Morgan Housel wrote a long article on money. You can read it here.
They say its long but I have read some long stuff. This one is really long. Its 16 pages, 8000 words. On Pocket, it lists that if we were to listen to this article it will take 35 mins.
But I felt is one of those article that, if I just take one weekend to read through it in detail, I will gain a lot of things out of it.
So this article is my meditation on it. I will list out what I learn from each point (well about 14 out of the 20)
Morgan Housel started out writing at the Motley Fool and now at the Collaborative Fund, which is a venture capital firm providing early stage and seed funding to technology companies.
Most of the well respected investors, and a lot of investors locally pay attention to his writing because every article since his Fool days is just that good. You can subscribe to Collaborative Fund’s blog to tap into what he is reading, and what he is writing.
He reads a lot, particularly a lot in various trajectories, especially looking through things from the lens of history. He invests his money (from what I understand) in 50% index funds and 50% long term stocks like Berkshire Hathaway, Markel that he would not sell.
Contrast this to the place where he worked, which primarily sells newsletters in active investing, and venture capital which tends to be a way of investing where we take an active bet on choosing which companies have the best chance to do well.
I feel that this article is one that is a distillation of all the stuff he has read, his experience and what he understand from his interaction with the knowledgeable peers he have access to.
And that is worth my Sunday.
1. Underestimating the need for Room for Error, not just financially but mentally and physically.
This was like number 13 in the list, but because Morgan Housel raised this as the remedy to many things, I decided to move this up, so that we can understand the context of why this is something that we need to understand.
Ben Graham once said, “The purpose of the margin of safety is to render the forecast unnecessary.”
Margin of safety is a very common concept to protect yourself from downside in active investing.
Essentially it is having a fail safe in case the thesis is wrong. Even if your thesis is wrong, you have enough room so that you will not lose money, or lose a small amount.
Novice investors who read a text tend to be rather rigid in their methodology. What they are expecting is that, at the end of a valuation exercise, you get a result of either “got value” or “do not have value”.
In reality, even if you determine that some is trading below its intrinsic value, or that your thesis points out that the future may not as dim as people think, the reality is that there is an uncomfortable feeling things could turned out otherwise.
There is a challenge to a strong conviction.
And it happens again and again.
Having that room for error, is to build in enough gap in your process/plan/system that in case you are wrong in your opinion/deduction, you emerge relatively strong still.
If you have that in your process/plan/system, you have a higher conviction in your wealth building.
You basically build in probability of failure into your plan.
Room for error lets you endure, and endurance lets you stick around long enough to let the odds of benefiting from a low-probability outcome fall in your favor. The biggest gains occur infrequently, either because they don’t happen often or because they take time to compound.
Somewhere in one of the points below, he will explain compounding takes time, and takes inactivity. For that to happen you need to endure enough.
Finally, Morgan highlights the important point that the gap is not just monetary.
Can you survive your assets declining by 30%? On a spreadsheet, maybe yes – in terms of actually paying your bills and staying cash-flow positive. But what about mentally? It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest. You – or your spouse – may decide it’s time for a new plan, or new career. I know several investors who quit after losses because they were exhausted. Physically exhausted. Spreadsheets can model the historic frequency of big declines. But they cannot model the feeling of coming home, looking at your kids, and wondering if you’ve made a huge mistake that will impact their lives.
Mind blown. Very well said.
The math may tell you that with your knowledge of investing, you should be investing, if not you will not be able to beat inflation. At times, you have to step back and think what do we invest for. What is the priority.
To endure, it might mean less volatility, less equity, less small/micro-caps if you have already reach your wealth accumulation goal.
The opposite is also true. If you are young and starting your wealth accumulation, the margin of safety, against the “potential losses in opportunity costs” of not investing and missing out on a great bull run can be huge.
Find a fundamentally sound investing strategy, stick to the plan, work on the process, learn where you are in your overall goal.
Room for Error is also a concept we can apply in our lives.
I hear this narrative too much in my conversations with others.
