “He lets everybody else talk, while he sits back and says nothing.”
In 1870, 46% of jobs were in agriculture, and 35% were in crafts or manufacturing, according to economist Robert Gordon.
Today, that’s flipped. Thirty-eight percent of jobs are now designated as “managers, officials, and professionals.” These are decision-making jobs. Another 41% are service jobs that often rely on your thoughts as much as your actions.
If your job is to build cars, there is little you can do when you’re not on the assembly line. You detach from work and leave your tools in the factory. But if your job is to create a marketing campaign—a thought-based and decision job—your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you’re making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning.
If your job is to build cars, there is little you can do when you’re not on the assembly line. You detach from work and leave your tools in the factory. But if your job is to create a marketing campaign—a thought-based and decision job—your tool is your head, which never leaves you. You might be thinking about your project during your commute, as you’re making dinner, while you put your kids to sleep, and when you wake up stressed at three in the morning. You might be on the clock for fewer hours than you would in 1950. But it feels like you’re working 24/7.
When you see someone driving a nice car, you rarely think, “Wow, the guy driving that car is cool.” Instead, you think, “Wow, if I had that car people would think I’m cool.” Subconscious or not, this is how people think.
There is a paradox here: people tend to want wealth to signal to others that they should be liked and admired. But in reality those other people often bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth as a benchmark for their own desire to be liked and admired.
It’s a subtle recognition that people generally aspire to be respected and admired by others, and using money to buy fancy things may bring less of it than you imagine.
Money has many ironies. Here’s an important one: Wealth is what you don’t see.
We tend to judge wealth by what we see, because that’s the information we have in front of us. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success.
When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.
Investor Bill Mann once wrote: “There is no faster way to feel rich than to spend lots of money on really nice things. But the way to be rich is to spend money you have, and to not spend money you don’t have. It’s really that simple.”
But wealth is hidden. It’s income not spent. Wealth is an option not yet taken to buy something later.
Losing weight is notoriously hard, even among those putting in the work of vigorous exercise.
Exercise is like being rich. You think, “I did the work and I now deserve to treat myself to a big meal.” Wealth is turning down that treat meal and actually burning net calories. It’s hard, and requires self-control.
There are, of course, wealthy people who also spend a lot of money on stuff. But even in those cases what we see is their richness, not their wealth.
The danger here is that I think most people, deep down, want to be wealthy. They want freedom and flexibility, which is what financial assets not yet spent can give you. But it is so ingrained in us that to have money is to spend money that we don’t get to see the restraint it takes to actually be wealthy.
It’s difficult to learn from what you can’t see. Which helps explain why it’s so hard for many to build wealth.
Past a certain level of income people fall into three groups: Those who save, those who don’t think they can save, and those who don’t think they need to save.
The first idea—simple, but easy to overlook—is that building wealth has little to do with your income or investment returns, and lots to do with your savings rate.
The biggest reason we overcame the oil crisis is because we started building cars, factories, and homes that are more energy efficient than they used to be.
The world grew its “energy wealth” not by increasing the energy it had, but by decreasing the energy it needed.
Investment returns can make you rich. But whether an investing strategy will work, and how long it will work for, and whether markets will cooperate, is always in doubt.
If you view building wealth as something that will require more money or big investment returns, you may become as pessimistic as the energy doomers were in the 1970s.
If you view it as powered by your own frugality and efficiency, the destiny is clearer.
Wealth is just the accumulated leftovers after you spend what you take in. And since you can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.
And since you can build wealth without a high income, but have no chance of building wealth without a high savings rate, it’s clear which one matters more.
Learning to be happy with less money creates a gap between what you have and what you want—similar to the gap you get from growing your paycheck, but easier and more in your control.
Past a certain level of income, what you need is just what sits below your ego.
Everyone needs the basics. Once they’re covered there’s another level of comfortable basics, and past that there’s basics that are both comfortable, entertaining, and enlightening.
Think of it like this, and one of the most powerful ways to increase your savings isn’t to raise your income. It’s to raise your humility.
When you define savings as the gap between your ego and your income you realize why many people with decent incomes save so little.
