Utility of wealth – a reflection on “rational” investing

Today a friend queried:

 “why should a fully rational investor, concerned only with growing wealth indefinitely over time (which is pretty much all investors) care at all about  short term fluctuations in their portfolio?”

Ignoring the question, I focused on what seemed like an odd premise – since when is growing wealth indefinitely over time the only thing which concerns investors?

This reflects a viewpoint, especially common in the economics profession, that the continuous positive utility of wealth is a valid foundation, not to be questioned. Not withstanding problems surrounding risk aversion, I have more basic reservations about this simplistic model of our utility-maximizing strategies in relation to investing.

Wealth,  in terms of money, and it’s growth, simply serves to buy us more experiences. (Material things are experiences too – shoes are the experience of not hurting your feet when walking on rocks, for example). Money is great because it is fungible, i.e. you can use it to buy most things/experiences, especially if you have lots of it.

But there are some things money can’t buy – for example, prestige, respect, affection, and pride. Or, more precisely, there are a some things it is more efficient to procure through non-monetary resources than through monetary ones. You have to remember money is just a medium of exchange, and the market price of the medium of exchange may not be the most efficient means of achieving your ends given your resources set.

Many people implicitly “buy” certain “experiences” with how they invest their portfolio. For example, they might “buy” the chance to beat the market by accepting higher fees from a more active manager. They might “buy” contentment or peace of mind by investing in a socially responsible fund, which makes them feel good about how they invest. They might “buy” entertainment or pride by trading actively themselves, with the goal of out-performing. In all of these cases they are exchanging potentially lower expected returns for a better investing experience. And if that is marginally more important to you than having even more money in the future, it’s a good deal.

Make no mistake, the only purpose of spending money is to make you feel good one way or another, and some investing habits are  just another way of finding a hedonic bargain.  Sometimes, more money is the least effective thing at making you happier.

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