Introduction to
‘The Psychology of Money’
While others struggle with financial stability their entire lives.
Today, we’re going to explore a groundbreaking book that delves into this very question: ‘The Psychology of Money’ by Morgan Housel. In a world where financial advice is often reduced to oversimplified dos and don’ts, ‘The Psychology of Money’ offers a fresh perspective, encouraging us to understand our own unique money mindset.
Lesson 1: Wealth is not the same as money.
Now let’s start with a question: What comes to mind when you hear the words wealth and money? You might think they’re the same, but ‘The Psychology of Money’ offers a different perspective.
It suggests that wealth isn’t about the money you accumulate; it’s about the money you keep.
We know money is what we earn from our jobs, our businesses, or our investments. It’s a medium of exchange—we trade our time, skills, or goods for money.
Wealth, on the other hand, is what we save and invest. It’s the part of the money that we don’t spend. Wealth buys you freedom—freedom to do what you love, freedom to take risks, and freedom from worrying about the future.
Often, we equate wealth with a lavish lifestyle—fancy cars, luxurious houses, designer clothes—but these are just displays of money, not wealth. True wealth is invisible; it’s the money that’s been saved and invested, not the money that’s been spent.
So understanding the difference between wealth and money is crucial because it changes our perspective on financial success.
As Morgan Housel puts it, the world is filled with people who look rich but are poor and people who look poor but are wealthy. So which one would you rather be?
Lesson 2: Luck and Risk
In the second lesson in the psychology of money, Morgan Housel introduces us to two often overlooked factors in financial success: luck and risk. Luck is when unforeseen opportunities come your way; it’s the good fortune you didn’t necessarily earn or foresee.
Risk, on the other hand, is an exposure to danger or loss—the potential downside of any decision we make.
In the world of finance, both luck and risk play a huge role. Sometimes people become wealthy because of luck—they were in the right place at the right time or made a decision that unexpectedly paid off. On the other hand, people can also lose money due to unforeseen risks—a sudden market downturn, an unexpected expense, or a bad investment.
We often hear stories of self-made millionaires who built their fortunes from scratch, but these stories often overlook the role of luck and risk. Yes, hard work and smart decisions are important, but so are luck and the ability to navigate risks.
Understanding the role of luck and risk in financial success can help us make better financial decisions.
It reminds us to be humble when we succeed, knowing that luck played a part, and to be resilient when we fail, knowing that risk is part of the process.
As Morgan Housel puts it, the only factor that you have control over is how you save, invest, and think about money. If you master that, you have won.
Lesson 3: Never Enough
Moving on to the third lesson, Never Enough, it explores our insatiable desire for more. Humans have a tendency to always want more—a raise, a new car, a bigger house.
You know there’s always something else we desire. This isn’t necessarily a bad thing, as it can drive us to work harder and achieve more.
But when it comes to money, this desire can lead to stress and dissatisfaction. This phenomenon is often referred to as the hedonic treadmill. We work hard to earn more money, thinking it will make us happier, and it does—but only for a while.
Soon, we adapt to our new standard of living, and the cycle begins again. We’re running on a treadmill, exerting effort but not getting any closer to lasting happiness.
The pursuit of more can lead us to take unnecessary risks, spend beyond our means, and sacrifice our health and relationships for the sake of wealth. It can also blind us to the wealth we already have.
So understanding that more is never enough can help us break free from the hedonic treadmill. As Morgan Housel puts it, the hardest financial skill is getting the goalpost to stop moving, but it’s one of the most important.
Lesson 4: Confounding Compounding
Next up, the fourth lesson is Confounding Compounding, and it’s all about the power of time and patience in growing wealth.
If you don’t know, compounding is the process where the value of an investment increases because the earnings on an investment—both capital gains and interest—earn interest as time passes.
Imagine you have $100 in a bank account that earns 10% interest per year. After one year, you’ll have $110. But in the second year, you’ll earn interest not just on your original $100 but also on the $10 you earned in the first year.
So at the end of the second year, you’ll have $121. That extra $1 is the result of compounding.
The power of compounding isn’t in the interest rate, but in the amount of time you allow it to work. The longer you leave your money invested, the more time it has to grow, and the more profound the compounding effect becomes. This is why starting to save and invest early is so important.
Many people underestimate the power of compounding because its effects aren’t immediately visible. It’s like watching a tree grow day by day—you might not notice any change, but over years and decades, a tiny sapling can grow into a towering tree.
That’s why understanding compounding can fundamentally change the way we approach saving and investing.
As Morgan Housel puts it, the ability to stick around for a long time without interruption is what makes compounding magic.