The Psychology of Money

 Two topics impact everyone, whether you are interested in them or not: health and money. 

The healthcare industry is a triumph of modern science, with rising life expectancy across the world. 

Scientific discoveries have replaced doctors’ old ideas about how the human body works, and virtually everyone is healthier because of it. 

The money industry—investing, personal finance, business planning—is another story. 

Finance has scooped up the smartest minds coming from top universities over the last two decades. 

Financial Engineering was the most popular major in Princeton’s School of Engineering a decade ago. Is there any evidence it has made us better investors?

I have seen none. 

Through collective trial and error over the years we learned how to become better farmers, skilled plumbers, and advanced chemists. 

But has trial and error taught us to become better with our personal finances? 

Are we less likely to bury ourselves in debt? 

More likely to save for a rainy day? 

Prepare for retirement? 

Have realistic views about what money does, and doesn’t do, to our happiness? 

I’ve seen no compelling evidence. 

Most of the reason why, I believe, is that we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance). 

And that, to me, is as fascinating as it is important. 

Money is everywhere, it affects all of us, and confuses most of us. Everyone thinks about it a little differently. 

It offers lessons on things that apply to many areas of life, like risk, confidence, and happiness. Few topics offer a more powerful magnifying glass that helps explain why people behave the way they do than money. It is one of the greatest shows on Earth.

1. No One’s Crazy

People do some crazy things with money.

But no one is crazy. 

Here’s the thing

People from different generations,

raised by different parents who earned different incomes and held different values,

in different parts of the world,

born into different economies,

experiencing different job markets with different incentives and different degrees of luck,

learn very different lessons.

So all of us—you, me, everyone— go through life anchored to a set of views about how money works that vary wildly from person to person.

What seems crazy to you might make sense to me.

The person who grew up in poverty thinks about risk and reward in ways the child of a wealthy banker cannot fathom if he tried. 

The person who grew up when inflation was high experienced something the person who grew up with stable prices never had to.

The stock broker who lost everything during the Great Depression experienced something the tech worker basking in the glory of the late 1990s can’t imagine. 

The Australian who hasn’t seen a recession in 30 years has experienced something no American ever has. 

On and on. The list of experiences is endless.

Spreadsheets can model the historic frequency of big stock market declines. But they can’t model the feeling of coming home, looking at your kids, and wondering if you’ve made a mistake that will impact their lives. 

Studying history makes you feel like you understand something. But until you’ve lived through it and personally felt its consequences, you may not understand it enough to change your behavior. 

We all think we know how the world works. But we’ve all only experienced a tiny sliver of it. 

As investor Michael Batnick says,

“some lessons have to be experienced before they can be understood.” We are all victims, in different ways, to that truth.

2. Luck & Risk

"Nothing is as good or as bad as it seems"

Luck and risk are siblings. They are both the reality that every outcome in life is guided by forces other than individual effort. 

NYU professor Scott Galloway has a related idea that is so important to remember when judging success—both your own and others

“Nothing is as good or as bad as it seems.”

Bill Gates went to one of the only high schools in the world that had a computer. 

The story of how Lakeside School, just outside Seattle, even got a computer is remarkable. 

Bill Dougall was a World War II navy pilot turned high school math and science teacher. 

“He believed that book study wasn’t enough without real-world experience. 

He also realized that we’d need to know something about computers when we got to college,”

recalled late Microsoft co-founder Paul Allen.

Most university graduate schools did not have a computer anywhere near as advanced as Bill Gates had access to in eighth grade. And he couldn’t get enough of it.

Lakeside’s computer wasn’t part of its general curriculum. It was an independent study program. Bill and Paul could toy away with the thing at their leisure, letting their creativity run wild—after school, late into the night, on weekends. They quickly became computing experts. 

During one of their late-night sessions, Allen recalled Gates showing him a Fortune magazine and saying,

“What do you think it’s like to run a Fortune 500 company?”

Allen said he had no idea.

“Maybe we’ll have our own computer company someday,”

Gates said

Microsoft is now worth more than a trillion dollars.

Evans was as skilled with computers as Gates and Allen. Lakeside once struggled to manually put together the school’s class schedule a maze of complexity to get hundreds of students the classes they need at times that don’t conflict with other courses. 

The school tasked Bill and Kent children, by any measure, to build a computer program to solve the problem. 

It worked. And unlike Paul Allen, Kent shared Bill’s business mind and endless ambition.

“Kent always had the big briefcase, like a lawyer’s briefcase,”

Gates recalls.

“We were always scheming about what we’d be doing five or six years in the future.

Should we go be CEOs?

What kind of impact could you have?

Should we go be generals?

Should we go be ambassadors?”

Whatever it was, Bill and Kent knew they’d do it together.

After reminiscing on his friendship with Kent, Gates trails off. 

“We would have kept working together. I’m sure we would have gone to college together.” Kent could have been a founding partner of Microsoft with Gates and Allen. 

But it would never happen. Kent died in a mountaineering accident before he graduated high school. 

Every year there are around three dozen mountaineering deaths in the United States.⁹ The odds of being killed on a mountain in high school are roughly one in a million.

Luck and risk are both the reality that every outcome in life is guided by forces other than individual effort. 

They are so similar that you can’t believe in one without equally respecting the other. 

They both happen because the world is too complex to allow 100% of your actions to dictate 100% of your outcomes. 

They are driven by the same thing: You are one person in a game with seven billion other people and infinite moving parts. The accidental impact of actions outside of your control can be more consequential than the ones you consciously take.

If you give luck and risk their proper respect, you realize that when judging people’s financial success—both your own and others’—it’s never as good or as bad as it seems.

Years ago I asked economist Robert Shiller, who won the Nobel Prize in economics, “What do you want to know about investing that we can’t know?” 

“The exact role of luck in successful outcomes,” he answered. 

I love that response, because no one actually thinks luck doesn’t play a role in financial success.

But since it’s hard to quantify luck and rude to suggest people’s success is owed to it, the default stance is often to implicitly ignore luck as a factor of success.

After spending years around investors and business leaders I’ve come to realize that someone else’s failure is usually attributed to bad decisions, while your own failures are usually chalked up to the dark side of risk. When judging your failures I’m likely to prefer a clean and simple story of cause and effect, because I don’t know what’s going on inside your head. 

“You had a bad outcome so it must have been caused by a bad decision” is the story that makes the most sense to me. But when judging myself I can make up a wild narrative justifying my past decisions and attributing bad outcomes to risk.

Be careful who you praise and admire. Be careful who you look down upon and wish to avoid becoming.

Some people are born into families that encourage education; others are against it. Some are born into flourishing economies encouraging entrepreneurship; others are born into war and destitution. I want you to be successful, and I want you to earn it. But realize that not all success is due to hard work, and not all poverty is due to laziness. Keep this in mind when judging people, including yourself. 

Therefore, focus less on specific individuals and case studies and more on broad patterns.

You’ll get closer to actionable takeaways by looking for broad patterns of success and failure. The more common the pattern, the more applicable it might be to your life. 

Trying to emulate Warren Buffett’s investment success is hard, because his results are so extreme that the role of luck in his lifetime performance is very likely high, and luck isn’t something you can reliably emulate.

Bill Gates once said, 

“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” 

When things are going extremely well, realize it’s not as good as you think. 

You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly. 

But the same is true in the other direction. 

Failure can be a lousy teacher, because it seduces smart people into thinking their decisions were terrible when sometimes they just reflect the unforgiving realities of risk. The trick when dealing with failure is arranging your financial life in a way that a bad investment here and a missed financial goal there won’t wipe you out so you can keep playing until the odds fall in your favor.                                                          

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