Tell Me How You Really Feel - Mindfully Investing

In my last post, I presented a way to systematically assess an investor’s cumulative mood in response to market returns and volatility over the history of the U.S. stock market. Because emotions are inherently subjective, I called this a “semi-quantitative” assessment, which I dubbed the “Happy-Crappy Investometer” (H-C Meter for short). Because mindful investors are long-term investors, I applied the H-C Meter over 10-year periods and examined three popular portfolios: all-stock (S&P 500), all-bond (U.S. 10-year Treasury Bond), and 60% stocks/40% bonds.

I detailed my methods for building the H-C Meter in my last post. The rolling 10-year results for every possible investing decade from 1927 through the end of 2019 are shown in this graph.

It turns out that most of the time the theoretical mood of the all-stock investor was substantially better than either the all-bond investor or the 60/40 investor. Assuming that the historical returns feeding the H-C Meter tell us something about future returns, the probabilities of various possible moods for investors in these three portfolios are summarized in this graph.

If past is prologue, then the H-C Meter says there’s a 70% probability of feeling “good” or “great” when investing in an all-stock portfolio and only a 20% to 30% probability of these positive moods with the other two portfolios. And surprisingly, all-bond investors can expect to endure some degree of negative mood 19% of the time, while all-stock investors can expect negative moods only 11% of the time. I concluded in my last post that, if your investing goal is to maximize your mood over the long term, then the all-stock portfolio seems like the best pick.

What Does This Tell Us About Emotional Reality?

I find the H-C Meter results pretty consistent with my own investing experience over the last 20 years. But as I noted last time, some readers may feel like the H-C Meter results are overly optimistic, particularly with the stock market drenched in fear right now. We all recognize that emotions are inherently subjective, and probably no two people feel exactly the same when put in a similar situation. So, this post examines several cognitive factors popularized by Daniel Kahneman in “Thinking, Fast and Slow” that may cause your view of your own investing emotions to differ from mine or the H-C Meter results.

My goal here is not to defend the H-C Meter as depicting emotional reality because it has clear limitations as I discussed last time. But the H-C Meter provides a decent yardstick that might help us, along with some mindful introspection, to better measure how we really feel about current market events and why.

What’s Your Emotional Time Frame?

Due to data availability, the above H-C Meter calculations stop on December 31, 2019, and we all know what happened right after that. And right now, most stock investors would probably describe their current mood as substantially worse than it was three months ago. So, I added year-to-date returns as of March 31, 2020, for the S&P 500 (-19.6%) and 10-year U.S. Treasury Bond (+10.5%) indices to extend my rolling 10-year graph into the recent bear market as shown in this graph.

The right-most data point on the blue line suggests that stock investors experienced a major dip in long-term mood over the last three months, but their mood is still firmly in the “good” range with a score of +86.

Perhaps you’re surprised that the H-C Meter score for stocks didn’t dive even lower in the last three months. But recall that each point on this graph represents the cumulative mood score for someone investing over 10 years. Over the 10 years ending December 31, 2019, the stock market produced a stellar annualized return of 13.5%. A $10,000 lump sum invested at the start of 2010 would have been worth over $35,000 at the end of 2019. And as of the end of March, that investment would still be worth about $29,000, or nearly 3 times the original value. So, the most recent H-C Meter reading reasonably reflects the mood of a stock investor who is still way ahead of where they were 10 years ago.

However, someone who just started stock investing would reasonably feel way worse than the H-C Meter would suggest. If we focus the H-C Meter on just the last three months (and ignore the previous 10 years), the mood scores look considerably different:

All-stock portfolio score = -63 (bad)

All-bond portfolio score = +31 (tolerable)
60/40 portfolio score = -9 (tolerable)

When confined to a 3-month time frame, the H-C Meter results suggest the mood of the short-term stock investor is well into the “bad” range, though not yet in the “terrible” range. But I’d guess that almost no one reading this post had the supremely bad luck of first investing within the last 3 months¹; most of us have been investing for a few years at least.

So, when you think about your overall investing mood, ask yourself whether you’re focused on the last three months or your entire investing lifetime.

Whose Emotions Are These?

At its core, the H-C Meter is a “hedonometer”, an idea proposed by British economist Francis Edgeworth in the 19th century. A hedonometer is an imaginary instrument that measures the level of pleasure or pain for a person at any given moment. The cumulative measurements across many moments can be used to quantify an experience like a typical workday or an activity like a round of golf. Because they’re imaginary, hedonometers are usually informed by survey questions posed at regular intervals to study subjects about their current mood or specific emotional states. But in this case, the H-C Meter uses stock/bond returns and volatility as an indicator of an investor’s mood.

The inherent problem with hedonometers is that people generally don’t report their emotional state consistent with a cumulative hedonometer result. Rationally speaking, it makes perfect sense that our aggregate mood over a day would be determined by the summation of our moods from each minute of that day. But alas, emotions aren’t rational.

