Psychology Of Money

These notes are primarily based on the ideas and learnings from "The Psychology Of Money: Timeless Lessons On Wealth, Greed, And Happiness", 1st Edition, by Morgan Housel in 2020. The description of the book mentions: "Money - investing, personal finance, and business decisions - is typically taught as a math-based field, where data and formulas tell us exactly what to do, but in the real world people do not make financial decisions on a spreadsheet, but rather they make them at the dinner table or in a meeting room, where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together". The author shares short stories which explore the strange ways people think about money. Overall, the premise of the book is made clear from the beginning and can be summarized as "doing well with money has a little to do with how smart you are and a lot to do with how you behave". There is some subjectivity with regard to some of the presented ideas, such as the critic of the idea of diversification across time from Barry Nalebuff and Ian Ayres. Other concepts, many of which are often neglected, are presented for further thought and consideration.

Introduction

With regard to finances, the level of success a person is able to attain does not depend on their background, education, training, experience, and connections. Someone with none of these things, like Ronald Read (who was a janitor and became a multi-millionaire through investing), is able to outperform anyone with the best of these things. The primary factor with regard to finances is behaviour (with a bit of luck as a secondary factor).

No One Is Crazy

Personal experiences with money will only be a minute sliver of what actually happens in the world, but these personal experiences will dominate how someone thinks the world works with money. Unfortunately, the things someone learns through personal experiences are much more compelling than the things they learn from second-hand sources. This leads to disagreements when making decisions involving money, as most people have formed different opinions and priorities based on their personal experiences. In an ideal situation, someone should use reputable second-hand sources to make decisions based on theory, goals, and characteristics of the options available to them. However, in the vast majority of cases, people make decisions based on the personal experiences which they have uniquely lived through in the past and, in almost all of these cases, these personal experiences are not an accurate reflection of how the world actually works with money.

This is, of course, completely irrational from an objective perspective. However, every financial decision someone chooses makes rational sense to them at that moment and justify the criteria they need to satisfy based on the information they have gathered from their personal experiences. For example, the lowest-income households in the United States spend $412 a year on lottery tickets on average, which is 4 times the amount of those in the highest-income households (meanwhile, 40% of Americans cannot come up with $400 in an emergency). In this example, people in different income brackets have come to different conclusions on whether it makes sense to buy lottery tickets, where the reasoning for this conclusion is most likely to have been based on their personal experience with money.

Another issue to consider is that the decisions someone needs to make with money are relatively new from a historical scale. For example, the entire concept of retirement is, at most, only 2 generations old. Before 1940 in the United Sates, the reality was that most Americans worked until they died (and it was probably even worse outside of the United States). Similarly, education was not readily available in the past with the share of Americans over the age of 25 with a degree increasing from less than 1-in-20 in 1940 to 1-in-4 in 2015 (which could explain why so many people make poor decisions around student loans). Another aspect is the access to debt which did not become common until after World War II. The majority of society only has 20 to 50 years of experience in the modern financial system.

Luck And Risk

Nothing is ever as good or as bad as it seems. There are circumstance which are generated by nothing other than random luck and risk, where individual effort can only ever have a secondary effect. There is luck involved in every success and there is risk involved in every failure. In a general sense, for every person who gets lucky with success, there is another person who gets unlucky with failure. Likewise, for every person who takes a risk for success, there is another person who takes a risk for failure. If luck and risk are given their proper respect, it is realized that, when judging financial success, it is never as good or as bad as it seems.

As an example, Bill Gates and Paul Allen are the founders of Microsoft and happened to go to one of the few high schools in the world which had a computer at the time of their schooling. In 1968, there were roughly 303,000,000 high school students, about 18,000,000 of them lived in the United States, about 270,000 of them lived in Washington state, a little over 100,000 of them lived in the Seattle area, and only about 300 of them attended Lakeside School. In other words, 1-in-1,000,000 high school students attended the high school which had the combination of resources and foresight to purchase a computer. Bill Gates even said: "If there had been no Lakeside, there would have been no Microsoft". There was nothing inherently special about Bill Gates, but he had a 1-in-1,000,000 head start above everyone else, which was the result of luck above anything else.