We do not know what the future holds, so let’s spend and enjoy while we can.
Since I am strong as an Ox now in my 20s, malleable, I am not going to stop working. Why would we want to stop working? Why build up a bunch of money so that we can retire early?
In one of the points below, he explains we often underestimate how long our lives, aspirations, values stay the same.
When your situations change, much to your horror, you do not have any “gap”.
A key use of wealth is using it to control your time and providing you with options. Financial assets on a balance sheet offer that.
Building wealth is not just to work towards a goal other people like. You cannot deny that wealth is a support for your life goals. And not having enough limits what you can do.
2. A tendency to underestimate the role of luck, that if there is risk, the opposite is luck
If Morgan put this as the topic one, I guess this is the most befuddling to him.
In this job of investing, I always state we need to acquire competency to do it well. However, its such a unique job that you need to acquire the competency but in some cases, even if you try hard enough, you might not get the result.
For some, they have a minimal competency but due to luck, they made a lot of wealth really fast.
Having a positive sequence of years where the market doing well, and not having any fear due to not encountering any challenge to your paradigm is luck in itself.
If you have started in these 10 years, your emotions might not be scarred and can readily deploy a large percentage into equities. And your results would be better because equities were the good performing asset class.
The same is also true about our career.
We overestimate how well we do in school and its effect on our career, our own value add.
However, sometimes we are just lucky to be in a country where we have ample opportunities to do white collar work, earn a good remuneration, have subsidized housing, that is safe from natural disasters, crimes.
We could have competency but born in a totally bad timeline or country.
A good example is financial blogging. The reason investment moats got to where it is today is luck, because I am not an exceptional investor, that my blog got traction at a period where it was able to get traction.
We basically didn’t start our blog in this cut throat period where financial blogs are sprouting up like nobody’s business.
Was there hard work yes, but I cannot deny I was in a period where Facebook and Google’s algorithm was much relax.
If we admit there is risk, the probability things do not go according to the standard plan negatively, then it is equally likely there is luck when things go our way positively.
The amount of our result is due to lucky, is something we cannot ascertain.
We tend to overestimate its role in our end result.
3. 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.
This is probably my favorite out of all that he is written.
Morgan gives the example that when we wishes to get a new car we have the option of paying for a new one, getting a used one for much less and stealing it.
If we pay the price for a new car, we accept the volatility and uncertainty. If we pay less for the used car, we can find a more predictable car with less uncertainty on performance but the payoff is lower. Or we can be risk seeking, by stealing the car, get it for free.
It is the same as if we wish to earn a 10% annual return over the long run.
Many look at the 10% and in their mind, think the return is a given.
Usually, if there is a higher return, there is some “costs” to it.
In investing, a lot of the times it is
- uncertainty that the business will have positive or negative luck, things you do not know about
- volatility in price due to how mass group of market participant behave, and you reacting negatively to their behavior
- business is cyclical or in a stage where they could do really well or really badly
Just like the car thief, people think they can get away with it.
They want the reward without the risks happening to them.
But the uncertainty is always there, and often the probability is larger than expected.
This happens when you buy a stock hoping it goes your way (similar to hoping you do not get caught stealing a car).
In the same way, we underestimate that there is a cost to a good salary sometimes.
Some people I know get a $140,000/yr salary and their job is really low stress, goes home from 9 to 6, with a 2 hour lunch and tea break in between.
For some, they pay you $160,000/yr but the work that you do are really to clean up some really bad shit (which is why someone left in the first place). The number of hours you put in, the lost family and personal time are the cost of it.
In some work, you have to spend on entertainment, keeping up with the culture by changing a large part of your lifestyle, to suit that image. That comes with a monetary cost that many are unaware.
In the book your money or your life, Vicki’s life energy trade off theory makes us reflect on this very well.
We also often failed to show that in order to be so low stress in a high paying job, it requires us to go through a lot of shit in the earlier years, to do a lot of the grunt work, to not see day and only go in at dark times and emerge in dark times, to be scolded by rough bosses and users for a long time.