People with enduring personal finance success—not necessarily those with high incomes—tend to have a propensity to not give a damn what others think about them. So people’s ability to save is more in their control than they might think. Savings can be created by spending less. You can spend less if you desire less. And you will desire less if you care
People with enduring personal finance success—not necessarily those with high incomes—tend to have a propensity to not give a damn what others think about them.
Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment.
Savings in the bank that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate.
More fields will fall into this category as digitization erases global boundaries—as “software eats the world,” as venture capitalist Marc Andreesen puts it.
Intelligence is not a reliable advantage in a world that’s become as connected as ours has. But flexibility is.
Having more control over your time and options is becoming one of the most valuable currencies in the world. That’s why more people can, and more people should, save money.
You’re not a spreadsheet. You’re a person. A screwed up, emotional person. It took me a while to figure this out, but once it clicked I realized it’s one of the most important parts of finance.
Do not aim to be coldly rational when
Do not aim to be coldly rational when making financial decisions. Aim to just be pretty reasonable. Reasonable is more realistic and you have a better chance of sticking with it for the long run, which is what matters most when managing money.
In the early 1900s Wagner-Jauregg began injecting patients with low-end strains of typhoid, malaria, and smallpox to trigger fevers strong enough to kill off their syphilis.
He won the Nobel Prize in medicine in 1927. The organization today notes: “The main work that concerned Wagner-Jauregg throughout his working life was the endeavour to cure mental disease by inducing a fever.”
We now have better, more scientific evidence of fever’s usefulness in fighting infection. A one-degree increase in body temperature has been shown to slow the replication rate of some viruses by a factor of 200.
One study was blunt: “Treatment of fever is common in the ICU setting and likely related to standard dogma rather than evidence-based practice.”³⁶
It may be rational to want a fever if you have an infection. But it’s not reasonable.
That philosophy—aiming to be reasonable instead of rational—is one more people should consider when making decisions with their money.
A rational investor makes decisions based on numeric facts. A reasonable investor makes them in a conference room surrounded by co-workers you want to think highly of you, with a spouse you don’t want to let down, or judged against the silly but realistic competitors that are your brother-in-law, your neighbor, and your own personal doubts.
There are few financial variables more correlated to performance than commitment to a strategy during its lean years—both the amount of performance and the odds of capturing it over a given period of time.
Invest in a promising company you don’t care about, and you might enjoy it when everything’s going well. But when the tide inevitably turns you’re suddenly losing money on something you’re not interested in. It’s a double burden, and the path of least resistance is to move onto something else.
There’s a well-documented “home bias,” where people prefer to invest in companies from the country they live in while ignoring the other 95%+ of the planet. It’s not rational, until you consider that investing is effectively giving money to strangers.
Acting on investment forecasts is dangerous. But I get why people try to predict what will happen next year. It’s human nature. It’s reasonable.
Stanford professor Scott Sagan once said something everyone who follows the economy or investment markets should hang on their wall: “Things that have never happened before happen all the time.”
A trap many investors fall into is what I call “historians as prophets” fallacy: An overreliance on past data as a signal to future conditions in a field where innovation and change are the lifeblood of progress.
But investing is not a hard science. It’s a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing, which can make even smart people nervous, greedy and paranoid.
Richard Feynman, the great physicist, once said, “Imagine how much harder physics would be if electrons had feelings.”
The mental trick we play on ourselves here is an over-admiration of people who have been there, done that, when it comes to money.
The mental trick we play on ourselves here is an over-admiration of people who have been there, done that, when it comes to money. 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.
Two dangerous things happen when you rely too heavily on investment history as a guide to what’s going to happen next.
1. You’ll likely miss the outlier events that move the needle the most.
The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound. How, for example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing bubble, which led to the financial crisis, which led to a poor jobs market, which led tens of millions to seek a college education, which led to $1.6 trillion in student loans with a 10.8% default rate. It’s not intuitive to link 19 hijackers to the current weight of student loans, but that’s what happens in a world driven by a few outlier tail events.
Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make that mistake again.’ But, in fact, 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; that we should use past surprises as an admission that we have no idea what might happen next.
1. History can be a misleading guide to the future of the economy and stock market because it doesn’t account for structural changes that are relevant to today’s world.
