The Psychology of Money 5 – Pessimism, Stories, Conclusions & Confessions

Psychology of Money

Today’s post is our fifth visit to a recent book – The Psychology of Money by Morgan Housel.


Since the world tends to get better (despite what the mainstream media might tell you), optimism is the smart long term bet. (( I am ignoring entropy – and specifically, death – here ))

  • But pessimism often sounds clever and gets a lot of attention (thanks again, mainstream media).

Tell someone that everything will be great and they’re likely to either shrug you off or offer a sceptical eye. Tell someone they’re in danger and you have their undivided attention.

This is why economists have predicted 23 of the next two recessions.

Morgan starts with loss aversion, as described by Kahneman:

When directly compared or weighed against each other, losses loom larger than gains. This asymmetry between the power of positive and negative expectations or experiences has an evolutionary history. Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.

Morgan makes the point that money is global or at least national, so more people are simultaneously affected by bad conditions than say by bad weather.

  • Even so, stock falls of a few per cent get much more attention than equivalent stock market rises.

And while few question or try to explain why the market went up –  isn’t it supposed to go up?—there is almost always an attempt to explain why it went down.

There’s also a tendency to extrapolate pessimistic trends without accounting for how markets, technology and society adapt.

  • Covid is the most recent example, but perhaps climate change falls into the same box.
  • Decades ago we had the threat of an ice age, and of running out of oil, plus acid rain and the hole in the ozone layer.

Morgan also notes that progress and success take a long time, but setbacks and tragedies happen overnight.

  • He tells the story of how nobody noticed that the Wright Brothers had invented aeroplanes.

Frederick Lewis Allen wrote in 1952:

People were so convinced that flying was impossible that most of those who saw them flying about Dayton [Ohio] in 1905 decided that what they had seen must be some trick. It was not until May, 1908—nearly four and a half years after the Wright’s first flight—that experienced reporters were sent to observe what they were doing,

And it took more years before the commercial and military applications were accepted.

Morgan looks at medical progress:

The age-adjusted death rate per capita from heart disease has declined more than 70% since 1965 – enough to save something like half a million American lives per year.

No headlines about that.

We could have a Hurricane Katrina five times a week, every week and it would not offset the number of annual lives saved by the decline in heart disease.

The same is true of stock markets:

A 40% decline that takes place in six months will draw congressional investigations, but a 140% gain that takes place over six years can go virtually unnoticed.


Chapter 18 is about why stories are more powerful (to most) than statistics.

See also:  The Psychology of Money 2 - Staying Rich, Tails, Freedom & Cars

People believe stories because they want them to be true.

  • And in the case of the market, because they can profit from them.

People believe in financial quackery in a way they never would for, say, weather quackery because the rewards for correctly predicting what the stock market will do next week are in a different universe than the rewards for predicting whether it will be sunny or rainy next week.

The actively managed fund industry is a good example.

  • Bernie Madoff is another.

We even like economic forecasts.

The other reason we crave stories is to fill in the gaps in our understanding of the world.

Here’s Kahneman again:

Hindsight, the ability to explain the past, gives us the illusion that the world is understandable. It gives us the illusion that the world makes sense, even when it doesn’t make sense.


Chapter 19 is Morgan’s summary of what we’ve learned so far.

  • He starts with the changing relationship between doctor and patient (doctors used not to ask what the patient thought about the proposed treatment), drawing an analogy with financial advice.

I don’t believe in financial advice for most people – you should figure out how to do it yourself – but what Morgan means is this:

I can’t tell you what to do with your money, because I don’t know you.

Financial advisors are required by law to get to know their clients (or at least to collect a lot of information about them), but the point stands.

  • Morgan is just making clear that this chapter isn’t advice, in the same way that this blog isn’t advice.
  • It’s not personal, just guidance.

Here are a few highlights from what Morgan has to say:

  1. It’s never as good or as bad as it looks.
  2. Saving money is the gap between your ego and your income, and wealth is what you don’t see.
  3. Manage your money in a way that helps you sleep at night.
  4. The single most powerful thing you can do is increase your time horizon.
  5. You can be wrong half the time and still make a fortune.
  6. Use money to gain control over your time.
  7. Be nicer and less flashy.
  8. Save.
  9. Define the cost of success and be ready to pay it, because nothing worthwhile is free.
  10. Worship room for error.
  11. Avoid the extreme ends of financial decisions.
  12. Risk pays off over time, but be paranoid of ruinous risk.
  13. Make sure your actions are not being influenced by people playing a different game.
  14. There is no single right answer; just the answer that works for you.

In Chapter 20, Morgan tells us how he handles his own money.

  • It won’t surprise you to find that it’s in accordance with the principle of this book.

Sandy Gottesman billionaire founder of First Manhattan, asks interviewees:

What do you own, and why?

This is similar to Talab’s point:

Don’t tell me what you think, show me your portfolio. (( It’s a constant source of frustration to me that financial journalists and market commentators never reveal how they invest – and when they do, it’s always index funds ))

Morgan reports that:

Half of all U.S. mutual fund portfolio managers do not invest a cent of their own money in their funds, according to Morningstar.

Morgan draws an analogy with doctors, who often choose not to fight their terminal illnesses in the way they do those of their patients.

See also:  The Psychology of Money 4 - Errors, Change, Price & Other People

Independence has always been my personal financial goal. Independence, to me, doesn’t mean you’ll stop working. It means you only do the work you like with people you like at the times you want for as long as you want.

It’s mostly a matter of keeping your expectations in check and living below your means. Independence is driven by your savings rate. And your savings rate is driven by your ability to keep your lifestyle expectations from running away.

Morgan owns a house.

[This] is the worst financial decision we’ve ever made but the best money decision we’ve ever made. Mortgage interest rates were absurdly low when we bought our house. The independent feeling I get from owning our house outright far exceeds the known financial gain I’d get from leveraging our assets with a cheap mortgage.

We also keep a higher percentage of our assets in cash than most financial advisors would recommend—something around 20% of our assets outside the value of our house. We never want to be forced to sell the stocks we own. Everyone will eventually face a huge expense they did not expect.

He also owns index funds:

I started my career as a stock picker. I’ve shifted my views and now every stock we own is a low-cost index fund – a combination of U.S. and international stocks. I think for most investors, dollar-cost averaging into a low-cost index fund will provide the highest odds of long-term success.

And that’s it – we’ve reached the end of the book.

  • It’s been a pleasant journey, but it hasn’t had much impact on how I will approach investing.

I’ll be back in a couple of weeks with a summary of all the articles.

  • Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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The Psychology of Money 5 – Pessimism, Stories, Conclusions …

by Mike Rawson time to read: 5 min