Morgan Housel, of the Collaborative Fund, is one of the best financial writers working today. His latest piece, The Psychology of Money , is nothing short of a tour de force of investing advice.
Housel brings his unique insights and analogies to 20 topics such as ‘confirmation bias’, the power of compounding—not just through interest rates but also technology and ideas- and the overreliance on historical information.
Here is the first part, and you click to the full article at the link above.
Let me tell you the story of two investors, neither of whom knew each other, but whose paths crossed in an interesting way.
Grace Groner was orphaned at age 12. She never married. She never had kids. She never drove a car. She lived most of her life alone in a one-bedroom house and worked her whole career as a secretary. She was, by all accounts, a lovely lady. But she lived a humble and quiet life. That made the $7 million she left to charity after her death in 2010 at age 100 all the more confusing. People who knew her asked: Where did Grace get all that money?
But there was no secret. There was no inheritance. Grace took humble savings from a meager salary and enjoyed eighty years of hands-off compounding in the stock market. That was it.
Weeks after Grace died, an unrelated investing story hit the news.
Richard Fuscone, former vice chairman of Merrill Lynch’s Latin America division, declared personal bankruptcy, fighting off foreclosure on two homes, one of which was nearly 20,000 square feet and had a $66,000 a month mortgage. Fuscone was the opposite of Grace Groner; educated at Harvard and University of Chicago, he became so successful in the investment industry that he retired in his 40s to “pursue personal and charitable interests.” But heavy borrowing and illiquid investments did him in. The same year Grace Goner left a veritable fortune to charity, Richard stood before a bankruptcy judge and declared: “I have been devastated by the financial crisis … The only source of liquidity is whatever my wife is able to sell in terms of personal furnishings.”
The purpose of these stories is not to say you should be like Grace and avoid being like Richard. It’s to point out that there is no other field where these stories are even possible.
In what other field does someone with no education, no relevant experience, no resources, and no connections vastly outperform someone with the best education, the most relevant experiences, the best resources and the best connections? There will never be a story of a Grace Groner performing heart surgery better than a Harvard-trained cardiologist. Or building a faster chip than Apple’s engineers. Unthinkable.
But these stories happen in investing.
That’s because 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.
Grace and Richard show that managing money isn’t necessarily about what you know; it’s how you behave. But that’s not how finance is typically taught or discussed. The finance industry talks too much about what to do, and not enough about what happens in your head when you try to do it.
This report describes 20 flaws, biases, and causes of bad behavior I’ve seen pop up often when people deal with money.
- Earned success and deserved failure fallacy: A tendency to underestimate the role of luck and risk, and a failure to recognize that luck and risk are different sides of the same coin.
I like to ask people, “What do you want to know about investing that we can’t know?”
It’s not a practical question. So few people ask it. But it forces anyone you ask to think about what they intuitively think is true but don’t spend much time trying to answer because it’s futile.
Years ago I asked economist Robert Shiller the question. He answered, “The exact role of luck in successful outcomes.”
I love that, because no one thinks luck doesn’t play a role in financial success. But since it’s hard to quantify luck, and rude to suggest people’s success is owed to luck, the default stance is often to implicitly ignore luck as a factor. If I say, “There are a billion investors in the world. By sheer chance, would you expect 100 of them to become billionaires predominately off luck?” You would reply, “Of course.” But then if I ask you to name those investors – to their face – you will back down. That’s the problem.
The same goes for failure. Did failed businesses not try hard enough? Were bad investments not thought through well enough? Are wayward careers the product of laziness?
In some parts, yes. Of course. But how much? It’s so hard to know. And when it’s hard to know we default to the extremes of assuming failures are predominantly caused by mistakes. Which itself is a mistake.
People’s lives are a reflection of the experiences they’ve had and the people they’ve met, a lot of which are driven by luck, accident, and chance. The line between bold and reckless is thinner than people think, and you cannot believe in risk without believing in luck, because they are two sides of the same coin. They are both the simple idea that sometimes things happen that influence outcomes more than effort alone can achieve.
After my son was born I wrote him a letter:
Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging of entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself.
- 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.
Say you want a new car. It costs $30,000. You have a few options: 1) Pay $30,000 for it. 2) Buy a used one for less than $30,000. 3) Or steal it.
In this case, 99% of people avoid the third option, because the consequences of stealing a car outweigh the upside. This is obvious.
But say you want to earn a 10% annual return over the next 50 years. Does this reward come free? Of course not. Why would the world give you something amazing for free? Like the car, there’s a price that has to be paid.
The price, in this case, is volatility and uncertainty. And like the car, you have a few options: You can pay it, accepting volatility and uncertainty. You can find an asset with less uncertainty and a lower payoff, the equivalent of a used car. Or you can attempt the equivalent of grand theft auto: Take the return while trying to avoid the volatility that comes along with it.
Many people in this case choose the third option. Like a car thief – though well-meaning and law-abiding – they form tricks and strategies to get the return without paying the price. Trades. Rotations. Hedges. Arbitrages. Leverage.
But the Money Gods do not look highly upon those who seek a reward without paying the price. Some car thieves will get away with it. Many more will be caught with their pants down. Same thing with money.
This is obvious with the car and less obvious with investing because the true cost of investing – or anything with money – is rarely the financial fee that is easy to see and measure. It’s the emotional and physical price demanded by markets that are pretty efficient. Monster Beverage stock rose 211,000% from 1995 to 2016. But it lost more than half its value on five separate occasions during that time. That is an enormous psychological price to pay. Buffett made $90 billion. But he did it by reading SEC filings 12 hours a day for 70 years, often at the expense of paying attention to his family. Here too, a hidden cost.
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.