The 401(k) is 42 years old. The Roth IRA is younger, created in the 1990s. So personal financial advice and analysis about how Americans save for retirement today is not directly comparable to what made sense just a generation ago. We have new options. Things changed.
The average time between recessions has grown from about two years in the late 1800s to five years in the early 20th century to eight years over the last half-century.
There are plenty of theories on why recessions have become less frequent. One is that the Fed is better at managing the business cycle, or at least extending it. Another is that heavy industry is more prone to boom-and-bust overproduction than the service industries that dominated the last 50 years.
The pessimistic view is that we now have fewer recessions, but when they occur they are more powerful than before.
Graham died in 1976. If the formulas he advocated were discarded and updated five times between 1934 and 1972, how relevant do you think they are in 2020? Or will be in 2050?
An interesting quirk of investing history is that the further back you look, the more likely you are to be examining a world that no longer applies to today.
There’s a common phrase in investing, usually used mockingly, that “It’s different this time.” If you need to rebut someone who’s predicting the future won’t perfectly mirror the past, say, “Oh, so you think it’s different this time?” and drop the mic
It comes from investor John Templeton’s view that “The four most dangerous words in investing are, ‘it’s different this time.’”
Michael Batnick put it: “The twelve most dangerous words in investing are, ‘The four most dangerous words in investing are, ‘it’s different this time.’”
The further back in history you look, the more general your takeaways should be. General things like people’s relationship to greed and fear, how they behave under stress, and how they respond to incentives tend to be stable in time. The history of money is useful for that kind of stuff.
But a tiny group of blackjack players who practice card counting can teach ordinary people something extraordinarily important about managing money: the importance of room for error.
History is littered with good ideas taken too far, which are indistinguishable from bad ideas. The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—“unknowns”—are an ever-present part of life.
Benjamin Graham is known for his concept of margin of safety.
But my favorite summary of the theory came when he mentioned in an interview that “the purpose of the margin of safety is to render the forecast unnecessary.”
But people underestimate the need for room for error in almost everything they do that involves money. Stock analysts give their clients price targets, not price ranges.
The pundit who speaks in unshakable certainties will gain a larger following than the one who says “We can’t know for sure,” and speaks in probabilities.
Harvard psychologist Max Bazerman once showed that when analyzing other people’s home renovation plans, most people estimate the project will run between 25% and 50% over budget.⁴³ But when it comes to their own projects, people estimate that renovations will be completed on time and at budget. Oh, the eventual disappointment.
The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong. Bill
The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound. So the person with enough room for error in part of their strategy (cash) to let them endure hardship in another (stocks) has an edge over the person who gets wiped out, game over, insert more tokens, when they’re wrong.
Can you survive your assets declining by 30%? On a spreadsheet, maybe yes—in terms of actually paying your bills and staying cash-flow positive. But what about mentally? It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest.
Spreadsheets are good at telling you when the numbers do or don’t add up. They’re not good at modeling how you’ll feel when you tuck your kids in at night wondering if the investment decisions you’ve made were a mistake that will hurt their future.
“The best way to achieve felicity is to aim low,” says Charlie Munger.
An important cousin of room for error is what I call optimism bias in risk-taking, or “Russian roulette should statistically work” syndrome:
An important cousin of room for error is what I call optimism bias in risk-taking, or “Russian roulette should statistically work” syndrome: An attachment to favorable odds when the downside is unacceptable in any circumstances.
When tanks were desperately needed on the front lines, something happened that surprised everyone: Almost none of them worked.
Out of 104 tanks in the unit, fewer than 20 were operable. Engineers quickly found the issue. Historian William Craig writes: “During the weeks of inactivity behind the front lines, field mice had nested inside the vehicles and eaten away insulation covering the electrical systems.”
Out of 104 tanks in the unit, fewer than 20 were operable. Engineers quickly found the issue. Historian William Craig writes: “During the weeks of inactivity behind the front lines, field mice had nested inside the vehicles and eaten away insulation covering the electrical systems.” The
What kind of tank designer thinks about mouse protection? Not a reasonable one. And not one who studied tank history.
A good rule of thumb for a lot of things in life is that everything that can break will eventually break. So if many things rely on one thing working, and that thing breaks, you are counting the days to catastrophe.
