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OPINION

A Christmas message

A Christmas message
December 18, 2014
A Christmas message

The trouble with Christmas is simple. The gifts we give to others are worth less to them than the money we spend because we buy stuff they don't want: "bath salts - how nice". Exchanging gifts therefore destroys value. Joel Waldfogel at the University of Minnesota has estimated that in the US 18 per cent of the money spent on Christmas presents is wasted and in Europe around 9 per cent is. With around £6bn likely to be spent on presents this year, this implies that around half a billion pounds of value will be destroyed.

And Indians shouldn’t feel smug: the same is true for Diwali gifts.

From a narrow economistic point of view, Scrooge was right: "What's Christmas to you but a time for paying bills without money; a time for finding yourself a year older and not an hour richer?"

But, of course, Scrooge was a fool. He failed to see that money isn't everything, or even the main thing. Modern economics has confirmed this. It has found that although money does buy happiness, it does so to only a limited degree. Friends and family matter more. Nick Powdthavee at the London School of Economics has estimated that a good social life can raise well-being by as much as an extra £85,000 of annual income - three times as much as the average wage.

From this perspective, Christmas makes economic sense even though it costs money. It's a time for paying attention to friends and family - the things that really make us happy.

There's more. Not only does the narrow-minded pursuit of wealth not make us much happier, it might not even work in its own terms, because it might not maximise our wealth either. As John Kay points out in Obliquity, our objectives are often best met not by pursuing them directly but by aiming at other things instead. The world, he says, is just too complex for us to calculate a direct route to riches.

There are (at least) three ways in which this is true for retail investors.

One is that not paying attention to the stock market can protect us from what Richard Thaler and Shlomo Benartzi, two US economists, have called "myopic loss aversion." The idea here is that your chances of losing money on shares diminish as your time horizon increases. For example, there's almost a 50-50 chance of the market falling in any one day even if annual returns are a healthy 5 per cent. But there's only around a 36 per cent chance of a loss over two years and a less than 25 per cent chance of a loss over five. Granted, the chance of a big loss increases over time; shares are unlikely to fall 20 per cent in a day but can easily do so in a year. But, say Benartzi and Thaler, for some types of attitude to risk, shares are more attractive over long horizons than short ones.

This implies that if we look at the market every day we'll infer that it’s a bad investment whereas if we look only occasionally, we'll infer that it’s a better one and so will be more likely to invest in equities.

In this sense, someone who spends their time thinking about things other than the market might well end up with a better asset allocation than someone who obsesses over market moves.

This is true in another way. Because equities are volatile and (largely) unpredictable, a huge chunk of news about them is noise rather than signal. If we pay close attention to the market we might therefore trade not on genuine information but on mere wind. Brock Mendel and Andrei Schleifer at Harvard University have shown how this can cause investors to buy over-priced assets. And economists at the University of Mannheim have shown how it leads investors into poor-performing but high-charging funds, as they mistake luck for skill.

Someone who doesn't think about investing but merely leaves their money in tracker funds can therefore do better than one who tries to beat the market. If you pay attention to day-to-day talk about the market, you might well sell when shares are cheap - because that's when everyone is gloomy - but buy when they are expensive because that's when everyone cheerful.

There's more. Being unhappy is itself a cause of bad financial decisions. Sadness makes us impatient and thus encourages us to spend more and save less: it's called retail therapy for a reason. This implies that if we can make ourselves happy by having good friends and family and rewarding work and leisure interests we will protect ourselves from some bad decisions. If money can't buy happiness, happiness can buy money.

Sadly, however, things aren't quite so simple. The investor who doesn't pay attention to the market might also be ignorant of the basic principles of investing, which could be expensive unless he trusts his money to tracker funds. Happy investors are also apt to be over-confident and so prone to over-invest in risky stocks and to over-estimate their chances of spotting good stocks and funds. And the investor with a good social life might spend too much in an attempt to keep up with the Joneses and be misled into poor investment decisions by peer pressures.

There are two points here. One is that investing is part of life. What we do when we are not investing - how we feel, how much time we think about other things, what sort of social life we have - can colour our investment choices for good or bad. The other is that we might be able to make better investment decisions by pursuing objectives other than money. In this sense, there is an investment message when I wish you a happy Christmas.