Unfortunately, there is also an example of risk going wrong involved in this story about Bill Gates. Kent Evans and Bill Gates became best friends in 8th grade and, according to Bill Gates, Kent Evans was the best student in the class. However, Kent Evans died in a mountaineering accident before he graduated from high school. Every year, there are around 36 mountaineering deaths in the United States, such that the odds of being killed on a mountain in high school in the United States are roughly 1-in-1,000,000. Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort - everyone is playing a game with 7,000,000,000 other people and an infinite number of moving parts. Luck and risk are doppelgängers.

The difficulty in identifying the components of luck, risk, and skill is one of the biggest problems faced when trying to make a decision, especially when trying to learn about the best way to manage money. So, as a word of caution, it is always necessary to be careful who is praised and admired, just as it is always necessary to be careful who is looked down upon and avoided. It cannot be fully known whether the outcomes for a particular person were a result of the distribution between luck, risk, and skill - it is extremely unlikely that something can be attributed to effort alone. With a high probability of success, it is still possible for someone to fail due to the existent low probability of failure. With a high probability of failure, it is still possible for someone to succeed due to the existent low probability of success. Not all success is due to hard work and not all poverty is due to laziness - keep this in mind when judging people.

Following on, it should also be kept in mind that personal success is a lousy teacher, as it tends to seduce smart people into thinking they cannot lose. When things are going well, people will attribute their success to skill, but they are almost never as good as they think and do not acknowledge the role luck played in bringing their success. Just as quickly as success is realized, it is possible for risk to take it away as the story changes. However, the corollary is also true and failure is also a lousy teacher, as someone can make the correct decision and still fail due to risk from external circumstance outside their control.

Never Enough

As put forward by John Bogle, for a large portion of society, especially including many of the most wealthy and powerful, there seems to be no limit on what enough entails. The question to be asked is why some people, who are worth hundreds of millions in many cases, would be so desperate for more that they risk everything (wealth, prestige, power, and fame) in the pursuit of even more. As summarized by Warren Buffett, most people are willing to risk what they do have and do need for what they do not have and do not need - it is just plain foolish.

The hardest financial skill is getting the goalpost to stop moving, but it is one of the most important financial skills. It gets dangerous when the taste of having more increases ambition faster than satisfaction - one step forward makes someone feel as though they are falling behind. In a large way, social comparison is the problem here. The ceiling of social comparison is so high that virtually no one will ever reach it - it is a battle which can never be won, as there is always someone else to compare against. Alternatively, it is possible to avoid participating in the game from the beginning. Enough is never too little and there are many things never worth risking, regardless of the potential gain (reputation, freedom, family, friends, happiness, etc).

Confounding Compounding

It is an absurdity difficult to comprehend that, as of 2019 at the age of 89 with a net worth of $84,500,000,000, Warren Buffett has accumulated $81,500,000,000 billion after his 65th birthday and $84,200,000,000 billion after his 50th birthday (due to an average annual return of 22%). If something compounds with a little growth serving as the fuel for future growth, a small starting base can lead to results so extraordinary they seem to defy logic. It can be so logic-defying that most people underestimate what is possible, from where the growth comes from, and to what the growth can lead. The skill is investing, but the secret is time.

Just considering the increase in hard drive storage, there was an increase of 296 megabytes from 1950 to 1990, but there was an increase of 100,000,000 megabytes from 1990 to 2019. A technology optimist in 1950 might have predicted that it was likely possible for hard drive storage to become 1,000 times larger or maybe even 10,000 times larger. Instead, it became 30,000,000 times larger within a single lifetime. Even in just 2004, Bill Gates criticized Gmail, which had been recently launched, by questioning why anyone would need a gigabyte of storage.

