- It is addictive to focus on portfolio optimizations, the next big thing that promises financial gain, or working long hours toward a promotion. Calling it addictive is not hyperbole. In a 2001 study using FMRI to measure brain activity, Hans Breiter and coauthors, including Daniel Kahneman found that obtaining more money activates the same regions of the brain as illicit drugs.
Maybe that doesn't sound so bad. More money is always better than less, right? Well, here's the problem.
From your brain's perspective, more money is always better than whatever you have today, even if you already have a lot of money. Knowing that more money is addictive and important question for every human investor to ask themselves is how much is enough? I would venture to say that enough is the amount needed to fund a good life.
But to fund a good life, we need to know what a good life looks like. I'm Ben Felix, Portfolio Manager at PWL Capital. In this episode of Common Sense Investing I'm going to tell you how the pursuit of a good life relates to your investment decisions.
(upbeat music) Money has the unique ability to move economic value through time. Money made from work done today can be used to fund spending in the future. Time and money are both finite resources that we have to make allocation decisions about on a daily basis.
There's no objectively optimal way to allocate time and money, but I'm going to argue that for human investors, these decisions should be anchored in the objective of living a good life. So we need to know how to find a good life. Fortunately, there is a substantial body of academic literature on this topic.
A large portion of happiness seems to be heritable. Meaning that in sample populations, environmental factors fail to completely explain differences in happiness. Martin Seligman who's credited with starting the field of positive psychology suggests a basic equation for human happiness.
Happiness equals your biological set point plus your circumstances, plus the factors under your voluntary control. Research and positive psychology has suggested varying levels of contributions from each of these items over time. The important insight for financial decision making is that your circumstances, your environmental and demographic factors, like where you live, your health, age, education, intelligence, and gender don't seem to matter all that much to happiness.
But your voluntary activities, how you choose to allocate your time and money, do allow you to exercise significant control over your happiness. Voluntary activities are more important than circumstances in explaining differences in happiness. The reason the circumstances don't seem to matter much is that humans are incredibly adaptable.
We adapt quickly to our circumstances, both good and bad. This doesn't mean that circumstances should be ignored altogether. In "The Happiness Hypothesis", Jonathan Haidt explains that noise, especially variable or intermittent noise, interferes with concentration and increases stress.
So living next to a busy intersection or otherwise noisy area may not be ideal. Commuting, particularly in heavy traffic, increases stress and is not easily adapted to. And being in control or even just the feeling of being in control increases happiness.
There's also lots of evidence documented in John Zelensky's book, "Positive Psychology" that living near and spending time in nature increases happiness. In broad terms, there are two types of happiness, experienced happiness, which is best described as good feelings and a reflective happiness or a life evaluation, which is best described as a deeper sense of fulfillment or being your best self. Good feelings like pleasure and comfort are referred to as hedonia.
For example, eating chocolate or petting a soft bunny can be hedonic. Hedonia contrast with eudaimonia, which was first described by Aristotle and is best translated to flourishing. Hedonia is relatively easy to think about.
You know it when you feel it. Eudaimonia takes more reflection and thought. One way to measure eudaimonia is using the Cantril Ladder.
Imagine a ladder with 10 steps numbered from zero to ten, the top step represents the best possible life for you and the bottom is the worst. On which step of the ladder do you feel that you are standing on. Eudaimonia is more about living well, while hedonia is more about feeling good.
Both Eudaimonia and hedonia are important aspects of a happy life, and neither are sufficient on their own. Together they result in a wellbeing. Martin Seligman proposed five distinct components of wellbeing in his five factor PERMA model.
Positive emotion, which is feeling good. Engagement, which is flow or being absorbed in a challenging task. Strong, healthy relationships.
Meaning, a sense of purpose beyond yourself. And accomplishment, achieving valued goals. Each of these elements is pursued for its own sake not as a means to an end, and is defined and measured independently of the other factors.
The PERMA model for wellbeing highlights that a happy life is more than experiencing pleasant feelings. This can be a challenge for humans because of our two speed brain. In "Thinking Fast and Slow", Daniel Kahneman delineates two types of thinking, system one and system two.
System one operates automatically and quickly with little or no effort, and no sense of voluntary control. System two allocates attention to the effortful mental activities that demand it, including complex computations. The vast majority of our daily decisions are carried out by our system one brains.
