Money is a sensitive topic, and people’s emotions often get in the way when making financial decisions.
However, understanding how emotions influence financial decisions can help you avoid common emotional traps.
In the book The Psychology of Money, author Morgan Housel explores the relationship between psychology and finance, offering insights on how to make better financial decisions.
This article outlines 6 key lessons from the book that can help you become more aware of your emotions and make better financial decisions.
Wealth is What You Don’t See
People often make the mistake of judging others’ wealth by what they see. For instance, if someone drives a Porsche, people assume that the person is rich.
However, that may not be the case. The person may have purchased the car on credit, leaving them with less than $100,000 to spend.
If that person kept the money and drove a regular car, they would have an additional $100,000 to use. This lesson emphasizes that having money that you can use is what makes you rich, not the appearance of wealth.
The lesson illustrates the difference between wanting to be rich and wanting to look rich.
People who want to be rich focus on building wealth and having money they can use, while people who want to look rich focus on buying expensive things to impress others.
If you spend money to show others how much money you have, you will quickly have less money.
Money Buys Freedom
Money may not buy happiness, but it can buy something even more valuable – freedom. Having financial security gives you the ability to control how you spend your time. This is more important than your salary or job prestige. Being able to do what you want, when you want, with the people you want is one of the things that brings the greatest happiness.
Money can also buy options. People who live paycheck to paycheck can’t afford to take time off when they’re sick, as they may not have enough money to pay their bills.
People with low savings don’t have much time to look for a new job if they’re fired and may end up in a stressful job they don’t like.
Those who have six months of savings aren’t afraid of their boss because they know they won’t be ruined if they take some time to look for another job. People who have even more savings can afford to work in jobs with lower pay but more flexible hours.
Until a certain point, having money saved gives us more and better options, providing more control over our lives.
Being Reasonable is More Important than Being Rational
When making financial decisions, we often look for the option that we believe will bring the best results. Instead, we should look for the option that lets us sleep better at night. This lesson emphasizes the importance of being reasonable rather than being rational.
For example, if a friend has $5,000 to invest, he may choose to put all his money into the market, believing that the market will grow quickly.
Alternatively, he could choose to invest $500 each month for ten months. The first option may seem more appealing, but it can lead to a lot of stress if the market crashes.
The second option may not produce the largest profits, but it provides more security and allows the friend to sleep better at night.
Nothing is Free
Every investment we do has a hidden price, and no, it is not a monetary price, as you might expect. It is an emotional one, like fear, doubt, or stress.
The problem is that most of the time, we are not aware of it until it is time to pay. So instead of looking at it as a fee that we need to pay to have the benefit, we feel like we are given a fine, and we hate it.
The solution is to learn, for each investment, what the fee is that we are supposed to pay. And when it comes, be willing to pay it. Let me share an example.
I have a friend, Matt, who bought a bitcoin some years ago for $7.5 thousand dollars. Matt believed in the project and decided to invest a huge sum of his money.
He was pretty happy with his choice in the beginning because bitcoin doubled to $15 thousand.
However, a few months later, it dropped for a whole year, reaching the bottom at around $2.5 thousand dollars. Matt suffered.
Each time he went to the app, checking bitcoin’s price, he cried inside. Each time it dropped 10%, his legs shook.
Matt questioned several times his choices and if he should sell what he had left. But he held on, and three years later, bitcoin slowly recovered and reached a new record of $55 thousand dollars, bringing new confidence to Matt’s face. It now looks easy. He just had to buy it and wait. But Matt’s success had a huge emotional price, which Matt wasn’t expecting.
When investing, always remember that there is a price to pay. Take it as a fee and not as a fine.
The Importance of Serendipity
We all like to think that success comes from hard work, intelligence, and talent. While those things are important, there is another factor that is often overlooked, and that is serendipity. Serendipity is the occurrence and development of events by chance in a happy or beneficial way.
Many successful people have had a bit of luck on their side, whether it was meeting the right person at the right time or stumbling upon an opportunity they never expected. However, it’s not just about being lucky; it’s also about being prepared for those opportunities when they arise.
In the world of investing, there is a term called the “lucky fool.” This refers to someone who invests in a stock without really knowing what they are doing, and by pure luck, they end up making a significant profit. The danger is that they think it was their skill and knowledge that led to the success, and they continue to take risks without fully understanding the consequences.
The lesson here is to be prepared for the opportunities that come your way, but also recognize that luck plays a role in success.
Time is the most valuable commodity
We can always make more money, but we can never make more time. Time is the one thing we have a finite amount of, and we never know how much of it we have left. That’s why it’s essential to make the most of the time we have.
One of the ways we can do that is by making smart financial decisions that allow us to have more control over our time. As we discussed in lesson nº2, money can buy us freedom and options, which ultimately gives us more control over our time.
It’s also important to recognize that time is valuable, not just in terms of our ability to do what we want with it but also in terms of its effect on our investments. The longer we hold onto our investments, the more time they have to grow and compound.
