Nick Maggiulli writes this wonderful blog on personal finance using lots of data analytics. But this is a rare one that is less about data and more about the psychology of personal finance. He addresses a counter intuitive point about how as our wealth increases, our appetite for risk reduces. Shouldn’t we be able to afford to lose when we have enough to lose? He explains why not using two different lenses. First, the lifestyle lens: “….every step up The Wealth Ladder creates a sort of lifestyle floor that people don’t want to go below. For example, once you know what it’s like to not worry about grocery prices, you don’t want to go back to a world where you do.
….the more wealth you have, the more wealth you require for a large lifestyle change. Going from taking a bus/train to taking a plane might cost 1.5x-2x more depending on where you’re traveling. But going from flying first class to flying private will cost 10x more. It’s these exponential increases in cost for marginal increases in convenience that creates this step-like structure for wealth.
As a result, it becomes optimal to de-risk as your net worth increases. So while you can take more risk as you get richer, it doesn’t mean that you should.”
Second, through the work of the Nobel prize winning psychologist, Daniel Kahneman’s prospect theory: “…while the financial cost of a loss goes down with more wealth, the psychological cost goes up.…once you’ve won the game, the value of gaining a dollar plummets while the pain of losing a dollar soars. This is the fundamental principle behind prospect theory. Prospect theory states that people react to gains and losses asymmetrically. In other words, the pain of losing $100 is larger than the pleasure of winning $100, at least for most people.
And when you’re wealthier, it’s like prospect theory on steroids. If you had a $2M net worth, the pain of losing $1M is significantly larger than the pleasure of gaining an additional $1M. It might even be larger than the pleasure of gaining $4M.”
We would like to add to this – if the idea of life is to optimise for happiness, research shows that wealth as a factor of happiness plateaus beyond a point. When you have ‘enough’ to cover your needs, it is relationships, health and social support that drives the happiness quotient. It is a different matter that most of us struggle to know what is ‘enough’.
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Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
