In his book, The Psychology of Money, author Morgan Housel dives into the psychology of our money and investing choices and establishes what separates the rich from everyone else. Housel dives into how our past experiences can inhibit our financial goals and how having goals and incorporating simple concepts like compound interest can help us succeed financially.
Just as our past experiences and personalities significantly impact our personal lives, these same psychological factors also impact our financial lives. To that point, our current relationship with money is substantially influenced by past experiences.
For example, Housel discusses people who lived through The Great Recession and are now scared of reinvesting. Others may look down upon these timid souls and judge them as crazy. Still, the author says we shouldn’t judge them or dismiss their behavior because we may be guilty of our own financial behavioral flaws.
Unless we can recognize these flaws and biases, we won’t be able to correct our behavior and move forward. If it sounds like marriage counseling, it’s because the same psychology that informs our relationships control our financial decision-making.
One of the main points Housel drives home is that we all have experiences that may be causing us to lose in the world of investing and finances, but it doesn’t have to be a life sentence. We must learn to make investment decisions based on our goals and investment options rather than experiences to overcome our obstacles.
In exploring the psychology of money, Housel shares a series of anecdotes or insights to drive home particular points. One of these insights is that Warren Buffett is a prime example of the power of compound interest. The power of compounding can bring you financial independence, but to leverage the power of compounding, you have to seek out investments that cash flow or provide income. Assets like common stocks that rely purely on appreciation for gains do not fit this category.
The power of compounding can make you rich from exponential gains. Warren Buffett is an example of this. His current net worth is $84.5 billion, but he accumulated $84.2 billion after his 50th birthday. Some would criticize Warren Buffett for investing in boring companies like railroads and airlines, but his formula of investing in tangible businesses with an intrinsic worth that cash flow and appreciate has worked for him.
Going along with the concept of compounding, Housel offers another related insight. Good investing is about not screwing up. Good investments need cash to flow, and they need time to compound.
Speculative investments carry too much risk of screwing up since they’re like buying a lottery ticket by their nature. It’s gambling, and these types of speculative investments are not ideal for building wealth since they don’t have cash flow, and the returns can not be reinvested to compound wealth.
The last little nugget from Housel’s book that made an impression on me was his advice to stop judging people by their visible wealth. The wealthy aren’t necessarily the ones with all the mansions, fast cars, and toys. They’re usually the ones living below their means because they believe money should be deployed to more productive uses than to show off to your neighbors.
If you can get the idea out of your head that wealth isn’t what you see from the street but what goes on in the middle of the night when you have investments making passive income for you in your sleep.
Emotional biases and experiences may have led to bad investment decisions in the past, but they don’t have to rule your financial future. The idea behind therapy is to train yourself to move beyond the habits formed from past experiences that prohibit you from growing and progressing as a person or sabotaging your relationships.
The same holds true for your relationship with money. Past experiences may have led to bad investment choices, but you can learn to overcome them by remembering and incorporating a few simple concepts.
Housel made such a big deal out of compounding in a psychology book is revelatory but makes complete sense. We can take all the guesswork and the psychology out of our investment choices by investing in productive assets.
Passive income generated while you sleep, which takes care of itself, is exactly what some investors who have had bad experiences or hang-ups in the past need. It removes all the brain damage and the stress, and the good news is anyone can do it.
