- ” The premise of this book is that doing well with money has a little to do with how smart you are and a lot to do with how you behave. And behavior is really hard to teach, even to smart people”
- Financial success is not a hard science. It is a soft skill where how you behave is more important than what you know. This is why it is possible for a janitor in the financial realm to beat a financial executive when it comes to investments. But it’s not possible for a janitor to beat an architect when it comes to designing buildings or professionals when it comes to a core skillset.
- Two topics impact everyone whether we are interested in them or not: money and health. While health is a topic where modern science has helped achieve great advancements in, financial engineering was not. This is because Finance has approached the topic of money based on laws and rules, not emotions and nuance
- Engineering is not controversial because there is consensus on the principles and rules that guide it. Eingineeris could agree on why a bridge collapses if a certain force is applied to a part of it. Finance is different. This is because emotions get involved. The financial behavior of someone might be deemed to be complete normal to them but crazy to others.
- The book is divided into 20 biases and takeaways that shape how humans deal with money
- First: No one is crazy. Each human being is a product of a certain environment, certain household, certain dad and mom who have values that guide their thinking when it comes to money. This means that each one of us has unique experiences and values that dictate their views on money. Someone who’s gone through the hardship of the great depression would have a certain attitude towards investing that someone else who’s just read about it will not. Similarly, someone who’s gone through a time of rapid inflation will
- “Take stocks. If you were born in 1970, the S&P 500 increased almost 10-fold, adjusted for inflation, during your teens and 20s. That’s an amazing return. If you were born in 1950, the market went literally nowhere in your teens and 20s adjusted for inflation. Two groups of people, separated by chance of their birth year, go through life with a completely different view on how the stock market works”
- “Every decision people make with money is justified by taking the information they have at the moment and plugging it into their unique mental model of how the world works. Those people can be misinformed. They can have incomplete information. They can be bad at math. They can be persuaded by rotten marketing.
- They can have no idea what they’re doing. They can misjudge the consequences of their actions. Oh, can they ever. But every financial decision a person makes, makes sense to them in that moment and checks the boxes they need to check. They tell themselves a story about what they’re doing and why they’re doing it, and that story has been shaped by their own unique experiences. Take a simple example: lottery tickets”. Majority of Americans who buy lottery tickets are those who are poor. they spend on average 412/year on it. Yet 40% of Americans can’t come up with a 400 dollars in an emergency which is to say that these same poor people are blowing up their money on something they have one in a million chance of winning. Logic sames
- Luck and Risk are both forces reminding us that not everything in life is controlled by our actions. Bill Gates had one in a million luck to get his hands on a computer in the 60s while he was in high school. If there was no computer there, there’d be no MSFT according to Gates. How the high school got the computer was also extremely unlikely to happen. A lot of things had to go right for that one in a million chance to pan out for gates and get his hands on that computer. In contrast, Kent experienced a very unlikely scenario but in the opposite direction: he had an accident while rock-climbing and died. An extremely unlikely outcome for a high-school student.
- Luck and risk are both reminders that you do not have 100% control over the things that happen to you in life. This is because there are actions that happen outside of your control that could end up having disproportionate impact on your life.
If you buy a stock, and that stock does not do well over 5 years. Was that a bad decision or just bad luck? If the stock had 80% chance of being a successful investment over the next 5 years, was your investment a failure because the scenario with the 20% probability panned out or is it because you misjudged the situation from the oustset and got the 80%-20% wrong altogether? we tend to go easy on ourselves when things do not work out and blame luck while we tend to go hard on others when things do not work out for them and assume bad decision-making: it was a direct result of their own actions. - In an ideal world, you’d be able to attribute outcomes to luck or actions, but we have brains that prefer easy answers without appetite for nuance.
- Another example where it is hard to tell whether success was based on actions or luck is Rockeffeller. He did not follow the laws and a judge labeled him as a law-evading criminal. However, his actions were viewed as business-savvyness in the face of outdated laws that stood in the face of innovation. It is easy to see how his story could turn out differently – similar to Enron’s. When do we draw the line between evading laws being a good entrepreneurial instinct and when would it be considered a crime?
- “one lucky break or one supremely shrewd decision! can we tell them apart? not easily!”
