The Psychology of Money
For this week’s PIO, we switch gears from our usual market and economic focused material to look at personal finance, specifically the role of emotion and behaviour in our financial lives. The study of behavioural finance takes the insights of psychological research and applies them to financial decision making. The field assumes humans are irrational (we often act on emotional and cognitive biases). We want to identify areas where our emotions can impact financial decisions. Once acknowledged, we can adapt behaviour to improve economic outcomes and life satisfaction. In this write up, we look at two approaches aiming to achieve this.
Saving Example: Pre-Authorized Contributions (PACs) Many clients will have heard this term mentioned in conversations with our team. PACs systematically transfer a pre-specified amount from your bank account to your investment account on a set frequency (e.g., bi-weekly). PACs put your savings on autopilot, taking the decision making and emotions of market timing out of the picture. Aligning PACs with paycheques further reduces the risk of spending money intended for savings. As the inflows land in your portfolio, the cash is then invested. This results in Dollar Cost Averaging (purchasing an investment periodically regardless of recent price movement) and removes any consideration of market timing. Figure 1 displays hypothetical monthly purchases of Apple Inc. (AAPL) since 2021 at various prices.
Spending Example: Many Small Purchases Over Few Big Ones In the 2011 paper If Money Doesn’t Make You Happy, Then You Probably Aren’t Spending It Right, the authors Dunn, Gilbert, and Wilson provide eight principles designed for consumers to find more happiness when spending their money. The third principle asserts “by purchasing many small pleasures instead of a few big ones, we will be happier.” Initially, this may seem counterintuitive. After all, we often look forward to big purchases such as a new car or a lavish vacation. The authors argue that human adaptation is inevitable. This causes large expenditures to lose their shine sooner than anticipated, whereas smaller purchases offer more variety and less adaptation. For example, instead of purchasing an expensive sofa to maximize happiness, we could be treating ourselves to drinks with friends more often.
“This means that” we should look to identify the emotions associated with saving, spending, and investing money. There is an opportunity to improve financial wellbeing and happiness by planning for the emotions and resulting behaviours. If you are interested in setting up a PAC or discussing spending and happiness, please do not hesitate to contact me. PAML mainline: 604 682-7312.
Citation
Dunn, E. W., Gilbert, D. T., & Wilson, T. D. (2011). If money doesn’t make you happy, then you probably aren’t spending it right. Journal of Consumer Psychology, 21(2), 115–125. https://doi.org/10.1016/j.jcps.2011.02.002
National Instrument 31-103 requires registered firms to disclose information that a reasonable investor would expect to know, including any material conflicts with the firm or its representatives. Doug Johnson and/or Pathfinder Asset Management Limited are an insider of companies periodically mentioned in this report. Please visit www.paml.ca for full disclosures.
*All returns are time weighted and net of investment management fees. Returns from the Pathfinder Partners’ Fund and Partners’ Real Return Plus Fund are presented based on the masters series of each fund. The Pathfinder Core: Equity Portfolio and The Pathfinder Core: High Income Portfolio are live accounts. These are actual accounts owned by the Pathfinder Chairman (Equity) and client (High Income) which contain no legacy positions, cash flows or other Pathfinder investment mandates or products. Monthly inception dates for each fund and portfolio are as follows: Pathfinder Core: Equity Portfolio (January 2011), Pathfinder Core: High Income Portfolio (October 2012) Partners’ Fund (April 2011), Partners’ Real Return Plus Fund (April, 2013), and Partners’ Core Plus Fund (November 2014).
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