Life After Full-time Work Blog

Dr Meir Statman’s new book, “A Wealth of Well-Being,” expands our decision-making into several domains, to add to our happiness 

Once upon a time there was a field of study called finance, about how people make financial decisions. And the field was without form, and void; and academic darkness was upon the face of the subject. And mathematically-inclined economists said, Let there be light; and they attempted to shed light on the subject.

They did this by looking at many kinds of decisions everyday people have to make, and, as academics will, they built a mathematical theory of decision-making, in which all people are “rational,” that is, they systematically evaluate all possible outcomes and then select the optimal outcome. This comes from the construction of differential equations, the solutions to which are the optimal outcomes.

An erudite friend of mine says that these early financial economists had “physics envy.” In physics there are forces like gravity which act predictably rather than randomly, so equations can be constructed which not only always have the right solutions, but which can also predict how bodies are going to act under defined circumstances – a highly desirable state of affairs. Of course human beings don’t act that way with their finances. But if you postulate that all human beings are perfectly rational, then you can derive equations for these perfectly rational human beings. And that’s what the financial economists did.

And they saw these equations, and saw that they were good. And that was the first day of financial economics.

In fact the subject stayed that way for a long time. I remember that when I moved into economics from my earlier specialization in mathematics – oh, let’s just say, many decades ago – I wondered why these mathematically relatively simple equations carried such importance in finance. But hey, that’s the way it was.

It was a long time later that finance started to evolve into what is now called behavioral finance, describing actual behavior rather than theoretical optinization. Whose behavior are we talking about? Why, of course those human beings who aren’t “rational.” Does this make them irrational? In the early days, yes, that’s exactly how we were all thought of (because of course every single one of us is short of total rationality). In fact, when Dr Daniel Kahneman (who won the Nobel Prize for Economic Sciences in 2002, for his work in the behavioral field) was asked why he and his colleague Dr Amos Tversky (who, incidentally, died before he could share the prize with Kahneman) were describing the behavior of these irrational people, he said something like: “We’re not talking about irrational people, we’re talking about ourselves.” (I can’t locate the actual quote.)

At any rate, that established the first generation of behavioral finance, in which at least actual behavior was described, rather than just conceptual optimal behavior.

The second generation arrived some years later. It was already clear that people’s behavior didn’t accord with what theory suggested were the only possible rational courses of action. Now the reason was gradually understood: it’s because it isn’t only financial outcomes that people consider. Dr Meir Statman concluded that we like three kinds of benefits: utilitarian (it benefits us in a practical way); emotional (it has a direct impact on our happiness); and expressive (it says something about us to the world). If the only measurement scale we use is financial, then yes, we should make “rational” decisions. But if we’re prepared to accept a less than optimal financial outcome because we gain more of one of the other forms of benefit, then we are indeed still rational, because the decision-making context is much wider than the narrow financial one that those mathematical economists postulated. Meir didn’t argue about expanding the use of the word “rational” to include these broader criteria; instead, he simply called such people “normal” – and I wrote a blog post on it, entitled “What a relief to be called normal!”  (That doesn’t mean we can’t still act in stupid ways: not every decision made by normal people is sensible.)

And everyone saw that that was good. And normal people were the second behavioral generation.

I mentioned in that blog post that the broader concept of life well-being (as a rough definition, the state of being happy or healthy or prosperous – in other words, not just a financial measure) was being expanded into a third generation, in which the domains that generate well-being are all being considered. What are these domains? Think of family, friends, health, work, education, religion and society: all of them affect how we feel. So all of them affect our well-being. And the question of how we behave in each of these realms is the fundamental question of this third generation of thinking.

Meir has just published a book on the subject. It’s called “A Wealth of Well-Being: a holistic approach to behavioral finance.” It’s a treasure! It appears to be directed at financial advisors, financial planners and investors, but I interpret that final group “investors” much more broadly and consider that it includes all of us – those “normal” people from Meir’s previous work. This latest book tells us what sort of trade-offs normal people encounter in each of those domains, so that, understanding them, we can make better decisions in the sense of enhancing our well-being.

The research involved is astounding. One simple measure: the text takes up roughly 270 pages of the book; the research references then add another 100 pages! Of course none of us will bother with the references: that’s just academic completeness, so for us the book is a very reasonable length.

When I read it, the Preface drew me in, emotionally, and my involvement grew from there. The stories helped me to learn about life.

But, at this early stage of the third generation, no big conclusions stood out for me (except perhaps that thinking of our life well-being is always sensible, with any big decisions). Life isn’t that simple. There are some people in some circumstances who enhance their well-being by acting in a certain way; different people, or in different circumstances, can come to the opposite conclusion. Meir is thorough, explaining the backgounds, with a wealth of human anecdotes and quotes to bring it all to life. He adds a summary of what each chapter covers in a paragraph following that chapter’s name, in the table of contents, and that’s very helpful too.

And, right at the end, his final chapter is called “Conclusion,” and this takes the many pieces and draws together a story to bind them together.

I’m going to read it all again, starting (this second time) with the “Conclusion,” to see if I can pick out some bigger themes. Meanwhile, this book launches the third generation of thinking on the subject, and I’m very grateful for it. I hope you get a lot out of it, too.

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Takeaway

This book describes how our decisions impact our happiness, our health and our wealth.

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