Book Summary: The Psychology of Money (All chapters explained)

Luck & Risk

This is a very important point that a lot of self-help books trivialize. Luck and risk are always a factor in any success or failure an individual has.

Now to what degree these two forces affect an outcome, that remains uncertain and cannot be predicted.

The author explains the role of luck by using Bill Gates’ example.

In 1968, there were around 303 million high-school-age people around the world. Only 300 had the luck to attend the Lakeside school, which happened to be the only high school at that time with a computer.

Bill Gates was one of those lucky students. He met his Microsoft co-founder Paul Allen there, and the two hit it off instantly.

They had another classmate by the name of Kent Evans. According to Gates, Evans was the best student in their class. Like Gates and Allen, he was also skilled with computers and shared Bill’s business mind.

He was best friends with Bill. He could have been a founding partner of Microsoft with Bill and Paul.

But he died in a mountaineering accident before he could graduate high school. The odds of dying mountaineering in high school are one in a million.

Bill Gates experienced one-in-a-million luck by being at the only school during his time with a computer. Kent Evans experienced a one-in-a-million risk by dying on a mountain in an accident. The same force working in opposite directions.

We tend to judge people’s actions as genius or stupid based on the results they achieve. When risky actions produce good results, we consider the action-taker a genius. But when someone taking a similar action fails in their endeavors, we call them crazy.

So understand this – Not all success is due to hard work, and not all failures are due to laziness.

Keep this in mind when you judge people, including yourself.

That’s why it’s better to focus less on individual cases and more on broad patterns. Observe the patterns which are common for success and failure in different individuals. Then try to replicate them and see what results you get.

Never enough – when rich people do crazy things

The author highlights this truth by presenting the story of Rajat Gupta. How he rose from being an orphan in Kolkata’s slums to being on the board of directors of five public companies.

By 2008, Gupta was reportedly worth $100 million. Most people couldn’t even think of what they would do if they had that obscene amount of money.

But Rajat knew exactly what he wanted to do. He didn’t want to be a mere millionaire. He wanted to be a billionaire!

He indulged in insider trading and went to prison for that. His career and reputation were forever ruined.

It is one thing when people commit fraud and scams because they are living in poverty and need money to survive and feed their families.
What the rich, corrupt people indulge in is throwing away all their prestige, power, wealth, and freedom for want of more. Because they never had a sense of enough.

As Warren Buffet says, “If you risk something that is important to you for something that is unimportant to you, it just does not make any sense.”

So, it is imperative that you never risk what you do have and need for what you don’t have and don’t need.

Confounding Compounding

Out of the $84.5 billion net worth that Warren Buffet has, $81.5 billion of it came after he became 65 years old.

That’s the power of compounding.

Warren Buffet didn’t become one of the richest men on earth simply by being a very good investor.

No.

He attained that position by being a very good investor since he was a child.

If he had started investing in his 30s and retired by 60, he could still have been rich, but very few people would have ever known about him.

Buffet began serious investing when he was ten years old. And he continued it for several decades.

The secret to Warren Buffet’s success is time and patience. Earning good returns consistently over a long period of time.

This is what generates ridiculous, incredible amounts of wealth.

Getting wealthy versus staying wealthy

The skills required for getting money differ from those required for keeping it.

You need to take risks, be optimistic, and put yourself out there if you want to make a lot of money.

The opposite is true for keeping money.

You have to be humble and accept that luck did play a part in your success, and it could be gone at any moment. You need to prepare for a future where you might not be so lucky, and whatever you have received could be taken away from you just as easily.

As the famous saying goes – The most important part of any plan is to plan on the plan not going according to plan.

Tails you win – you can be wrong half the time and still make a fortune

This lesson teaches that every mega success is followed by many failures. But the success must be grand enough to offset the failures.

For example, most of the products Amazon introduce fails, but the ones that succeed, like Amazon Prime and AWS, cover up all the experimenting and failing.

When we look at the successes of others, we tend to overlook that most people’s success comes from a small percentage of wins.

This makes our own failures and setbacks seem pretty big in comparison. The reality could be that the successful role model you are looking up to could have failed as many times as you did.

The only difference could be that when they got things right, they got them more right than you did. It’s not about how often you are right or wrong about things.

It’s about how much money you make when you get things right versus how much you lose when you get things wrong.

You could be wrong more often, but if you lose very little money from being wrong but gain huge sums of money when you are right, you can still become wealthy.

Life is a numbers game. You can have more failures than wins; just ensure you gain a lot in wins and don’t lose much in failures.

Freedom

The greatest wealth money can buy is the freedom to do what you want with your time.

There is no better feeling than getting up in the morning and being able to do whatever you want for the day.

You can love doing something, but being forced to do it on a schedule that you can’t control, invokes similar feelings as doing something you hate. Psychologists call this phenomenon reactance.

One interesting point the author highlights in this chapter is that in the 1950s, most jobs were labor based.

People did their manual work, left their job, returned home, and their mind was at rest. Now, most jobs are thinking jobs, so your mind constantly thinks about the work.

And thanks to portable devices like mobiles and laptops, you can be summoned anytime for work-related purposes.

The author also shares some research on old people and what they think matters most for happiness.

Not one of them stated hard work or having more money than others was most important.

Most placed the highest value on spending quality time with friends and family and being part of something greater as providing the most happiness. Of course, but you need money to achieve that freedom first.

Man in the Car Paradox

People aren’t impressed with your possessions as much as you are.

You may want to get that latest iPhone or luxury car as you believe this will make people respect and admire you.

But when people see these expensive objects, they imagine how nice it would be if they possessed them. They are not thinking about the person who owns those expensive objects.

