You might be under the impression that because we are cultivating zen vibes here, it’s all going to be uplifting and inspiring. Wrong. Today’s topic is existential dread.
Bad things happen. They happen all the time. They happen at the level of society; at the level of the the individual; at the level of the portfolio; at the level of the portfolio line item. Much of the time there is no good goddamn reason for it. We are trapped in an asylum on a rock hurtling through space and oh, by the way, the inmates are the ones running the asylum.
Happy Monday all!
When it comes to financial planning and investing, there are certain shibboleths we wield to ward off existential dread. These shibboleths wear the face of empiricism. Chief among them are normative assumptions about life expectancy and capital market returns, spoken in the language of mean reversion.
We are terrible at predicting economic regimes. We are equally terrible at predicting cycles in style premia (growth, value, etc). Yet, for some reason, we are remarkably comfortable accepting normative assumptions about capital market returns over various periods.
“We have to start somewhere.” Yeah, I know. Perfect is the enemy of good enough.
But I prefer to start with suffering. Ask yourself: what is my maximum regret? Interestingly, in my straw polling of acquaintances, no one has ever identified “foregone investment gains” or “failure to maximize expected utility” as max regret. Max regret is untimely death. Max regret is a market crash at the start of retirement. Perhaps foregone gains are the max regret for some readers, though. And that’s okay! This is a big tent. My friends at Epsilon Theory have written extensively about minimizing max regret as an organizing principle not only for investment portfolios and financial plans, but for life. I happen to agree.
The organizing principle for financial matters should be minimizing the max regret scenario.
Max regret is wonderfully flexible in helping clarify your (or someone else’s) thinking about money. For example, there is always colorful public debate over personal spending as a percentage of income. People make passionate arguments on all sides of this. What’s more, there is a lot of money to be made providing capital-A Answers. This topic is like religion for people. For some people it IS religion. This is hardly a coincidence, and I plan to write about it some day. In the meantime, if you’re angsty about how much to spend or save, I’d suggest identifying your max regret.
If your max regret is risk-centric, target higher savings.
If you are hedonistic, spend more and enjoy the now.
I’m not here to tell you how to live. I suspect most people want a balance of security and hedonism, and where they struggle is prioritizing things. That is precisely where thinking about max regret helps. Prioritize what will minimize your max regret. Relax! There’s no right or wrong here.
But there are tradeoffs. (Cue existential dread again)
We suffer partly because we know, deep down in our bones, our life decisions involve tradeoffs. Life offers its occasional arbitrages. But for the most part, we are making risky trades. You can trade time for money. You can trade money for time. You can pull spending forward or delay gratification. I’m all for delayed gratification. My personal regret function pushes me in that direction. But in defense of hedonism, it’s not as though you earn points for dying with a large pool of assets. If I am fatally injured in a car accident this week, my dying thought isn’t going to be “boy am I glad I maxed my Roth IRA contribution this year.”
Risk cannot be destroyed, the saying goes, only transformed. Yous buys your ticket and yous takes your chances.
Finance is a microcosm of the human condition, and nature is red in tooth and claw.