The Psychology of Money, subtitled "Timeless Lessons on Wealth, Greed, and Happiness" — a book that's sure to delight and inspire you!

The wonderful author of this book is Morgan Housel, who used to write a financial column for the Wall Street Journal.

Housel has a knack for uncovering the unchanging laws of human nature in vast historical data sets. He then looks through these laws to see how they can inspire people in the present.

I'd love to know why! Let's dive right in and start with an incident from the book. We all know and love Graham, the investment guru who wrote the book "The Intelligent Investor." This book is a real treasure! It's known as the "investment bible" for good reason. It's got all the theory you could possibly need, and it also provides lots of practical formulas. Author Hauser read the book when he was just a young man and was first introduced to the wonderful world of investing. He was absolutely enthralled by the investment formulas in the book and felt like he could get rich by acting on them.

However, as he gained more and more experience in investing and learned more about the ins and outs of it, he came to understand that you can't just apply the formulas and specific guidelines in the book to make investments. For instance, one of Graham's helpful tips is that those who like to play it safe should avoid picking stocks that are trading at more than 1.5 times the book value. However, if you were to follow this guideline to the letter in the 2010-2020 U.S. stock market, you'd be left with only insurance and bank stocks to choose from! To put it another way, this guideline doesn't really work that well in practice.

On the other hand, if we take a closer look at how the book "The Intelligent Investor" was revised over time, we'll see that Graham made five revisions between 1949 and 1972. So, by 1972, was it all wrapped up? Oh, goodness, no! It's just that after this year, he was physically unable to do so. So let's see how relevant these formulas will be in 2023! By 2050, who knows?

It's so interesting how a lot of the specific knowledge and formulas in investment and finance books are really like that, with significant temporal and spatial limitations. So, Hauser thinks we should pay more attention to the universal significance of things. For example, we should recognize that human nature is driven by greed and fear. We should also acknowledge that people respond to pressure in different ways, depending on their psychological state. And we should recognize that people experience different reactions after they've undergone psychological repair. Hauser says he really likes Voltaire's quote, "History never repeats itself, but mankind always repeats itself." He thinks this quote is really relevant when it comes to our relationship with money. That's why he loves looking at the history of money to find the human and psychological patterns behind it. He thinks it's so interesting to think about what we can do to capitalize on those findings!

Today, I'm excited to share three key takeaways from Hauser's findings. I'll make it easy for you by summarizing each of these three reminders in one sentence:

One: It's okay to be reasonable even if you're not 100% rational.

Two: If you want to stick around for a while, it's good to leave a little room for error.

Three: How we spend our money is often shaped by our past experiences.

These three sentences might sound simple at first, but as we take a closer look, you'll see there's more to them than meets the eye.

Part One

Let's dive in and look at the first statement together. When it comes to making decisions about money, reason trumps absolute rationality.

Let's start with a wonderful man, Markowitz, who won the 1990 Nobel Prize in economics. I'm sure many of you are already familiar with this incredible individual, who has made a significant impact in the world of finance. He came up with the portfolio theory in the 1950s, which was the first time anyone had put investments into a quantitative framework. It's known as the "big bang theory" of finance.

I'd love to know why you say so! Because before he came up with this theory, even though we all knew that there was a risk involved in investing, nobody really knew how to measure it or calculate it. Nobody really knows, do they? But Markowitz's theory is really cool because it transforms this kind of abstract concept into something that can be calculated. He came up with a way to help people figure out the best way to invest their money by creating an analytical framework that helps people calculate a portfolio of assets that minimizes risk and maximizes return. This portfolio can include stocks, bonds, commodities, foreign exchange, and so on.

This theory really paved the way for the modern investment analysis industry. Before this, people felt that investing was an art. Let's take Graham, for instance, the father of value investing. He's a bit like studying individual stocks, which is a real art form. But then along came Markowitz's theory, which showed that investment isn't just about analysing individual assets. It's also about finding the best combination, which requires lots of global calculations and analysis. And this is something that many Wall Street bigwigs are also into, night and day.

So, let's go back to Markowitz the man. I'm sure he did a great job analyzing his own quantitative investments! I'd love to know if he crafted a diversified portfolio of assets for himself!

Someone actually asked Markowitz: I'd love to know how you manage your own investments!

So, Markowitz just gave a little shrug and said, It's really quite simple! I just buy half of the bonds and half of the stocks.