So, if your aim is to get respect and admiration, having humility and standards, and behaving in a dignified way are much better approaches than buying expensive products.

Wealth is what you don’t see

The fastest way to lose money is by spending money to show people how much money you have.

People with expensive cars are not necessarily wealthy. The author says he has known many such people who owned expensive cars to give the illusion of having wealth but, in reality, were just a step away from bankruptcy.

If you become a millionaire and spend 1 million dollars, guess what? You are no longer a millionaire!

The author explains this tendency of people by comparing it with weight loss. People often exercise and then eat junk food believing that they worked out so much, so now they deserve some good food.

Similarly, people believe that since they work so hard to earn money, they should now spend it to buy something to feel good about. To maintain wealth, you need to have self-discipline and patience.

Save Money

In this chapter, the author explains that to become wealthy, it is more important to save money than earn it.

The amount you earn is not always in your control due to life being uncertain. But what percentage of your earnings you save is always in your control.

The best way to save money is to stop comparing yourself to others. Most people fail to save money because they want to display their wealth in front of others.

In today’s times, it is more important to be flexible than to be intelligent. Today competition has become global, and there are many intelligent people globally.

If you have savings, you can be flexible in changing your career, planning early retirement, etc.

Reasonable > Rational

It’s easy to be rational on paper, but not real life. We do not like to be uncomfortable or hurt.

We worry about our family and loved ones’ futures. We must be answerable to them and don’t want the dinner table conversations to be super awkward.

Having a fever is not bad for our bodies. It is something that gets triggered when our body is fighting bacteria and infections.

Still, we go to doctors and get medicines for it. Why? Because we don’t like to live in discomfort.

The marginal benefits we get from fever – assistance in fighting off an infection – do not compensate for the problems and hurt we face due to it – headaches, dizziness, shivering, and needing a day off work.

Similarly, some financial plans might seem very good on paper and spreadsheets. But when it comes to executing them in real life, people take into account the fact that will this allow them to sleep soundly at night.

If you invest in a company you don’t care about, you might benefit from the dividends when the times are good, and the company is in profit.

But when the company is not doing well, you will have to face the double burden of losing money on a company you don’t even want to be a part of.

Whereas, if you had invested the same amount of money in a company you are passionate about, you would be able to tolerate the losses better.

At least you would feel satisfaction about being part of their mission, the team, the product or services, whatever it is that matters to you.

Surprise

In this lesson, the author states that the financial field is not like medicine, astronautics, or science.

Doctors can accurately predict what medicines are to be prescribed for a particular disease as human body parts operate the same way they did hundreds of years ago.

Similarly, space scientists can determine how long it will take for a spacecraft to travel a distance as the calculation is done using logic and maths.

In finance, history doesn’t matter much because people are unpredictable and make decisions based on emotions.

That’s not the case in other fields. In science, we can accurately predict the behavior of an electron as they don’t have emotions. How hard physics would be if electrons had emotions!

It is important to understand that just because something hasn’t happened yet does not mean it can never happen. The best lesson we can learn from surprises is that the world is surprising.

The world structure keeps changing with time. A few decades ago, hardly anyone would have invested in Tech companies. But now, they are ruling the stock markets.

This doesn’t mean that history is entirely irrelevant to finance. Instead of looking at specific trends and results, what you can do is take general takeaways from the history of money.

Things like how people behave under stress, manage greed and fear, and respond to favorable circumstances tend to be consistent over time.

Room for error

Plans seldom go according to plans. Life is volatile and uncertain. Crazy things happen in life.

You should refrain from taking risks that can ruin you, no matter how tempting their potential rewards might seem. To get ahead in life, you should take risks, but no risk is worth taking if it can wipe you out.

Just to be safe, always save more than you think is necessary for future protection. The wisdom lies in making yourself future-proof.

Many times the risks are of a nature that we never even imagined. Like the start of a pandemic or war.

Consider that whatever you think can go wrong in your life will one day go wrong, and save accordingly. That’s why never be too dependent on any one thing, like staying dependent only on your paycheck for your bills.

When you onboard an airplane, they have backups. In fact, they have backups of their backups.

Some examples the author suggests for a frugal living are finding joy in inexpensive activities like taking a walk, reading books, and listening to podcasts.

You’ll Change

It is not just life that is unpredictable and keeps changing. The same can be said about your moods, desires, and goals.

They change over time. And this is why it’s difficult to plan properly for the long term.

In your childhood, maybe your dream job was to ride a tractor. Then you grew up and understood how society functions, so you decided to become a lawyer.

Then you saw that you have to work day and night while practicing law, so you took up some other part-time work.

Then you started being worried about your future and retirement, so you started searching for another high-income job.

At any moment in time, we think that now we have understood everything about life, and we will never change further. But most often, that’s not how it goes.

That’s why people who were so excited to get a tattoo once now desperately want it removed. People who once fought their families to get married are now fighting cases in court to get divorced!

That’s why the author suggests avoiding the extreme ends of financial planning. Maintaining a balance is necessary.

Don’t give all your time to work, or you will regret later on that you never lived a personal life. Similarly, don’t ignore your finances completely, or else you will suffer when you go through financial difficulties.

Nothing’s Free

If you want big rewards in life, then you must be prepared to take big risks.

The same rule applies in the financial market. The only difference, the risks involved here are –

• to live with uncertainty, face your fears, and have patience in times of volatility.
• Having control of your emotions when you observe the prices of your purchased stocks fluctuate wildly.

 
By buying at every boom and then selling the stocks at every recession, you won’t be able to make much profit.