Morgan Housel: Investor, Historian, Psychologist
Morgan Housel is one of the most fascinating people I know.
A former financial columnist, Morgan is now a partner at Collaborative Fund. I imagine his job involves identifying and investing in the companies of tomorrow, but I know him for the pithy wisdom he puts out weekly.
As expected, he writes about finance and investing. What’s unexpected is that a lot of the lessons that you can learn aren’t confined to just that field. There’s history, psychology, business, and pretty much anything you can apply to your own life.
I’ve went back in time to dig up his articles since his days as a columnist and put them into categories. You’ll find that they overlap, which is another sign that Morgan draws from multiple disciplines in his writing.
If you want more, check out his latest book, The Psychology of Money.
Table of Contents
Many Powerful Ideas Are Simple
Morgan’s lesson for newcomers to finance that’s applicable to everything else:
Simple almost always beats complex. That’s true for investing, mortgages, insurance, and everything else related to money. If there’s one thing I wish I knew when I graduated, it’s that.
Simple rules triumph in a complex world. Bonini’s Paradox states that the more complete a model of a complex system, the less understandable it becomes. Morgan provides one more reason why we shouldn’t pursue complexity: you’re going to make mistakes:
If you’re going to act on a problem that is monstrously complex and uncertain, the stripped-down, rules-of-thumb response is not only good enough. It can be superior to tripping over yourself in pursuit of something that appears marginally more accurate.
The U.S. constitution is 7,591 words. A typical business management book covering a single topic is perhaps 250 pages, or something like 65,000 words. […]
Complexity gives a comforting impression of control, while simplicity is hard to distinguish from cluelessness. In most fields a handful of variables dictate the majority of outcomes. But only paying attention to those few variables can feel like you’re leaving too much of the outcome to fate. The more knobs you can fiddle with – the 100-tab spreadsheet, or the Big Data analysis – the more control you feel you have over the situation, if only because the impression of knowledge increases.
There’s a simple idea in investing. If you want to know what stock to buy, look at Main Street instead of Wall Street. The power of taking this simple idea seriously might surprise you:
J.M. Smucker makes jelly and instant coffee. Its stock is up 1,211% since 1995. Microsoft changed how almost every human on the planet processes information. Its stock is up less, 1,183% since 1995. McCormick makes garlic powder. Its stock is up 1,423% since 1995. Oracle has a near-monopoly database management software. Its stock is up 1,419% since 1995. V.F. Corp makes jeans and flip-flops. Its stock is up 1,444% since 1995. Cisco Systems connects the entire world together in one place. Its stock is up 1,018% since 1995. Valspar makes industrial coatings, and has returned 1,521% since 1995. Adobe makes some of the most popular software in the world, and has returned 1,230%. Google is one of the most exciting companies of all time. Its stock is up 345% since 2008. Altria makes cigarettes in the rapidly declining U.S. market. Its stock is up 494% since 2008.
The best-performing industry over the last 50 years, by far, is consumer staples – things like food, toothpaste, and toilet paper. The worst-performing industry, by far, is technology.
Granted, this was in 2016, and technology stocks have since soared. But it’s amazing how such a simple idea has served as a reliable guide for investors who have decided to pick their own stocks.
And among the simple ideas shared by Morgan, this is my favourite. Nothing comes close to this mix of prose and math:
What if Buffett got serious about investing when he was age 22 – just out of college – instead of age 10? Imagine he spends his 20s learning about investments, and his net worth at age 30 was in the still-impressive 90th percentile. Using today’s net worth percentiles and adjusting them for 1960s-era inflation, that would mean he’d be worth about $24,000 at age 30. Now we can do some fun calculations. If, at age 30, Buffett was worth $24,000 instead of the $1 million he actually accumulated, and went on to earn the same returns, how much would he be worth today? $1.9 billion. That’s 97.6% lower than his actual net worth of $81 billion.
The punchline is that 97.6% of Buffett’s current success can be directly tied to the base he built in his teens and 20s. Like World War II-era stuff. $1.9 billion is nothing sneeze at. But you’d need twice as much to make Bloomberg’s list of 500 richest people in the world. Which is to say: Without the capital base Buffett built before he could grow a beard, you’d probably never have heard of him.
[…] It is so easy to overlook how powerful it can be to take something small and hammer away at it, year after year, without stopping. Because it’s easy to overlook, we miss the key ingredients of what caused big things to get big. How can most of Buffett’s success be attributed to what he did as a teenager? It’s so crazy, so counterintuitive. And since it’s crazy and counterintuitive we overlook the right lessons. So we write 2,000 books on how Buffett sizes up management teams when the biggest and most practical takeaway from his success is, “Start investing when you’re in third grade.”