Daniel Kahneman presents data from colonoscopies where the patients reported their subjective discomfort levels each minute during the procedure. You’d think that the level of unpleasantness for the entire colonoscopy reported by the test subjects would align with the intensity (vertical axis) and duration (horizontal axis) of discomfort reported throughout the procedure as shown in these graphs.

Consistent with my H-C meter calculation, you’d expect Patient B to report a worse experience than Patient A. That’s because the area under the curve, or the cumulative pain intensity across the time of the procedure, is larger for Patient B than Patient A. But surprisingly, at the end of the procedure Patient A reported a worse experience than Patient B.

A statistical analysis of all the data showed that the best predictors of a patient’s reported experience were the combined metrics of peak pain intensity and pain intensity at the end of the session. Because pain duration was a poor predictor, Kahneman calls this cognitive effect “duration neglect”. Duration neglect appears in other experiments too. For example, when test subjects were exposed to two benign procedures², one of which had a longer duration of pain, 80% of the subjects selected the objectively more painful procedure for a repeat experiment!

Kahneman concludes that we have two selves. One part of us assesses our emotions as we experience them, and another part of us assesses emotions as we remember them. If Kahneman is right, the experiencing self will report investing emotions relatively consistent with my H-C Meter graphs. But when asked to look back at how a past decade of investing felt, the remembering self might disagree with the H-C Meter graph. The remembering self might report that a decade scored as “happy” by the H-C Meter was actually pretty “crappy”, particularly if the mood briefly plunged to “terrible” levels and there was a slight downswing in returns performance at the end of the decade.

Kahneman notes that the opinions of both selves can be important to us under different circumstances. For example, most parents report a poor mood when actively taking care of children, which is the view of the experiencing self. On average, those same parents report the overall effect of child-rearing on their life as highly positive, which is the remembering self looking back at child-rearing so far. Even though the remembering self sometimes makes objectively wrong decisions, like picking a more painful procedure, few us like the idea of heeding the experiencing self’s opinion about child-rearing. Some times we value the experienced view and sometimes we value the remembered view.

However, while most of us cherish the idea of child-rearing, few of us cherish the idea of investing, which is considered an unpleasant chore by all but the most enthusiastic hobby investors. This implies that the remembering self may be biased towards a gloomy outlook about investing in general.

Further, the concept of mindfulness, as advocated here at Mindfully Investing, has a natural affinity with the experiencing self. Mindfulness focuses on the experienced but only acknowledges the brief passage of the remembered through our minds. Mindfulness teachers go so far as to say that the only thing that’s real is what’s happening in the present moment. Because the past no longer exists, our memories and how we feel about those memories are imaginary in the most fundamental sense. And because I share that view, I feel like the H-C Meter results, which take the more objective view of the experiencing self, are a good approximation of my own investing emotions over the last couple of decades.

When you think about your investing mood, which of you is making the assessment? The current bear market has been underway for less than three months, which is a brief glimmer as compared to the minimum prudent holding period of 10 years for stocks. Is your current mood focused on the peak pain? Are you neglecting the duration of the bear market so far? If you feel like the last few years of stellar stock returns were totally “ruined” by the last three months, whose view is that?

How Much Thought Have You Given It?

Kahneman’s research also indicates that the perception of our emotions and moods can be altered by many factors, some of which appear almost entirely irrelevant. In one example, Kahneman describes an experiment in which the test subjects (single students) first answer a question about how many dates they’ve had in the last month and then answer a question about how happy they’ve been over the last month. It turns out that the first answer (number of dates) is correlated with the second answer (happiness level), but only when the question about dating is asked first. Otherwise, there was no correlation between the two answers. The pairing of the happiness question with other questions about finances or family relationships elicited the same pattern of responses. Kahneman calls this effect a type of “substitution”, where we substitute a readily available answer in place of a more difficult answer.

If you stop and think about it, answering a seemingly simple question about your level of happiness is a complex undertaking, assuming you’re trying to give an accurate answer. Think about all the different ways you might go about assessing your happiness and the many different factors that you might want to weigh and inter-balance. Perhaps last month you broke your leg, got a pay raise, your neighbor yelled at you, your child got a good grade in math, you got a jury summons, you found five dollars on the sidewalk, etc. What’s the summation of all that good and bad? And how do you factor in all the stuff that didn’t even make it on the list?

Further, Kahneman found that our reported level of happiness can be easily swayed by seemingly inconsequential events. In another experiment, half the test subjects “luckily” found a dime (planted by the researcher) before answering a life-happiness questionnaire. And of course, the folks who found the dime before completing the questionnaire reported significantly happier lives than those who found no dime.

When I read stuff like this, I wonder if any of us understand much at all about how we truly feel, regardless of whether we’re considering one hour or the entirety of life. Our feelings seem to be a slave to the slightest suggestions of daily circumstances.

