The the key takeaway from the first chapter of Morgan Housel’s remarkable book, The Psychology of Money – “Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works.”
This book is one of the best behavioral books we’ve read about investing and personal finance, because it approaches the topic from a refreshingly human perspective.
Many authors approach the topics of investing and money like hard sciences: If A = B and B = C, then A = C. Morgan Housel reminds us that as humans, and not computers, we make financial decisions based more on our personal experiences than on objective financial truths. He argues persuasively that working with an understanding of our money psychology, rather than denying or ignoring it, is constructive to our financial success.
We believe “The Psychology of Money” is such a well-written exposition of the money behaviors we all grapple with, and the resulting lessons we learn about wealth, greed and happiness, that we give a copy to every client and ask them to read it at the beginning of our relationship together. Developing shared frames-of-reference is key to all relationships, and this is especially true when managing other people’s money. We encourage all investors to pick up a copy of the book and read it from cover to cover. Chapter One, entitled “No One’s Crazy,” highlights that society lacks a single set of agreed-upon truths when it comes to each of us and our money.
“People from different generations, raised by different parents who earned different incomes and held different values, in different parts of the world, born into different economies, experiencing different job markets with different incentives and different degrees of luck, learn very different lessons,” Housel writes.
If you were born in 1950, you might have spent your formative years learning that the stock market is a place where your money stagnates. If you had the luck to be born in 1970, you might have learned that the stock market is a powerful engine to grow your wealth.
If you were born in the 1960s, you might have learned that price inflation is something to fear. If you were born in the 1990s, on the other hand, you probably wouldn’t understand older folks’ fear of inflation.
Our experiences can differ not just in terms of our age, but also our gender, race and socioeconomic status. More than our innate intelligence, it’s the context into which we’re born that determines our understandings of how money, and indeed the broader world, work. If we have different viewpoints on money, it’s not because you’re crazy, or I’m crazy, Housel writes. It’s because our experiences are different.
So if human psychology figures heavily into our understanding of money and our financial decision making, what happens when our less-than-rational brains are put in charge of saving and investing for our retirement or our other financial goals?
As a species, we certainly haven’t had enough time to evolve into making optimal retirement-investing decisions at all times. After all, the 401(k), which is the centerpiece of many Americans’ retirement-funding strategy, didn’t even exist until 1978 and Roth IRAs are 20 years younger than that.
In the first chapter of “The Psychology of Money,” Housel exposes the very subjective mental models that drive our decisions. In doing so, he sets up a contrast with investing and finance, which is inherently logical and mathematical. How to bridge the gap?
We believe the answer is three-fold: First, know thyself ‒ your history and aspirations, and your strengths and weaknesses. Second, operate from a plan and a roadmap. And third, seek advice from highly qualified professionals who have the technical skills to create the plan and roadmap, the managerial skills to carry out the related processes, and the behavioral investment skills developed from deep capital markets experience.
If you would like help in understanding your “mental money models” and investment behaviors, we may be able to help.