Psychological Wealth & The Return On Our Investments

The following post is a contribution from Dr. Brett Steenbarger, Clinical Associate Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY. Dr. Steenbarger works as a performance coach for hedge fund portfolio managers and traders in New York City.

"A little while ago, a very successful money manager told me of one of the core long positions in his portfolio. He commented in an offhand way that he hoped the trade moved against him in the near term, because he wanted to get larger in the position. Another trader I was working with at that time had the same position in his book for the same fundamental reasons. When the position did indeed sell off, the successful manager added to his holding; the other scrambled out of the trade. Over the subsequent weeks, the successful manager profited nicely from his idea. The other trader failed to reenter the position, bemoaning the fact that he was not making money and could not chase the trade now that it had moved higher.

Two investors had the same idea, the same position, and conducted the same research and wound up with very different outcomes. One responded to normal, expectable adverse movement as opportunity. The other responded to it as threat. One experienced fulfillment; the other frustration. Out of that fulfillment, the first manager was able to devote a small amount of capital to an intriguing idea that had the potential for a very large payoff. The second manager did not feel he could afford to lose money on a speculative idea and missed that profitable trade as well. Seeing those portfolio managers–and recognizing how similar they were in their ideas, but how different they were in their psychologies–crystallized for me an important factor differentiating successful investors from less successful ones: the former sustain a high level of psychological wealth; the latter operate with chronically depleted emotional capital.

What Is Psychological Wealth?

In their excellent text Happiness: Unlocking the Mysteries of Psychological Wealth,  researchers Ed Diener and Robert Biswas-Diener explain that, “Psychological wealth is the experience that our life is excellent–that we are living in a rewarding, engaged, meaningful, and enjoyable way.” The psychologically wealthy person is one who experiences a richness of positive emotions and who also is deeply satisfied with the life she or he is living. This captures much of the difference that I have seen between successful and unsuccessful investors: the ones who thrive in markets are those who enter the financial arena already psychologically wealthy. The ones who struggle look to markets to provide them with a happiness and satisfaction they struggle to generate otherwise.

The psychologically impoverished investor suffers when losing money, yet when trades work out, the returns generated are never sufficient to bring authentic satisfaction. “I should have had more of it on,” one manager told after a trade worked out well. Right then and there, that manager took a chunk of emotional capital and flushed it down the drain. Sure enough, frustrated by not making more money, that manager sized the next trade aggressively and took a larger than prudent loss when the position moved against him on a surprise economic report.

Diener and Biswas-Diener identify a number of markers of psychological wealth, including life satisfaction, happiness, spirituality and meaning in life, positive attitudes and emotions, loving social relationships, engaging work and life activities, and a strong set of values and specific goals to realize those. Financial markets do not provide positive returns all the time to even the best investors. What makes the best the best is the ability to build their psychological wealth even during times of drawdown. They accomplish this by cultivating investment processes that express and extend their strengths and by pushing themselves to learn from mistakes and setbacks.

Imagine two people going to the gym to work out and build their strength. One fails to complete ten reps at a given weight, takes this as a challenge, moves the weight lower, completes the reps, and adds a group of exercises to build the relevant muscles. The second cannot complete ten reps at the same weight, takes this as a failure, and ends the workout early. Over time, who will be energized? Who will be demoralized? Who will develop themselves? Who will stagnate? Who will build confidence and the ability to act with confidence? Who will reinforce a sense of helplessness?

Performance is the return on our emotional capital. In the gym, at the workplace, in relationships, or in financial markets, psychological wealth is what gives us the staying power to perform at our best in challenging situations.

How Do We Build Our Emotional Capital?

The good news is that an array of positive psychology research finds that we can meaningfully add to our psychological wealth.  If we consider each day as an opportunity for a well-being workout, then we can identify specific activities to generate:

* Happiness – experiences of joy and pleasure;

* Satisfaction – experiences of gratitude and fulfillment;

* Energy – experiences of physical and emotional vitality;

* Affection – experiences of closeness and intimacy.

Imagine filling out your calendar at the start of each week. The first items that go into your time slots each day are scheduled activities that will bring happiness, satisfaction, energy, and affection. That means doing things you love doing, appreciating what you have and what you are able to do, exercising your body and mind, and building quality time for the relationships that matter. Now, after those activities populate the calendar, the rest of your time is available for work, completing life’s myriad errands and tasks, sleep, and relaxation.

In other words, if you view those positive activities not just as fun things to do in your leftover time, but as essential psychological wealth builders that keep you at your peak, then you make life fit into what you need to do to build your emotional capital. The surprising reality is that this enables you to be like the successful investor: far more able to pursue opportunity, far more resilient with respect to setbacks.

Does your investment process give you energy or drain you of it? That, I’ve found, is one of the best predictors of who will succeed–in life, as well as in markets."

Brett N. Steenbarger, Ph.D.