The Directed Life

Notes from Morgan Housel’s The Psychology of Money

Date read: 1/13/2023

• Everything has a cost. Find the hidden cost, evaluate if it’s worth paying, then pay it.
• Define the game you’re playing
• Incorporate a margin of safety into every decision
• Tails drive everything
• Financial independence is the goal. The mark is different for everyone, but the goal is to be in control of your time
• Luck and risk are two sides of the same coin
• The goal is to remain in the game as long as possible and let compound interest do its thing
• Don’t keep moving the goalpost. Get off of the hedonic treadmill

Understand everyone has their own unique experience with money (page 11):

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.

The challenge (page 13):

The challenge for us is that no amount of studying or open-mindedness can genuinely recreate the power of fear and uncertainty.

People make decisions based on what they know, often forgetting to account for what they don’t know (page 18):

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.

The concepts of saving, investing, and retirement are still in their infancy (page 19).

Control what you can control while recognizing you are largely not in control (page 25):

Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort.

Leverage (page 32):

Countless fortunes (and failures) owe their outcomes to leverage.

Staying in the game (page 34):

The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.

Thinking about risk (page 41):

There is no reason to risk what you have and need for what you don’t have and don’t need.

Hardest financial skill is to stop moving the goalpost (page 41).

Having “enough” is a worthwhile goal. Never think of enough as too little (page 42).

Remembering how powerful compounding is (pages 52,53):

The danger here is that when compounding isn’t intuitive we often ignore its potential and focus on solving problems through other means. Not because we’re overthinking, but because we rarely stop to consider compounding potential.

It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.

Become financially unbreakable. By being unbreakable you can stay in the game the longest and let compounding have its greatest effect (page 62, quote from page 63):

Merely good returns sustained uninterrupted for the longest period of time—especially in times of chaos and havoc—will always win.

Margin of safety (page 64):

Room for error—often called margin of safety—is one of the most underappreciated forces in finance. It comes in many forms: A frugal budget, flexible thinking, and a loose timeline—anything that lets you live happily with a range of outcomes.

You can gain over the long run even when the short run appears chaotic (page 65):

Destruction in the face of progress is not only possible, but an efficient way to get rid of excess.

Long tails events typically drive everything (page 72):

The great art dealers operated like index funds. They bought everything they could. And they bought it in portfolios, not individual pieces they happened to like. Then they sat and waited for ta few winners to emerge.

Wealth is the means to the ends of control and independence (page 83):

The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.” … The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.

Reiterated here (page 84):

Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time.

Almost every job now is reminiscent of Rockefeller’s, so we should spend our time accordingly (page 87):

Rockefeller’s product—his deliverable—wasn’t what he did with his hands, or even his words. It was what he figured out inside his head. So that’s where he spent most of his time and energy … he was constantly working in his mind, thinking problems through.

There’s a paradox that we want to acquire goods to signal our wealth to others, even though everyone else is playing this same game and doesn’t admire us but admires the goods we have instead. Everyone is using other people’s status signals as benchmarks for what they need to acquire to now be admired (page 93).

The way to wealth (page 98):

The only way to be wealthy is to not spend the money that you do have.

The value of wealth is relative to what you need. Develop a high savings rate and low material desires and you have just created a wealth engine (page 105):

Learning to be happy with less money creates a gap between what you have and what you want—similar to the gap you get from growing your paycheck, but easier and more in your control.

Flexibility and control over your time are wealth’s unseen returns (page 107).

Developing soft-skills in today’s global economy (page 109):

In a world where intelligence is hyper-competitive and many previous technical skills have become automated, competitive advantages tilt toward nuanced and soft skills—like communication, empathy, and perhaps most of all, flexibility.

The importance of understanding tail events (page 126):

The majority of what’s happening at any given moment in the global economy can be tied back to a handful of past events that were nearly impossible to predict.

The average time between recessions keeps increasing (page 130).

Identifying broad patterns from history (page 133):

The further back in history you look, the more general your takeaways should be.

Margin of safety in your thinking (page 138):

The wisdom in having room for error is acknowledging that uncertainty, randomness, and chance—”unknowns”—are an ever-present part of life. The only way to deal with them is by increasing the gap between what you think will happen and what can happen while still leaving you capable of fighting another day.

Why it’s important (page 140):

Room for error lets you endure a range of potential outcomes, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor.

Use room for error whenever estimating future returns—Morgan always assumes his will be 1/3 lower than the historic average (page 142).

Think of your money as barbelled: risk taking on one end, extreme risk aversion on the other (page 143).

The importance of a savings gap (page 145):

The biggest single point of failure with money is a sole reliance on a paycheck to fund short-term spending needs, with no savings to create a gap between what you think your expenses are and what they might be in the future.

People are poor forecasters of who they will be in the future (page 150).

Fee vs. fine (page 162):

Thinking of market volatility as a fee rather than a fine is an important part of developing the kind of mindset that lets you stick around long enough for investing gains to work in your favor.

How bubbles form (pages 169,171):

Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.

Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.

Big takeaway—knowing what game you’re playing (page 173):

Few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are.

On optimism (page 177):

Optimism is the best bet for most people because the world tends to get better for most people most of the time.

We humans exhibit an asymmetric aversion to loss (page 181).

Iron law in economics (page 183):

Extremely good and extremely bad circumstances rarely stay that way for long because supply and demand adapt in hard-to-predict ways.

The Wright brothers’ first joint invention was a printing press (page 185).

Growth vs. destruction (page 186):

Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in an instant.

Finding the price in investing (page 187):

In investing you must identify the price of success—volatility and loss amid the long backdrop of growth—and be willing to pay it.

Keep in mind how incentives are influencing your own financial goals (page 197).

Principles (pages 207,209):

Respect the power of luck and risk and you’ll have a better chance of focusing on the things you can actually control … Saving money is the gap between your ego and your income, and wealth is what you don’t see.

A gap between what what could happen in the future and what you need to happen in the future in order to do well is what gives you endurance, and endurance is what makes compounding magic over time.

Safest bet is dollar-cost averaging a percentage of your paycheck into a low-cost index fund like Vanguard (page 219).