Is there no such thing as a crazy financial strategy? Review of The Psychology of Money by Morgan Housell

The Psychology of Money was recommended by YouTuber Ali Abdaal as one of the books that changed his whole perspective on money. I’ve enjoyed a lot of his videos and perspective (I recommend checking his channel out), so I decided to read this one for myself.

I’m always a bit sceptical about book recommendations from people I don’t know, but this one didn’t disappoint!

The core concept of The Psychology of Money

The book isn’t meant to be a “do this to get wealthy” guide, although later chapters start talking about investments.

I guess Morgan had to fill up some more pages?

The aim of the book is to explain and rationalise why people do what they do with their money. To make sense of investing ideas.

The book achieves this pretty well and is a blissfully easy read, so makes for good bedtime reading.

I read most of these books on my commute or in bed after a hard day of working in law, so I appreciate an easy read!

My top takeaways from the book

There was a lot of interesting stuff in here, most of which is readily applicable to FIRE and explains why not everyone in the world is doing this.

My favourite takeaway points are explained below.

There is no such thing as a crazy investment strategy

Every generation has to deal with a different economic scenario.

Our grandparents and great-grandparents had to deal with the very real threat of a run on the banks. Our parents had to deal with the extreme inflation of the 1970s and various strikes. Until the last decade, Stocks and Shares ISAs weren’t really a thing, and the original tax-free investment amount was tiny. Real estate was the way retail investors made money through the 1990s. Until very recently, index fund investing wasn’t accessible for most people and you had to buy shares either at great expense through a stockbroker or through a fund managed by your bank.

In 2008, the US sub-prime mortgage sector failed because debts were sold on in packages of debts to diversify the risk of stupidly-high risk debts. This didn’t work, then we hit a time of perpetual low interest rates and government bonds that are, frankly, worthless.

Now we’ve hit high levels of inflation and market concern because the Bank of England has raised interest rates to the heady heights of, err, 0.75%.

The point is that every generation has needed to respond to different strategies. Housell explains that the lessons which were smart ideas at the time tend not to be un-learned as the situation changes, leading to ideas that seem daft later.

If you’re expecting a run on the banks because you’ve seen it twice, cash under the mattress seems like a solid plan. Bitcoin became popular because 2008 showed that banks can’t be trusted to act sensibly with the money supply, so it might be a good idea to have a digital hard money supply beyond the fiat system.

Anyway, Housell argues that most people don’t make stupid decisions because they’re crazy: they make seemingly crazy decisions as a rational response to their experiences.

Every investment can be made to work… but there’s a cost

I thought this was a powerful idea, and it definitely links in to what I saw while working in Private Wealth.

Logically, think about it this way. Back in the day, your parents might have told you that you were mad for buying shares. Mine certainly did. There was a lot of money to be made, but the cost of making that money was:

• You had to stomach price volatility, with every price drop reported on the news
• You had to lose the use of the cash you’d invested for 3-10 years
• Fees for buying were quite high until the last decade
• You had to learn about diversification and rebalancing yourself – or pay an (expensive!) financial advisor to do it for you
• There wasn’t a lot of access to information to help you learn – so you had to go and find it.

The point here is that all investments have a cost, but some costs are bigger than others.

For comparison, a Bitcoin investor from 2017-2020 had to stomach an 80% volatility, but had they held on to 2021 would have made huge profits. You can allegedly make 8-13% tax free gain on investing in whisky (no joke), but how do you know which ones to buy and when to sell? What if the whisky market collapses? You can make big profits flipping houses, but you need capital up front and you need to know what to look for, or be willing to hold on to an asset for a while to get your return.

I’ve long held onto the idea that anything can be an asset in the right hands, and it seems The Psychology of Money agrees with me.

Reasonable strategies are better than rational strategies

I’m going to use my paying off the mortgage early decision as an example here. Regular readers will recall that we hit 60% LTV and are now coasting along with base payments for now.

In theory, mortgage debt is ultra-cheap. You’re not going to get finance cheaper in most situations, except maybe a margin loan for shares.

To be clear: I do not advocate a margin loan for shares, I just don’t judge if you decide it’s for you.

This means that, rationally, you should pay off as little into the mortgage as you possibly can and invest the potential overpayments.