Linear thinking is so much more intuitive than exponential thinking - it is simple to do mental addition, but it is quite difficult to do mental multiplication. This is the reason most people fail to understand compounding when it comes to investing. There are books on economic cycles, trading strategies, and sector bets, but the most powerful and important book should be called "Shut Up And Wait" with just a single page showing a long-term chart of economic growth. Intuitively, it seems to make sense to devote effort to trying to earn the highest short-term investment returns. However, the counter-intuitiveness of compounding may be responsible for the majority of disappointing investing decisions. In a way, investing is like a short-term game or long-term guarantee, where the historical odds of making money in the markets of the United States are around 50% over 1-day periods, 68% percent over 1-year periods, 88% over 10-year periods, and (so far) 100% over 20-year periods.

Getting Wealthy Vs Staying Wealthy

Investing is not necessary about making good decisions, but rather it is about not consistently making bad decisions. There are many ways to get wealthy, but the only way to stay wealthy is through frugality and paranoia. Many people are very good at getting wealthy, but very few people are good at staying wealthy - getting money is one thing, keeping it is another.

40% of companies successful enough to become publicly traded have lost effectively all of their value over time. The Forbes 400 list of the richest Americans has, on average, roughly 20% turnover per decade for causes which do not have to do with death or transferring money to another family member. Getting money requires taking risks and being optimistic, but keeping money requires humility, frugality, and fear of losing the money just as fast - essentially, this aligns with an acceptance that luck can be attributed to some portion of any success (and, in extreme cases, a large portion of the success), so past success can never be relied upon to repeat indefinitely or even again. Once someone has money, it should be about survival and sticking around for a long time - essentially, this aligns with the counter-intuitiveness of compounding.

Most people have likely heard of the investing duo of Warren Buffett and Charlie Munger, but forty years ago there was a third member of the group, named Rick Guerin. Warren Buffett had said: "Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry". Unfortunately, Rick Guerin was levered with margin loans through the downturn from 1973 to 1974 and got margin calls which forced him to sell his Berkshire Hathaway stock at under $40 per share. Each of them were equally skilled at becoming wealthy, but Warren Buffett and Charlie Munger had the additional skill of staying wealthy.

Essentially, it is required for an investor to want to be financially unbreakable more than they want spectacular short-term returns (just sticking around guarantees spectacular long-term returns). In addition, planning is important, but the most important part of every plan is to plan on the plan not going according to plan. A plan allows someone to know if their actions are reasonable and, by surviving and adapting to real-world tests, plans are able to be refined to be reasonable. Many bets fail, not because they were wrong, but because they were mostly right in a situation which required things to be exactly right. In the end, being optimistic about the future but paranoid about the plan for the future is vital. It is necessary for short-term paranoia in order to exploit long-term optimism.

Over the last 170 years, 1,300,000 million Americans died while fighting 9 major wars; roughly 99.9% of all companies which were created went out of business; 4 presidents of the United States were assassinated; 675,000 Americans died in a single year from a flu pandemic; 30 separate natural disasters each killed at least 400 Americans; 33 recessions lasted a cumulative 48 years; number of forecasters who consistently predicted any of those recessions rounds to zero; stock market fell more than 10% from a recent high at least 102 times; stocks lost 33% of their value at least 12 times; annual inflation exceeded 7% in 20 separate years; and, according to Google, the words "economic pessimism" appeared in newspapers at least 29,000 times. Also, while this was happening, the gross domestic product per capita increased by 20 times in the United States.

Tails, You Win

It is possible to be wrong more than half the time and still make a fortune. The great art dealers, such as Heinz Berggruen, bought vast quantities of art (similar to the operations of index funds - always diversified and never individual pieces). A small subset of the large collections turned out to be great investments and were held for a sufficiently long period of time to allow the portfolio return to converge upon the return of the best elements in the portfolio. There was no particular skill or luck involved.

