You can know everything there is to know about optimal portfolio construction, you can recite Fama, Sharpe or Markowitz in your sleep but, as an investor, if you aren’t able to manage your own behaviour, you will likely fail to achieve your investment goals.
One of the best-selling books about finance and investing in recent years is The Psychology of Money: Timeless lessons on wealth, greed, and happiness by Morgan Housel. (1)
In it, Housel explores how our temperament and emotions drive the financial decisions we make, and how recognising these patterns can lead to better outcomes.
Here are the book’s top tips on how to avoid harming your own portfolio.
Be clear about your objectives
For Morgan Housel, financial success starts with understanding what you really want — not what you think you want. Ultimately, he says, “controlling your time is the highest dividend money pays.” Put another way, it’s the ability to wake up every morning and say, “I can do whatever I want.”
Of course, being financially independent requires you to save, and the easiest way to find money for savings is to spend less on things you don’t need. Do you really want that bigger house, that brand-new car, or more designer clothes? Remember, “using your money to buy time and options has a lifestyle benefit few luxury goods can compete with.”
Don’t play someone else’s game
Human beings are very social animals. We care greatly about belonging to a group and what other people think of us. This, the book explains, is one of the biggest obstacles to our financial independence. Why? Because we naturally try to impress. And yet, says Housel, “spending money to show people how much money you have is the fastest way to have less money.”
You can save more by spending less. You can spend less if you desire less. And you will desire less if you care less about what others think of you. In other words, stop taking financial cues from people playing a different game to your own.
Know your own personality
Another important lesson The Psychology of Money teaches is the value of self-awareness. We’re all different, and each of us has our own behavioural traits. A successful investment outcome depends on understanding who you are and what makes you tick.
“We all do crazy stuff with money,” writes Housel, “and what looks crazy to you might make sense to me… We all make decisions based on our own unique experiences that seem to make sense to us in a given moment.”
So work out the behavioural tendencies you have that might trip you up. Do you tend to get over-excited when things are going well? Do you like to follow the herd? Or do you have a half-glass-empty personality? Do you panic in a crisis? Understanding and countering these biases can lead to more rational financial choices.
Identify your risk capacity
Another respect in which we differ from one another as investors is our capacity of risk. All investing involves a degree of risk, and yet our circumstances are all unique. Some people can afford to take more risk than others, and indeed some people need to. Similarly, some of us are happy to take risks that make others feel distinctly uncomfortable.
So it’s very important, says Housel, to understand your personal capacity for risk, and to balance the need for returns with an appropriate amount of caution. To quote the book, “there is no reason to risk what you have and need for what you don’t have and don’t need.”
Focus on the long term
Something else that Morgan Housel stresses in the book is the importance of adopting a long-term perspective when it comes to money and investing.
It can be hard to keep a level head when the markets have fallen sharply, or when we learn that a friend or colleague appears to have made a small fortune on a particular investment. But trying to time the market or chasing short-term gains often leads to poor decision-making.
“If you want to do better as an investor,” says Housel, “the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing.”
Be market-agnostic
If you watch CNBC or read an investment magazine, you’ll find plenty of pundits with strident views about the financial markets, or about which stocks, funds or sectors you ought to invest in.
But a key message from The Psychology of Money is that it pays to be agnostic about the markets and specific investments. No one knows what the markets will do in the short-to-medium term. What investors really need is “a mindset that can be paranoid and optimistic at the same time”. It takes more effort to accept nuance than to see things in black and white, but it’s the right approach.
So too is diversification. Spreading your investments across different asset classes, industries and regions of the world reduces the risk you are taking.
Stay humble
Finally, Morgan Housel’s book stresses the importance of learning from past mistakes and being a humble investor. Avoiding overconfidence and being open to continuous learning is crucial.
“We all think we know how the world works,” he writes. “But we’ve all only experienced a tiny sliver of it.”
He also urges readers to acknowledge the role of luck in financial success and failure. “When things are going extremely well,” he says, “realise it’s not as good as you think. You are not invincible, and if you acknowledge that luck brought you success then you have to believe in luck’s cousin, risk, which can turn your story around just as quickly.”
The Psychology of Money is, in short, a hugely insightful book. We can all benefit from being reminded from time to time about the harm that our behaviour can cause to our financial well-being. And don’t forget, the whole point about behavioural blind spots is that you can see them in other people, but not in yourself. And believe me, we all have them.
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products
Robin Powell is a journalist, author and editor of The Evidence-Based Investor.
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