In "The Happiness Hypothesis", Jonathan Haidt uses the metaphor of an elephant, system one, and a rider, system two. The elephant responds to its surroundings and acts on animalistic instinct, including wanting to impress others and rise in the social ranks. The rider can think into the future, plan and learn, but it does not have full control over the elephant.
Our elephant wants to seek pleasure, avoid pain, and climb the social ranks. But the other factors in the PERMA model require the rider, who we have to consciously engage to moderate the elephant's behavior. The elephant seeks the kind of pleasure that comes from eating food or winning big on a stock pick.
But the actions that satisfy the elephant are often in conflict with flourishing. Enjoying too much food can lead to weight gain, and taking excessive risk picking stocks can lead to an unnecessarily wide dispersion of outcomes with a heavy skew toward negative ones. The relationship between our two speed brains, our five factor understanding of wellbeing, and how we use our time and money is critically important to financial decision making.
Letting the system one brain, the elephant, determine financial priorities may result in short term, experienced happiness at the expense of reflective happiness. We are willing to trade our time for money at work, but working harder for more money is not always an obvious trade off. In a 2018 paper titled "Happiness Income Satiation "and Turning Points Around the World", Jeb, Tay, Diener, and Oishi found using a global representative sample of over 1.
7 million people that the income satiation point for experienced happiness is 60,000 US dollars globally. And 65,000 US dollars in North America. Above this level of income, people in the sample did not experience more happiness.
Experienced unhappiness stops decreasing at $75,000 globally, and $95,000 in North America. For life evaluation, reflective happiness, the satiation points are $95,000 globally and $105,000 in North America. The authors of the study found in some regions, including North America, there is a turning point where life evaluation deteriorates with higher levels of income.
They speculate that the causation could be that high incomes are typically accompanied by high demands on time, which might also limit opportunities for positive experiences like leisure activities. Money can increase positive emotion, decrease negative emotion, and increase positive life evaluation. But in all cases, there is a satiation point.
And in a case of life evaluation, there's even a point where more income seems to be related to a decrease in happiness. To understand money's role and wellbeing, we can think back to the PERMA model. Money is a necessity to meet basic needs and reduce stress.
Both important for positive emotion. Money allows us to invest in skills, hobbies, and activities, driving engagement. Money affords shared experiences, memberships, and the time needed to build and maintain relationships.
Money frees up time to be involved in things greater than the self like family, politics, work, community, and social causes. And money can fund the path to achievement and mastery in sports, hobbies, or work. It's clear that money has a role to play, but it is a mistake to focus on money rather than what it affords.
In "Time Smart How to Reclaim Time "and Live a Happier Life," Ashley Whillans explains that people who value time more than money are likely to be happier, make more frequent social connections, have a stronger relationship with their spouse, and be more satisfied with their job. Valuing time over money is also prosocial. When we feel that we have more time, we are better able to serve other people, which in turn increases our own happiness.
Whillans argues that we're living in a time poverty epidemic. People who are time poor are less happy, less productive, and more stressed out. Some of the biggest causes of time poverty relate directly back to the pursuit of money.
People incorrectly believe that earning more money today will allow them to be happy in the future. And they tend to undervalue their time. Instead of being so willing to trade time for money, as many of us, are working less and trading money for time by outsourcing unpleasant tasks can increase happiness.
Gaining time affluence is important to a happy life, but what you do with your time also matters. Active leisure activities like volunteering, socializing, and exercising are related to happiness. Flow, the state of emergent in a task that is both challenging and aligned with your abilities is a state that many people value even more than pleasure.
The activities that tend to result in persistent happiness are not big, expensive, experiential, or material purchases. The best things in life really are free, or at least they're not luxury goods. This doesn't mean that all spending is bad.
The 2010 paper titled "If Money Doesn't Make You Happy "Then You Probably Aren't Spending It Right" by Dunn, Gilbert, and Wilson explains some of the biggest problems are our inability to make accurate, effective forecasts. And our tendency to adapt quickly to our circumstances. People are often wrong about what will increase their happiness in the future and for how long that happiness will last.
The authors offer some suggestions. Spending on experiences is more impactful to happiness than spending on things. People are happiest when they're engaged in what they are doing and experiences can provide this engagement.
Reflecting on past experiences enhances mood more than reflecting on past material purchases. And people tend to anticipate and remember experiences more than things. It's also harder to adapt to experiences than to things, since each experience is unique, while things are static.
