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The Psychology of Money

How does the stock market work, what is the best time to buy or sell a particular stock? Believe it or not, emotions play a huge role in your financial success.
To understand this further, one needs to go back into the human history of greed, optimism, and envy.

The premise of this book is that doing well with money has little to do with how smart you are and a lot to do with how you behave.

A genius who loses control of their emotions can be a financial disaster. The opposite is also true. Ordinary folks with no financial education can be wealthy. if they have a handful of behavioural skills that have nothing to do with formal education.

The author provides two very interesting examples to prove this point –
The author was working in a Luxury Hotel as a valet and he observed that one frequent guest was a technology executive. He was a genius, having designed and patented a key component in Wi-Fi routers in his 20s. He had started and sold several companies. He was wildly successful.
The author narrates that one day this guy handed one of his colleagues several thousand dollars of cash and said, “Go to the jewellery store down the street and get me a few $1,000 gold coins.”
An hour later, gold coins in hand, the tech executive and his buddies gathered around by a dock overlooking the Pacific Ocean. They then proceeded to throw the coins into the sea, skipping them like rocks, cackling as they argued who’s went furthest. Just for fun.

You may wonder how long this behaviour could last, and the answer was “not long.” Few years later, this executive went broke.

Story#2 “Ronald James Read was an American philanthropist, investor, janitor, and gas station attendant.”
Read fixed cars at a gas station for 25 years and swept floors at JCPenney for 17 years. When he died at age 92, he had earned $8 Million.

It turned out there was no secret. There was no lottery win and no inheritance. Read saved what little he could and invested it in blue-chip stocks. Then he waited, for decades on end, as tiny savings compounded into more than $8 million.

Let's look at the top 7 Learnings from this book -

Learning 1 – It all depends on when you were born and your beliefs.

Your World View is largely dependent upon your experiences, and the time you were born. For example – the whole perspective of a wealthy person who experienced high inflation during his growth years versus a person who only experienced stable prices with the least inflation will differ. Again, the son of an unemployed person and son of a successful stockbroker comes from different walks of life and they learn different lessons about risk and reward, investing and managing money.
We all think we know how the system works, but usually, we experience a very insignificant part of the world. That’s probably the first lesson - we know less than we think we do know.

Learning 2 - Personal Experiences drive financial decision Making

People invest basis their experiences, and sometimes can tend to be irrational.

Example – An avg. low-income household spends about $400 on lottery tickets even though the chances of winning that lottery are extremely low. Surprisingly, the same low-income household finds it difficult to arrange for the emergency fund of $400. Is this behaviour rational? You never know; but it's not exactly illogical.

Learning 3 – Luck Play a Huge Role in financial Success

According to economists, the income of two siblings is more closely co-related than their height and weight. For example, if your brother is rich and tall, you are also likely to be rich and tall.

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 nowhere in your teens and your 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.
We tend to underestimate or overestimate the role of luck in our lives. If someone else does well, we say that the person is lucky; if we succeed unexpectedly, however, we tend to believe it's because of our hard work and strategic timing.

Learning 4 – Focusing on Broad Patterns rather than specific examples will help you make better investment decisions

Example – John D Rockefeller, one of the most successful entrepreneurs in history. When he started, he faced a lot of problems. The laws in the United States were not supportive of his businesses. He simply ignored them. In the hindsight, his success may be because he refused to let outdated laws come in the way of his innovation. But if he would have failed, we would have probably appreciated his example and way to wealth.

So, what to do? Well, stick to analysing patterns of success or failure. The more common the pattern of success, the more likely you can apply it to your life and financial goals. For example, studies have shown that people who control the structure of their days are more productive and happier with their work than those who don’t.

Learning 5 – When is ENOUGH – Envy and Greed

Rajat Gupta, a hugely successful investment banker, was born in a slum in Kolkata. He worked his way up and became the CEO of the Management Consultancy firm Mc Kinsey. When he retired in 2007, he was worth over $100 million. But he wanted to be a Billionaire.

In 2008, in the middle of the financial crisis, Gupta, who was a board member of Goldman Sachs, learned that Warren Buffett was to invest $5 Billion in Goldman to keep the company afloat. Sixteen seconds later, Gupta bought 175,000 shares of Goldman Sachs.

This was insider trading and hence illegal, but Gupta’s earnings from this investment further went on to make over $17 million in multiple deals. This didn’t make him a billionaire, but he landed up in prison. The moral of this story - envy and greed trigger bad calls. This can lead to far more losses than gains.

Learning 6 – Getting Rich V/s Staying Rich

In 1927, Jesse Livermore, made a fortune on wall street and by the time he had reached age 30, he was worth thousands of dollars at today's valuation. Then, just before the stock market crash of 1929, he took a shot position, betting that stocks would decline, and he was correct. In a few days after the crash, he had made $3 Billion in today's valuation. He thought he was invincible now. He placed larger and larger bets until his fortune was gone. Finally broke and indebted, he took his own life just 11 years after in 1940.

Sometimes, getting rich is far simpler than staying rich.

Learning 7 – You can be Wrong half the time and still create a lot of wealth.

Heinz Berggruen, who was forced to flee Nazi Germany, worked as a journalist with a side-line interest in Art Criticism. In 1940, he bought a small watercooler by an artist called Paul Klee for $100. And his passion for collecting modern art began. 50 years hence, in the 1990s Heinz became one of the most successful collectors of art in the world. In the year 2000, he sold his entire collection to the German government for over 100 million euros.

According to research, all collectors do the same thing – they buy a vast variety and quantity of Art. Some of these collections turn out to be multi-baggers while others are Duds. It’s a bit like an index fund, risks are evenly spread, and a few outliers make for exceptional results.

Conclusion –

Financial Decisions are a lot more complicated in real life than in textbooks. A lot of our investment decisions are not rational.
A lot of these decisions are driven by our experiences, the times we were born, and the current market conditions. Luck also plays a significant role.

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