- We need to realize that in life not all success is created by hard work, and also not all failure is created by laziness. Thus, we should focus more on patterns of success and failure and learn from them, and less so on outliers. Warren Buffet’s success is quite extraordinary that luck could not be ruled out. However, people who have control of their time tend to be happy. That is a broad enough of an observation that it can be replicated.
- It is very important to have a sense of enough: the point at which the financial achievement you have realized is enough. Otherwise, Madoff and Gupta – ex-ceo of McKinsey, would be examples of what would happen when we do not have enough. Both were multi-millionaries, very rich and had legitimate income sources, but that was not enough.
- “There is no need to risk what you have and do need for what you do not have and do not need.” It is one of those things that is as obvious as it is overlooked.
- The hardest financial lesson is to get the goal post to stop moving. This is because as we achieve a pre-set goal, greed and envy could very well kick in and have us take greater risks in search of more. This could end up being a vicious cycle that only a catastrophic event would end it. Happiness is results minus expectations.
- You need to stop comparing your income and wealth to those who earn more than you are. This is because this game of comparison will have no ceiling and will never stop. Consider a baseball player who makes 500k/year. He’s rich but when he compares himself to a top baseball player who makes 43mil/year, he’s broke. That same top baseball player will also be considered poor if he compares himself to a top hedegefund manager who makes in a month what the baseball player makes in a year. And the cycle goes on.
- The inability to deny a potential dollar will catch up to you. Enough may seem like you’re leaving potential on the table but it also avoids getting you into situations you regret. You will take unnecessary risks
- Reputation is invaluable. Freedom and health are invaluable. Family and friends are invaluable. You do not want to do things to harm them. This is why enough is important.
- Overlooking the power of compounding is what takes us down the path of assuming unnecessary risks. The concept of compounding and its power is not intuitive to us humans. The ice ages, for example, did not occur because of very cold winters, but more so because cool summers – think capital-preservation, allowed for snow to build on top of each other and compound over time. Snow begets more snow and the cycle continues. Warren Buffet was worth 300million when he was 50. About 3.5 when he was at retirement age. He made the majority of his wealth in late age. His biggest success factor is investing when he was 10 vs the fact that he made the right investment decisions. Most books do not talk about that. The power of compounding is something that’s hard for us to remember.
- “You can’t blame people for devoting all their effort—effort in what they learn and what they do—to trying to earn the highest investment returns. It intuitively seems like the best way to get rich. But good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can repeat as time goes on”
- Getting money is one thing. Keeping it is another. Getting money requires taking risk, being optimistic and putting yourself out there. Keeping money requires the humility that you could lose what you have earned
- Survival Mentality is so key with money. First it helps you avoid taking risks that will wipe you out. Second, it enables you to compound your gains.
- The book tells the story of Rick, who apparently worked with Charlie and Warren. He disappeared after some time though. That is because he was levered and in the 1973-1974 crisis, he had to sell his stocks for a margin call. Warren said that Rick was just as smart as he was and Charlie, he was just in a hurry to get rich. Charlie and Warren thought they were going to get rich and were not in a hurry for that to happen.
- Applying the survival mindset to the real world comes down to three things:
- You need to become financially unbreakable. Becuase you recognize that doing so means that you’ll be around for a very long time, and that gives compounding the opportunity to work its wonders. Striking big returns that are not reproducible is not as important as earning good and repeatable returns over a very long period of time
- Have a plan and part of the plan needs to include what you will do if things do not go according to plan. You can say “if the market returns 9% that’s great, but if it only returns 4%, I’ll still be okay too”. This requires looking at the events of the past 20 years: sep 11, recession causing home foreclosures and job losses, pandemic, inflation.
- A parallel personality that is optimistic yet cognizant of the negative events that will happen along the way to success. This requires conscious effort because it’s easier for us to judge things as black or white than to see nuance.
- There was this person who moved from Germany to the US in 1936, fledding the Nazis.His life was unremarkable. He got into art and started buying collectables. At the turn of the century though, he sold a bunch of items he had to the German government for a 100million Euros – considered a donation since the private market value for them exceeded a billion euros. Some called this skill, some called luck, Horizon investment had a different explanation for it “Lots of art investments were made overtime, and a subset of these investments made outsized returns that the return of the portfolio was skewed and converged towards these investments.