Your payback is an upper management position where you do not have to deal directly with this anymore.
And I get this a lot, especially dealing with my friend SG Budget Babe. She probably gets the positive aspect of being popular and being able to communicate with the new generation better than many of us old folks but a also a lot of the negative aspect about doing it as a female, young and very popular.
My comments to those negative aspect: If you think its a good formula and so easily done, and there are no cost to it, try replicating it and achieve the same level of success.
We at BIGScribe, or as a finance community, would like to see more finance blogs with a female take!
There are costs that you are not able to see. There is a story behind a 3000% return. There is a story behind a successful investment portfolio. There is a story behind why someone that everyone knows is rich suddenly have to declare bankruptcy or commit suicide.
Get into the inner sanctum, then you will see more of the rewards and the costs.
4. Rich Man in the Car Paradox
For someone that has read enough of financial porn, this one is really damn subtle, and perhaps that is why its so fascinating.
This stuff isn’t subtle. It is prevalent at every income and wealth level. There is a growing business of people renting private jets on the tarmac for 10 minutes to take a selfie inside the jet for Instagram. The people taking these selfies think they’re going to be loved without realizing that they probably don’t care about the person who actually owns the jet beyond the fact that they provided a jet to be photographed in.
Morgan explains that I want wealth, so that it signals to people that I should be admired and like.
However, those people do not see me in the picture, but only what I have as the benchmark of what they want, wish they have, so that they too can be admired and like.
This is damn power.
Its like people imagine themselves in the stuff and lifestyle, that you are only a silhouette.
That is god damn depressing if you ask me, especially after we spend so much of our life energy earning the money, to buy this, just so that we gain some recognition.
Perhaps what he says, humility, empathy, graciousness and intelligence, are better ways to gain respect and recognition.
5. The First Rule of Compounding: Never Interrupt it Unnecessarily. But that is Impossible.
I didn’t even realize there is a first rule to this.
However it is true.
Suppose you have a wealth machine that is able to generate 10% return, that you can reinvest to the wealth machine, and let the reinvestment compound as well, you don’t want to stop the sequence.
Unless you wishes to use its function which is to spend it.
That is how I think of investments & savings as a compartmentalized wealth machine.
The reality is that many of us don’t get the effect of compounding. I know because I kept interrupting because I thought I NEEDED to interrupt it.
I can always find some justification why I need to do it as an active manager. Looking back, there are times that make sense, there are times that is irrational.
Your mileage might vary compare to mine.
Part of the reason people like Grace Groner and Warren Buffett become so successful is because they kept doing the same thing for decades on end, letting compounding run wild. But many of us evolve so much over a lifetime that we don’t want to keep doing the same thing for decades on end.
The paradox here is that some things, in order for it to work, has to be kept as inactive as possible, but our life situation changes so much.
To put it in another way, our life goes through stages, and life changes, and that goes counter to this first rule of compounding.
If there is one additional lesson I learn here is that: We over-estimate how long we can stick to something, while underestimating how short we stick to something else.
A lot of my peers that are younger thought that their life would not change so much.
I would always like engineering. Just because I enjoy it in my first project at work so much and that means I would enjoy it for the next 30 years.
So I plan my life, my wealth according to this idea that I will be in engineering for the next 30 years.
However, office politics and other working culture would eventually make you realize that what you enjoyed as a junior engineer might be the only time you get to enjoy engineering work.
You eventually lose yourself in the corporate bureaucracy in order to get the higher salary to fulfill your life goals.
And this mismatch causes a lot of mid life anxiety.
Another very prevalent overestimation is to extrapolate that just because you are mentally strong and have great vigor in your 20s, that you will have the same drive, vigor and energy in your 30s, 40s and 50s.
And so you plan your pace of life, career and wealth according to that.
This is why many young adults say “I have time.” “I can delay this” “I will get to this when I really need it”
I dunno about you, but I am more experienced but i am cognitively weaker nowadays.
The energy is also lower due to the compounding of negative health costs.
