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My first book, The Psychology of Money, is 19 short chapters.
And I've been asked once or twice on different interviews, which one of them is my favorite?
And I think a lot of people in that situation would use the classic like oh, that's like asking me which one's my favorite child.
And for me, it's not that at all.
I know exactly which one of these chapters is my favorite because it had the biggest impact on me personally.
Like which one of these topics in my own personal life, when I'm managing money within my family, was the most influential to me?
And to me, it is the idea that we should not aim to be rational with our money.
We should just aim to be merely reasonable.
I'll tell you in a second where I first found this idea and why it was important to me.
But I think at a high view, let me explain this idea.
We are not machines.
We are emotional, screwed up, biased, hormonal humans.
And therefore nobody should expect that any one of us me you, anyone else can or should aim to be rational.
Like we just do what the spreadsheets tell us to do.
It's just not realistic for anybody.
And I think the person who says, oh, I'm very rational.
I am unemotional about my money is almost certainly lying, not only to you, but lying to themselves.
Let me tell you where I came up with this idea.
When it first sparked in my head, like, oh, okay, I'm starting to get it.
I see it now.
Julius Wagner Jarek was a 19th century psychiatrist, and he had two very unique skills.
One was he was very good at pattern recognition.
And the other was that what most other doctors saw as crazy ideas, he viewed as merely bold ideas that should be pursued.
Werner Jarek once noticed that his patients who had severe syphilis which back then in the 19th century was a fatal diagnosis with no treatment his patients tended to actually recover from it if those patients had the added misfortune of having some other very severe medical illness.
And what he figured out?
What he started to realize was that the reason these patients, who also had malaria or whatever it was, would recover from their syphilis is because they had, from their other ailment, severe fevers.
And those fevers were doing a lot of work in wiping out their syphilis.
Because we've known for a long time that fevers aid the body when fighting infection.
So, Werner Eurek jumped to the logical conclusion.
In the early 1900s, He would take his syphilis patients and he started purposefully injecting them with low-end weak strains of typhoid, malaria, or smallpox. with the idea that he was intentionally, on purpose, going to infect these patients so that they would have very high fevers once they were injected with malaria or smallpox.
And within a couple days or a couple of weeks, those very high fevers would help the body wipe out their syphilis.
And lo and behold...
It worked.
He showed in these studies in the early 1900s that syphilis, which went from virtually fatal for everybody if you infected them with malaria on purpose, 60 of those patients survived and were cured, which was an amazing therapy.
He called it malariotherapy.
He was literally injecting people with malaria to give them a fever to wipe out their syphilis, and it worked.
He won the Nobel Prize in Medicine in 1927.
Now...
Fast forward to today, and thankfully, mercifully, we have penicillin.
We don't need to inject people with malaria anymore to cure their syphilis.
We have other treatments.
That's gone.
It looks like barbaric medicine.
But Warner Urich was one of the first doctors back then or today, one of the only doctors, who recognized that fevers were so important in the aid of the body fighting infection that you should go out of your way.
You should want a fever.
It is rational to want a fever.
And we knew it then, we knew it today.
Fevers are great.
So then the question is, why was he such an oddball back then and today?
Why do no doctors today, not only do they not prescribe fevers, but if you have a fever...
Almost every doctor will say, take some Tylenol, take some Advil, wipe that thing out.
Fevers are bad.
We don't want them if we know they're helpful.
And look, I'm not a doctor.
If you are a doctor and you're listening to me talk here, I'm saying something wrong.
Feel free to reach out.
But I have a theory for why this is.
Why virtually every doctor today says, we don't want fevers.
Take Tylenol.
Get rid of it.
And the reason is that fevers hurt.
They're miserable.
You feel like crap.
You're shivering under a blanket.
You don't have a lot of energy.
They're no fun.
And so it is rational to want a fever to aid your healing.
It is not reasonable, because what a doctor wants to do is yes, cure your illness, but also cure your illness within the confines of what a patient is willing to tolerate.
And most people.
If they have a fever including myself and for my kids, of course they have a fever say look, even if this is helpful, I'm not willing to tolerate it.