So, how much thought have you really given to your current investing mood? How do you know that your current mood isn’t an overreaction to the situation? What extraneous factors might be driving your investing mood?

What Are You Focused On?

When looking at the myriad trivialities that can affect our moods, it seems impossible to identify which trivialities matter most. If I find a dime but then stub my toe, do the two events cancel each other out, causing me to report a “tolerable” level of life happiness? Or does one thing matter much more than the other? These sorts of questions compound exponentially when we consider the thousands of events that occur in a day, week, or year.

Kahneman proposes that what we focus on—what we pay attention to—is key to understanding our moods. He says, “Any aspect of life to which attention is directed will loom large in a global evaluation [of happiness]…which can be described in a single sentence:

Nothing in life is as important as you think it is when you are thinking about it.“

Kahneman gives plenty of supporting examples from experiments including:

When focused on the idea of weather, people think Californians are happier than midwesterners. Instead, surveys show that Californians and mid-westerners report roughly equivalent levels of happiness.
When focused on a car they enjoy driving, people overrate the contribution of the car to their life happiness.

When asked about the happiness of a paraplegic, people focus on the medical condition and assume that paraplegics are much less happy than the paraplegics themselves report.

One theme that Kahneman finds in these examples is that attention is usually withdrawn from a new situation as it becomes more familiar. And as the attention withdraws, the impact of the situation on our emotions diminishes.

What aspects of your investing life are you currently focused on? Do you think you will be focused on these same things three months from now? Are there other objective data about your current investment situation that you could focus on instead?

How Do Your Genes Feel?

If that wasn’t enough, there’s good evidence showing that we’re born with a certain temperament that’s dictated by genetics. Some studies estimate that 20% to 60% of our temperaments are determined by our genes. This may help to explain why income level is often uncorrelated with reported happiness above a certain income threshold, which is about $75,000 for people in relatively high-cost-of-living areas in the U.S. In this case, the money we earn (an environmental factor) is important to happiness, but only below a certain income level, and above that level, genetic factors may take over. Similarly, researchers have shown that perceived happiness is less related than might be expected to other environmental factors including employment, family stability, education level, and health. And a few specific genes have been identified that significantly correlate with reported levels of happiness in surveys.

Do you find that you usually feel similarly about your investments regardless of how the markets are doing?

Conclusions: Guided by Our Better Selves

If recent market events are making you feel down in the dumps, I’m hoping that this review of emotional factors will make you stop and reflect. The factors I’ve described suggest some ways we might help ourselves feel a bit better about the ongoing market crisis:

Focus on your total returns since you’ve started investing, instead of the short-term top-to-drop statistics that media headlines usually cite.
Focus on metrics that speak to the experiencing self like duration of the pain, and pay less (no) attention to metrics that speak to the remembering self, like peak pain and the most recent trend.
Focus on the present situation rather than the story you’re telling yourself about what happened to your investments over time.

Consider extraneous or minor events that may be having a disproportionate impact on your mood. Briefly list all the most objective and most important facts about the current status of your investments and focus on those.
Consider where you’re currently focused and consciously try to shift your attention to (and show gratitude for) the aspects of your investments, or life in general, that contribute to your happiness.

Can you simply think yourself into feeling better? I submit that it’s far from impossible. It seems like a trite example, but I find that just by consciously keeping a smile on my face, I can often boost my mood regardless of what’s happening around me. I’d say that the above suggestions for feeling better should work at least as well as smiling.

I’ve argued in the past that emotional and cognitive biases are sometimes avoidable with prolonged rational thought. Recall that in one Kahneman experiment 80% of the subjects picked the more painful of two procedures to repeat; they made the “wrong” choice. And Kahneman notes that the experimenters had to follow careful procedures to not inadvertently tip off the subjects as to the “right” answer. Even with all that, 20% of the people made the “right” choice anyway. Further, after reading all this, I doubt that you would pick the more painful of the two procedures if you went into the experiment tomorrow. While clearly, we’re prone to many emotional factors and biases, there’s evidence to suggest that at least some of the time we’re able to avoid those biases.

However, I agree with Kahneman’s opinion that most cognitive biases are nearly impossible to avoid on a daily or routine basis. And giving prolonged rational thought to every decision we make in a day would be tiresome and infeasible. But I think we can approach important long-term decisions like mindful investing more deliberately and avoid many of the most consequential emotional and cognitive biases. And because long-term investing is measured in decades, we have plenty of time to fully consider when to change or maintain our current investment strategy for objective reasons.

1 – If you did start investing in the last three months, you have my sincere condolences. But take solace in the fact that even investors that always buy at stock market peaks generally do pretty well, if they hold on to their investments for the long-term.

2 – The experiment required the subjects to voluntarily immerse their hands in cold water for a set period.