A lot under estimate this wellness aspect. It will cost you money next time.
Morgan’s solution here: Have enough balance, or in Nie Feng’s (from the comic Feng Yun) words don’t go all the way. Leave enough room for margin of error. Have enough balance of what you have determined to be relatively right things.
6. Anchored-to-your-own-history bias: Your personal experiences make up maybe 0.00000001% of what’s happened in the world but maybe 80% of how you think the world works.
And that’s a problem. When everyone has experienced a fraction of what’s out there but uses those experiences to explain everything they expect to happen, a lot of people eventually become disappointed, confused, or dumbfounded at others’ decisions.
This part explains that while we experience the same stock market, our relationship with it might be different. For some, the 1997 financial crisis, follow by the 2000 to 2002 bear then then 2008 period, left a really bad experience, that we need to time the market, that you cannot build your wealth through equities.
For the young ones, who started in 2010, they have no issues with negative downsides. The conclusion is that eventually they will make their money in equities since their experience is totally different from the previous folks.
The same thing can be said about in engineering.
The experience of my seniors that graduated in 1995, 2004 will be totally different from the current batch.
The top performing ones can go into banking back office and earn a great salary. Now, a lot of these stuff are outsourced.
Back then, IT functions are known more as costs centers and the government have a lax foreign employment policy that puts pressure on the IT career.
In contrast, there is a need in IT talent for what I deemed expansionary IT functions, in contrast to the IT functions in the past. Computer science was frown upon due to how easily we could replaced by cheaper labor.
Now, you need really good grades in order to get into a local computer science faculty.
You have something to look forward to as well, in working for Facebook, Google, Grab, Companies that are looking for data scientist, data analytics, cyber-security.
We need to remember our narrative about the same thing may not always be the same.
7. Finance is not one of the fields where the Past offers concrete directions about the future.
This is filed under the Historians are Prophets fallacy: Not seeing the irony that history is the study of surprises and changes while using it as a guide to the future. An over-reliance on past data as a signal to future conditions in a field where innovation and change is the lifeblood of progress.
The idea is that the path to the future is buried within the data.
However Morgan cites in the article many examples where this is wrong.
Great evidence of the configurations in the past is very different:
- Different USA savings system for retirement are very young thus we cannot actually fix what is the right way Americans should save for retirement
- Venture Capital industry do not exist before the last 25 years. We do not have a deep history of investment cycles, backing entrepreneurs, failure rates to learn on
- Tech stocks were non existent 50 years ago. Financial stocks were only included in S&P 500 in 1976
- The stories we tell ourselves and our preferences for goods and service do not stay still, they keep changing.
He however cites constants that we can learn from history:
- People’s relationship to greed and fear, how they behave under stress
- Their response to incentives
These tend not to change.
8. Under-appreciating the power of compounding, driven by the tendency to intuitively think about exponential growth in linear terms.
The punchline of compounding is never that it’s just big. It’s always – no matter how many times you study it – so big that you can barely wrap your head around it.
This is new porn.
Morgan highlights that our brains can only think linearly. Because of that, we are often blown away by the effects of compounding. Compounding requires us to be able to view things exponentially.
Due to our inability to see, we often ignore its potential and focus on solving problems through other means.
Physicist Albert Bartlett put it: “The greatest shortcoming of the human race is our inability to understand the exponential function.”
He cites that there are many books written about how Warren Buffett built his fortune, but there isn’t a lot that highlights that he has been doing the same fundamentally sound process over and over again.
And a lot is due to inactivity.
Morgan highlights that we should just let time work out our returns. Chasing the high returns tend to work only in a few situations because you will realize they are one off events and over the long run they tend to kill our confidence.
This might be link to what I learn from Cullen Roche, when it comes to passive exchange traded funds investing.
The ideal way is to view a portfolio of low cost exchange traded funds as a 20 year savings plan. In the short run there will be a lot of volatility, but in the long run, you earn a greater return on this savings plan.
So in the short run don’t get fxxked up by the volatility.