Give me some Tylenol so I can stop shivering under a blanket.
Fevers are rational.
They are not reasonable.
And I think that idea that even if something is rational and the statistics tell you you should do it but it's not fun, so you don't because it's not reasonable that, I think is a very important concept in finance and investing as well.
My theory here is that most investment models, like from Wall Street and from academia, maximize for risk adjusted returns.
That's what they're trying to maximize.
But in the real world, virtually every investor, particularly individual investors, want to maximize for sleeping well at night and being proud of themselves in a very complicated world.
It's just like a different goal.
Wall Street wants to maximize for being rational.
And most people in the real world, if you actually dig into it, just want to be reasonable.
Harry Markowitz won the Nobel Prize in economics for exploring the mathematical trade-off between risk and return.
Many years ago, the Wall Street Journal asked him how, given his work, he had structured his own portfolio.
Like this is a guy who won the Nobel Prize for very complicated equations to maximize risk and reward.
And Harry Markowitz replied, quote I visualized my grief if the stock market went way up and I wasn't in it, or if it went way down and I was completely in it.
My intention was to minimize my future regret.
So I split my contributions 50-50 between bonds and equities.
Now that idea like minimizing my future regret is hard to rationalize on paper but it's very easy to justify in real life.
Like what is the mathematical equation or even the logic for minimizing future regret?
Like maybe you could put that into a formula.
But most people don't.
But in the real world, that's what you actually want.
A rational investor makes decisions based off of facts, but a reasonable investor makes them at the dinner table with your spouse, who you don't want to let down.
And I think that's okay.
That's real life.
It's better to embrace reality today than pretend it doesn't exist and be slapped by humility tomorrow.
Many years ago I interviewed Dr Daniel Kahneman, who passed away not too long ago, and he said something that really stuck with me.
I asked him.
I said what has been the biggest shift in your thinking after all your years of research?
And he said, quote, That's a hard one.
When I started in this line of work 40 years ago, I believe that imposing your rationality on thinking was a feasible objective.
I was a great believer in decision analysis and in systematic approaches to decision making.
And I believe that was going to happen.
And then it turns out that decision analysis has not conquered the world as I expected it to.
So from that point of view, I may have become a little bit more pessimistic than I was.
I really thought that you could improve your systems of judgment and of decision making fairly easily.
I still believe they can be improved, but I am less optimistic about it.
And so what I got from that?
What I think he's saying is getting people to be rational is extremely difficult.
It's very appealing the idea that oh, give people enough information in the right mental models and they'll make rational decisions.
Realistically, as I think Kahneman found over his 50-year career, it's just not like that.
There was a different time.
When I asked Kahneman in one of these interviews, I said how has studying behavioral finance and our biased decision-making over your career made you better at making decisions you personally?
And he was like, oh, it has not at all.
Because I think the reality of it is he and I and you and everybody has their own unique individual faults and biases and emotions and hormones that influence how we make decisions.
And therefore, we should not pretend that we can be rational.
Very important point I want to make here is, when I say we can't be rational, I'm encouraging you.
You should be reasonable.
You should not be unreasonable.
You know, I think a lot of people will use that idea of like, oh I'm not rational, so I can go day trade bankrupt penny stocks.
That's unreasonable.
That's not reasonable.
There is a boundary on accepting your own quirks and limitations that needs to be accepted.
Let me give you two examples of what I mean in finance when I say you should just aim to be reasonable.
There is a very well documented in investing trend which is called the home bias, which very simply states that most American investors only own American stocks.
Most German investors only own German stocks in Japan.
They almost always own Japanese stocks, et cetera, et cetera, et cetera.
It is not rational at all to assume that the best stocks that you should own are the ones that are located closest to your house.
That's not rational in the slightest.
It doesn't make any sense.
It's very reasonable, though I think that if it makes it easier for you to take the leap of faith, it's going to make it easier for you to hold stocks for the long run if you are familiar with them.
And you're familiar with them because you drive past their headquarters or their locations every day on your way to work.
That's actually very reasonable.
