Episode 7 of At The Rotterdam is our first book review.
Morgan Housel’s Psychology of Money is a masterpiece, packed with easy to understand anecdotes explaining why we struggle so much with money, wealth and our financial lives. But to us, the investing advice is beyond legendary.
We recommend reading the book in its entirety. But here are the gems and how they fit with our understanding of investing on At The Rotterdam.
Housel begins in Chapter 1 asking why people do crazy things with money. Any good behavioral finance book will give us more than enough “reasons”. Knowing why we are poor investors is the first step to becoming good investors. We’ll be going more into detail on each of the potentially fatal biases in later episodes.
In Chapter 2 he deals with luck in investing. If there are a billion coin flips, there will be long runs of heads or tails. By complete chance. If there are a billion investors, some by complete chance will look like long-term winners. Yet have no skill at all. Once you realize markets are unpredictable, the rational investment process can begin.
Chapter 4 covers compounding. The old adage “time in the market beats timing the market” is popular for a reason. US stocks have performed over the long run. And Buffet has performed better than most. But the sheer quantum or money he has is a result of achieving those investment returns over almost 80 years, starting when he was 14. Housel reveals that if Warren had started at 30 and retired at 60 he would be worth only $12 million, not the $100 billion he currently has. Compounding takes time to goose returns.
Chapter 5 shows how important diversifying your investments is in order to preserve wealth. Chapters 11, 12 and 13 tell a similar story, but also add patience, planning for disasters and low leverage. While many people get rich on one asset, usually their business or even their employer’s, diversifying among many assets and types of assets is the best way to keep rich.
The goal is to have an unbreakable portfolio for the money that you need for your future. That doesn’t mean that every investment has to be safe. In fact “barbelling” a portfolio with safe assets on one side and risky assets on another can sometimes be more efficient than all medium-risky assets. As Nassim Taleb says, “You can be risk loving yet completely averse to ruin.” We will have a lot to say about these issues in future episodes.
Chapter 6 explains why barbelling might be better, introducing the value of the “power law” to investing: Generally a few great investments drive the returns of the market. You only need one Apple or one Facebook to have amazing returns from investing. Being diversified and using part of the barbell to purchase high risk companies helps maximize the probability you get one of those winners in your lifetime. No guarantees though.
Chapter 15 is close to our hearts. Housel points out that holding stocks through a down market is not free. It costs mental anguish and real dollars (at least temporarily). You need to pay this price to get the long term investment returns that have historically occurred (back to “time in the market”. Because most investors can’t stomach this pain, then try to “time the market”: trading in and out, generally underperforming the market by a large margin. See our Falling Knives and Drawdowns episodes. That is also why “Macro Doom Porn” (episode 4) is so dangerous.
Chapters 16 and 18 are about investing for your own goals, and not someone else’s. The stakes are high (our financial freedom) so we tend to want to take advice. From everyone with any semblance of a credential. Be aware, however, that advice givers often have ulterior motives. And that humans are terrible forecasters.
Chapter 17 tells us not to be too pessimistic. Yes, a lot of bad things happen. But markets have had positive returns in the long run in spite of World Wars, epidemics, recessions, etc.
Chapter 19 has tons of conclusions and advice, including:
Manage your money so you can sleep at night: diversify and leave room for error
The easiest way to be a better investor is to increase your time horizon. We hate that generally. It’s hard to be patient. Stay in the market.
Be OK with losses and things going wrong.
“Play your game” = Invest your way.
“Respect the mess”. Economics and finance are not sciences. Prediction is impossible.
To conserve wealth and grow it, understand tail risk (risk of catastrophic events), leverage, and the unpredictability of markets. People are lousy forecasters and in any event the market is unknowable.