“Irrevocable” Portfolios

“Irrevocable” Portfolios

On the Hidden Brain podcast titled You 2.0: Decide Already!, Shankar Vedantam interviewed Harvard University psychologist and author Dan Gilbert.  They open with the observation that humans are the only species that think about the future and the cause and effect associated with our choices.

More specifically, we think about which choices will make us the happiest.  The problem is, we aren’t very good at predicting the future or what level of happiness will be attained by making said choice.

In fact, according to the research that Dan and his team conducted, simply having choices at all can decrease our level of happiness.

Here is an excerpt from the interview:

VEDANTAM: You once subscribed to the very popular belief that, I think, I still subscribe to – that more freedom always equals more happiness. And if I remember correctly, you conducted a study once that found that this wasn’t quite right. And at the time, I think, you told me that you’d been living with your girlfriend for more than a decade. And you saw the data, and you decided to make some changes in your life.

 

GILBERT: (Laughter). You have a very good memory. So, like many people, I used to believe that the more freedom, the better. How could you be less happy when you had more choices?  Well, we know now a lot about why more choice sometimes makes people less happy. In our study, we brought students in, and we created a photography course. And we had all of them work with us for a long time learning how to do black-and-white photography.

Then, at the end of the course, we gave them two photographs that they had taken. And we said they could keep one and we were going to keep one. Well, this was horrible for them. They wanted to keep both. They had a tough decision to make. In one group, we said, if you ever change your mind about which photograph you want, just let us know. We’ll swap with you. We’re going to keep this on file forever, so if took A, and you want B, we’ll swap B for A, for as long as we both shall live. Another group was told your decision is final. Once you make this decision, the photograph that you’re donating to us gets sent off to England. It’ll never be seen again.

 

VEDANTAM: And, of course, if you presented those choices to me, I would say I would want to be in the first group because I would preserve my options. If I took a photograph home and didn’t like it, I could come back and trade it in for the one that I did like.

 

GILBERT: Exactly, and that’s not even just a good guess. We actually did exactly that in another study. We asked people which group they wanted to be in. And just like you, they overwhelmingly want to be in the first group. But what’s interesting is we tracked the happiness of the people who had made these decisions over the course of several weeks. And what we found is that people who made an irrevocable decision – one they couldn’t change – were much happier with the choice they made. When you’ve made an irrevocable decision, you rationalize it. Once something’s gone and gone forever, the mind gets to work figuring out why what it got is really better than what it lost.

 

But when a decision isn’t irrevocable, when you can remake it and revisit it and change your mind any time, what do you do? You just ruminate about it, right? You buy a sweater and you know you can take it back any time. And every time you put it on, you look in the mirror and you think, oh, I don’t know. Maybe it’s not a good fit. Maybe it’s not a good color. Maybe I ought to bring it back. On the other hand, if this sweater was bought at a place that won’t take it back, you look in the mirror and you say, gosh, that looks good.

This got me thinking about the idea of irrevocable portfolios.   More specifically, whether people would be happier with their portfolio if they were unable to change it and a byproduct would be better performance.  (You’d obviously have to be able to change it occasionally as actual needs change.  I’m referencing irrevocable with exception of significant life events or perhaps just once per year.)

Most readers of this site know that the more you change your investments, the more likely it is that your portfolio will underperform.  So, this strategy could at least reduce/eliminate the behavioral drags on performance.

So, this just leaves us with the first question about happiness.  If the investor is initially comfortable with the portfolio knowing it’s in line with their financial plan, would the inability to changes the portfolio cause less worry and additional happiness?

If so, what would cause this additional happiness?  Would it be due to the hypothetical better return?  Or would they be happier in general since there would be no opportunity cost associated with other investments?  Or would their happiness increase simply because there is nothing they can do about it and therefore spend that time doing something else?

Do we stress more about market downturns simply because we’re able to make changes to our portfolio and therefore the line of thinking becomes coulda/woulda/shoulda?  When we look in the rearview mirror of our portfolio, the decisions are obvious.  Not so much in real time.  So often, it seems we look at our portfolios because we believe there is something we should do rather than just sitting there.

If you were unable to change the investments, would you spend the time you’d ordinarily spend worrying/looking at your portfolio with your children/grandchildren instead?  I’d like to think it would cause a ripple effect of positivity.

I’m not sure how you’d test this theory in the real world, but if this argument has merit, how might you implement this strategy?  You could consider scheduling a recurring date with yourself or your advisor once per year to review and only at that time make changes to your portfolio.

So, once you’ve set up a portfolio that is in line with what your financial plan calls for, consider making it irrevocable except once per year or until there is a significant life event.

Would investors pay for what is essentially less flexibility?  It seems so counterintuitive, but if it led to more happiness and better returns, would it be worthwhile?

This is not a post to encourage ignorance about your portfolio, but simply an idea that could encourage better behavior and perhaps a happier life.  I think there is definitely some value in this strategy, but getting investors on board with such a philosophy might be a bridge too far.

Certainly, an interesting podcast listen.  Only about 25 minutes if you’re interested.

Dan Gilbert also wrote the bestseller Stumbling on Happiness.

 

 

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