I'm sure you're wondering why he's called the "father of the portfolio" when it seems like he designed a portfolio that's pretty simple. Markowitz was happy to explain: I can see how it would be a bit unsettling if the stock market has been down and I've put all my money into it. It would also be a bit disappointing if the stock market has been up but I didn't participate. So my investment principle is to try to avoid any future regrets.

This whole thing is really quite interesting! There's a lovely saying I like to remember: don't look at what someone says, look at what they do. Markowitz came up with a set of analytical frameworks for absolute rationality that many people use. However, when it came to himself, he decided to throw that framework away and use a different set of ideas. I'd love to know why! I think it was just a choice that felt right for him and made sense.

So, what would you say is a logical investment decision for us? Of course, everyone's situation is different, but I just had to share this amazing quote from the book: "The reasonable investment program must be one that lets us sleep at night." Isn't that so true? As luck would have it, I once heard financial whiz Xu Yuan say that when he was in school, his teacher, macroeconomist Song Guoqing, told his students: remember, when you're investing in the future, don't let your position and strategy affect your sleep. This is pretty much what this book is saying! I also found something really interesting in the book. It was a quote from Warren Buffett. He said something similar back in 2008 at Berkshire's shareholders' meeting. He said, "Even if it came down to a situation where I had to choose, I would never trade a night's restful sleep for the chance to make more gains." That's what makes sense to him, and I totally get it!

So, you might be wondering, why is it that reason trumps absolute rationality in investment decisions? It's really quite simple: it makes sense to stay the course! Absolute rationality is all about cold, hard calculations. But rationality also takes the human factor into account, which is really important! And remember, when we're talking about sticking to a strategy, it's important to consider the feelings of the people involved. After all, we can't disregard the feelings of people!

It's a lot like losing weight. Stick to a healthy diet and exercise every day. It'll be worth it in the end! But it can be tough, and it's easy to get discouraged. That's why some fitness trainers suggest adding a day off or an "indulgence day" to your week. You can even have one or two extra bites of your favorite snacks in the morning! The first thing you need to do is make sure you have a snack or two of your favorite foods at breakfast. One really great reason to do this is that it just makes sense and helps you stick to it!

I totally get it. Some people just love eating healthy and exercising every day. It's not painful for them, and that's great! Absolutely! If that's the case, then this lifestyle is perfect for them.

When we realize this, it actually inspires us to develop an investment strategy!

It's totally understandable that many people find it challenging to stick to long-termism in the investment field. When you encounter some volatility, it's only natural to feel the urge to pull out. The author offers a fascinating perspective on this phenomenon. They suggest that we often avoid sticking to our investment targets or strategies because we don't fully embrace them.

Let's say you invest in a business because you think it has a bright future. You might not be that interested in its specific industry, though. So, if everything goes well after you've made the investment, you'll probably feel pretty good about it. But, if things take a turn for the worse, it can be really disappointing to lose money on a project you're not that interested in. Then, you might find yourself turning away and moving on to something else. But if you're interested in the investment from the start and you love everything about the business, even if it temporarily struggles with earnings or hits a low point, you're more likely to stick with it. This is a great point! If you believe in and love the investment, you're more likely to stick with it for a little while longer. After all, you're investing your hard-earned money, and you want to feel like you're doing something worthwhile.

You might also hear that many professionals suggest that for most ordinary investors, it's a good idea to invest in a large-cap index fund. They say that the investment returns will be better than going to the stock market and tossing yourself around! For example, financial scholars Xu Yuan and Mr. Zhang Xiaoyu, who we're lucky to have on our show today, have publicly expressed this view. I'm happy to say that the author of this book shares this point of view, and his own family's investment is indeed a great example of this. However, the author also said that, from a reasonable point of view, not everyone is going to apply to this program. This is totally understandable! We all have our own preferences when it comes to investing. For instance, one investor the author knows has a great strategy. They invest primarily in diversified funds, but also hold a small percentage of stocks. He says he buys stocks not because he thinks any one stock will beat the broader market, but because he just loves stocks! He loves studying them and he loves the thrill of tracking the ups and downs of prices. So, it would make sense for him to hold some stocks, which would be easier for him to stick with.

I also remember reading in the book Father Buffett Taught Me Things that Warren Buffett's son said he'd seen his dad every day since he was a kid, buried in the study of financial statements of all kinds of companies, looking for those undervalued "value of the depression" gems and enjoying it. Even after making a lot of money and becoming the "God of Stocks," Buffett still wears his beloved khaki pants and works six days a week. He's very much the same himself! For others, value investing might require a lot of perseverance to stick to the investment philosophy. But for Buffett, it's his passion!

