The Wealthy Mind: How Psychology Shapes Your Finances

Introduction

Do you want to be rich or wealthy? Did you know there was a difference between the two? The Psychology of Money explains what that difference is. In this physiology of money book, Morgan Housel shares 19 short stories illustrating how we think about money.

He considers how past experiences can worsen our long-term financial gains. Moving the goalposts and being coldly rational can have a similar effect. Instead, set clear and sensible financial goals that don’t depend too much on how things have been in the past.

Diverse Paths in Investing

“Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of wellbeing than any of the objective conditions of life we have considered.” — Morgan Housel

Our current relationships with money are based on our past experiences. Housel uses the example of people who struggled during the Great Recession, which started in 2007 and are now scared of reinvesting.

We shouldn’t judge others for their financial decisions. We have all had different experiences of investing. We must learn to make investment decisions based on our goals and investment options rather than experiences. The world is always changing. Relying on your experiences means you’re basing your decisions on knowledge of a different world.

Bill Gates Competitive Edge

“Focus less on specific individuals and case studies and more on broad patterns.” — Morgan Housel

Luck and risk are an integral part of finance. Do not assume that individual effort alone will allow you or others to be successful. Take Bill Gates. He is highly talented and works extremely hard. But, he also had a competitive advantage because he attended one of the few high schools in the world at that time to own a computer.

There are infinite moving parts within the world. The accidental impact of actions outside your control often has a greater effect than your conscious decisions. So, work hard and take risks but also consider the role that luck plays in finance. This should also help you develop greater humility when things are going right and compassion when they are going wrong.

Rich

Rich People Are More Likely to Make Crazy Decisions. Rich people often make illogical financial decisions. The goalposts seem to move the more you earn. Countless rich individuals have lost everything because they felt the millions they had were not enough.

Learn from these failures by not risking what you have and need for what you don’t have and don’t need. Saying “enough” is realizing that an appetite for more will push you to the point of regret.

Warren Buffett Is a Prime Example of the Power of Compound Interest. Compound interest can bring you financial freedom. That said, the human brain struggles to understand the power of compounding.

Warren Buffett is a good example of compound interest in action. Many believe his wealth is entirely due to his knowledge of sound investments, as he has been making good investments since a young age. But compound interest plays a huge part.

His current net worth as of October 2024 is $147 billion, but he accumulated $84.2 billion after his 50th birthday. This shows the power of compounding. The key to compounding isn’t about earning the highest returns. You want pretty good returns that you can stick with for the longest period.

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Success in Investing: Avoid Errors

“Margin of safety is raising the odds of success at a given level of risk by increasing your chances of survival. The higher your margin of safety, the smaller your edge needs to be to have a favorable outcome.” — Morgan Housel

Effective investing is less about making sound decisions and more about consistently not making mistakes. Financial success can be summarized by one word: survival. The most financially successful are those who have been able to stick around for a long time. You can only grow your wealth if you have given an asset time to compound.

Getting money requires risk-taking, optimism, and putting yourself out there. Keeping money requires the opposite: humility. Try to make yourself financially unbreakable rather than focusing on big returns. Humility is also about planning with the expectation things won’t go according to plan. This is your margin of safety and is one of the most underappreciated forces in finance.

Here are a few examples of ways you can start establishing a margin of safety:

• Frugal budget – When your income increases, still try to live below your means.
• Flexible thinking – Be willing to accept new information and ideas about investing as technology and ideas develop.
• Loose timeline – Avoid ditching investments impulsively if they drop in price. If you start with a loose timeline, you are better able to ride the downswings and benefit from the upswings.

Do the Average

The most successful, rich, and famous people are there because of a one-in-a-million event. As most of our attention goes toward these huge events, it can be easy to forget their rarity. Try to avoid underestimating how rare and powerful these events are.

Investors can be wrong half the time and still make a fortune. An investing genius is someone who can do the average thing when all those around them are making rash decisions.

The Illusion of Wealth and Fame

Consider the Rich Man in the Car Paradox. If we see a nice car, we may daydream about having that car, and everyone thinking we’re cool. The paradox is that we’re not thinking about the driver of the nice car we spotted, yet we believe that if we had such a car, everyone would be thinking about us.

We can apply this more broadly to wealth. People acquire wealth because they believe it will make them liked and admired. But others just use wealth as a benchmark for their desire to be liked and admired.

Look Beyond Visible Wealth

“Financial success is not a hard science. It’s a soft skill, where how you behave is more important than what you know.” — Morgan Housel

Some people use newfound wealth as an opportunity to show off. We should stop judging people’s wealth by what we see. Those who decide not to buy something now and to buy something later will stay wealthy for longer.

Being rich is based on current income, while your wealth is hidden and is the income that isn’t spent. Wealth’s value lies in offering you options, flexibility, and growth to one day purchase more stuff than you can right now.

Your Savings Rate Is Key

Your income or investment returns are less important than your savings rate. Your value of wealth should always be relative to what you need. A high savings rate means having lower expenses than you otherwise could. Having lower expenses means your savings go further than they would if you spent more.

Your savings rate is the financial decision you have the greatest control over. When you define savings as the gap between your ego and your income, you realize why many people with decent incomes save so little.

Stop Focusing on Historical Data

A mistake some investors make is believing the Historians as Prophets Fallacy. This mistake is an overreliance on historical data to predict future financial interest. The reality is that innovation and change are integral to finance.

Because the world changes, basing your investments solely on past performance is a bad decision. History can be a misleading guide to the future of the economy and stock market. It doesn’t account for structural changes relevant to today’s world.

Market Volatility Has a Fee

Everything in life has a price. The key to a lot of financial matters is figuring out what that price is and being willing to pay it. However, the price of investing isn’t immediately obvious. You should view any market volatility as a fee rather than a fine. If you can do this, you are more likely to stay in the game long enough for investment gains to work for you.

The trick is convincing yourself the market’s fee is worth it. That’s the only way to properly deal with volatility and uncertainty. Work out whether it is an admission fee worth paying, as there’s no guarantee it will be returned.

Find Your Personal Financial Identity

Speak to knowledgeable friends or read books from financial experts to develop your understanding of finance. Avoid taking financial advice from people with different quantities of money and end goals than you. Discover your personal financial identity, then listen to those who complement this identity.

Final Summary and Review

The Psychology of Money is a collection of tips from a two-time winner of the Best in Business award. This book highlights the importance of noticing the difference between being rich and being wealthy. Rich people often make risky decisions based on historical data. Wealthy people realize that protecting their money by avoiding mistakes is the key to success.

The book is relatively short but packed with fun and timeless financial lessons on how to deal with money. The title of the book may lead some readers to believe it’s a deep dive into the behavioral economics and decision analysis of all aspects of money. They may find it a rudimentary take (albeit an insightful one) on these topics.