The Psychology of Money

Published on October 11, 2020

Like Warren, I had a considerable passion to get rich, not because I wanted Ferraris — I wanted the independence. I desperately wanted it.”

— Charlie Munger

The world can appear vastly unequal in terms of the goods and services that people are able to consume. To the slum dweller in Mumbai or Rio de Janeiro, the lifestyle of a middle class American would seem utterly unbelievable. A middle class American would find the spending power of a family worth $20 million completely inconceivable. And the family worth $20 million cannot conceive of the spending power of a billionaire like Warren Buffett or Jeff Bezos.

Wealth can buy material goods and services and this is what most people focus on, both in terms of satisfying their desire to consume as well as their desire to appear successful in the eyes of their peers. But a relentless focus on the material goods that wealth can purchase badly misses the point.

The truth is that time is the currency of life.

The ability to control your time means that you have the ability to control how the most valuable resource you own is spent. The middle class American’s life expectancy might not be quite as long as the life expectancy of a billionaire. Money can indeed purchase better medical care and, for some people, that can provide more time. But the truth is that Jeff Bezos and Warren Buffett cannot hope to enjoy multiples of the time that the rest of us can enjoy on this earth. Their time is limited, just as time is limited for all of us. However, they have both had something that most of us do not have: the ability to control how they spend every day of their lives starting from a very early age.

Most people will never be worth $5 million or $20 million, let alone worth billions. But it is within the power of people earning middle class incomes to design their lives in a manner that gives them increasing control of their time, and with that control comes the prospect of an increased level of satisfaction with life and greater happiness.

As Morgan Housel writes in The Psychology of Money, “The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.” If you are reading these words and nodding your head in agreement, you are vastly ahead of the game because this idea is far outside the mainstream of how people view money. For most people, the thought of money is inextricably linked with the goods and services it can buy and how those things will make their lives better and happier. The idea of saving money is grudgingly conceded to be a necessary, but distasteful, thing that responsible people must do. Most consumers view the next paycheck or bonus in terms of what it can buy, not the independence it can provide. And this makes intuitive sense at first glance. Aren’t the wealthy happier than the middle class and the middle class happier than the poor? It seems obvious that this would be the case. How could it not be the case when money can be used to buy so much cool stuff?

For someone in poverty, being able to consume more stuff clearly will increase happiness. The ability to have as much food as your family needs, to have warm clothing in the winter, to be able to air-condition your home in summer, and to have a washer and dryer to avoid going to the laundromat — these are all tangible improvements for someone moving from poverty into the middle class. But beyond a certain point, hedonic adaptation takes hold. You keep ratcheting up your consumption, which brings transitory happiness at best, but soon find yourself right back where you started, except now your baseline set of expectations has grown requiring you to maintain your spending to avoid feeling deprived.

Morgan Housel has been writing about finance and investing for over a decade, getting his start at The Motley Fool and later writing a column for The Wall Street Journal. Housel is currently a partner at the Collaborative Fund and writes frequently on personal finance topics. His approach to money and investing is to view it through the lens of psychology because the human element stands far above all other factors when it comes to the results a person can expect to achieve over time. As Housel notes, investing is one of the very few fields that offer ordinary people daily opportunities for extreme rewards. If you view money through the lens of consumption, the temptation to try your luck in this casino can be overwhelming. However, if you view losing money or interrupting the process of compounding as losing control of your time and sacrificing your liberty, the temptation to gamble is much reduced.

Tame Your Ego

Ego is often the root cause of dysfunctional financial decisions. What are we really trying to accomplish when we buy a fancy house or a $100,000 car? Sure, such things might offer personal utility and enjoyment, at least for a while. But eventually, hedonic adaptation takes over and these new things become the baseline. What many people who consume such items are actually trying to do is signal to others that they have “made it”. They are successful and wealthy and should be looked up to. They want to be admired. And maybe even envied.