The author says that the phrase "do what you love" can sometimes feel a bit empty if you take it out on its own. It's like a lucky draw of chicken soup advice! However, if you use it as a strategy to keep yourself on a certain path for a longer period of time, you'll be amazed at how powerful it is!

Part Two

Alright, in the first part of what we chatted about earlier, we were talking about how being reasonable beats absolute rationality when it comes to making decisions about money. I'd love to know your thoughts on this! Because it'll be easier for you to stick with it!

But you might be wondering, what's the point of all this persistence? I'm happy to give you two straightforward answers!

First, it helps your investment strategy succeed! The author of this book, who is an expert in organizing academic research, found something really interesting. Even though scholars are trying to measure investment returns, there are different approaches. Some research looks at the rate of return, while others focus on investment strategies that can earn money over a certain period of time. But here's the thing: the research shows that the performance of your investments is a really important factor. So, it's super important to stick to your investment strategy, even when things look tough. For instance, some scholars have discovered that in the U.S. stock market, there's a 50% chance that an investment strategy will help you make money in a day, a 68% chance of making money in a year, and an 88% chance of making money in ten years. And the longer you invest, the more likely you are to see a positive return!

And there's another great reason to stick with your investment strategy: persistence allows room for compound interest to show its power. We all know that compound interest is not about getting huge returns. It's about consistently adding up your returns over time. You've got to give your wealth time to grow year after year if you want to see the power of compound interest in action! It's like planting an oak tree! In just one year, you might not notice much change. But give it ten years, and you'll see a big difference. And in fifty years, you'll have a tree that's truly grown!

That's what persistence is all about, my friend! From this perspective, it's so great to see how all those factors that help you stay in the game for longer are really enhancing your advantage!

I'm sure you'll agree that making sensible decisions is a big factor in all of this. And in the other chapters of the book, I've seen another really important factor: creating a sense of survival first. The author says this realization is really important, whether you're investing, planning your personal career, or running a business.

For example, there was this one time when Michael Moritz, the billionaire president of Sequoia Capital, went on a well-known talk show. The host asked him: How did Sequoia Capital become one of the most successful venture capital organizations? That's a big question! Moritz was quick to point out that longevity is a key factor. He said that some venture capital firms only manage to stay afloat for about 5 to 10 years, but Sequoia Capital has managed to keep itself going strong for 40 years!

The moderator then asked with a smile, "How did you do it?"

Moritz said he thinks it's because they've always been really afraid of being eliminated from the industry. So when they come up with different business and investment plans, they always think about how they can make sure the company will stick around. It's so important to make sure that each strategy helps the company to survive longer and better, or at least, not threaten the company's survival. For instance, they'll steer clear of options that could bring in a lot of money, but if they don't work out, they could put the company in a really tough spot. They truly believe that the most important thing is to survive for a long time without being eliminated or forced to give up.

Warren Buffett also had something to say on the matter. He said that one of the most important things for successful investing is to "don't get off the table." That is, at least make sure you survive. Stay alive and you have a better chance of winning!

I'm sure you've heard the story of Warren Buffett and Charlie Munger many times before. But did you know something really interesting? Guess what! When they first started Berkshire, there was actually a third member of the trio called Rick Guerin. So, I'd love to know how this person disappeared! Back in 1973-1974, during the U.S. recession, Rick saw an investment opportunity. He was really excited about it! He saw the potential to leverage loans to invest. Unfortunately, Rick misjudged the situation. He unfortunately lost a lot of money, but thankfully he was able to put his stake in Berkshire up for sale to Warren Buffett at a low price. This meant that he wasn't able to share in the later earnings of Berkshire.

Later on, Buffett himself said: "Charlie and I always knew that we would become very rich, but we are not in a hurry to become rich. We're just happy to be where we are now!" Rick was as smart as we were, but bless his heart, he was just a little too eager.

Another thing we can learn from Rick Guerin and Sequoia Capital is that if we want to make sure we're around for the long run, we've got to remember that no gain is worth the risk of losing everything. This is also one of the key phrases that the book really hammers home.

