Psychology of Money: Personal Finance and Decision-Making

Personal finances and the decisions associated with them are much less obvious in the real world than they are described in economics textbooks. Many actions, such as buying a lottery ticket while bankrupt, may seem irrational, but they can be explained. The same goes for investment decisions, which are often based on our youthful experiences rather than an analysis of the current market situation. In simpler terms, our behavior related to money is primarily the result of deeply ingrained biases in our consciousness.

Experience with Economics and Money

The Great Depression, a global economic crisis that severely impacted the United States, left millions of workers across America without food and shelter. However, when John F. Kennedy was asked about his family’s experiences during that period at a campaign meeting, he responded that his family did not feel the effects of the crisis at all. Moreover, the Kennedy family, which already had significant wealth at the time, only increased their fortune during those years. A few years later, while studying history at Harvard, John Kennedy realized the extent of suffering that many people endured during that time.

Everyone has a different economic experience, and it’s not just a matter of dividing people into rich and poor.

For example, a wealthy person will have a different attitude toward money if they spent most of their life in conditions of hyperinflation compared to a wealthy person living in times of price stability. Everyone thinks they know how the world works, but the key to understanding the psychology of money is recognizing that there’s much we don’t know.

Making Financial Decisions

When economists build models of financial behavior, they often make the mistake of assuming that people make rational decisions based on self-interest and income growth.

However, reality looks somewhat different. Take, for example, lottery ticket purchases. The average low-income family in the United States spends $411 a year on lotteries. Meanwhile, 40% of U.S. households struggle to save those same $400 for a rainy day. Unfortunately, these are often the same families. Is this behavior rational?

Luck and Financial Success

Before writing the book, the author had the opportunity to speak with Nobel laureate Robert Shiller. He asked him if he would reveal the secret of his investment approach. Shiller’s response was, “Don’t underestimate the real impact of luck on outcomes.”

Most investors and entrepreneurs may not agree with this, but in reality, it’s challenging to calculate the role luck plays in the success or failure of various ventures.

Patterns and Achieving More

Bill Gates once said that success is a lousy teacher. When pursuing our own goals, we tend to overestimate the success of individual actions. By emulating billionaires who are changing the world and underestimating the role of luck, we can lose sight of the bigger picture and broader economic patterns.

An alternative to blindly imitating the behavior of specific individuals is studying the common patterns of success and failure.

What Does “Being Rich” Mean?

Personal finances and the decisions associated with them are much less obvious in the real world than they are described in economics textbooks. Many actions, such as buying a lottery ticket while bankrupt, may seem irrational, but they can be explained. The same goes for investment decisions, which are often based on our youthful experiences rather than an analysis of the current market situation. In simpler terms, our behavior related to money is primarily the result of deeply ingrained biases in our consciousness.

Morgan Housel, the author of the book “The Psychology of Money,” asserts that the human factor is the key to financial success. If we want to understand why some people drown in debt while others amass vast fortunes, we don’t need to study interest rates. We need to understand the psychology of making financial decisions.

Saving Is Easier Than Preserving

Jesse Livermore was one of the first major stockbrokers in the United States and a founding figure of Wall Street. His personal fortune amounted to $100 million. In 1929, he predicted the stock market crash and began opening only short positions (aiming to profit from falling prices). At a time when vast fortunes were crumbling, and stock market investors were jumping out of windows, he earned $3 million.

Considering himself a genius, he began to make larger and riskier trades, which ultimately led to his bankruptcy and suicide in 1940.

If 50% of Your Decisions Are Wrong, the Path to Wealth Is Not Closed

One of the greatest art collectors was Heinz Berggruen, a refugee from Nazi Germany. After studying at the University of California, he became a popular journalist and art historian. He bought his first painting in 1940 for $100 and, 60 years later, sold his collection to the German government for $100 million. The collection included numerous works by Klee, Picasso, and Matisse. How did he know what to buy?

According to research, all great collectors buy everything they can get their hands on. Some purchases turn into hits over the years, while the majority are mediocre works.

Berggruen’s collection followed a similar principle. He simply bought paintings by unknown artists. This strategy actually applies to all types of investments and is known as the “long tail” concept. Giants like Amazon and Netflix use it.