From the September 2007 issue of Investment Advisor • Subscribe!

Save Them From Themselves

Seems clients are really bad at predicting what will make them happy

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."

All of this means that most of us are struggling through life trying to recreate the highs and avoid the lows, both of which are unlikely to reoccur anyway, while overlooking the small, consistently good things we could easily give ourselves that would have a major impact on our happiness. Just thinking about it is enough to make me unhappy.

Bringing it all Back Home

Lamentable as this sangfroid is, you might ask, what's it got to do with financial advice? On one level, financial planners are already well aware of the fallibility of people's predictions about what will make them happy. How many initial client interviews begin with the question: "What I need to know is where to invest my money to make the highest returns." As if the highest possible returns were the key to their financial futures, much less their happiness. Much of financial planning, of course, is dedicated to refocusing clients on their true goals, their real needs, and minimizing the risks they have to take to reach them.

Gilbert's work also contains much that isn't so obvious. People almost universally believe having more money will make them happier, yet he tells us that study after study reveals that just isn't so. "Having money makes you happier when it moves you from poverty to middle class-from making, say, $10,000 a year to $50,000. Then you don't have to worry about your next meal. After that, every dollar increases your happiness much less than the dollar before it did. It's like feeding pancakes to a starving person. The first five are incredibly satisfying, but once you reach a point of satiety, the tenth pancake isn't making you that much happier than the ninth, if at all."

When you've reached far into the realm of diminishing returns, as have most clients (and most financial advisors, for that matter), it's a lot trickier to figure out what will bring us long-term financial happiness. The list of things with which we delude ourselves as being worthy goals is endless. In addition to just more money, and bigger jobs, we also turn to more, and better, stuff: bigger houses, cooler cars, more exotic vacations, hipper clothes, ritzier country clubs, the list goes on and on.

"Most people tend to spend their wealth in ways that don't maximize their long-term satisfaction," writes Gilbert. "They buy material possessions instead of fulfilling deeper, more profound needs, such as peace of mind or intimacy with a partner."

This is why the promise of financial planning--that is, real financial planning--is so attractive to people: It may not make you more intimate with your spouse, but it's all about peace of mind. You may not make your clients rich, but in the words of financial planning pioneer Jim Schwartz, you'll help them to realize they'll have "enough." Enough to cover their obligations to children and parents, and to not worry about where that next meal or rent check is coming from.

The Life Planning Thing

Gilbert's work also explains why the natural evolution of financial planning is into life planning. Veteran planners who have helped hundreds of clients travel confidently deep into the "enough" zone, began to realize that to help those clients attain higher levels of happiness required asking questions far beyond how to gather more assets. What could you do that would make you happier? Where would you want to do it? And, with whom would you want to do it?

He also offers some helpful insight for those who'd like to help their clients down the life-planning road. Because our brains overweight our memories with bad experiences, we tend to shy away from making changes in our lives that we might later regret. Studies show that most people say they will feel more regret if they take a chance and lose, than if they take no action.

But in the long run, Gilbert says, "What people regret most are the things they did not do. We tend to play it emotionally safe. We stay with the familiar, warding off our imagined regrets and often creating real lifelong ones." Perhaps the greatest value financial planners can give their clients is to help them sort out what will truly make them happy. And then encourage them to make the necessary changes in their lives to get there. Remember, it's not our peak experiences that ultimately make us happy; it's the small things, that experienced consistently bring us the greatest happiness. Like a good book that helps us to understand ourselves a little better, or a trusting relationship between a financial planner and his or her clients.

Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at rclark7000@aol.com.

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