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Behavioural lessons to improve your financial success

The lessons in ‘The Psychology of Money’ that stood out to us at Overberg Asset Management.

I was introduced by a friend of mine, to a new investment and personal finance book called The Psychology of Money, written by Morgan Housel. I am very grateful for this introduction because it just happens to be one of the best investment and personal finance books I have ever read. The best part about it is the fact that the book is not overly complicated and is written in layman’s terms making it an easy and enjoyable read.

In the book, Housel shares various lessons about wealth, greed, and happiness. The core lesson of the book is about behaviour and how people’s wealth or how well they manage their money is not necessarily determined by how much they know (IQ or education) but by how they behave. For example, highly intelligent individuals unable to control their emotions can be financial disasters while ordinary individuals with no financial education can be wealthy if they adopt certain behavioural skills.

Below are some of the lessons in The Psychology of Money that stood out:

Never enough: Stop moving your goal post. Expectations rise with results but if expectations rise faster than results you will never be satisfied and keep on moving your financial goalpost. It is like a dog chasing its tail, it never ends. The capitalistic world we live in is great at creating wealth and envy. Wanting to surpass your peers may provide you with the motivation to work hard but life isn’t satisfying without a sense of enough. Happiness as they say is results minus expectation. Housel says “an insatiable desire for more – will push you to the point of regret”. Freedom, family, friends, being loved and happiness is invaluable and the best chance one has to keep these things is to know when to stop taking chances that might harm them. In other words, knowing when is enough financially.

Confounding and compounding: Many books have been written about the best investor in the world, Warren Buffet. But Buffet does not have the best return record of all time, that title belongs to Jim Simmons (66% compounded annual return). Nevertheless, Buffet is far wealthier. Why, because he has been investing successfully for over a very long period. Long enough for the magic of compounding to take place. Housel summarises it as follows: “Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be once-off hits that can’t be repeated. It is about earning pretty good returns that you can stick with, and which can be repeated for the longest period of time because that is when compounding runs wild”. Start investing early because time is the most important factor in investing. As Housel puts it, “Time makes little things grow big and big mistakes fade away”.

Tails you win: Tails drive everything. For people not familiar with the term, it refers to events in statistics with a low probability of happening i.e., outliers. These events are plotted in the tails when looking at probability distributions which means they are far from the average or expected outcome. The idea is similar to the 80/20 rule which means 80% of your returns come from 20% of the invested time. Your decisions as an investor most of the time will not have a significant impact on your investments, but what you do during the abnormal days – the 1% of the time or less – when the market around you is going crazy. Housel sums it up by saying the following, “A good definition of an investment genius is the man or woman who can do the average thing when all those around them are going crazy”. Tails drive everything which is why many things can go wrong in investing.

Freedom: Freedom in this context refers to the ability to control your own time. Housel mentions Angus Campbell, a psychologist in 1910 at the University of Michigan, who wrote that, “Having a strong sense of controlling one’s life is a more dependable predictor of positive feelings of well-being than any of the objective conditions of life we have considered”. In other words, doing what you want, when you want, and with whom you want is the broadest factor that makes people happy. More than their high-paying job, luxurious house, or fancy sports car. The biggest benefit that money has is the ability it gives you to control your own time. That is real freedom. “Using money to buy time and options has a lifestyle benefit few luxury goods can compete with”, notes Housel.

Save money: According to Housel, “Saving is the gap between your ego and your income, and wealth is what you don’t see”. Investment returns can make you rich, but often are uncertain and out of your control because of the market, economic and political factors. But saving is in your control and has a guaranteed chance of being as effective in the future as it is today. Wealth is the money that is left over after you have spent what you generated. You can save even though you might not have a high income, but you cannot build wealth if you do not save a lot.

Conclusion:

To summarise, in the world of money, financial outcomes are often driven by luck, independent of intelligence and effort, and two, financial success is not a hard science it’s a soft skill, and how you behave is more important than what you know.

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Werner Erasmus

Overberg Asset Management

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