It sounds simple. And it is. But don’t mistake simple for easy.
Everyone wants a shortcut. It’s always been this way, but I suspect it’s getting worse as technology inflates our benchmark of how fast results should happen. Hacks are appealing because they look like paths to prizes without the effort. Which, in the real world, rarely exists.
There’s a scene in Lawrence of Arabia where one man puts out a match with his fingers, and doesn’t flinch. Another man watching tries to do the same, and yells in pain. “It hurts! What’s the trick?” he asks. “The trick is not minding that it hurts”, the first man says. Another useful hack.
Risk and Luck
Risk means there’ll always be outcomes outside your control.
Not every poor investment is the result of a poor decision. No matter your strategy, investing is a game of probabilities. And even really high-probability bets won’t always work out in your favor. Just as you can be right for the wrong reasons, you can be wrong for the right reasons. … You can be wrong half the time and still make a fortune … You shouldn’t play Russian Roulette even if the odds are in your favor.
We lie to ourselves about risk.
Risk and luck are different sides of the same coin, but we treat one as critically important, and the other like it doesn’t exist – at least for you, when you succeed. This is partly about ego, but even more about the desire to identify patterns of what works, relishing the thought of repeating those actions to win again in the future. We love narratives that explain things, and the most comfortable narrative is, “I’m good at this and will continue to be good at it.”
Paying attention to known risks is smart. But we should acknowledge that what can’t see, aren’t talking about, and aren’t prepared for will likely be more consequential than all the known risks combined. That’s how history has worked.
There are normal consequences of risk, and then there are tail end consequences. The tails are all that matter.
In investing, the average consequences of risk make up most of the daily news headlines. But the tail-end consequences of risk – like pandemics, and depressions – are what make the pages of history books. They’re all that matter. They’re all you should focus on. We spent the last decade debating whether economic risk meant the Federal Reserve set interest rates at 0.25% or 0.5%. Then 36 million people lost their jobs in two months because of a virus. It’s absurd.
Tail-end events are all that matter. Once you experience it, you’ll never think otherwise.
Most economic data references “the economy,” in the aggregate or average. But no one lives in the economy. They live in their economy. And the difference between “the” and “their” is now enormous, and growing.
Pessimism comes across as smart because it appears to be cognisant of risks, appeals to those who believe that misery loves company, often provides a call for action, sounds like someone trying to help you, and is often based on an extrapolation of current trends. However, pessimists are the best indication of what’s unsustainable, and thus probably about to change, and thus the soil of what’s to be optimistic about.
Keep your eye on the ball. Don’t lose sight of what’s important.
An owner walks a dog on a generally predictable route, though along its way, the dog jumps around randomly, stops to smell leaves, and barks at other dogs. The owner and the dog in this scene can be analogised to businesses and markets respectively. What is surprising] is that almost all investors, big and small, seem to have their eye on the dog, and not the owner. As you navigate your life as an investor, pay more attention to the owner (businesses) and less to the dog (markets).
Options should always be weighed against their alternatives:
Awful decisions can be smart if the alternative is worse … Chesley Sullenberger intentionally steered an Airbus A320 into the Hudson River with 150 passengers onboard. Which is something you should never, ever do. Unless your plane has lost power and the only other option is to crash into the world’s second largest city. Then it is absolutely the best thing to do, and will turn you into a hero.
Another phenomenon that comes from not having perspective: thinking that you are right and others are wrong. The solution is to talk to other people, especially those you disagree with, and are in different emotional states than you are.
Congress has an 11% approval rating but an 85% reelection rate. How does that happen? It’s actually simple. Most people cannot stand Congress as a whole but like and approve of their local Congressman. In lots of areas of life, people’s basic psychology is to be optimistic about their own decisions but pessimistic about other people’s choices.[…] The root of so many investing problems is that people think errors, bad behavior, mistakes, and overconfidence applies to other people, but not themselves. Almost all of us think this way.
Being a contrarian is difficult. There’s a way to be contrarian, and you’re probably wrong about how to be one.
Everyone thinks they’re a contrarian. Which they can’t be, of course. By definition, most people are the consensus they think they’re outsmarting.
