A by-product of a booming equity market is the rush of how-to books that get published, each attempting to assure its reader that the elusive pot of investment gold is there for the taking for anyone who survives reading the next 250 pages of the author's tome. In that cacophony, it is rare indeed to find a true gem that will likely outlast the current bull-run and make it to the list of investment classics you would want on your bookshelf for a long time to come. I refer to Morgan Housel's 'The Psychology of Money'. Writer, columnist and partner of Collaborative Fund, Morgan Housel has written a book that displays maturity well beyond his years.
Housel writes about an approach to personal finance that stresses that 'personal' is more important than 'finance'. "Financial success is not a hard science. It's a soft skill, where how you behave is more important that what you know." For people who are intimidated with the jargon of investing, this should be music to the ears. Housel calls this "the psychology of money".
Your personal experience determines your approach to investment
Housel makes the point that every person (and generation) has an attitude about money that is based on economic circumstances during their growing-up years, and investment choices and risk preferences differ widely among people. While an individual's personal experience is a tiny percentage of how the world works, it dominates his view of the world. "Some lessons have to be experienced before they can be understood." In 2006, two economists looked at 50 years of "survey of consumer finances" to see what Americans did with their money. The economists reported, "Our findings suggest the individual investors' willingness to bear risk depends on personal history" - in other words - just "dumb luck of when and where you were born".
People born when inflation is raging will approach bond investments differently from those born when interest rates are in a persistent decline. Attitudes towards risk are not based on models that are suggested by a spreadsheet, and what may appear rational to one investor can appear unacceptably high-risk to another. It is often the 'reasonable' that trumps 'rational'.
Luck and risk are two sides of the same coin
Housel quotes Nobel Prize winner Robert Shiller's answer to a question he posed, "What do you want to know about investing that we can't know?" Shiller's response: "The exact role of luck in successful outcomes".
The future is unknown. No strategy can work 100 per cent of the time. All too often success is attributed to skill or risk-taking ability, while failure is attributed to poor decision-making. But these are difficult to separate. Zuckerberg turned down an offer by Yahoo to buy-out Facebook for $1 billion in 2006 - a decision that proved to be correct, and Zuckerberg is classified as a genius. The same Yahoo turned down an offer by Microsoft to acquire it. The outcome for Yahoo was totally different and the management is criticised as fools. Housel suggests that when trying to find role models, we should resist the impulse to seek out successful individuals - instead focus on broad patterns where more consistent success has been achieved. While extreme outcomes dominate the news, averages are more replicable and trends in averages offer more actionable information to investors.
Don't move the goal post
What made Rajat Gupta, a highly regarded, financially successful individual at the top of his industry, indulge in insider trading? A sense of not having enough - when compared to those who he hobnobbed with. Comparison with someone who has more is a recipe for unhappiness because there is always someone out there who will have more. "Happiness is just results minus expectations." When a financial goal is achieved at a level that allows for a comfortable existence, it is important not to move the target.
Housel refers to the power of compounding, where due to the non-linear nature of growth, small amounts can grow to astronomical numbers over time. He goes on to suggest that rather than seeking outlier returns, steady returns over extended periods make for "financial unbreakability". When making a financial plan, it is important to plan for the plan to not work. Successful investing is about keeping a margin of safety so that longer-term investments are not disrupted when things don't go as per plan - as they inevitably won't. Housel points out that unless there is enough left in the tank to stay in the game after a vicious bout of volatility, investors may well have to exit at inopportune moments without the means to get back in.
"A barbelled personality" is Housel's recommended strategy for investors - where you are optimistic about the future but "paranoid about what will prevent you from getting to the future". He uses this to explain why often successful entrepreneurs become paupers because of the risks they take. Making money and keeping it are two differing skills - the first requires an optimistic outlook to the world and a belief that problems will tend to sort themselves out. The second needs a degree of paranoia about the unexpected and its ability to disrupt the best-laid plans. These, often contradictory impulses, lead to people witnessing volatility in their own journey to financial independence.
Housel makes a case for living within one's means - and saving without a 'goal' - simply because the surplus offers an individual the ability to control how he spends his time - the most important commodity there is!
Almost everything that Housel writes has been written about before. Yet what makes this book truly remarkable is the way he brings together the entire story of why it is all right to make investment choices that allow one to sleep well at night rather than 'optimise' for some imaginary goal. Keeping surplus cash enhances financial unbreakability, and being able to stay invested in volatile times ensures that compounding can do its thing. There is indeed no need to pursue highly risky strategies or measure performance against some successful individual - when all that is required for happiness is to build enough capital to have the freedom to decide how to spend your life the way you want. A book that should be read ever so often.