9. Most attempts at contrarianism is just irrational cynicism in disguise – and cynicism can be popular and draw crowds
This is filed under Attachment to social proof in a field that demands contrarian thinking to achieve above-average results.
Morgan highlights the ultimate irony:
The Berkshire Hathaway annual meeting in Omaha attracts 40,000 people, all of whom consider themselves contrarians. People show up at 4 am to wait in line with thousands of other people to tell each other about their lifelong commitment to not following the crowd. Few see the iron.
Morgan makes the case that it is difficult to be a contrarian.
Real contrarianism is when your views are so uncomfortable and belittled that they cause you to second guess whether they’re right. Very few people can do that. But of course that’s the case.
Real contrarianism doesn’t happen because it entails me going for high stakes betting, that can go very right or very wrong. When I lose money, I get emotional.
So to prevent this, I surround with like minded people.
So basically contrarian tends to need to be in a lonely place.
10. An appeal to academia in a field that is governed not by clean rules but loose and unpredictable trends.
Morgan raised the example of how Noble Prize winner for economics Harry Markowitz invest his own money.
It is very very different from his theory on how much we should have in bonds versus stocks.
There are many things in academic finance that are technically right but fail to describe how people actually act in the real world. Plenty of academic finance work is useful and has pushed the industry in the right direction. But its main purpose is often intellectual stimulation and to impress other academics. I don’t blame them for this or look down upon them for it. We should just recognize it for what it is.
I see this a lot.
I have friends who read all these well researched books and advice people to implement this because it is backed by science and evidence.
The problem, as Morgan Housel alludes is that finance is not just about the quantitative but also the behavioral aspect.
You cannot ignore a system which includes how you will behave.
The example cited here is that young investors should use 2 times leverage in the stock market because statistically it offers better returns.
This is similar to some of my retirement planning and financial independence withdrawal strategies. There are many theories behind and would let you know the pros and cons, which one, math wise makes the most sense.
However, in reality, the way we live life is not so mechanical. It also goes back to what Morgan say that we overestimate how constant our life is:
- When things are bad we do get worried if our money can last, and would not increase our spending mechanically just like the assumption that we will raise our spending 3% a year
- Statistically, to ensure your money last for 40-50 years in an early retirement, you should have a high percentage in stocks. We all know that. However, how sure are we that emotionally we can live with that volatility and uncertainty?
- Statistically, we should invest the buffer cash and not keep too much cash as it is a drag, and affects the sustainability of our retirement portfolio. But can you tahan not having much cash?
Morgan’s solution: have enough humility and room for error.
11. Wealth is what you don’t see. We tend to judge wealth by what we see. We can’t see people’s bank accounts or brokerage statements. So we rely on outward appearances to gauge financial success. Cars. Homes. Vacations. Instagram photos.
Singer Rihanna nearly went broke after overspending and sued her financial adviser. The adviser responded: “Was it really necessary to tell her that if you spend money on things, you will end up with the things and not the money?”
This is a very popular idea, but seldom hear people articulate it this way.
The crux of what Morgan said is that the social utility of money is at the polar opposite end of what is needed to grow money.
You need to set aside money. To do that you cannot spend it.
If you set aside money, wealth accumulates.
As I said from my observation of my friends, they equate rich with whether you are driving an Audi, or BMW. Cars are expenses guzzlers, especially in Singapore.
However, my friends often equate that, a luxury car like Mercedes show that this person have taken care of a well paying job, or other areas of their finances, THEN they get this luxury car.
The luxury car is a byproduct of being rich.
This is not wrong. My more well off friends do drive these vehicles. They are a by product of them being rich.
However, what they failed to understand is not many have taken care of “the other areas of their finances”.
When most people say they want to be a millionaire, what they really mean is “I want to spend a million dollars,” which is literally the opposite of being a millionaire.
12. We have a tendency to be influence by other’s actions, when they are playing a completely different game
This one is basically saying we are each running our own leisure run towards our life goals.
Do not run at another’s pace. It might kill you.