In finance, long tails at the farthest ends of a distribution of outcomes have tremendous influence, where a small number of events can account for the majority of outcomes. These events are 1-in-1,000 or 1-in-1,000,000 events. In this unintuitive way, it is possible to be wrong most of the time and still end up being stupendously right - it is expected for most things to fail while only a few succeed. In almost all cases, anything which is huge, profitable, famous, or influential is the result of a tail event and, when most attention goes to the result of a long tail event, it is easy to underestimate the rarity of these events and associated positive or negative consequences.

For example, out of 21,000 financings by venture capital from 2004 to 2014, 65% of investments lost money, 2.5% of investments made 10 to 20 times, 1% of investments made more than 20 times, and 0.5% of investments (about 100 companies) made more than 50 times. Most startups fail and only a select few succeed spectacularly. This is similar for publicly traded companies, where J. P. Morgan Asset Management reported that the overall return of the Russell 3000 index came from only 7% of companies which outperform by at least 2 standard deviations since 1980. Despite this and 70% of the companies effectively losing value, the Russell 3000 index has increased more than 73 times since 1980.

As a recent example, how an investor behaved between late 2008 and early 2009 likely had more impact on the returns over their lifetime than anything else they had done previously. Investing can be seen as hours and hours of boredom punctuated by moments of sheer terror, where the success of an investor depends on their response during the moments of sheer terror. An investing genius is someone who can do the average thing when all those around them are going crazy.

At the Berkshire Hathaway shareholder meeting in 2013, Warren Buffett said that he has owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger followed this by saying that "if you remove just a few of the top investments of Berkshire Hathaway, its long-term track record is pretty average". In a similar sentiment, George Soros once said that "it is not whether you are right or wrong which is important, but how much money you make when you are right and how much money you lose when you are wrong".

Freedom

The highest form of wealth is for someone to have the ability to control their lives by being able to do anything they want. This includes whatever they want, whenever they want, with whoever they want, and for as long as they want. Some research, specifically from Angus Campbell, has shown that, from the objective conditions of life considered, the most dependable predictor of positive feelings of well-being is a strong sense of control (more than salary, housing, work, prestige, etc). The greatest intrinsic value of money is its ability to provide control over time and using money to buy time has a lifestyle benefit with which few luxury products can compete.

In the United States, the inflation-adjusted median family income was $29,000 in 1955 and it has increased to just over $62,000 in 2019. The median American home increased from 983 square feet in 1950 to 2436 square feet in 2018 (notably, the average new American home now has more bathrooms than occupants). Cars are faster and more efficient, televisions are cheaper and sharper, medication is effective and accessible, communication is instant and widespread, and almost everyone has a smartphone. However, it does not seem that the average American is much happier. Unfortunately, there has not been much progress with regard to the average American having control of their time. A large contribution to this is due to most jobs requiring thought and decision-making, but this thinking cannot necessarily be detached from and simply left behind outside of working hours.

In the 1950s, John D. Rockefeller was one of the most successful businessmen of all time. He was also a recluse, spending most of his time by himself, rarely speaking with other people, and deliberately making himself inaccessible. When asked about his silence during meetings, John D. Rockefeller often recited a poem: "A wise old owl lived in an oak; The more he saw, the less he spoke; The less he spoke, the more he heard; Why aren't we all like that wise old bird?" (old English nursery rhyme). In a time when jobs involving physical labour were dominant, it was his job to have thoughts and make decisions. Today, most jobs resemble those of John D. Rockefeller and it has led to most people losing more control over their time.

Karl Pillemer interviewed numerous elderly Americans and concluded: "No one said that, to be happy, you should try to work as hard as you can to make money to buy the things you want. No one said that it is important to be at least as wealthy as the people around you and only if you have more than they do is it real success. No one said that you should choose your work based on your desired future earning power. Your kids do not want your money (or what your money buys) anywhere near as much as they want you. Specifically, they want you with them" (from "30 Lessons For Living").