[…] It can’t be good because a false sense of contrarianism offers assurance that you are onto something others don’t see. What’s particularly dangerous is when you have support from others in the contrarian community – fellow New Yorkers, to continue the analogy. It’s the land of the free lunch: The power of feeling like a contrarian with the comfort and confirmation of peer support. And like most free lunches, it rarely exists.
The good news – the solution to the irony of contrarianism – is that deep contrarianism isn’t necessary to achieve good returns. A market that generally agrees with you can still offer a nice long-term return, especially if your edge is found in being more patient than the crowd, rather than trying to outsmart it. Too much effort is spent attempting to be contrarian for contrarian’s sake, when there’s plenty of room to get ahead being patient in a market where most people, most of the time, are pretty smart.
Bias and Worldviews
We used to think the universe revolves around the Earth. That changed. What remained the same is how egocentric we are. Here’s Morgan:
People believe what they’ve seen happen exponentially more than what they read about has happened to other people, if they read about other people at all. We’re all biased to our own personal history.
Things that happened a long time ago stay with us. Or as Morgan puts it, wounds heal but scars last.
There’s a long history of people adapting and rebuilding while the scars of their ordeal remain forever, changing how they think about risk, reward, opportunities, and goals for as long as they live. A study of 20,000 people from 13 countries who lived through World War II were 3% more likely to have diabetes as adults and 6% more likely to suffer depression. Compared to those who avoid the war, they were less likely to marry and less satisfied with their lives as older adults.
The biggest problem when analyzing the past is that you know how the story ends. That makes it impossible to put yourself in other peoples’ shoes and understand what they were thinking or feeling when they made decisions.
But it can be done if you give people the benefit of doubt.
Start with the assumption that everyone is innocently out of touch and you’ll be more likely to explore what’s going on through multiple points of view, instead of cramming what’s going on into the framework of your own experiences. It’s hard to do. It it’s uncomfortable when you do . But it’s the only way to get closer to figuring out why people behave like they do. Which is the puzzle we’re all trying to solve.
Acknowledging What You Don’t Know
‘I don’t know’ are three of the most underused words in investing. What’s really interesting about finance – and I think this is true for a lot of fields whether you’re in physics, math, chemistry, history, or whatever it is – the more you learn, the you more you realize how little you know.
Ignorance is bliss, illusion is not:
Daniel Kahneman’s book Thinking Fast and Slow begins, “The premise of this book is that it is easier to recognise other people’s mistakes than your own.”
This should be every market commenter’s motto. It is an unfortunate aspect of human nature that we do not have enough perspective on ourselves. Humans have developed a series of heuristics that make it for us, especially in a modern world, to see our own mistakes.
Ignorance sometimes leads to mass delusion:
The heart of pluralistic ignorance is having misperceptions about how others in your peer group think. And that’s usually what happens when you have a view about an investment that you assume isn’t held by a large percentage of other investors. Take the Berkshire Hathaway annual meeting, which is coming up next week. It’s 40,000 people, all of whom consider themselves contrarians. People show up at 4 am to wait in line with thousands of other people to tell each other about their lifelong commitment to not following the crowd. Pluralistic ignorance at its finest.
And perhaps the most important lesson of all – there are some things you can’t know.
Psychology Daniel Kahneman said something really smart the other day: “Whenever we are surprised by something, even if we admit that we made a mistake, we say, ‘Oh I’ll never make that mistake again.’ But, in fact, what you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising.”
Historian Niall Ferguson’s plug for his profession is that “The dead outnumber the living 14 to 1, and we ignore the accumulated experience of such a huge majority of mankind at our peril.”
Read more history and less forecasts:
Think of all the 2020 market forecasts published in December. Oof. Authors of these reports – most of which have been quietly removed – might say, “I couldn’t have foreseen Covid-19 in December, and it upended my entire forecast.” To which my response would be, “Yes, that’s my point.” If you claim an ability to foresee events, you can’t use events you didn’t foresee as an excuse – especially when unforeseeable events move the needle most. When a company reports poor earnings it’s often said they missed analysts’ estimates. But earnings don’t miss estimates; estimates miss earnings.
There are common themes across different fields:
There’s as much to learn about your field from other fields than there is within your field. Most professions, even ones that look wildly different, live under the umbrella of “Understanding how people respond to incentives, how to convincingly solve their problems, and how to work with others who are difficult to communicate with and/or disagree with you.”
You want to learn by reading, and you want to have lots of inputs and a strong filter when you read.