The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.
An underpinning of psychology is that people are poor forecasters of their future selves.
Imagining a goal is easy and fun. Imagining a goal in the context of the realistic life stresses that grow with competitive pursuits is something entirely different.
Many of us wind through life on a similar trajectory.
Only 27% of college grads have a job related to their major, according to the Federal Reserve.⁴⁶ Twenty-nine percent of stay-at-home parents have a college degree.⁴⁷ Few likely regret their education, of course. But we should acknowledge that a new parent in their 30s may think about life goals in a way their 18-year-old self making career goals would never imagine.
Long-term financial planning is essential. But things change—both the world around you, and your own goals and desires. It is one thing to say, “We don’t know what the future holds.” It’s another to admit that you, yourself, don’t know today what you will even want in the future. And the truth is, few of us do. It’s hard to make enduring long-term decisions when your view of what you’ll want in the future is likely to shift.
The End of History Illusion is what psychologists call the tendency for people to be keenly aware of how much they’ve changed in the past, but to underestimate how much their personalities, desires, and goals are likely to change in the future.
At every stage of our lives we make decisions that will profoundly influence the lives of the people we’re going to become, and then when we become those people, we’re not always thrilled with the decisions we made.
I know young people who purposefully live austere lives with little income, and they’re perfectly happy with it. Then there are those who work their tails off to pay for a life of luxury, and they’re perfectly happy with that. Both have risks—the former risks being unprepared to raise a family or fund retirement, the latter risks regret that you spent your youthful and healthy years in a cubicle.
Regrets are especially painful when you abandon a previous plan and feel like you have to run in the other direction twice as fast to make up for lost time.
Compounding works best when you can give a plan years or decades to grow. This is true for not only savings but careers and relationships.
Aiming, at every point in your working life, to have moderate annual savings, moderate free time, no more than a moderate commute, and at least moderate time with your family, increases the odds of being able to stick with a plan and avoid regret than if any one of those things fall to the extreme sides of the spectrum.
“When I asked Danny how he could start again as if we had never written an earlier draft,” Zweig continued, “he said the words I’ve never forgotten: ‘I have no sunk costs.’”⁴⁹
Sunk costs—anchoring decisions to past efforts that can’t be refunded—are a devil in a world where people change over
Sunk costs—anchoring decisions to past efforts that can’t be refunded—are a devil in a world where people change over time.
Responding to critics who said his actions were wrong and what he should have done was obvious, Immelt told his successor, “Every job looks easy when you’re not the one doing it.”
The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.
Most investors with even a little experience know that volatility is real and common. Many then take what seems like the next logical step: trying to avoid it.
The question is: Why do so many people who are willing to pay the price of cars, houses, food, and vacations try so hard to avoid paying the price of good investment returns?
The answer is simple: The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good.
The answer is simple: The price of investing success is not immediately obvious. It’s not a price tag you can see, so when the bill comes due it doesn’t feel like a fee for getting something good. It feels like a fine for doing something wrong.
It sounds trivial, but 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.
Blaming bubbles on greed and stopping there misses important lessons about how and why people rationalize what in hindsight look like greedy decisions.
Part of why bubbles are hard to learn from is that they are not like cancer, where a biopsy gives us a clear warning and diagnosis. They are closer to the rise and fall of a political party, where the outcome is known in hindsight but the cause and blame are never agreed upon.
I don’t think we’ll ever be able to fully explain why bubbles occur. It’s like asking why wars occur—there are almost always several reasons, many of them conflicting, all of them controversial.
But let me propose one reason they happen that both goes overlooked and applies to you personally: Investors often innocently take cues from other investors who are playing a different game than they are.
When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.
An iron rule of finance is that money chases returns to the greatest extent that it can.
Bubbles aren’t so much about valuations rising. That’s just a symptom of something else: time horizons shrinking as more short-term traders enter the playing field.
The average mutual fund had 120% annual turnover in 1999, meaning they were, at most, thinking about the next eight months. So were the individual investors who bought those mutual funds.
The formation of bubbles isn’t so much about people irrationally participating in long-term investing. They’re about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself.