- The way things work in finance is that events that occur at the tailend of the distribution could have a disproportionate impact on the outcome. That is not an intuitive concept for humans that they can make the wrong call on investments half the time and still come out winning
- When we look at a role model, we neglect to notice that a majority of their success came from a few events or actions. By neglecting to notice that, we look at ourselves, observe our own struggle, occasional failures and think that we can never be like them. We feel demotatived. We do not consider that they might have been right just as often as we have been, but maybe when they were right, they were just more right than us. Tails in business matter a big. Failing is okay as long as it’s not the last thing that you stop at.
- “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.”
- “Money’s greatest intrinsic value—and this can’t be overstated—is its ability to give you control over your time. To obtain, bit by bit, a level of independence and autonomy that comes from unspent assets that give you greater control over what you can do and when you can do it. A small amount of wealth means the ability to take a few days off work when you’re sick without breaking the bank. Gaining that ability is huge if you don’t have it. A bit more means waiting for a good job to come around after you get laid off, rather than having to take the first one you find. That can be life changing. Six months’ emergency expenses means not being terrified of your boss, because you know you won’t be ruined if you have to take some time off to find a new job. More still means the ability to take a job with lower pay but flexible hours. Maybe one with a shorter commute. Or being able to deal with a medical emergency without the added burden of worrying about how you’ll pay for it. Then there’s retiring when you want to, instead of when you need to. Using your money to buy time and options has a lifestyle benefit few luxury goods can compete with”
- The thing that makes tail events easy to underappreciate is how easy it is to underestimate how things compound. How, for example, 9/11 prompted the Federal Reserve to cut interest rates, which helped drive the housing debt cycle, which helped triggered the financial crisis, which led people to lose their jobs and seek education. This resulted in massive student debt. It’s hard to foresee in advance all of this
- The thing we should learn from surprises is that hte future is hard to predict, not try to learn how to predict surprises in the future
- The world is full of random events, and we would be smart when planning to factor in what our plan will be when and if things do not go according to plan.
- Having a room for error in your plans gives you the ability to endure for the long terms, and when you endure, you increase the likelihood that you’ll be present to benefit from infrequent but hugely profitable opportunities. Bill Gates understood this concept and this is why when he founded MSFT, he came up with the idea to have enough cash in the bank to pay employees’ salaries for a year
- There are a few specific places for investors to think abour room for error.
- One is volatility: can you survive a 50% dip in the stock market? not just technically, but also emotionally? spreadsheets will give you the mathmatical answer, not the emotional answer
- Second is saving for retirement: you can bank on the stock market returning 7% since that was the rate it returned in the past, but what if the future returns do not match the past’s? what if you happen to retire in the midst of a terrible recession?
- You have to take risk to get ahead but no risk that can wipe you out is ever worth taking. If your odds of winning when it comes to something is 95% and if the 5% chance of losing means having unrecoverable impact, then that is not a bet worth taking.
- This is why you sould take a bar-belled approach to your money: you can risk some but be terrified with taking wipe-our risks with a lot of it. This is not inconsistent. It is simply recognizing that your chances of winning increase the longer you are around to play. The longer you are around to do what you want, when you want and for however long you want has inifite ROI
- A good rule of thumb in life is that anything that can break will eventually break one day. If you have not created contingency or backup plans for this, you are allowing for a single point of failure event to happen.
- One of the principiles of psychology is that people are poor forecasters of their future selves. Planning and envisiioning a goal is all fun and good. Executing on the plan in the midst of everything else that is going on in life is something else.
- A 5-year old kid dreams of being a tractor driver when they grow up. To them, nothing better than a career where they start with “vroom, vroom, beep beep” and taking turns with the tractor. As they grow up and become a teenager, he may realize that such profession is not appealing – both from an income or status perspective. He decides instead to become a lawyer – more prestigious with good income. As they start practising law though and realize the number of hours that go into it, they may decide to quit working and stay at home to help raise kids and save up on daycare expenses. When in their 70s they realize that they have spent too much time at home and life passed them by.
