The Psychology of Portfolio Happiness

“Healthy Anchoring”

There's a concept that most people are familiar with called the hedonic treadmill. In essence, it's the human tendency to constantly pursue one pleasure after another, assuming each successive pleasure will provide lasting happiness.

One financial area I routinely see this concept in action is regarding the value of our portfolio. Each time our portfolio attains a new all-time high, this becomes our new baseline for happiness and we’re miserable each time the value falls below that threshold.

Eventually, our portfolio returns to or surpasses the previous plateau, thereby setting a new high-water mark. This cycle of happiness to misery and back again repeats itself endlessly as the market ebbs and flows along its historically rising trendline. Hence, the treadmill.

As a recent example, suppose your hypothetical portfolio peaked at $1,500,000 at the start of 2022. Given the recent performance of both stocks and bonds, most portfolios are still down at least 10% (or $150,000 in our example) from their all-time high.

Regardless of the amount, this decline is difficult to endure because we now compare our current portfolio value exclusively to our high-water mark of $1,500,000.

This is a process known as "anchoring," and it's what feeds the misery portion of our treadmill. The 2020s have offered plenty of opportunities for both misery and anchoring given the continuous stream of apocalyptic headlines and two bear markets—one 34% decline (2020) and another 25% decline (2022).

The inevitable result of this exhausting "up, down, up, down, up, down" experience is that most of us have overlooked the big picture of investing in the 2020s.

In fact, since January 2020, the market has offered a total return of more than 8% per year. Given the craziness we've experienced, this is pretty surprising and remarkable, no?

Hypothetically, if investors had been offered this return at the start of this period, I'd guess that most would have gladly signed up.

Unfortunately, that's not how most people view these results today. Due to the route we've taken to achieve these returns, many investors have anchored themselves to their most recent high resulting in a year’s worth of misery in many cases.

I'm quite sure this is not a healthy approach to investing. So, how can we change our thinking in a way that may actually help us stay focused on the long term?

We often talk about having proper time horizons for investing into the future, but we rarely discuss the need to view past performance with the same perspective of time.

Instead of focusing on the last quarter or year, what if we intentionally anchored our emotions to a portfolio with more appropriate time horizons, like five or ten years? I'd consider this to be a healthy form of anchoring. It helps to "zoom out" in respect to time horizons for both the past and the future.