Making active investments

Picture this. You want to buy a luxury car or better yet, a yacht. Would you prefer to use your hard-earned income, inheritance money or lottery winnings to buy it?

The question may sound illogical to you, if you are an economist. After all, money is money!

So, it should not really matter whether you use your hard-earned money or lottery winnings.

The satisfaction, economists would argue, comes from consuming the product. But most of us are not economists.

And the source of money does matter to us!

Satisfaction derived

If you are typical person, you would prefer to use your hard-earned money to buy the luxury car. The satisfaction you derive from buying luxury products with your hard-earned money is much more than the satisfaction you get when you buy them from inherited money or lottery winnings. Why?

In one experiment, scientists asked subjects to play a computer game. One group was given money during the game based on their performance while the other group was given money independent of the performance.

Using functional magnetic resonance imaging (fMRI), scientists studied the brain activity of the subjects while they were playing the game. They also observed subjects' reaction by measuring their skin responses.

The scientists found that the brain activity and skin responses of subjects in the group that received the money based on performance were higher than the other group.

Conspicuous Consumption

This means you and I are aroused when we earn rewards actively than when we earn them passively.

By the same logic, we should be aroused when we buy products of conspicuous consumption (read status or luxury goods) with our hard-earned income; for buying such products with active income is a matter of pride, indicating our status in the society.

We react the same way when it comes to our investment decisions.

In this case, we prefer active investment income compared to passive income. Suppose you have to choose between investing in an index mutual fund and buying stocks directly. You will most likely choose the latter. Why?

Selecting an index fund requires little skill. You just have to buy one that closely tracks the index and charges lower fees.

But creating a stock portfolio requires meaningful effort. Naturally, the joy of watching your portfolio outperform the index fund is immense!

Interestingly, the joy when the loss on your stock portfolio is less than that on the index fund is even more, although you have actually lost money!

It is one thing to buy luxury products with your hard-earned money. But you would agree that it is quite another to make active investments just for kicks!

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