The 13 Principles of “The Psychology of Money” to Thrive in Business
In the 1991 movie Defending Your Life, the character Daniel Miller is determined to negotiate a salary raise with his boss. The day before, he secures the help of his wife to bounce off his negotiation skills and land the number of his dreams: $65,000.
The D-day comes and when his boss says, “Daniel, I am prepared to offer you $49,000,” Daniel rushes and says, “I’ll take it!” The sheer anxiety of sitting in front of his boss to negotiate such a critical thing got the worst of him, and he ended up way far from his objective.
So, how many opportunities do not get lost due to a lack of understanding of the psychology involved in our relationship with money?
In Morgan Housel’s book, The Psychology of Money, there is a great premise that can be translated into 13 principles. The premise is, good money management has little to do with the correct use of formulas or complex investments, and rather depends on how people relate to it and how they manage emotions when making a decision.
1. Find humility in success and compassion in mistakes
Morgan Housel raises in his book the question that things are never as good or as bad as they seem. The world is big and complex, and business people need to be humble when they succeed, and compassionate when they make poor decisions.
This is more so when luck and risk are variables that are difficult to identify. Anyone in the world of business and investment must acknowledge the power that both have, to be able to focus on those things that can be controled.
2. Less ego, more wealth
The way you close the gap between your income and your ego is to save money. In his book, Housel explains that wealth is the unseen difference between the two, and to build wealth you must cross out all the things that you could buy today.
Keep in mind that, no matter how much you earn, becoming a millionaire and accumulating wealth in the future will not happen unless you control your impulses today.
3. Manage your money in such a way that you sleep peacefully at night
This principle of The Psychology of Money is one of the most important on a personal level, as it allows business people to understand that, although an investment can be very profitable on paper, it may not fit their life goals.
This means that your peace of mind should prevail over the aspiration to achieve returns on your money, or the obligation to save a specific percentage. Very importantly, finances are personal, so, investing in a risky way will allow some people to sleep well at night, while some prefer to save 40% of their income. Both cases are totally valid.
4. To be a better investor, increase your time horizon
Warren Buffett says that time is the most powerful force when it comes to investing your money. While you cannot control luck or risk, when time comes into the equation, it makes mistakes fade and small things grow.
In the long term, your investments will grow incredibly thanks to compound interest. In the long term, specific errors are offset by the natural power of the market. The less you interrupt your investments, the more chances you have to accumulate incredible figures.
5. You can be wrong half the time and still build a fortune
Investors must accept that many things will not turn out the way they expect —there will be many mistakes along the way. So how is it possible to build a fortune when you’re wrong half the time?
This is because a small percentage of things explain the vast majority of results. This is known as the Pareto principle —in money management, it is applied so that 20% of the investment decisions you make will produce 80% of your results.
When you see things from this perspective, you will stop looking at your individual investments and start looking at their performance based on your entire portfolio. For example, you will be able to understand that it is okay to have a lot of bad investments and a few good ones that drive most of your results.
On the contrary, if you analyze each decision individually, you will fall into the trap of thinking that those who make good decisions are more brilliant, and those who make mistakes, lose the most.
6. Use your money to control your time
Without a doubt, one of the keys to being happy is having more control over your time. Basically, this is the ability to do what you want, when you want, with whom you want, and for as long as you want.
This is the best return investors can get from their money. In summary, the trick is to apply this principle to increase the wealth —or income-ego— gap, and to build —invisible— wealth whose performance allows you to control time.
7. Be more frugal and less flashy
What do business people want when they fancy a car, a sizable house, or an expensive watch? For Morgan Housel, what they truly seek is respect and admiration from others, and the most efficient way to achieve this is through kindness and humility.
No one is as impressed with their possessions as they are —so, when looking for respect and recognition, successful people develop frugality and focus on their human side to help others.
8. No need to have a specific reason to save money
This is one of the most important principles of The Psychology of Money when it comes to achieving financial growth and independence. While people save for a car, a down payment on a house, or a medical emergency, they must also learn to save for things that are impossible to predict.
9. Define the cost of success and be willing to pay for it
In business —and life in general— nothing worthwhile is fast, fair, or easy —and in many cases, the associated cost is very high.
This is the case with uncertainty, doubt, and regret, which are common costs in the financial world. They are often part of the story of a successful business, and people must see them as fees to achieve a dream lifestyle.
10. The importance of the margin of error
The wider the gap between what could happen in the future and what you need to happen, the better. This is known as the margin of error, and it is a fundamental principle for staying in the money game and allowing time to work its magic.
If a financial future has a very small margin of error, any setback or unexpected event could take people out of the game, lead them to make hasty decisions, and divert from their goals. So, as a rule of thumb, it is best to look for ways to widen this gap to need less from the future.
11. Avoid the extremes in financial decisions
This rule is about having a financial balance and avoiding extremes that lead to high levels of commitment to projects or goals.
No matter what goals and desires, it is essential to remember that they will change over time. Housel advises to keep this in mind when deciding something in the present and to have space, time, and resources for other projects.
12. Risk pays off over time
A hasty decision that does not contemplate the possible scenarios will take investors out of the game. So, the key is to make decisions and have a mindset that will guarantee the longest stint.
The longer investors are in the money game investing, growing, and learning, the better their results will be. In this context, calculated risks will yield a good profit margin in the long term, while calculated risks that do not imply such a high cost will keep investors in the market in the short term.
13. Define the money game you are playing
Finances are a personal matter. Housel invites investors to make sure their actions are not influenced by people who are in a different game.
This is why the vast majority of people who are intelligent, informed, and study the world of finance, rarely agree on anything. Why? Because each person has their own goals, desires, and investment horizons.
What is the best investment? What is the best decision? The one that works best for them based on that criteria.
Written by Jacob Wolinsky.
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