You can actually see this very clearly in Buffett's own investment strategy, which is really quite inspiring! He always made sure to keep enough cash in the company account, never borrowed to invest, and often, when the asset price bubble was just starting to form, he'd sell some assets and hold on to the cash. Take the financial crisis of 2008, for example. Buffett didn't just survive, he thrived! I'd love to know why! He was smart to sell stocks before the crisis. He had a lot of cash on hand, and he picked up some great deals after the crisis. It's no surprise he made a lot of money!

You might be wondering: if this is the case, are you afraid to miss the opportunity? Buffett's view is that there's no need to be afraid. There will always be opportunities, but it's so important to make sure you stay at the table first! When we read the book "Capital Returns," we also chatted about Marathon, a long-winning company in the field of asset management. They have a great philosophy: "Stay away from bubbles, even if it is too early." It's a similar meaning to what we've discussed.

So, to put the concept of "survival first," it's important to remember that "no gain is worth the risk of losing everything." On top of all that, this book also has a helpful reminder: to make it through the long run, you need to leave enough room for error.

The lovely Graham, our very own investment guru, came up with the concept of "margin of safety." The author of this book has a very intelligent way of thinking that we think you'll find really interesting.

Have you ever wondered what the term "margin of safety" really means? It's really quite simple! Let's say you think a company is worth 10 dollars. Its price in the market is 9 dollars. You decide not to enter the market and wait a little longer. After two days, the market suddenly gives a price of 7 dollars. You decide to enter the market. So, 7 dollars compared to your expected 10 dollars, discounted out of this 3 dollars, is the margin of safety in your mind. It's always a good idea to leave enough "margin of safety," which just means setting the number as large as possible.

Let's say you think this company is worth 10 dollars. When you look at the market price, it's at 9 dollars. But then, wouldn't you know it, the market price fell a lot, down to 6 dollars! It's totally normal to feel a bit unstable in this situation. But if you leave a little more margin of safety, say 7 dollars to enter, then the loss will be much less. And then if you leave a little more, you may not have entered the market now, so you wouldn't have lost anything.

So, when it comes to investing, it's always a good idea to leave a little extra "margin of safety." It's a simple concept, but it can make a big difference! For instance, no matter how much you value a company, it's always a good idea to start with the heart of this number and then give it a little discount, say five or six percent. Once you've done that, you can start thinking about buying the stock. This is something that many value investors have found works well over the years.

Of course, this idea of leaving enough "margin of safety" isn't just for investments. Let's take personal financial planning as an example. If you're expecting your future annual investment returns to be 8%, it'd be a great idea to base your future money planning on this figure. I wouldn't recommend it, if I were you. I'd say a better approach is to make a discount on the expected basis. That way, even when the rate of return is only 4%-5%, you can still make your plan a reality!

In life, there are so many ways to make sure you've got a "margin of safety." You can have a looser schedule, a flexible plan, a plan for the unexpected, and a budget that always allows for a little leeway. The authors say that it's not that we're looking in the wrong direction, but that we just need to leave a little more room for error in our plans. It's like how many folks see the long-term trend of stock prices, but because their account didn't have enough "reserves," it fell victim to short-term fluctuations.

In a nutshell, in this world full of uncertainty, there will be times when things don't go as planned. Nobody can guarantee that their predictions will always be right. And by leaving a little extra room for error, we're making sure we've got enough safety net to get through tough times. Even if you make a mistake, you won't have to worry about leaving the market in a fiasco.

Now, in the first two parts, we chatted about two important reminders from the book. The first is that reason is better than absolute rationality. The second is that if we want to survive for a long time, we have to leave enough margin of safety. In this next part, we'll chat about the third reminder, which is really helpful for understanding other people and how they change in different situations. It's all about how a person's past experiences affect how they spend their money.

Our experiences shape us, and it's something we all go through in life. Take, for instance, people who had a rough childhood and didn't get the nutrition they needed. They often become more interested in food as adults. Similarly, folks who've experienced betrayal in a relationship may become more cautious and suspicious of their partners.

When it comes to money, experience also plays a big part in how we treat it. For example, the study found something really interesting! It turns out that people who just entered the stock market and made money after encountering losses were more reluctant to cut meat and stop loss. On the other hand, people who just entered the stock market and lost money were more likely to admit when they were wrong and stop loss in a timely manner.

Back in 2006, two economists from the U.S. National Bureau of Economic Research did a really in-depth study of how Americans manage their money. The study showed that the decisions we make about investing in our lives are influenced a lot by our experiences, especially the things we do and learn in our twenties. It's totally understandable! At this age, people are just starting to learn how to manage their money and are also just getting to know the world of economics.