Man In The Car Paradox

There is no one who is impressed by possessions as much as the owner of those possessions. Most people think possessions send a signal that someone is smart, rich, tasteful, important, and has made it. However, when most people see prized possessions, they could not care less about the owner of these possessions and they only care about how those possessions would reflect if they were the owner. Thus, there is a paradox, where people tend to want to own possessions to signal to other people that they should be admired, but, in reality, those other people often bypass admiring the owner, not because they do not think the possessions are admirable, but because they use those possessions as a benchmark for their own desire to be admired with no actual consideration for the owner (they care about the possessions, not the owner of the possessions).

People think they want an expensive car, fancy watch, big house, or bright jewellery, but they actually want respect and admiration from other people and they think having these things will bring it to them - it almost never does, especially from the people whose respect and admiration someone would actually want. This is a subtle recognition that people generally aspire to be respected and admired by other people and using money to buy luxury products may bring less of it than would be expected. Again, from the people whose respect and admiration someone would actually want, humility, kindness, and empathy will bring more respect than possessions ever will.

Wealth Is What You Do Not See

If someone decides to spend money to show other people how much money they have, this is the fastest way for them to have less money. For example, someone driving a car of $100,000 might be wealthy, but the only data point about their wealth is that they have $100,000 less than they did before they bought the car (or, most likely, $100,000 more in debt). In many ways, wealth is what is not seen - nice cars never driven, diamonds never bought, houses never mortgaged, watches never worn, branded clothes forgone, and first-class upgrades declined.

When most people say that they want to be a millionaire, what they might actually mean is that they would like to spend a $1,000,000. A distinction can be made between rich, as current income, and wealth, as income which is not spent. It is somewhat counter-intuitive, since spending money will make someone feel rich, but it will also make them less wealthy at the same time. Usually, it is not hard to spot if someone is rich and they will most probably go out of their way to make themselves know, but wealth is hidden through years of accumulation to offer options, flexibility, and growth in the future. For most people, the only way to become wealthy is to avoid appearing rich and spending money on unnecessary things (and maybe this is actually a good thing depending on whose respect is desired).

The problem is that it is easy to find rich role models (visible short-term success), but it is often difficult to find wealthy role models (hidden long-term success). The world is filled with people who look modest but are actually wealthy and people who look rich but live at the edge of insolvency. At the end of the day, money talks while wealth whispers.

Save Money

Past a certain level of income, people fall into those who save, those who do not think they can save, and those who do not think they need to save. Excluding the first group, people tend to find it difficult to grasp the intangible benefits of money which saving provides, but these intangible benefits (options, flexibility, and growth) can be much more valuable and capable of increasing happiness than most tangible alternatives. In a way, saving is a hedge against unexpected surprises at the worst possible moments.

Over long periods of time, building wealth has little to do with income or investment returns and lots to do with savings rate. Personal savings and frugality can be completely controlled with a constant effectiveness throughout time, but income and, especially, investment returns are more variable and less controllable. It can be pointless to focus on and try to optimize the things which cannot be controlled - many hours of research may not be worth only slightly outperforming a much simpler portfolio.

The value of wealth is relative to individual circumstances. If someone is happy with a simple lifestyle, then they do not need to accumulate as much as someone who is always in the pursuit of more. Often, spending beyond a pretty low level of materialism is mostly a reflection of ego approaching income, as a way for someone to spend money to show other people that they have (or had) money. In other words, savings can be seen as a representation of the gap between income (after basic needs) and ego. One of the most powerful ways to increase savings is to raise humility and appreciation, rather than seeking to increase income.

In the past, the talent pool of competition was from hundreds to thousands with a regional restriction to local towns, but, today, the talent pool of competition has increased to millions or billions with no significant regional restrictions. As digitalization removes global boundaries, this is especially true for jobs involving thought and decision-making (teaching, marketing, analysis, consulting, accounting, programming, journalism, medicine, etc). It is no longer possible to stand out based on skills alone, unless someone is the very best in their field worldwide.