What do you expect people to do when momentum creates a big short-term return potential? Sit and watch patiently? Never. That’s not how the world works. Profits will always be chased. And 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.
Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them. But when you don’t know why someone behaves like they do you won’t know how long they’ll continue acting that way, what will make them change their mind, or whether they’ll ever learn their lesson.
Many finance and investment decisions are rooted in watching what other people do and either copying them or betting against them.
But while we can see how much money other people spend on cars, homes, clothes, and vacations, we don’t get to see their goals, worries, and aspirations.
We call everyone investing money “investors” like they’re basketball players, all playing the same game with the same rules
Pessimism isn’t just more common than optimism. It also sounds smarter.
Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way.
Pessimism just sounds smarter and more plausible than optimism.
John Stuart Mill wrote in the 1840s: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.”
The question is, why? And how does it impact how we think about money?
Only 2.5% of Americans owned stocks on the eve of the great crash of 1929 that sparked the Great Depression.
Only 2.5% of Americans owned stocks on the eve of the great crash of 1929 that sparked the Great Depression. But the majority of Americans—if not the world—watched in amazement as the market collapsed, wondering what it signaled about their own fate.
There are two topics that will affect your life whether you are interested in them or not: money and health.
Oil historian Daniel Yergin writes: “86% of oil reserves in the United States are the result not of what is estimated at time of discovery but of the revisions” that come when our technology improves.
Assuming that something ugly will stay ugly is an easy forecast to make. And it’s persuasive, because it doesn’t require imagining the world changing
A third is that progress happens too slowly to notice, but setbacks happen too quickly to ignore. There are lots of overnight tragedies. There are rarely overnight miracles. On January 5th, 1889, the Detroit Free Press pushed back against the long-held dream that man could one day fly like a bird. Airplanes, the paper wrote, “appear impossible”:
A third is that progress happens too slowly to notice, but setbacks happen too quickly to ignore.
Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.
Optimistic narratives require looking at a long stretch of history and developments, which people tend to forget and take more effort to piece together.
For example, the age-adjusted death rate per capita from heart disease has declined more than 70% since 1965, according to the National Institute of Health.⁶³ A 70% decline in heart-disease death is enough to save something like half a million American lives per year. Picture the population of Atlanta saved every year.
In investing you must identify the price of success—volatility and loss amid the long backdrop of growth—and be willing to pay
In investing you must identify the price of success—volatility and loss amid the long backdrop of growth—and be willing to pay it.
Pessimism reduces expectations, narrowing the gap between possible outcomes and outcomes you feel great about. Maybe that’s why it’s so seductive. Expecting things to be bad is the best way to be pleasantly surprised when they’re not. Which, ironically, is something to be optimistic about.
Once the narrative that home prices will keep rising broke, mortgage defaults rose, then banks lost money, then they reduced lending to other businesses, which led to layoffs, which led to less spending, which led to more layoffs, and on and on.
But stories are, by far, the most powerful force in the economy. They are the fuel that can let the tangible parts of the economy work, or the brake that holds our capabilities back.
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.
It seems crazy. But if you desperately need a solution and a good one isn’t known or readily available to you, the path of least resistance is toward Hajaji’s reasoning: willing to believe anything. Not just try anything, but believe it.
People believe in financial quackery in a way they
Investing is one of the only fields that offers daily opportunities for extreme rewards. People believe in financial quackery in a way they never would for, say, weather quackery because the rewards for correctly predicting what the stock market will do next week are in a different universe than the rewards for predicting whether it will be sunny or rainy next week.
Consider that 85% of active mutual funds underperformed their benchmark over the 10 years ending 2018.
It’s hard for a policymaker to predict an outright recession, because a recession will make their careers complicated. So even worst-case projections rarely expect anything worse than just “slow-ish” growth.
Everyone has an incomplete view of the world. But we form a complete narrative to fill in the gaps.
Take history. It’s just the recounting of stuff that already happened. It should be clear and objective. But as B. H. Liddell Hart writes in the book Why Don’t We Learn From History?: [History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art.
[History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming 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.
[History] cannot be interpreted without the aid of imagination and intuition. The sheer quantity of evidence is so overwhelming that selection is inevitable. Where there is selection there is art.
Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense.
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.
