I don't often review books in these pages. For one thing, there are better forums for such pieces, and for another, there are very few books in the advisory world worthy of an entire column. However, every now and again, a book from the broader world at large comes along that has profound implications for financial advisors, as well.
One such work was the mind-bending Freakonomics, by Steven Levitt, which I wrote about in July 2006.
Levitt is quoted on the cover of an equally important book that I've just read: Stumbling on Happiness, by Daniel Gilbert: "Think you know what makes you happy? This absolutely fantastic book will shatter your most deeply held convictions about how the mind works." Probably little more needs be said about a book than Professor Levitt's praise, but since I at least purport to know more about financial advisors than does a University of Chicago economist like Levitt, let me explain why you need to read Gilbert's witty and well-written book.
First, although it was published last year, Stumbling on Happiness is now on the New York Times paperback best-seller list, so it's now available at a reduced price for all you cost-conscious financial planners (if that's not redundant). Possibly more important, Harvard psychology professor Gilbert's book uses the latest empirical data to explain why people are woefully bad at predicting what will make them happy in the future. Call me crazy, but this just may have important implications for things like, well, financial plans.
I'll spare you the long version, which you can read for yourself when you get the book (Alfred A. Knopf, 2006). Here are the CliffsNotes. While Gilbert reckons that man (well, humanity) is the only animal that can think about the future, because that talent is relatively new on the evolutionary timeline, it's also rather imperfect.
The problem, it seems, starts with our memory. Contrary to what you might think, when we remember something, we don't just play back as one might an episode of "The Sopranos" captured on our TiVo. Instead, to save memory space, our brains only record the highlights: the unusual, the unexpected, or strong emotions. Then, when we want to remember, writes Gilbert, "Our brains quickly reweave the tapestry by fabricating–not by retrieving–the bulk of information that we call memory. In other words, we recall the best of times and the worst of times, rather than the most likely of times."
Need proof? Consider your feeling that when you have a choice, you always pick the slowest traffic lane, or get behind the slowest driver. Statistically, of course, that's not really true. It's just that those times are so painful that they're the ones that stick in our minds.
Past Performance Is…
Now, when we apply our faulty memories to consider what the future may be like, it's no wonder that we often get it wrong. That's because we're basing our predictions of what will make us happy (and unhappy) on the peaks and valleys of the past, rather than our most common experiences. Consequently, we're choosing actions today that we think will result in once again attaining those peak experiences, or avoiding those low lows.
This, of course, makes a certain amount of sense. Trying to recreate that hole-in-one or avoid retelling a tasteless joke at a dinner party are indeed worthwhile goals. The problem is that neither is particularly likely to happen again. Which means that directing our future strategy to hit risky shots at the hole, or avoid telling any jokes, has a far greater chance of creating the unintended consequences of raising our scores and getting us invited to fewer parties.
To make matters worse, Professor Gilbert also writes, "Studies show that it's the frequency–not the intensity–of positive events in your life that really leads to happiness." Or, presumably, the frequency of negative events, rather than their intensity, that makes us unhappy. As an example, he relates that while his appointment to the Harvard faculty brought him higher pay and more prestige, the thing about his move to Cambridge that's clearly made his life happier is his newfound ability to walk to work.
As for our aversion to the downside, he tells us that "research shows disabled people have about the same levels of happiness as other people. We underestimate how resilient and happy we can be when faced with misfortune."
