Money is a part of everyone’s life, yet the way we handle it is often driven more by emotions than by logic. **Morgan Housel**, in his book *The Psychology of Money*, explains that financial success is more about how you behave than how much you know. This simple truth means that understanding the psychology behind our money decisions can help us make better choices with our finances.

1. Emotions Over Logic: Why We Don’t Always Make the Best Decisions

While it’s easy to believe that good financial decisions come from understanding markets or following expert advice, the truth is often different. Studies show that most people make money decisions based on emotions—such as fear, greed, or optimism—rather than facts. For instance, during the 2008 financial crisis, many people sold their investments in panic, locking in their losses, only to miss out on the recovery that followed.

According to research from Dalbar, the average investor significantly underperforms the market largely because of emotional decision-making. Over a 20-year period ending in 2020, the average equity fund investor earned just 7.7%, while the S&P 500 averaged 10.7%—a gap driven by behaviour, not market performance.

2. Compounding: The Power of Patience

One of the most powerful concepts in building wealth is compounding—earning returns on your returns. Yet, it’s often overlooked because the benefits of compounding take time to become visible. As Morgan Housel notes, “The single most powerful factor in investing is time.” The key to unlocking compounding is patience, something that is difficult for many because of our natural desire for quick results.

Warren Buffett, one of the world’s richest people, accumulated a significant portion of his wealth later in life. As Housel highlights in *The Psychology of Money*, if Buffett had started investing at 30 instead of 10, his net worth would be just a fraction of what it is today.

3. The Role of Risk and Uncertainty

We often misinterpret or underestimate the risk involved in financial decisions. Our minds are wired to avoid losses, which explains why people are more emotionally affected by a £100 loss than by a £100 gain. This psychological bias, called loss aversion, leads people to make overly cautious choices, often leaving potential gains on the table.

In reality, managing risk is about understanding your goals, timeframe, and the potential ups and downs along the way. Financial success is not about avoiding risk, but about taking the right risks. As Housel explains, “Risk is what’s left over when you think you’ve thought of everything.”

4. Social Comparison: The Thief of Financial Happiness

A common pitfall many fall into is comparing themselves to others, whether it’s the neighbour with the new car or the friend who brags about a successful stock pick. This can lead to financial stress, overspending, or investing in risky assets just to “keep up.” But as studies show, the joy we feel from financial success diminishes quickly when we compare ourselves to others. According to research published by The New York Times, most people’s happiness plateaus after an annual income of about £70,000. Beyond that, increases in income do not significantly improve life satisfaction.

5. The Importance of a Long-Term Mindset

A key takeaway from behavioural finance research is that having a long-term mindset can help you weather market volatility and avoid emotional reactions. As Housel notes, “Being rational with money means not just making good decisions but being able to live with the decisions you make.”

Financial planning, budgeting, and long-term investing strategies are not just about maximising returns—they are about creating a life where money works for you, not the other way around.

Conclusion: Managing Your Financial Behaviour

The psychology of money reveals that your financial behaviour plays a bigger role in your wealth than your level of financial knowledge. Understanding emotional triggers, recognising the power of patience and compounding, and staying focused on long-term goals can help you make better financial choices.

If you can start managing your behaviour with money, you’ll find that it becomes easier to build wealth, reduce stress, and reach your financial goals with confidence.

References:  

• Housel, Morgan. The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness. Harriman House, 2020.  

• Dalbar, Inc. “Quantitative Analysis of Investor Behavior 2020.”  

• The New York Times. “How Much Money Do You Need to Be Happy?”, 2020.