Morgan cites the example of Cisco’s run up in the 1999 dot com boom.
There are many participants in the climb. If you are a value investor you will think the company is not worth a lot. There is only one price to buy and it is much lower.
So you may have looked around and said to yourself, “Wow, maybe others know something I don’t.” And you went along with it. You even felt smart about it. But then the traders stopped playing their game, and you – and your game – was annihilated.
The traders are playing a total different game. Some may be gambling, some do have defined strategy. The strategies and rules are likely… very different from yours.
However, you just think they know something that you don’t.
I find this very common, and a lot of times, I kept asking myself this question in the past.
Do they know something more than I do, that’s why the price is going up/down?
This gets affected by your own personal plan as well.
We each have our own reasons for saving, for spending, executing a particular business strategy, our own philosophy of money, when we wish to retire.
We each have our own perception of how the markets work, the difference in our understanding of risk.
It all influence our wealth building plans.
To copy what someone else does, requires you to understand pretty well all these stuff.
If you monkey see monkey do, I guarantee you are going to be a mess.
13. Optimism bias in risk-taking, or “Russian Roulette should statistically work” syndrome: An over attachment to favorable odds when the downside is unacceptable in any circumstance.
The odds of something can be in your favor – real estate prices go up most years, and most years you’ll get a paycheck every other week – but if something has 95% odds of being right, then 5% odds of being wrong means you will almost certainly experience the downside at some point in your life. And if the cost of the downside is ruin, the upside the other 95% of the time likely isn’t worth the risk, no matter how appealing it looks.
What Morgan raised is that we tend to believe the probability numbers work in our favor, thus we play the game. However, deep down, we cannot tahan the downside if that 5% probability event happen.
It will leave us in ruin.
The investing guard rail to stop this is diversification. Its a delicate balance whether to concentrate or diversify. If you do not concentrate, you do not get the reward for the effort.
My own money is barbelled. I take risks with one portion and am a terrified turtle with the other. This is not inconsistent, but the psychology of money would lead you to believe that it is. I just want to ensure I can remain standing long enough for my risks to pay off. Again, you have to survive to succeed.
It is why 50% of Morgan’s wealth is in index investing probably. Reduce the effort, be diversified to prevent the risk of ruin, and let long term savings and compounding do the work.
He also highlights importantly the impact of ruin on us and why we should avoid it.
He emphasis again and again that one of the main utility of money is it provides options, to do what you want, when you want, and with who you want and why you want. We cannot buy that.
14. Believing that what just happened will keep happening shows up constantly in psychology. We like patterns and have short memories. The added feeling that a repeat of what just happened will keep affecting you the same way is an offshoot. And when you’re dealing with money it can be a torment.
The final one is filed under The three-month bubble: Extrapolating the recent past into the near future, and then overestimating the extent to which whatever you anticipate will happen in the near future will impact your future.
We have a level of obsession that the effects of events repeating again in the near future.
Its much of recency bias.
Morgan states that most of the time, when something big has happen, it does not increase the probability it will happen again. Rather things tend to mean revert.
Mean reversion seems to be a common theme in finance.
The conflict happens when if the repeated event happens again. Morgan raised that these are likely short term events, and shouldn’t tamper with your longer term goals.
The conflict I have here is that the strategies implemented can be different. Morgan advocates a longer term passive approach. If your approach is different, what he suggested might not be useful.
However, given the level of uncertainty cited in this article, it shows us navigating wealth building through a short term time frame is pretty hard.
15. Be Prepared to Roll with the Punches
In the end Morgan Housel provide what will work and they have less to do with money:
- long time horizons
- skepticism of popularity
It means that you have to be more anti-fragile.
I take it as: Money is important because it gives you options and that gives you freedom, independence and security. However, they are not the only thing that gives you that.
Ultimately, freedom, independence and security is partly our state of mind.
If you are already free, independent and secure due to the margin of safety in the plan that you created, and your psychology, you should do pretty well.
Let me know your thoughts.
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