If you only pick up books you know with certainty you’re going to like you’ll confine yourself to reading the same authors on the same topics. It gives fresh oxygen to confirmation bias and limits your ability to connect the dots between different fields and different cultures. Once you’ve flooded your desk with inputs comes the filter. It should be ruthless, taking no prisoners and offering no mercy. Similar to dating, a book you’re not into after 10 minutes of attention has little chance of a happy ending. Slam it shut and move on. You’re not a failure if you quit a book after three pages anymore than if you reject the proposition of a 10-hour date with someone you just met who annoys you.
And then you want to synthesise what you read by writing:
Writing is the ultimate test of whether your thoughts make sense or are merely gut feelings. Feelings about why something is the way it is don’t need to be questioned or analyzed in your head because they feel good and you don’t want to rock the boat. Putting thoughts onto paper forces them into an unforgiving reality where you have to look at the words as the same symbols another reader will see them as, unaided by the silent crutch of gut feelings. It’s hard to overstate how important this is in an industry where distinguishing what’s true from what you want to be true determines a big part of success.
Even then, there are some lessons that are difficult to tease out.
So much of success relies on your ability to learn. But learning can begin with good intentions and quickly backfire, because what caused something to fail or succeed is often specific to one scenario and can’t be extended to other examples. It’s hard to learn whether a company was brilliant or stupid based on outcomes — and it’s even harder to extend those lessons to future investments — because so much of what happens at one company is specific to that company, not to mention driven by chance and odds that could have gone a different way. Part of the problem is that the traits needed for success are also the traits that get people into trouble.
The Power of Incentives
Perverse outcomes are caused by mismatched incentives:
We demand incompatible things. We wish that doctors would patiently and thoroughly listen to their patients’ concerns, but we also want cheap healthcare, and we also expect that doctors can run a financially-viable business. We want fund managers to take risks by holding more “active share”, but we don’t want occasions where the fund hugely underperforms for any given period. So something always gives way. Doctors interrupt their patients about 20 seconds after they begin speaking, and fund managers don’t hold the appropriate amount of “active share” for optimal fund performance.
Wanting and needing something to be true messes with your ability to gauge its potential. Take lottery tickets. Most are purchased by low-income households. Why are people who can’t afford lotto tickets more attracted to them than people who can? Perhaps because the poorer you are the more desperately you want to believe that a big, easy payout is around the corner. This is especially true if you feel you have no chance or desire to become a doctor or a lawyer or a successful entrepreneur. If you view a lotto ticket as your only path to riches, you become faithful. Big stakes, few options. This is your shot.
Want to influence behaviour? Change the incentives.
People want to be good. But if there’s a natural nudge toward being good, incentives are a gale-force wind. […] One of my unpopular views after the financial crisis is that people were too critical of “greedy bankers,” because critics underestimate their own willingness to sell subprime bonds if a $17 million bonus were dangled in front of them. That’s not an excuse for breaking the law or causing havoc. It’s an observation that many good people will break the law and cause havoc if the incentives are there.
Inertia and Change
Deciding whether to do something isn’t just about whether or not it’ll work. It’s not even about the probability of whether it might work. It’s whether it might work within the context of a reference point – some gauge of what others consider “normal” to measure performance against.
When something is familiar and common, you set a low reference point. So most bad outcomes are placed in the “oh well, you got lucky, next time you’ll do better” category, while most wins are placed in the “easy money!” category. When something is new or unfamiliar, you have no idea where the reference point is. So you’re cautious with it, putting most bad outcomes in the “I told you so” category and most wins in the “you probably got lucky” category.
[…] When something is new and unfamiliar, the high reference point means not only will bad outcomes be punished, but some good outcomes aren’t good enough to beat “par”. So even high-probability bets are avoided.
This is why adoption and not innovation is the problem to solve:
It was years after the Wright Brothers’ first flight before people paid attention, let alone considered flying. Same for the car, the telephone, the computer, the internet, the index fund, solar power, and virtually every other great technology you can think of. It usually takes more time to convince people that your technology has changed the world than it does to invent a world-changing technology. This is easy to overlook because we implicitly assume a technology began around the time we started using it. But most were created years, even decades, before they caught on.
Features, Not Bugs
Things that are undesirable to you may seem like unfortunate problems when they are really just normal byproducts of everything that’s going on. You expect it to come with the territory. They’re features, not bugs.
A problem happens when you think someone is brilliantly different but not well-behaved, when in fact they’re not well-behaved because they’re brilliantly different. What kind of 32 year-old thinks they can take on GM, Ford, and NASA at the same time? A freakin’ maniac. The kind of person who thinks normal constraints don’t apply to them – not in an egotistical way, but in a genuine, believe-it-in-your-bones way. Which is also the kind of person who doesn’t worry about, say, Twitter etiquette.