Reasonable Greater Than Rational

In most cases, aiming to be mostly reasonable works better than trying to be coldly rational. A rational investor makes decisions based on numeric facts. A reasonable investor makes decisions based on minimizing future regret. People are social and emotional and, because of this, it is often realistic to expect them to be reasonable rather than rational.

In 2008, a pair of researchers from Yale published a study arguing that young investors should supercharge their retirement accounts using 2-to-1 margin when buying equities. They suggest investors should taper that leverage as they age, which lets them take more risk when they are young and can handle a magnified market volatility, and less when they are older. Even if using leverage wiped out an investor when they were young, it was shown that they would still be better off in the long run if they continued to follow the plan. This is a rational strategy, but it is almost absurdly unreasonable and no normal person would be able to follow this advice.

Surprise

Things which have never happened before happen all the time. History is essentially the study of things changing and, ironically, it is usually used as a map of the future. This leads to an over-reliance on past data as a signal to future conditions in a field where innovation and change are the constants of progress. Studying, or even experiencing, what happened in the past might not serve as any guide to what will happen in the future - it may even lead to over-confidence more than any actual forecasting ability.

In addition, relying on trends throughout history can often miss the outlier events which are the most important to consider. For example, 15,000,000,000 people were born in the 19th and 20th centuries, but the worlds would have been completely different if just a handful of them were not born, such as Adolf Hitler, Joseph Stalin, Mao Zedong, Gavrilo Princip, Fritz Haber, Albert Einstein, Bill Gates, and Martin Luther King - from another perspective, the minutest fraction (less than 0.0000000001%) of people are responsible for the majority of the events in the world. The thing which makes tail events easy to underappreciate is how easy it is to underestimate how things compound. The most common plot of economic history is the role of surprises, because there is no guarantee that the future will look anything like the past.

With regard to the stock market, it should be noted that there have been structural changes over time. The availability of investment accounts has changed with changes in the tax treatment of these accounts. There have been changes in indices and in sectors within those indices (financial companies were not included in the S&P 500 until 1976, while technology companies were virtually non-existent 50 years ago). In addition, regulations have changed around accounting rules, disclosures, auditing, and market liquidity. The further back someone looks, the more likely they are to be examining a world which no longer applies to today. This history of money is only useful for general trends.

Room For Error

In most casinos and for experienced players, blackjack has an edge around 1% in favour of the house to put the odds of the player winning at 49%. The fundamentals of card counting in blackjack are that no one can know with certainty which card the dealer will draw next, but, by tracking which cards have already been dealt, it is possible to calculate which cards remain in the deck and this can provide the odds of a particular card being drawn by the dealer. Someone who is card counting will then bet more when the odds are in their favour and less when the odds are against them. The important idea is that this is still a game of odds without certainty, but card counting tilts the odds very slightly from the house to the player. However, an added edge of 2% in favour of the player means the house will still win 49% of the time, so room for error is always required to withstand extended swings of bad luck.

The wisdom in having room for error through a margin of safety or redundancy is acknowledging that uncertainty, randomness, and chance are inescapable parts of life. The purpose of having room for error is to render the need for an accurate forecast unnecessary for success. Instead, it is better to consider a range of potential outcomes. For example, the markets of the United States have an inflation-adjusted annual return of 6.8% since the 1870s, but there is no guarantee that returns will not be lower in the future - based on the definition, half of historic returns have been less than 6.8%. As Charlie Munger said, "the best way to achieve felicity is to aim low" and, if things end up on the upside, it will be a pleasant surprise.

You Will Change

It is often difficult to accurately implement long-term planning, as most goals and desires change over time. Most people do not know what they want to do in the future and, as a result, only 27% of college graduates have a job related to their major, while 29% of stay-at-home parents have a college degree. The "end of history" illusion is what psychologists call the tendency for people to be keenly aware of how much they have changed in the past but to underestimate how much they are likely to change in the future.

