I just watched an outstanding TED talk by Daniel Gilbert, a professor of psychology at Harvard University, in which he discusses the science of happiness at some length. Watching this talk got me thinking about implications for investors in the stock market.
First, it is necessary to define terms. Gilbert contrasts two forms of happiness in his talk; these are natural and synthetic happiness. Natural happiness comes from pursuing something that you desire and then getting it. For example, your goal could be to attend Harvard University and use your studies to pursue a coveted career. If this goal is within your power, then pursuing and accomplishing it will grant you natural happiness.
Synthetic happiness, on the other hand, comes from being happy with what you get when you cannot control it. Perhaps your SAT scores and grades did not enable you to enroll at Harvard University, but you are willing to accept wherever you end up. Then you will experience synthetic happiness and this feeling of happiness could be just as real as the feeling of happiness from getting what you want. In general, we place far too many qualifications on things that must be accomplished in order to achieve happiness. Gilbert states that 90% of the time, achieving a major goal has little effect on our happiness only three months later.
It must be noted that: Freedom is the friend of natural happiness, but it is the enemy of synthetic happiness. In other words, when you are in control you achieve natural happiness by pursuing what you want. However, when you are not in control you achieve synthetic happiness by accepting what you get. The resulting conclusion is that we must accept what we cannot change, while burdening ourselves only when it is within our power to accomplish something.
Have you ever purchased something from a store and noticed that as long as you had the option to return it, you were never happy with what you had bought? For example, imagine you bought a video game, but you weren't sure if you wanted World of Warcraft or Donkey Kong. After reluctantly picking one at the store did you notice that as soon as you lost the option to return the game you stopped worrying about whether you had the right one, instead you were simply happy with what you had.
In a similar fashion, investors in stocks can be in a constant state of nervous uncertainty. Perhaps an investment in Coca-Cola (NYSE:KO) isn't the best way to improve my long-term purchasing power; maybe I should invest in PepsiCo (NYSE:PEP) instead? Alternatively, maybe the whole market is overpriced or the economy is about to fall off a cliff. This uncertainty could lead to happiness if you were able to come to a certain conclusion about what to do. However, due to the uncertainty of the market, it is most often impossible to know what the correct action is, particularly over short time horizons.
This leads to the conclusion that in order to maximize happiness investors should nearly always view the market as unpredictable and their investment decisions as unchangeable. It is only on rare occasions when asset prices are glaringly incorrect or the market is ignoring grave danger that an investor should take action by doing something.
Consider Warren Buffett as an example. Amazingly, his great wealth is due in large part to a relatively small number of investment decisions. Importantly, these decisions were made at times when solid stocks such as Coca-Cola or American Express (NYSE:AXP) were so glaringly underpriced that he took action by buying them. The remaining time he viewed the market as unpredictable and as a result there was no reason to take any action at all.
In a similar fashion, investors will achieve the maximum amount of happiness by viewing their past investment decisions as unchangeable for the vast majority of the time. Then they will simply be content and accept that the unpredictable nature of the market is not under their control. It is only on rare occasions that an investor needs to take any action at all.
At this moment there are a reasonable number of modestly valued companies with good fundamentals that could be purchased immediately if an investor wishes to put money to work in the market. Companies such as: AFLAC (NYSE:AFL), Discover Financial Services (NYSE:DFS), International Business Machines (NYSE:IBM), Kinder Morgan Energy Partners (NYSE:KMP) and Exxon (NYSE:XOM) are all wonderful businesses trading at low valuations compared to what they have enjoyed historically.
However, buying any one of these stocks today is not the only thing that must be done in order to be a successful investor. One must also hold the stocks until such a time when a rational decision would lead the investor to part with them. This decision could be due to valuation, business fundamentals or the macro economy, but it must be realized that many years could pass before the time to make this decision arrives. Until then the investor must be synthetically happy, realizing that the best kind of freedom is the freedom to do nothing at all.
Disclosure: I am long AFL, DFS, IBM, KMP, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Some of the positions above consist of options derived from the underlying security.