For instance, the two economists discovered that if a person experienced high inflation when they were young, they would likely invest less money in bonds later in their investing career. On the other hand, if a person was young when the stock market was booming, they would probably invest more money in stocks later in their investing career.

The Financial Times once had the pleasure of interviewing a very well-known bond manager named Bill Gross. Gross said that if he had been born 10 years earlier or later, he might not be doing this career now. He was lucky enough to be young just in time when interest rates plummeted and the price of bonds soared! This really affects Gross's view of investment opportunities. He sees bonds as a kind of money-printing machine. But Gross's father, part of a generation that grew up in a hyper-inflationary environment, saw bonds not as money-printing machines, but as wealth-crushing machines.

By now, we've probably all learned something new together! We've seen that how we spend our money is often influenced by our past experiences. So, what can we learn from this quote about the reality of things? I think it's these two sentences that really stand out to me:

It's so important to remember that what seems unbelievable to you might be perfectly logical to someone else. From what we've shared with you, it's clear that people's experiences and environments shape their views on investing and money in different ways. We all have different backgrounds, and that affects how we approach these things. It's not that anyone is wrong, it's just that we all have different perspectives. So, you know, sometimes when we see someone else's wealth decisions, we might think they're a bit irrational. But actually, from their own experience, it might just make total sense! And if you want to try to convince him to change his mindset, it might be a bit tricky too, because everyone prefers to believe their own personal experience rather than the persuasion of others. The author says that when it comes to money, very few people are really irrational. But we all have different ideas about what's "rational."

There's another important thing to remember from this part of the book. It's that our environment can change really quickly, but our hearts take a little longer to adjust.

Folks who've been through earthquakes or floods are more likely to be cautious. Those who've experienced recessions are more inclined to save more and spend less. And those who've faced closures and unemployment are more reluctant to take risks. The shock of change comes and goes, but the traces it leaves in a person's heart last a long time. It's okay to feel shocked by change, but try to remember that the effects of change can last a long time.

Do you remember the Asian Financial Crisis of the late 1990s? It was a tough time for everyone. Around that time, we noticed something interesting. Companies in all eight East Asian countries were holding more cash. I'd love to know why! Cash flow is king, as any entrepreneur who weathered the storm knows all too well. And would you believe that 10 years after the crisis, the cash holding ratio of enterprises is still as high as twice the level before the crisis!

Could it be that folks in East Asian countries are just more cautious? Oh, it's not just East Asia! Something similar has happened in many countries around the world. Let's look at some examples. After the 2008 financial crisis, folks in the United States saved more for 10 years, folks in the United Kingdom saved more for six years, and folks in the European Union saved more for four years.

The lovely financial scholar Shanshuai also talks about this example in her 2023 China Wealth Report. She affectionately dubbed it the "scar effect."

The reason for the "scar effect" is that our hearts are slow to change. The scars of a huge economy are made up of the scars of countless micro-individual hearts. It's so sad to see the impact on people's lives. We all know that shocks come and go, but the scars they leave behind take time to repair.

And in times like these, folks in an economy, while healing their own inner wounds, will undoubtedly need to adjust to this period of repair in the larger external environment.

So, how can we adapt? For example, Xiangshuai had a great suggestion: that individuals should adopt the idea of "bottom-line thinking and diversified allocation" in their investment decisions. The idea of diversified allocation is all about having a variety of different types of assets, currencies, investment periods, and methods. The bottom line is that it's really important to make sure you're protecting your assets. It's not a good idea to make too many trade-offs in return. For example, Xiang Shuai said, she knows some people around 2022 bought a lot of physical gold, as well as protection insurance products. These decisions are not for the sake of income, but to "protect the bottom," to build a safety net for personal wealth.

On a different note, I recently read a book called "Small but Beautiful." It's about how, during periods of slower growth and uncertainty, it's not always the best idea to focus on expanding your business as much as you can. In such a period, the species that will survive well "will likely not be behemoths like dinosaurs and whales, but smart species like sparrows that can quickly find new ecological niches."

In a nutshell, we all need a little healing in our lives, especially when we're going through tough times. It's like a city, a company, or even a person that's been through a lot and needs a little TLC to recover and grow stronger. We can all do our part by embracing resilience and understanding the new climate and soil conditions. It's about adapting, surviving, and evolving. The human heart is slow, but time is on our side.