How normal people should invest normally

I’m on a roll.

I’m razzing through investment literature at an unprecedented rate. Perhaps it’s this new lockdown, or maybe it’s because all the short-term noise is making me want to zoom out more and more.

Either way, I hope you don’t mind but today is another book review as I’ve smashed through it in a week and don’t want to wait!

It’s called The Psychology of Money, by Morgan Housel.

It’s nice, because it was recommended online by my favourite columnist of the last five years or so, Tim Harford. A good start, but when it arrived, who’s quote should adorn the front cover?

None other than our favourite investment thinker, who specialises in the psychological side of the markets, Howard Marks. He said, “Housel’s observations often hit the daily double: they say things that haven’t been said before, and they make sense”.

Looking good already…

The book itself it great. Short, readable, original and insightful – a rare combination. And then the final chapter, a postscript history of the American consumer, is just fantastic.

The book is structured as 19 lessons, structured as a story and a conclusion.

The stories are mostly interesting and entertaining, and the lessons are broadly… sensible.

In fact, that’s probably the defining theme of this book and why I like it so much – it appreciates balance. It advocates a reasonable portfolio, rather than one which is trying to be in the top 1% worldwide. It’s a book for the everyday investor, the saver, the soon to retire, the average Joe.

It doesn’t have lofty ideals about beating the market. It has smart ideas about how to think about money better.

Everyone pretends that investment is a maths-based enterprise. But for all the discounted cash flow calculations you perform, it doesn’t matter if you sell out in a panic near the bottom.

For all the improvements in mathematics, have we become better investors over the last few decades? Doesn’t seem so… That’s because investing is also a psychological challenge.

Housel starts off with one central point – that everyone feels differently about money. Everyone is shaped by the time, the place and the nature of their upbringing. People may seem to do crazy things with money, but it makes sense to them.

If you were a teenager in the seventies, you’ll retain a lifelong fear of inflation, while if you are a teenager now, you might not even know what it is!

The number one threat to your wealth is instead greed, explains Housel. The desire for more is what drives rich people to take unnecessary risks, which end up bankrupting them. They take for granted what they have, and risk it all for a little more. That, for the most part, is just human nature.

Housel argues that controlling our greed will allow us to do three things.

Avoid major losses, be humble enough not to chase excess returns, and be patient enough to allow compounding to work. Survival over decades is crucial to investment success.

If you are not greedy, unconcerned that there may be more gains out there, the compounding of the economy and of dividends will drive very good returns in the long run.

He points out that almost all of Warren Buffett’s wealth has been built after he turned 50. His secret is not an amazing annual return – 22% per year is great but others have done better. Instead, his secret is time.

He started earlier than most, and he’s kept going a lot longer than most.

If he’d retired at 65, he would have around $8 billion. Instead, he is 90 and has $85 billion.

By trading very little, and essentially “betting on America”, he has allowed compounding to do its work. Slow and steady wins the race.

Charlie Munger, his right-hand man, said “the first rule of compounding is: don’t stop it unnecessarily”.

This leads me on to a second great insight from the book.

People change. You change. In fact, if you’re the same at 50 as you were at 30 then you’ve wasted 20 years. Saving gives you the flexibility to change, and adapt.

Don’t get wealthy, stay wealthy

Housel is big on savings too.

He points out that there’s a difference between being rich and being wealthy. Rich people show off and have flashy cars and expensive clothes. But what he’s found through life, which we can probably all relate to, is that flashy people are more flashy than they are rich.

Wealth however, you don’t see. Wealth is in savings, investments. It’s in flexibility. If you have an expensive car, you’ve also got expensive insurance. If your life takes a turn for the worse, you may have to cash it in and take a step down the ladder. You are “fragile”, as Nassim Taleb would say.

Whereas a wealthy person whose money is in their savings and investments has flexibility. If they lose their job, they don’t have to take the first one that comes along. They can wait for the right one, which they’ll enjoy more, may pay more or give more flexibility.

This factors into another one of his points, which is perhaps not investment related, but life related.

Money is overrated, once you get to a certain point.

That point may be different for each person, but it’s there.

