Does money buy happiness?
Yes - and it's crucial to properly defining your goals.
Many individuals are facing challenging times given the rise of inflation. Living a comfortable life is getting more difficult. Investing can be used as a tool to combat the two ‘knowns’ we all face in the future. Inflation will continue to mean a dollar today is worth more than a dollar tomorrow. Increasing life expectancy means that you will have to sustain yourself for longer in retirement. Things will cost more, and for longer.
The notion of wealth maximisation is investing to have the most money possible. Many investors either subconsciously or outwardly have this goal. The pressure for higher returns becomes more acute during challenging times. This approach intuitively makes sense. Who wouldn’t want ot have the most money? The issue is that this strategy mostly leads to poorer outcomes. It is not the concept that is the problem. It is the behaviour that it encourages.
A logical extension of trying to have the most money possible is to chase returns. An investor trying to have the most money possible will constantly be searching for where the highest returns are and then moving money to that sector, asset class, product – whatever it is at the time. This is not a sustainable way to invest.
When so many people are struggling with cost-of-living pressures it is natural to think that life would be better with more money. I've been contemplating the financial pressures so many Australians are facing and the potential for this pressure to lead to poor investment outcomes. This train of thought leads me to thinking about the Easterlin paradox. The Easterlin paradox links wealth to happiness. Easterlin studied the correlation between money and happiness across multiple countries. He found that happiness increased up until a point – where more money didn’t equal more happiness. It held true across countries and cultures. People find happiness is where their needs are met, but as all income rises through the population, additional income does not contribute to happiness.
Other studies have shown that the majority of people would rather earn $50,000 a year while other people make $25,000, instead of earning $100,000 a year while other people get $250,000. This is assuming that prices of goods and services will stay the same.
It is easy to see how investing can be used as an excuse to speculate in the name of creating wealth. However, for me – the correct financial structures, building an emergency fund and investing for my future has been a tool that has helped me improve my quality of life.
Money can buy happiness
I recently had a few specialist doctor appointments – a reality of getting older. I was warned that it was going to be expensive – it ended up being $600 upfront with a 40% Medicare rebate the next day. This appointment had been booked earlier, so I had time to plan for the cost and understand I was going to be hit with the upfront expense when I got there.
I couldn’t help but think about the people who may feel compelled to put off these appointments because they can’t afford it. 3.7 million households ran out of food in the last year. It’s estimated that between 4% and 13% of the Australian population are food insecure. Those that are constantly thinking about their next meal would barely have the capacity to consider a $600 upfront cost for a non-urgent specialist appointment. I would’ve had to reconsider this specialist appointment for a large chunk of my adult life. I’m not alone.
The people that say money doesn’t buy happiness are those that already have enough. Many of the Australians who have experienced financial stress would agree that they would be happier if their bills were paid. Any Australian who has experienced coercive financial control would agree that they would be happier if they had the means to get themselves out of that situation. Any Australian who has a chronic illness and has to stagger specialist medical care would agree that they would have more peace of mind.
The easy answer to this is just ‘make more money.’ Of course, that is not feasible for the vast majority of us. If it were, we’d already be doing it. Making more money is impossible for those in retirement and living off a finite capital base.
How we know we’ve found the right balance
Many of us are not anywhere close to reaching the point in the Easterlin curve where we are not enjoying ourselves more from each dollar that we earn.
Defining your financial goals and costing them is crucial in meeting the balance between the risk you take in your portfolio and achieving your financial goals.
Sometimes, costing goals can be extremely difficult, especially costs far into the future. I’ve written about costing goals like healthcare in retirement before.
How to properly define your goals
We have written, presented and spoken (see below) extensively about defining goals. It is the first step in our four-step portfolio construction process:
1. Defining goals
2. Working out your required rate of return
3. Asset allocation
4. Selecting Investments
Constructing your portfolio in this way means that you have a structure and framework behind your investments. It discourages poor investor behaviour and gives you a north star that you’re able to use to understand whether you are on track to achieve your goals. It allows you to tie investments to your goals, and ultimately provide justification for whether you decide to buy, hold or sell. This is why goals are important. It means that you have structure around your decision-making process, and makes it less likely you will chase performance.
Purpose of the research
Morningstar has conducted new research that revisits the framework for the goal-setting process. Although the research focuses on how financial advisers can help their clients during the goal-setting process, there are lessons for self-directed investors as well.
The purpose of the research is to understand the best way to uncover financial goals.
Understanding your financial goals is paramount to being able to properly plan and invest for them.
Due to cognitive biases, people can be strangers to themselves and what you think may be a financial goal might not actually reflect your true motivation.
Research findings
When investors that took part in the study were asked outright to name their financial goals they tended to list common financial goals. For example, retirement or buying a house.
These are called ‘surface goals’. When investors were put through a framework to dig deeper for their goals – they ended up changing. The changes reflected their values like donating to causes that they believe in and maintaining relationships with family and friends. These are called ‘deeper goals’.
For example, a person’s original Surface Goal could be to buy a vacation home in Watsons Bay. Upon further review, this person’s Deeper Goal may be to spend dedicated quality time with their family, which they hope to achieve via the Watsons Bay vacation home. However, this same Deeper Goal can also be achieved by buying a much more ‘affordable’ house in Avoca.
Why you need to dig deeper for goals
The results showed that treating your goal setting as a multi-step endeavour can help you understand what you’re trying to achieve, and what is going to make you happy.
Instead of surface level goals. There are deeper motivators that will be uncovered. That is what an investortruly wants to achieve.
How to dig deeper for goals
Step 1: List your top three financial goals.
We suggest doing this privately, so you don’t feel anchored to what first comes to mind or embarrassed if you decide to change your mind later.
- Most important goal:
- Second most important goal:
- Third most important goal:
Step 2: Take a look at the master list of common financial goals.
Are any of the goals on the list important to you? Write down the ones that are.
- To be better off than my peers
- To pay for personal self-improvement (e.g., go back to school, learn a skill)
- To experience the excitement of investing
- To start a new business
- To buy a house
- To help pay for my kids’ college education
- To stop working and do something I love
- To go on a dream vacation
- To relocate in retirement
- To care for my aging parents
- To give to charity or other causes I care about
- To feel secure about my finances in retirement
- To feel secure about my finances now
- To leave an inheritance to my loved ones
- To retire early
- To pay for future medical expenses
- To not be a financial burden to my family as I grow older
- To manage my debt
Step 3: Look at your initial list and master list. Consider the goals you wrote down and the goals you checked. Of these goals, what are the top three? Write them down in order of importance.
- Most important goal:
- Second most important goal:
- Third most important goal:
Step 4 (optional): Revisit the master list of common financial goals and cross out the goals that are least important to you. Sometimes identifying what you don’t care for can help clarify what really drives you.
The results
In the study, 75% of people change at least one of their top three financial goals after going through this process. The findings of the study suggest that investors benefit from a structured process when they’re defining their goals.
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