Carl Richards writes: “Risk is what’s left over when you think you’ve thought of everything.”
Psychologist Philip Tetlock once wrote: “We need to believe we live in a predictable, controllable world, so we turn to authoritative-sounding people who promise to satisfy that need.”
Business, economics, and investing, are fields of uncertainty, overwhelmingly driven by decisions that can’t easily be explained with clean formulas, like a trip to Pluto can.
They are surely wrong: the outcome of a start-up depends as much on the achievements of its competitors and on changes in the market as on its own efforts. However, entrepreneurs naturally focus on what they know best—their plans and actions and the most immediate threats and opportunities, such as the availability of funding.
But doctors and dentists aren’t useless, obviously. They have knowledge. They know the odds. They know what tends to work, even if patients come to different conclusions about what kind of treatment is right for them.
But doctors and dentists aren’t useless, obviously. They have knowledge. They know the odds. They know what tends to work, even if patients come to different conclusions about what kind of treatment is right for them. Financial advisors are the same.
Because it’s never as good or as bad as it looks.
Saving money is the gap between your ego and your income, and wealth is what you don’t see.
No matter how much you earn, you will never build wealth unless you can put a lid on how much fun you can have with your money right now, today.
Manage your money in a way that helps you sleep at night.
If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon.
No matter what you’re doing with your money you should be comfortable with a lot of stuff not working.
Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness.
Uncertainty, doubt, and regret are common costs in the finance world. They’re often worth paying. But you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid).
Avoid the extreme ends of financial decisions.
Sandy Gottesman, a billionaire investor who founded the consulting group First Manhattan, is said to ask one question when interviewing candidates for his investment team: “What do you own, and why?”
I love this question because it highlights what can often be a mile-wide gap between what makes sense—which is what people suggest you do—and what feels right to them—which is what they actually do.
Ken Murray, a professor of medicine at USC, wrote an essay in 2011 titled “How Doctors Die” that showed the degree to which doctors choose different end-of-life treatments for themselves than they recommend for their patients.⁷⁰
“What’s unusual about them is not how much treatment they get compared to most Americans, but how little. For all the time they spend fending off the deaths of others, they tend to be fairly serene when faced with death themselves.
There are basic principles that must be adhered to—this is true in finance and in medicine—but important financial decisions are not made in spreadsheets or in textbooks. They are made at the dinner table.
There are basic principles that must be adhered to—this is true in finance and in medicine—but important financial decisions are not made in spreadsheets or in textbooks. They are made at the dinner table. They often aren’t made with the intention of maximizing returns, but minimizing the chance of disappointing a spouse or child.
Charlie Munger once said “I did not intend to get rich. I just wanted to get independent.”
I mostly just want to wake up every day knowing my family and I can do whatever we want to do on our own terms. Every financial decision we make revolves around that goal.
Being able to wake up one morning and change what you’re doing, on your own terms, whenever you’re ready, seems like the grandmother of all financial goals.
Despite more than a decade of rising incomes—myself in finance, my wife in health care—we’ve more or less stayed at that lifestyle ever since. That’s pushed our savings rate continuously higher.
Nassim Taleb explained: “True success is exiting some rat race to modulate one’s activities for peace of mind.”
We own our house without a mortgage, which is the worst financial decision we’ve ever made but the best money decision we’ve ever made.
The independent feeling I get from owning our house outright far exceeds the known financial gain I’d get from leveraging our assets with a cheap mortgage.
Good decisions aren’t always rational. At some point you have to choose between being happy or being “right.”
Not being forced to sell stocks to cover an expense also means we’re increasing the odds of letting the stocks we own compound for the longest period of time. Charlie Munger put it well: “The first rule of compounding is to never interrupt it unnecessarily.”
If I had to summarize my views on investing, it’s this: Every investor should pick a strategy that has the highest odds of successfully meeting their goals. And I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.
I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us.
One of my deeply held investing beliefs is that there is little correlation between investment effort and investment results.
What happened in America since the end of World War II is the story of the American consumer. It’s a story that helps explain why people think about money the way they do today.
The short story is this: Things were very uncertain, then they were very good, then pretty bad, then really good, then really bad, and now here we are.

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The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness

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