It's not rational to say that you should own stocks just from your country, but it is a very reasonable thing to do because you and I, if you're from the United States, you understand Coca-Cola and Apple and Tesla.
You see them.
You might own them.
It is much more difficult to understand, you know, some Italian bank that you've never heard of.
Even if that bank is a very good investment, it might be, but I don't know anything about it.
It's very reasonable to only own stocks that are in your country, because those are the ones that you understand the most.
One other very personal example of this, and maybe this was why the chapter had such a big impact on me.
I wrote about this in my book and wrote about it many years ago.
In 2017, my wife and I paid off our mortgage, which was, I think, the worst financial decision we've ever made.
But I would describe it as the best money decision that we've ever made.
Let me explain to you my thinking.
At the time, our mortgage was a 3% fixed rate mortgage for 30 years.
Absolutely unbelievable.
People look at that today and salivate.
And we knew it at the time that that was amazing.
To be able to borrow money for 30 years at 3% feels like free money.
It was amazing.
And paying it off was a bad decision financially on a spreadsheet because I know I knew then and it was played out by history that we could have invested that money and earned a much higher return.
So rationally on a spreadsheet makes no sense, not rational.
It was still an amazing decision for us at the time.
And what is this?
It helped me sleep at night.
I loved the feeling at the time, back then and today, of being a sole breadwinner, of knowing, if something happens to me, my wife and kids are going to be okay.
This is our house.
This is not the bank's house.
You can't put that on a spreadsheet.
But it makes me feel great.
And still to this day, on the first of the month when a mortgage payment would normally be due, I have the sense of just like, ah yes.
I love that feeling.
And...
And it's not rational at all.
It is not rational in the slightest.
And so many times over the years when I, when I bring that up, some people will still try to get me in a corner and be like well, explain to me, like it doesn't make any sense, why you did it.
And I'm like, I know.
I know it doesn't make any sense.
That's the point.
Like it's not rational.
But I think it is not only reasonable, it was like spectacular for my family and I to do.
Almost without a doubt, it has been one of, if not the best uses of money that we've ever used.
And rationally, it makes no sense.
The only other analogy I can use to that is it's the same feeling that I get when I have a fever and I take Tylenol.
I feel great.
I'm so grateful for the medicine.
And it's not rational all at the same time.
That was our personal example, but I think everybody has some version of that, regardless of what it might be.
It's not rational to spend this much on travel.
Yeah, but you'll love it.
It's not rational to spend so little on housing.
Yeah, but you don't value it.
There's all these things.
That's like you can't explain it on a spreadsheet, but it makes perfect sense for you and your family.
One other thing that I do with my money is I hold quite a bit of cash.
More, not a crazy amount, but I don't know, what is it?
Maybe 20% of my net worth, something like that.
Almost every financial advisor would look at somebody my age and income and say you don't need to do that.
You can be more aggressive with your investments.
And I'm like, yeah, I know, but...
I think I've gone out of my way to try to understand my own personal risk tolerance, my family's risk tolerance, what our actual goals are, and just come to this conclusion of like, I'm not trying to be the world's greatest investor.
I'm trying to use money as a tool to help me sleep at night and live a better life.
I'm trying to use money as leverage to become the person who I want to be to spend more time with my kids and whatnot.
And I'm not trying to maximize the capital asset pricing model.
I'm just trying to use it as a tool to live a better life.
And that situation, having that much cash works for me.
I'm not saying it's rational.
I'm not saying you should do it.
I'm just saying it's reasonable within the confines of what I want out of money.
And everybody has something like that.
Daniel Kahneman's best work was documenting what he called loss aversion, which is the idea that people hate losing money more than they enjoy winning.
And I asked him, is that rational?
And he said, quote, well, that's a complicated issue.
If it's rational to live with whatever your nature is and to try to enjoy life as much as possible, then loss aversion is just a fact of life, like regret.
He said you may think that regret is a foolish emotion, but if you know that you're going to be susceptible to regret, it is not irrational to anticipate it and to act accordingly.
And that I think is very reasonable.
That's it for this episode.
Thanks again for listening and we'll see you next time.
