Let me ask you a question.
Why is wealth important to you?
The most superficial answer which would be universal to everyone, is that we never want to find ourselves in a situation where we have too many bills and a lesser amount of cash.
Dig deeper.
It could be because of the freedom it gives you to decide how to spend your time. When Billionaire Mark Cuban bought a private jet for $40 million in 1999, he said it was a “life and game changer”, because the asset he values most is time, and that purchase bought him time.
I know a couple who have no children, and they want to amass a great deal of wealth to give them a sense of security as they age.
It could be the chance to give your children opportunities you never had. The confidence that you can live in dignity or luxury. A sense of achievement and worth and status. The ability to help the less fortunate.
Behavioural finance expert Meir Statman says that there are three types of benefits people always search for. This is across activity, product and service.
Utilitarian: What does it do for me?
Expressive: What does it say about me?
Emotional: How does it make me feel?
People express themselves in the houses they own, the cars they drive, the clothes they wear, the accessories they buy, where their children study, and the list goes on and on. Let’s look at a few.
The Alberto Culver Natural Silk Shampoo advertising slogan was We put silk in a bottle. The shampoo actually contained some silk threads, but a company spokesman conceded that silk does not really do anything for hair. Statman believed that this probably made the product more valuable in the eyes of the consumer by adding expressive and emotional benefits to their utilitarian benefits. All shampoos deliver the utilitarian benefits of clean hair, but those who use Alberto Culver’s shampoos also reap the emotional benefits of believing their hair is silky (despite the possibility that the product makes their hair no silkier than that of people who use a generic shampoo.)
L’Oréal’s slogan, Because I’m worth it, instead of masking its beauty products’ prices, celebrates their prices, highlighting the expressive and emotional benefits of expensive products as symbols of high self-worth. Regarding the slogan, L’Oréal’s global brand president was quoted in an article as saying, “This is a celebration of self-esteem and confidence and what we think beauty is.”
In an advertisement for Patek Philippe watches, a handsome man stands next to his son in a luxurious setting, with the following caption: You never actually own a Patek Philippe, you merely look after it for the next generation. The expressive benefits of Patek Philippe watch ownership include an expression of refined taste and high social status. The emotional benefits include fulfilment and pride.
Owning a house is different from renting a house, even though in both cases you'll have shelter. There is an emotional and expressive benefit in ownership – pride. “I am a homeowner. I might have a mortgage on it, but I own the place.” That status is dear to many.
Alternatively, an individual may choose to stay in a plush locality. One that he cannot afford to purchase a house in, but can afford to rent. Because the address matters.
Houses are both, a consumption good and an investment, and have expressive and emotional benefits.
The benefits of jobs extend beyond the utilitarian benefits of money, to include expressive and emotional benefits. We express our identities in our jobs, whether a professor, policeman, technician, or physician. We take pride in accomplishments, find satisfaction in contributions to society, and enjoy memberships in communities of colleagues and friends. We lose more than money when we lose our jobs. We lose parts of our identities, pride in our accomplishments, and membership in our communities.
The benefits of investments, like those of jobs, extend beyond the utilitarian benefits of money to include expressive and emotional benefits. We express parts of our identities in our investments, whether those of a retirement saver, a day trader, a socially responsible investor, or an art collector. And we derive emotional benefits and suffer emotional costs from our investments, whether pride or regret, hope or fear.
Investing in hedge funds gives us a feeling of status and makes us feel proud. In a gathering, it is socially unacceptable to introduce yourself as a rich man, but if the conversation is around investments, you can drop the fact that you are into hedge funds. That of course will indicate that you are a reasonably rich man, because not everyone is eligible to be a qualified investor who is allowed to buy those hedge funds. That is the expressive benefit – you can hint that you are a rich man without saying that.
A young person may invest in a target-date fund. There is an emotional benefit, because this approach boasts simplicity, there's not as many decisions that have to be made, and that's comforting. With a target-date fund they gain utilitarian benefits and at the same time, they have a sense of calm that they are on their way to doing the right thing.
Insurance policies give us a sense of security and make us feel safe.
People buy lottery tickets because they cling to the hope of getting rich. The group that buys the most tickets or most frequently are people between the ages of 60 and 69, perhaps because this is an age where they realize that they cannot become physicians now or start the next Google, so their chance really is in winning a lottery. Suppose you told a lottery buyer that the odds of winning are not 1 in 100 million as he thought but 1 in 200 million. It would make no difference to him. He would still buy the lottery. It is just that smidgen of an opportunity between no chance and some chance that is giving people that urge to buy lottery tickets.
A lottery ticket has an emotional benefit (hope), an expressive benefit (I am a player, I'm in the game), and a utilitarian benefit (you might actually win).
How does this apply to you?
Answering the three questions (Utilitarian, Expressive, Emotional) will help you come to terms with your financial behaviour.
Meir Statman talks about a lady who had saved ample money to retire at age 60. Her saving and spending ethos derived from a poor childhood. She was always afraid that she would end up living in a box eating cat food. Her personal statement was “By nature, I’m risk averse.” That woman speaks in the language of risk, but she thinks in the language of financial security.
Answering those questions will also reveal why possession of wealth that makes us financially comfortable or even wealthy does not always bestow peace of mind and a sense of financial security.
All the above information has been taken from Meir Statman’s conversation with Jeff Ptak, Morningstar’s global director of manager research, and Christine Benz, Morningstar’s director of personal finance. And from Behavioral Finance – The Second Generation by Meir Statman.
