Financial vs. Life Well-Being: A Q&A with Meir Statman
Meir Statman, PhD is an author and a leading scholar on behavioral finance, as well as an advisor to Wealthfront’s investment team. In his new book, A Wealth of Well-Being: A Holistic Approach to Behavioral Finance, he explores the relationship between life well-being and financial well-being. In this interview with Dr. Statman, we discuss his new book, homeownership, and what diversification can teach us all about happiness.
Your latest book, A Wealth of Well-Being is about the relationship between financial well-being and life well-being. What inspired you to write a book on this topic?
MS: I often note that the biggest risks in life are not in the stock market. If you want real risk, I say, get married. And if you want more risk, have children. People laugh, because the point is obvious. Yet that point is regularly lost when we speak about financial well-being, neglecting life well-being.
Financial well-being comes when we can meet current and future financial obligations, absorb financial setbacks, and keep driving toward financial goals, such as adequate retirement income. Life well-being comes when we live satisfying lives, full of meaning and purpose. The domains of life well-being include finances, but they also include family, friends, health, work, education, religion, and society. We need financial well-being to enjoy life well-being, but it is life well-being that we seek.
I wrote this book to share what I have learned about financial and life well-being from my experiences and those of many others. I hope that my book will help readers reflect on their financial and life well-being, and enhance them.
As you researched the relationship between financial well-being and life well-being, what surprised you the most?
MS: I was surprised most by the relation between age and well-being. Think of your answer to the following question:
“Please imagine a ladder, with steps numbered from 0 at the bottom to 10 at the top. The top of the ladder represents the best possible life for you and the bottom of the ladder represents the worst possible life for you. On which step of the ladder would you say you personally stand at this time?”
We know this ladder as Cantril’s ladder, and the step you have chosen, 6, 7, 8, or 9, is a measure of evaluative well-being.
I thought that evaluative well-being is lower among the old than among the young, as aging brings frailty, declining independence, loss of loved ones, and approach of death. Yet studies show that the relation resembles a U-curve, declining from early adulthood into midlife, and increasing afterwards into old age.
Gaps between aspirations and situations likely underlie the U-curve. High aspirations when we are young, such as for high-income in satisfying careers, motivate us to aim for high future evaluative well-being at the cost of low present evaluative well-being.
Gaps between aspirations and situations widen in middle age, as we find that we have not advanced in our careers as much as we had aspired, that our business plans did not succeed, or that our paintings fit over sofas better than on walls of museums.
Aging brings many losses, yet we press down our aspirations as we age, gravitating toward activities that are more pleasing than self-improving, and accepting themselves for who we are, rather than who we were supposed to be. My own life experiences are testimony to the U-curve.
You write that people tend to underestimate the importance of financial well-being. Why do you think that is?
MS: At times, we underestimate the importance of financial well-being in life well-being, yet at other times we overestimate it.
We tend to underestimate the importance of financial well-being when asked to name the domains that enhance our life well-being by most. We usually place family at the top, perhaps followed by friends, health, and work, placing the finances close to the bottom. Yet our finances have a special place in our life well-being because they underlie all life domains. We need finances to support ourselves and our families, paying for food and shelter. We need finances to maintain our own health and that of our families, paying for the services of physicians and hospitals. We need finances to pay for education that would qualify us for well-paying and satisfying jobs, careers, and vocations.
Financial well-being is also important on its own, enhancing our life well-being, but we often overestimate its importance. We think that our life well-being would double when our wealth grows from $1 million to $2 million, but it does not, especially when we learn that our colleague’s wealth reached $3 million. And too many with $1 billion suffer diminished life well-being when they find that their competitor’s wealth reached $2 billion.
You write in the book that buying a home, which is an important financial and life milestone for many people, often enhances people’s well-being by a smaller amount than they expect. Is there anything prospective homebuyers can do to prepare for this?
MS: My wife and I were squeezed financially when we bought our first home in Cupertino in 1979 for $119,500. I taught extra courses at my university during the academic year and summer to afford the monthly mortgage payments. And we were squeezed again when we bought our current home in Cupertino in 1987 for $525,000.
The New York Times offers a calculator comparing the finances of renting a home and buying one. A recent headline says: “Renting saves you $133,000 over 10 years.” Yet I never calculated the relative financial benefits and costs of renting a home or buying it. Owning my home enhances my life well-being by more than renting it, offering expressive and emotional benefits beyond utilitarian ones. I derive expressive benefits from my home, because it expresses me as a homeowner to myself and others. I’m able to paint the walls any color I want or even move walls in a renovation. And I derive emotional benefits in pride and peace-of-mind, knowing that I am my landlord.
Still, prospective homebuyers must be aware of the downsides of owning a home, as maintenance is frequent and costly. I did not call a landlord when my dishwasher sprung a leak, destroying a good part of the ceiling of the floor below. I paid for a new dishwasher and for a ceiling repair.
You write that maintaining a good balance between spending and saving improves both current and future well-being. But you also note that it’s difficult to strike this balance. Why do you think this is?
MS: Spending more than our income is tempting and spending some of our income is necessary. But we know that we have to save some of our income when young if we are to enjoy adequate spending when we are old. We strike a balance between spending and saving by the mental tools of framing, mental accounting, and self-control. We frame money into two kinds of mental accounts, income and capital, and use the self-control rule of “spend income but don’t dip into capital” to balance spending and saving. For example, we transfer money from the income mental account to the capital mental account, such as by automatic deduction from our paycheck into our 401(k)-retirement saving account, but we stop ourselves from withdrawing money from our 401(k) account for spending by the rule of don’t-dip-into-capital.
People who are good at exercising these mental tools when young save substantial amounts, compounded by returns on their savings during the years between youth and old age. Yet many older people find the transition from saving and spending difficult when it is time to dip into capital when employment income diminishes or is gone.
For example, many older people with substantial 401(k)s resent withdrawing from them by the rules of Required Minimum Distribution (RMD), especially because withdrawals are subject to taxes. Some adult children resort to compelling their elderly parents into spending. My mother-in-law resisted replacing her rickety old sofa with a new one. Exasperated, my wife and her brothers bought her a new sofa and disposed of the old one. She smiled and said: “Well, you are dipping into your inheritance.”
Are there common investing mistakes you see people making that you think undermine both their financial and life well-being?
MS: Even people who maintain a good balance between spending and saving often diminish their financial and life well-being by investment mistakes. Good investments and investment behaviors are actually simple. Invest savings in low-cost diversified portfolios of stocks and bonds, such as those structured by robo-advisers, let the portfolios compound over years, and withdraw from them in retirement. Too many people, however, attempt to “beat the market” with speculative investments and heavy trading, shrinking their portfolios rather than expanding them, diminishing their financial and life well-being.
What is the number one thing you hope readers take away from this book?
MS: I hope that readers come to understand that while we need financial well-being to enjoy life well-being, it is life well-being that we should seek.
I also hope that readers would come to think of life well-being as a diversified portfolio of domains, finances, family, friends, health, work, education, religion, and society. Not all investments in investment portfolios are likely to yield exhilarating returns, but it is the overall portfolio’s returns that matters. The same is true in life well-being portfolios. Every person is likely to suffer low well-being in one or more of their domains, whether unsatisfying work, difficult marriage, serious illness, or early death. We must learn to use high well-being in some domains to compensate for low well-being in others.