- The History of Illusion is what psychologists call the tendency of people to be keenly aware of how much they have changed in the past but simultaneously underestimate how much they will change in the future. Sometimes we work hard on undoing things that we worked so hard on getting. Young adults spend good money to remove tattos they spent good money getting. Middle-aged adults rush to get divorces in a marriage they rushed to get themselves to. All of us are walking around with an illusion that our personal history has just come to an end and that we have arrived at the type of person that we have always wanted to be and we will want to be for the rest of our lives.
- Two things to keep in mind when making long-term decisions
- Avoid making decisions on either of the extreme ends of financial planning: do not plan for a life where you think you’ll need next to thing to be happy in life or a life in which you’ll work endless hours to achieve a very high level of income. The fuel for the History of Illusion bias is that we will get used to almost every situation so living with very little means or with lots of meony will wear off. Howver, the downside is the regret that comes with not living life and instead chasing dollars or not having money for retirement. You should plan for an option that gives you moderate amount of time to pursue hobbies, to pursue family time, and financial success. Regret will only grow bigger the deeper you go with an option and later finding yourself having to get out of it twice as fast as you went into it
- Realize that you are going to change in the future: You should accept that the chances of remaining happy by staying in a career that you picked when you were 18 years old is pretty low. The trick is to accept the reality of change and move on as soon as possible. you should have no sunk costs. Sunk costs are past efforts that cannot be refunded. Anchoring decisions to sunk costs make our futureselves prisoners to our past and different selves. It is akin to having a stranger dictate the direction of your life. Do not try to put decisions you have made in the past and that are no longer working for you on life support. Recognize when you need to cut your losses and move on.
- Every job looks easy until you’re the one doing it. That is because the difficulties faced in the arena are often invisible to the crowd.
- Why do financial crisis happen and why do they keep happening? it is because humans are greedy and greed is an indelible feature of the human race.
- It is difficult to really explain why financial bubbles occur and we may never be able to explain why they do. This is because bubbles cannot be identified right when they happen. They are identified in hindsight but their causes are hard to agree upon.
- One reason though why bubbles happen is when you follow the investment strategy of someone else who has a different goal than you.
- Optimism is the belief that over time, the odds of a good outcome will be in your favor despite setbacks along the way. Optimism is not the blind belief that everything will be great.
- Pessimism is more appealing because from an evolution perspective, species that paid particular attention to threats had a better chance of survival. In addition, we all have money and that is why bad financial news gets our attention.
- Assuming that things will stay bad when they are bad is an easy assumption to make. Pessimists assume that things will progress in a linear fashion, but people adapt and things change.
- Another reason why pessmisim comes more naturally to us is that progress is slow to notice but setbacks happen very quickly to be ignored.
- “Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.”
- In investing, you must be willing to pay the price for success: volatility and loss among the backdrop of growth, and be willing to pay for it.
- Humans have a tendency to take the path of least resistance when there is not a good solution known or readily available to a problem
- There is no greater force in finance than room for error, and the higher the stakes the wider it should be.
- Coming to terms with how much you don’t know means coming to terms with how much of what happens in the world is out of your control. And that can be hard to accept. This is why we look into the past and create our own explanation of why what happened did happen, even when our knowledge of the subject matter is limited.
- Humans need to believe that they live in a predictable and controllable world, and that is why they turn to authoritative -sounding people who promise to satisfy that need.
- The illusion of control is more persuasive than the reality of uncertainty.
- When planning, we tend to commit the following mistakes:
- over rely on our skills and neglect to think of the role that others will play in achieving our goals
- our rely on the role of skils and neglect the role of luck
- We focus on what we know and neglect what we do not know, making us overly confident in our beliefs.
- Helping you make better financial decisions: There is no one-size fits all when it comes to giving financial advice because like patients, each one’s situation is different. However, some general principles can be helpful in the long term:
- Get out of your way to be humble when things go right and be compassionate to yourself when things go wrong. The world is never as good or bad as it maybe seem at these points. Recognizing the rule of good luck an bad luck- risk, in decision outcomes help you formulate a more realistic understanding of the world and will ultimately allow you to focus on things you can actually control.