Experiences are more likely to be shared with other people and strong relationships are important to happiness. Keep in mind though that while spending on experiences may be better for happiness than spending on things, the best experiences don't have to cost a lot of money. Another way to deal with hedonic adaptation is buying frequent small pleasures rather than fewer large ones.
Dining out, going for coffee, and getting a pedicure more frequently likely provides more happiness than buying lavish vacations. Spending on other people is another persistent source of happiness. We are hardwired to want more money and nicer things, but adaptation quickly leads to a desire for even more.
Happiness tends to stop increasing at moderate to high, but not unattainable levels of income. Valuing time over money, engaging in active leisure activities, finding flow, building and maintaining strong relationships, spending money on experiences rather than things, spending on other people, and indulging in frequent small pleasures rather than fewer big ones are principles that can lead to increased happiness. In "The Geometry of Wealth" Brian Portnoy summarizes what matters to humans as the four C's.
Connection, the need to belong. Control, the need to direct one's own destiny. Competence, the need to be good at something worthwhile.
And context, the need for a purpose outside one's self. Money plays an important role in underwriting a life with connection, control, competence, and context, but money is not itself the objective. Designing a happy life based on these principles might look a lot different from what many people would otherwise imagine when they sit down to make a financial plan.
The traditional idea of setting your financial goals based on some projected retirement date and a rosy vision of the future is a flawed process due to our weak ability to forecast what will make us happy in the future and our tendency to adapt to our circumstances. It is also problematic due to something called the progress principle. We get pleasure from making progress toward a goal and from achieving the goal.
But while progress toward the goal offers continued pleasure along the way, post goal pleasure is short lived. In other words, when it comes to pursuing goals, it is more about the journey than the destination. Further complicating long distance goal setting is "The End of History Illusion", documented by Quoidbach, Gilbert, and Wilson.
Personalities, values, and preferences change over time. But people tend to believe that they've recently become the person that they will remain for the rest of their lives. People believe that who they are today is pretty much who they will be tomorrow, despite the fact that it isn't who they were yesterday.
One way to address these issues is by inverting the goal setting process. Try setting anti-goals. What are the things that you don't want in your life?
Rather than looking far into the future and making sacrifices today to achieve a future life that you may not like as much as you had expected, it may be more sensible to design the life that you want to live today by finding ways to remove your least favorite parts. Make the journey more pleasurable, since it's hard to predict what will make you happy in the future. Before making any major financial decision, I think it's important to ask yourself how it will impact the five factors of wellbeing, both now and in the future.
Not all decisions will relate to all five factors and making decisions that prioritize one over the others is fine as long as you understand the trade offs. I can't tell you what choices to make or what to value, but thinking about the factors that enable flourishing can help you make more informed choices toward a good life that is aligned with your values and interests. Different people will derive wellbeing from the five building blocks in the PERMA model differently.
A good life for you is not necessarily a good life for me. The research discussion this video is designed to be descriptive of the factors that enable a good life, not prescriptive to tell you how to live your life. But understanding the research can help you make better decisions.
The practical implications of moving away from the objective of more money toward the objective of a good life could be things like scaling back an aggressive savings goal to instead pay for a house cleaner, taking a lower paying but more enjoyable job that results in daily states of flow, donating to local charities and volunteering time instead of going on lavish vacations, or sticking to a sensible diversified investment strategy instead of trying to hit the lottery with individual stock picks. Interestingly, eliminating work which is often the primary target of financial planning, may deserve more careful thought. In "The Happiness Hypothesis", Jonathan Haidt argues that love and work are two of the most important ingredients for human happiness.
Love and work are crucial for human happiness because when done well, they draw us out of ourselves and into connection with people and projects beyond ourselves. Planning to work longer at a more enjoyable job can have a big impact on things like the amount of saving and risk taking required to fund financial independence. None of this is static.
Despite what people tend to think, personalities, values, and preferences change over time. The pursuit of a good life is more about the journey than the destination, and financial decisions should reflect this. Thanks for watching, I'm Ben Felix, Portfolio Manager at PWL Capital, and this is Common Sense Investing.
If you enjoyed this video, please share it with someone who you think could benefit from the information. If you want to hear more about the relationship between time, money, and happiness, you can listen to my conversation with Dr Brian Portnoy on episode 102, and Dr Ashley Whillans on episode 143 of the rational reminder podcast.