Housel asserts that “past a certain level of income, what you need is just what sits below your ego.” Would it bother you if your neighbors do not admire the car that you drive to work each morning? Or if they see you waiting for the bus a block away instead of driving at all? Would it bother you if your co-workers find out that you live in a more modest neighborhood than someone of your income could “afford”? As Housel says, people who are successful with their personal finances “tend to have a propensity to not give a damn what others think about them.”

Wealth is What You Don’t See

There are some interesting paradoxes in personal finance that seem totally obvious once you think about them but escape the consciousness of almost everyone. Housel’s chapter entitled “Wealth is What You Don’t See” gets the prize for an insight that is both extremely valuable and obvious, at least once you pause for a few moments to think about it.

When you see a person driving down the street in a Ferrari, what do you automatically think? “Oh, that’s a rich guy driving down the street.” But do we really know that about the driver? We have no real idea if that is the case or not. Housel uses his experiences as a valet at an upscale hotel to note several important things about drivers of expensive cars. One of the regulars at the hotel who drove a Porsche later showed up in an old Honda after the Porsche was repossessed. But when the regular drove the Porsche, did Housel admire the driver? No, he admired the car, not the driver! Driving a fancy car is evidence of either debt or extinguished wealth. It is not evidence of wealth.

Wealth is the nice cars not purchased. The diamonds not bought. The watches not worn, the clothes foregone and the first-class upgrade declined. Wealth is financial assets that haven’t yet been converted into the stuff you see.

That’s not how we think about wealth, because you can’t contextualize what you can’t see.

When most people say they want to be a millionaire, what they might actually mean is “I’d like to spend a million dollars.” And that is literally the opposite of being a millionaire.

The Psychology of Money, p. 98

What could be more obvious? If you want to be wealthy, you must defer consumption. Your wealth, to the extent you invest it in financial assets, is hidden from the world. Few things remain taboo in modern American society, but it is still taboo to go around talking about the size of your bank account or how many shares of stock you own. Those things are invisible whereas what you wear, what you drive, and the home you live in are visible to all. But all of those things are the opposite of wealth. Many people who consume such items are wealthy because they also have financial assets. But they are less wealthy when they consume these items. They may enjoy it, it may be easily affordable, and there’s nothing wrong with consumption, but the fact is that what people think of as wealth is really the opposite of wealth.

What Should You Do?

Providing financial advice is notoriously difficult and those who provide it have an awesome responsibility. Financial advisors are responsible for guiding a client’s financial health in the same way that a doctor is responsible for guiding a patient’s health. Most personal finance books have roadmaps that purport to be actionable things that people can do to achieve their objectives. But Housel does not provide specific prescriptions for what you should do with your money. Why? He doesn’t know you, he doesn’t know what you want, he doesn’t know when you want it, and he has no idea regarding your motivations. This is refreshingly honest but, as is the case with many areas of the book, quite obvious once you pause to think about it.

Instead of providing specific financial advice, Housel does a great job of framing money and wealth in the context of the psychology of human beings, recognizing that it is wrong to simply assume that others are crazy because their decisions do not seem rational to us.

However, this does not mean that the book lacks practical advice.

The wisdom contained in these pages is not going to come from some specific prescription regarding what to do with your investment portfolio, but it could convince people to have an investment portfolio because savings is important, whether you have a specific goal for saving or not. It could convince people that time is the true currency of life and that having control of that time is perhaps the ultimate benefit of wealth. It could increase the humility of those who believe that conspicuous consumption leads to recognition and respect.

It’s All About Freedom

The bottom line is that financial independence is not about what you can consume. It is also not necessarily about quitting your job and retiring. Instead, financial independence is about freedom. Freedom to choose to spend your time as you see fit. Freedom to not do things that you do not want to do. Freedom to not associate with people who you dislike.

When viewed through the lens of freedom, personal finance is no longer the boring and tedious topic that many perceive it to be. Instead, it becomes an essential component of living a good life.

The Psychology of Money
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