Snippets

Daily Read #22 – The Psychology of Money

2 Mins read

Quick snippets from my morning read on Tuesday, 17th November 2020

Today’s morning read follows our theme for this week, and it’s a fascinating insight into the psychology of money, specifically the investment mindset. It starts with a story of two people one with no financial background and the other with a wealth of investment banking experience. And it’s also an insightful look at the power of compound interest. It’s an very long article, but worth absolutely every minute spent reading it. A few small snippets are shared below.

The Psychology of Money by Morgan Housel

Investing is not the study of finance. It’s the study of how people behave with money. And behavior is hard to teach, even to really smart people. You can’t sum up behavior with formulas to memorize or spreadsheet models to follow. Behavior is inborn, varies by person, is hard to measure, changes over time, and people are prone to deny its existence, especially when describing themselves.

2. Cost avoidance syndrome: A failure to identify the true costs of a situation, with too much emphasis on financial costs while ignoring the emotional price that must be paid to win a reward.

Every money reward has a price beyond the financial fee you can see and count. Accepting that is critical. Scott Adams once wrote: “One of the best pieces of advice I’ve ever heard goes something like this: If you want success, figure out the price, then pay it. It sounds trivial and obvious, but if you unpack the idea it has extraordinary power.” Wonderful money advice.

3. Rich man in the car paradox.

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.

The paradox of wealth is that people tend to want it to signal to others that they should be liked and admired. But in reality those other people bypass admiring you, not because they don’t think wealth is admirable, but because they use your wealth solely as a benchmark for their own desire to be liked and admired.

5. Anchored-to-your-own-history bias: Your personal experiences make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.

Since no amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty, people go through life with totally different views on how the economy works, what it’s capable of doing, how much we should protect other people, and what should and shouldn’t be valued.

Keep that quote in mind when debating people’s investing views. Or when you’re confused about their desire to hoard or blow money, their fear or greed in certain situations, or whenever else you can’t understand why people do what they do with money. Things will make more sense.

8. Underappreciating the power of compounding, driven by the tendency to intuitively think about exponential growth in linear terms.

The punchline of compounding is never that it’s just big. It’s always – no matter how many times you study it – so big that you can barely wrap your head around it.

The counter intuitiveness of compounding is responsible for the majority of disappointing trades, bad strategies, and successful investing attempts. Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that kill your confidence when they end. It’s about earning pretty good returns that you can stick with for a long period of time. That’s when compounding runs wild.

Read the full and insightful article by Morgan Housel.

And as always, if you enjoyed this, check out the rest of our daily snippets, curated daily, right here on The Red Notebook.

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