- Less Ego, More Wealth: no matter how high your income is, you cannot build wealth unless you put a lid on how much spending you do now in exchange for saving and having more options in the future
- Manage your money in a way that helps you sleep well at night. This is different from saying that you should aim to earn the highest return or save a specific percentage of return. Some people sleep well if they’re focusing on getting the highest returns; others when they invest very conservatively. To each their own, but this should be a guiding principle.
- If you want to do better as an investor, the single most powerful thing you can do is to increase your time horizon. It makes little things grow big and allows for opportunity to recover from big mistakes. It cannot make luck and risk go away, but it pushes results closer towards what people deserve.
- Get used to things going wrong: get over the idea that most things have to go right in order for you to be successful. You can be wrong half the time and still make a fortune because a small minority of things account for the majority of outcomes. Be comfortable with not all of your investments yielding positive results because that is the reality. Look at your overall portfolio performance vs individual decisions. Judging by how you have done on individual investments makes winners look more brilliant than they were and losers appear more regretable than they should.
- Use money to gain control over your time, because the lack of ability to control how you spend your time is the most universal and biggest drag on happiness. The ability to do what you want, for as long as you want, with who want, when you want pays the highest dividend that exists in finance.
- Nobody is impressed with your belongings as much as you do: recognize that when you buy flashy things, you are trying to command respect and admiration, and you’re more likely to gain those things through kindness and humility than horsepower and chrome.
- Save for the sake of just saving. You do not have to have a reason to save. Life is full of surprises
- Define the cost of success and be ready to pay for it: nothing worthwhile is free. Recognize that many of the costs in the financial world do not have price tags. Regret, uncertainty and doubt are common costs in the finance world. Accept them as a fee (a price worth paying to get something nice in exchange) rather than fines ( a penalty you should avoid).
- Worship room for error: a gap between what you want to happen and what could happen in the future. Think of it as a conservative hedge that allows you to remain the game – gives you endurance, and that is what allows the power of compounding to work its magic over the long term.
- Avoid the extreme ends of financial decisions. Everyone’s goals and desires will change over time, and the more extreme your past decisions were the more you may regret them as you evolve.
- You should like risk because it pays overtime but avoid ruinous risk because it prevents you from taking future risks that will pay off over time.
- Define the game you are playing and make sure your actions that are not impacted by people who are playing a different game. Eg: investing vs trading.
- Respect the mess: smart, informed and reasonable people can disagree on finance because people have vastly different goals and desires.
- The author’s rules on money and finances:
- Grand rule: the biggest benefit money can provide you is the freedom to choose what you want to do, when you want do it, with whom and for how long.
- Author saw his parents live a very modest lifestyle as their dad was raising three kids while going to med school. As his dad became a doctor, the family did not allow their lifestyle expectations from running away.
- Similary, the author adopted a lifestyle in his early 20s with his wife that allowed him to live in a decent apartment, have decent food, decent clothes, decent cars. Comfortable but nothing close to fancy. When his income increased, their lifestyle stayed the same and their ability to save increased.
- Cofmrotabley living below what you can afford without much desire for me removes a tremendous amount of social pressure that many people in the modern first world subject themselves to.
- He keeps a high percentage of his assets in cash – ~20%. He recognizes that this is much higher than is typical, but that is what keeps him at ease, and he’s willing to trade the rational decision for what puts him at ease. Similiarly, he lives in a paid-off house that he did not take a mortgage on at a time when interest rates were at historical lows. He wants to minimize the chances of ever having to sell stocks at a bad time. Eliminating that possibility has been more important to him than increasing the long-term value of assets by taking on cheap debt and investing the cash instead.
- “”I can afford to not be the greatest investor in the world, but I can’t afford to be a bad one. When I think of it that way, the choice to buy the index and hold on is a no-brainer for us. I know not everyone will agree with that logic, especially my friends whose job it is to beat the market. I respect what they do. But this is what works for us.”
- “No matter how hard you try at investing you won’t do well if you miss the two or three things that move the needle in your strategy. The reverse is true. Simple investment strategies can work great as long as they capture the few things that are important to that strategy’s success. My investing strategy doesn’t rely on picking the right sector, or timing the next recession. It relies on a high savings rate, patience, and optimism that the global economy will create value over the next several decades. I spend virtually all of my investing effort thinking about those three things—especially the first two, which I can control.”
Tarek Naim's Blog 