The world is full of stories of people who risked what they had and desired things that they didn’t have and didn’t need.

He speaks of his own experience, dreaming of working in a bank because he wanted to be rich. But a few months into his first job as an investment banker, rolling in it, he was miserable.

You hear this kind of thing so many times from so many people – Mo Gawdat is another great speaker on his topic. Gawdat has written a book (Solve for Happy) and appeared on Elizabeth Day’s excellent “How to Fail” podcast.

Housel takes this point to an interesting and broad conclusion though.

That what matters most to people is having control.

Control over their time, how they spend it and who they spend it with.

Your work may pay you hundreds of thousands of pounds, but it will demand a proportionate amount of your time, your life, and your mental capacity.

What researchers have found is that having control of the main aspects of your life is the most important determinant of overall happiness. Money is one input to this, as it allows you to be in financial control, but time and people are also factors.

Balance is key because overloading on one factor – money – will almost always lead to the other two falling away.

Before I go on too long though, I want to pull it all together.

Housel argues that control and flexibility are key inputs to overall happiness in life. Financial control is one part of this. Being flashy and spending money do not contribute to this. Instead, savings and investments do. They give you the flexibility to do the things you want, when you want, with the people you want.

They make you resilient against shocks, which are literally unpredictable. They are adaptable, to your future needs and desires which you can’t yet predict.

Bringing it back round to investment, he says people should focus as much on staying wealthy as getting wealthy.

Getting wealthy involves risk taking, skill, and luck. Staying wealthy requires a calm combination of patience, frugality and an absence of greed.

Don’t risk what you have for something you don’t need.

Right now, I would take this to mean that you shouldn’t be trying to squeeze a few extra per cent out of the stockmarket when it’s looking pretty damn frothy.

Instead, it would probably be better to be thinking seriously about how to avoid losing money, taking lower risk, and safeguarding you and your family’s near-term future.

The American consumer: a history

To finish, I’d like a word on the final chapter.

Having reached his conclusions (essentially, stick with indices and ETFs – something I do not agree with at the moment), he goes on to write a postscript. It’s a history of the US consumer, and it’s absolutely fascinating. It’s incredible, and it blew me away a bit, to be honest!

I will try to give a five-sentence summary, but you really should go and read it for yourselves, as I can’t really do it justice here.

  1. After the war, there was concern about the economy, but by lowering interest rates, all the returning soldiers who wanted to settle down and start a family could do so.
  2. Having spent nothing and saved during the war, they could also afford to spend, which drove production of goods which led to a long boom in which mostly people were very equal because there was a limited range of goods you could buy – a fridge was a fridge.
  3. The recession and inflation of the 1970s cracked this beautiful scenario, and ever since, falling inflation and falling rates have made the rich richer, while social media and television have ramped up the “keeping up with the Joneses” effect of making people feel poorer.
  4. A small group has driven GDP and stockmarket growth since then, with their taxes falling more and their wages rising faster, and this has split what had been quite a homogenous, unified society after the war. Those left behind, used to being able to keep up, have tried to do so by taking on more and more debt which came crashing down in 2008.
  5. Some people haven’t forgotten what things used to be like, and as the situation worsened after 2008, they have cracked and voted for abrupt change – Brexit, Trump, Occupy Wall Street. These are symptomatic of the rallying cry, “this isn’t working”.

I’d say the key thing I took away from it was the way in which the expectations that were set for many people after the war have given way to the realisation that the economy no longer works the same for everyone, and that is what has caused a steady build-up of outrage.

It’s the psychology of the American consumer, it’s their psychology of money, and it’s changed.

I’ll leave it there, sorry this has gone on a bit! I do hope you found it worthwhile.

I did, and do encourage you as always to go away and read these books for yourself, each new one prompts new insights, ideas, thoughts, and revisions – which are all building up a better picture of how to go about investing our money.

Best wishes,

Kit Winder
Editor, UK Uncensored

  1. […] in our psychology. From Daniel Kahneman and Amos Tversky through to Howard Marks and Morgan Housel (whose excellent book The Psychology of Money we looked at last Friday), human psychology drives irrational behaviour in the […]

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