However, I took the reasonable decision that I wanted to be at 60% LTV. That percentage gave us freedom to explore other uses of the house, such as switching it to a letting, refinancing if times got tough, or becoming self-employed and switching to a mortgage for self-employed people (which is a bit more demanding than for regular salaried people).

The Psychology of Money makes the argument that a consistent strategy you stick to is a reasonable plan that beats a rational plan which terrifies you.

I completely agree with this point.

I worked out in a previous post if you had to choose between optimising your investments versus just saving a bit more from your budget – you should focus on the latter.

A sub-optimal portfolio that has more cash put into it will be effective at getting you to financial independence. The perfect portfolio but with less cash in it will make you wait a few extra years for freedom.

So, for me, the reasonable thing to do is to focus on optimising a budget and investing somewhere rather that chasing the most optimal returns.

Housell criticises the Lifecycle Investing strategy I reviewed previously, on the grounds that although it’s completely rational most people won’t rest easy with that much leverage in their portfolio. I guess it depends on your risk tolerance and conviction.

Pessimism is way more persuasive than optimism

One of the costs of investing is that although you expect a return, you’re not guaranteed one, and you risk your money.

The Psychology of Money argument is that humans aren’t inherently comfortable with risk. It’s a survival thing. If you see risk, your ancient ape-brain takes over and you have the desire to run back to the safety of the cave.

As a result, every pessimistic take on the stock market (or anything else) sticks in your mind better than any optimistic outlook.

We can see this in the way that news is reported. Every stock market drop gets a headline, but very few unexceptional recoveries make it into the 9 o’clock news. Sure, the big ones do, but not the little micro-gains that accumulate over time.

I didn’t realise it before reading this book, but it was something I was trying to allude to when I resolved to be more considerate of upside risk. Pessimism is tempting, but it closes your mind to opportunities and I would prefer not to let opportunities pass me by if I can help it!

There’s always the tendency to want more

Why do billionaire do stupid things, like commit fraud? How much greater freedom can you earn after a certain net worth?

Well, not a lot.

The Psychology of Money explains that there’s always a tendency to want more. Enough is never enough, for a lot of people.

I’ve seen this in the FIRE community recently. A lot of FI numbers are £800,000+. That’s fine, you do you, but I wonder how much of this is fixated upon maintaining capital continuously until you die… and at what cost.

£800,000 being spent at £40,000 a year is still 20 years of spending. It’s 26.7 years spending at £30,000 a year. If you can be happy with just £20,000 a year (the equivalent of a salary of £24,325) or £1,667 per month, that’s 40 years of spending. Assuming that you don’t invest it effectively and the pot only keeps up with inflation, that’s huge.

However, it will take you 16 years investing £20,000 per year and getting 10% compounding returns net of tax to generate this figure. That’s actually not bad, you just need to consider if the trade off is worth it.

Conversely, we worked out for our boat plan that we would only need £200-300k to disappear indefinitely, less if we are willing to earn some side cash to supplement it. If we can save £20,000 per year, we can be free in 6-8 years.

I’m not saying my plan is better or worse than yours. Honestly, I’m learning and blogging as I go. However, I think it’s important to consider how much is enough and how much is just your primitive drive for security taking over. It could save you years.

Who should read The Psychology of Money

I’d recommend this book to anyone, whether they are interested in FIRE or not. It’s a great read, and it’s short and friendly enough for non-finance-geeks to enjoy.

Final thoughts

I guess I liked this book so much because Morgan Housell’s ideas aligned so closely with mine. Confirmation bias, perhaps?

The book also puts into perspective a lot of the criticism I get from the FIRE enthusiasts about my stance on crypto. To critics, I’m that crazy guy who’s gambling away all my money on something they don’t want to understand. Conversely, I’m looking at the standard “just invest in index fund for twenty years” advice and thinking: is this really it?

Don’t get me wrong, I still base a lot of my thoughts on traditional investing. I’ve written about my ISA previously and I do still have a small allocation to gold, which I quite like. I overpay into my pension. My retirement will be earlier than most regardless, I’m just open to opportunities that will accelerate it.

Anyway, I got a lot of value from this book, and I hope you will too. Thanks to YouTuber Ali Abdaal for recommending it!