As Daniel Gilbert described, "at every stage of our lives we make decisions that will profoundly influence the lives of the people we are going to become and, then when we become those people, we are not always thrilled with the decisions we made - young people pay good money to get tattoos removed which teenagers paid good money to get, middle-aged people rushed to divorce people who young adults rushed to marry, older adults work hard to lose what middle-aged adults worked hard to gain, and on and on and on". Going further, "all of us are walking around with an illusion - an illusion that history, our personal history, has just come to an end and that we have just recently become the people who we were always meant to be and will be for the rest of our lives".

For the most likely outcome, it is usually better to avoid the extreme ends of planning for the future. For example, both the simplicity of having hardly anything or thrill of having almost everything will wear off eventually with changes in goals and desires. Aiming to have moderate annual savings, moderate free time, moderate commute to work, and moderate time with family, increases the probability of being able to maintain a plan and avoid regret than if any one of these things happens to fall to an extreme sides of the spectrum. Additionally, it is necessary to accept the possibility of change and avoid sunk costs.

Nothing Is Free

Everything has a price and the key to most things with money is just figuring out what that price is and being willing to pay it. This is harder in practice than it seems in theory - put another way, every job looks easy from the outside, because the challenges faced by someone in the arena are often invisible to those in the crowd. Like most things which are worthwhile, successful investing demands a price in the form of volatility, fear, doubt, uncertainty, and regret. These events and emotions are easy to overlook until they have to be dealt with directly and, unfortunately, most people see them as a negative fine rather than a simple fee. As a result, many people in investing try to avoid this price through tricks and strategies, but most of them will fail spectacularly with lower returns and higher volatility (while a lucky few will succeed). Market returns are never free and never will be.

Just to be clear, this is not referring to a fee to an investment fund or manager. This is referring to the risk inherent with having a positive expected return for an investment. A high fee to an investment fund or manager is just paying more money for a lower return and higher volatility (again, trying to avoid the price through tricks and strategies (without directly realizing it)).

You And Me

It is necessary to exercise caution when taking financial cues from other people who are playing a different game. For example, many people were buying individual stocks in 2000 and, after the bubble had collapsed, household wealth was reduced by $6,200,000,000,000. These people were playing a game to get rich quickly and, ultimately, it led them to temporarily ruining their lives. People often make financial decisions they will end up regretting and they often do so with scarce information and without logic, even if their decisions personally made sense to them at the time. In a way, blaming bubbles on greed misses important lessons about how and why people rationalize what in hindsight looks like short-sighted decisions.

The formation of bubbles is not so much about people irrationally participating in long-term investing. Rather, the formation of bubbles is about people somewhat rationally moving toward short-term trading to capture momentum which had been feeding on itself. In other words, it is not rational to expect traders and speculators, who are a significant portion of market participants (including fund managers with short-term goals), to do nothing and watch when there is momentum which creates the potential of large short-term returns. This behaviour is irrational from the long-term perspective of an investor, but it is possible for multiple behaviours to co-exist while being rational from their own perspective - problems occur when people playing different games mix cues.

Seduction Of Pessimism

Optimism is the best bet most of the time, because the world tends to get better for most people most of the time, where the odds of a good outcome are continuously favourable. However, pessimism has a special place, as most people like to hear that the world is going to end. In this way, optimism usually sounds like a sales pitch, while pessimism sounds like someone actually trying to help - it is seen as intellectually captivating and plausible, while optimism is viewed as being oblivious to risk. In a strange way, forecasts of outrageous optimism are never taken as seriously as forecasts of doomed pessimism.

As it was written by Matt Ridley, "if you say the world has been getting better, you may get away with being called naïve and insensitive; if you say the world is going to go on getting better, you are considered embarrassingly mad; but, if, on the other hand, you say catastrophe is imminent, you may expect a McArthur genius award or even the Nobel Peace Prize". Almost every group of people tends to think that the world is more frightening, violent, and hopeless than it really is in reality. It was even written by John Stuart Mill in the 1840s: "I have observed that not the man who hopes when others despair but the man who despairs when others hope is admired by a large class of persons as a sage".