People love the visionary genius side of Musk, but want it to come without the side that operates in his distorted I-don’t-care-about-your-customs version of reality. But I don’t think those two things can be separated. They’re the risk-reward trade-offs of the same personality trait.
An advantage in one situation can become a disadvantage in another. The problem is that you can’t really change course.
Quitting – or adjusting, or changing paths – on top is so hard, because no one knows where the top is. But if there’s any reliable way to know when it’s approaching, it’s when your success pushes you away from doing things that had been fundamental to that success. This is so obvious. But it’s elusive because success has a tendency of blinding you to what caused it and how those causes have changed over time.
Combining skills (or skill stacking) is where you can get an edge quickly:
Few talented people get all their value from being great at one thing. Being so good at one thing that it’s enough to make you extraordinary is rare. More likely are people who are pretty good at a few things and combine those things to make a big leap into something great. Steve Jobs was a pretty good technologist and a pretty good designer. Neither on their own was exceptional. But the combination of the two was extraordinary, creating the bronze of our time. Same with Einstein, who mixed good math skills with a good imagination to create pure genius.
The key to business and investing success isn’t finding an advantage. It’s having a sustainable advantage. Something that others either can’t or aren’t willing to copy once your idea is exposed and patents expire.
The best investors make frequent use of a “too hard” pile when it comes to investing. One of the many things that investors like Morgan Housel have learned from great investors like Charlie Munger is how much investing performance can be improved by just avoiding some of the boneheaded mistakes made by other investors. For example, there is no shame in admitting that a given business can’t be valued. There are plenty of other businesses that are understandable which present investment decisions that are not very difficult. Most of the time what an investor should do is nothing. And there is no better time to do nothing than when something is difficult.
On this point Warren Buffett likes to say “I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over.” These 1-foot bar jumping opportunities with big financial payoffs don’t appear very often, but when they do, it is wise to bet big.
Fees are something you pay for admission to get something worthwhile in return. Fines are punishment for doing something wrong. Disneyland tickets cost $100. But you get an awesome day with your kids you’ll never forget. Last year more than 18 million people thought that fee was worth paying. Few felt the $100 paid was a punishment or a fine. The worthwhile tradeoff of fees is obvious when it’s clear you’re paying one.The trick is convincing yourself that the fee is worth it. There’s no guarantee that it will be. Sometimes it rains at Disneyland. But if you view the admission fee as a fine, you’ll never enjoy the magic.
The S&P 500 rose 22% in 2017. But a quarter of that return came from 5 companies – Amazon, Apple, Facebook, Boeing, and Microsoft. Ten companies made up 35% of the return. Twenty-three accounted for half the return. Apple alone was responsible for more of the index’s total returns than the bottom 321 companies combined. […] Amazon drove 6.1% of the S&P 500’s returns last year. And Amazon’s growth is almost entirely due to Prime and AWS, which itself are tail events inside a company that has experimented with hundreds of products, from the Fire Phone to travel agencies.
A takeaway from that is that no matter what you’re doing, you should be comfortable with a lot of stuff not working. It’s normal. This is true for companies, which need to learn how to fail well. It’s true for investors, who need to understand both the normal tail mechanics of diversification and the importance of time horizon, since long-term returns accrue in bunches. And it’s important to realize that jobs and even entire careers might take a few attempts before you find a winning groove That’s how these things work.
And remember, reading this means you belong to the only species out of 8.7 million on this planet that can read. And our planet is the only one out of 100 billion in our galaxy that we know has life. So just reading this article is the result of the longest tail you can imagine.
A job that pays $100,000 a year in a field you love will probably be more financially rewarding than one paying $150,000 in a field you don’t, because the job you’re only in for the big paycheck increases the odds you’ll burn out or get bored and need to find a new calling. What is the quit rate among lawyers and investment bankers? I don’t know, but it has to be huge. And both can be great experiences with transferable skills. But if you focus on the money – and many lawyers and investment bankers do – I wonder how many would be better off just starting in a field they love and won’t burn out on, letting their career blossom as contacts and niche skills compound.
The trick is getting the hard parts – the down years, the failed product launches, the emails asking for help – to feel like fees instead of fines. Fees are something you’re happy to pay because you know you’re getting something greater in return. Fines are things you should avoid, a feeling that you’re being punished and need to do things differently.
Whatever you’re doing, you better love it.