Optimizing on Happiness

The market is up today. Are you as happy today as you were sad yesterday when the market was down?

Fish see the bait, but not the hook; men see the profit, but not the peril – Chinese proverb

People want to be happy. If you ask people what their goal is in life they often respond “happiness” or some derivative thereof.

An interesting observation is that many people follow investment approaches that they believe will yield the best return, and optimize on maximizing total returns. According the the Nobel winning research of Kahneman and Tversky published in 1979, people strongly to prefer avoiding losses than acquiring gains. Here is the wiki on prospect theory.

If someone were optimizing their “happiness in life” rather than just returns, then many people would rethink their investment programs. Losses and downside volatility become much more of a focus than pure return. The first and biggest step is a good asset allocation. Using some non-correlated alternatives could be another move forward.

I have mentioned a simple timing model as a method to further reduce one’s risk and drawdowns. While the Sharpe ratio is a decent metric, it does not distinguish between up volatility and down volatility, nor does it touch on drawdowns. Timing increases the Sharpe ratio from around .55 for buy and hold to around .85 for timing. Maximum drawdown decreases from around -20% to -10%.

MAR is a measure of return / maxdrawdown. It takes MAR from .6 for B&H to 1.25 for Timing. And the Ulcer Index, which measures the length and severity of drawdowns, improves from 4% down to 1.65%. The Information Ratio is around .55. Sortino is above the Sharpe (always a good sign).

Lots of investment jargon there, but the bottom line is that these metrics could all be called happiness metrics rather than statistics ratios. And that’s what it is all about at the end of the day. . .(This post reminds me a little of Bhutan’s GNP figure – gross national happiness.)

And joy is, after all, the end of life. We do not live to eat and make money. We eat and make money to be able to live. That is what life means and what life is for. -George Mallory

Have a great weekend.