Another consideration is that progression happens too slowly to notice, but setbacks happen too quickly to ignore. There are rarely overnight miracles, but there are frequent overnight tragedies. As a result, growth is driven by continuous effort over time, while destruction is driven by single points of failure and loss of confidence. In conjunction, this usually makes narratives around pessimism easier to fabricate, as the information is reduced and more recent.

When You Will Believe Anything

The world is driven by stories of narratives. This can be problematic, as a story can never provide a complete and objective view. The more someone wants something to be true, the more likely they are to believe a story which overestimates the odds of it being true. For example, consider that 85% of active funds underperformed their benchmark over the 10 years ending 2018 and this figure has been fairly stable for generations, but there is still almost $5,000,000,000,000 invested in these active funds regardless of their poor performance, which is simply due to the story of the chance to obtaining outperformance through the opportunity of investing alongside the next Warren Buffett. The larger the gap between what someone wants to be true and what they need to be true to have an acceptable outcome, the more they are protecting themselves from falling victim to an appealing financial fiction.

As said by Daniel Kahneman, "hindsight, the ability to explain the past, gives us the illusion that the world is understandable, which leads to the illusion that the world makes sense, even when it does not make sense". Unfortunately, everyone has an incomplete view of the world, but almost everyone forms a complete narrative to fill in the missing gaps. When someone does not understand something, they will create this narrative, instead of confronting the possibility that they are not able to come up with an explanation which makes sense based on their own unique perspective and experiences.

Forecasts generally do more harm than good by giving the illusion of predictability in a world where unforeseen events control most outcomes. The illusion of control is more persuasive than the reality of uncertainty, so people tend to cling to stories about outcomes being in their control.

All Together Now

Here are some short recommendations which can help in making better decisions:

• Go out of your way to find humility when things are going right and forgiveness or compassion when things are going wrong. Respect the power of luck and risk and you will have a better chance of focusing on things you can actually control. Do so when judging both yourself and others.
• Have less ego and more wealth. Saving money is the gap between your ego and your income, so wealth is created by suppressing what you could buy today in order to have more options in the future. You might think you want a fancy car or a nice watch, but what you probably want is respect and admiration. You are more likely to gain these things through kindness and humility than horsepower and chrome.
• Manage your money in a way which helps you sleep at night. If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. In most cases, this is preferable to trying to increase return by increasing risk.
• Become okay with a lot of things going wrong. You can be wrong half the time and still make a fortune, because a small minority of things account for the majority of outcomes.
• Use money to gain control over your time, because not having control of your time is such a powerful and universal drag on happiness. The ability to do what you want, when you want, with who you want, and for as long as you want pays the highest dividend which exists in finance.
• Define the cost of success and be ready to pay it. Nothing worthwhile is free and most financial costs do not have visible price tags. Uncertainty, doubt, and regret are common costs in the finance world and they are worth paying. However, you have to view them as fees (a price worth paying to get something nice in exchange) rather than fines (a penalty you should avoid).

Confessions

Every investor should pick a strategy which has the highest odds of successfully meeting their goals. Strangely, there is little correlation between investment effort and investment results and, for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success. According to Morningstar, even half of all fund managers in the United States do not invest any of their own money in their funds. Russel Kinnel, head of research at Morningstar, said that "fund managers are savvy investors, so they are less likely to invest in gimmicky, high-cost funds - I remember one firm telling us that they did not invest much in their own funds because they would rather invest in something cheaper".

In a way, beating the market should be hard and the odds of success should be low. If they were not, everyone would be able to do it and, if everyone did it, there would be no opportunity and things would break. No one should be surprised that the majority of those trying to beat the market fail to do so. It is just a game an investor can choose not to play.

Becoming financial independent is often a better goal than becoming wealthy, although becoming financial independent is usually followed by becoming wealthy. Charlie Munger said: "I did not intend to get rich, I just wanted to get independent". Achieving financial independence is mostly a matter of checking expectations and living frugally, where the chances of achieving financial independence is driven by savings rate above anything else.