How do you feel when life imposes constraints on you? Consider this. You can make your own investment choices for your retirement contribution or you can be told by your employer that your provident fund contribution will be invested in government securities. Which would you prefer? It turns out constraints are good for your emotional well-being.
Picture this. You have just retired and are looking to create a cash flow stream to sustain your post-retirement living expenses. You can use the money in your retirement account to buy a product that will pay you Rs 50,000 every month during your lifetime and that of your spouse, whoever lives longer. Back-of-the-envelope calculations show that you will receive 7 per cent yield before taxes.
Or, you can use the money in your retirement account to invest in a stock-bond portfolio. You figure that this portfolio will fetch a return of 10 per cent before taxes. Which would you prefer — the fixed cash flow product or the stock-bond portfolio?
If you are a typical individual, you will prefer the stock-bond portfolio, given the higher expected return. Of course, stock investments carry risk. If the stock market crashes, you may not have enough money to sustain your living expenses during your lifetime.
Forced acceptance
But what if your employer compulsorily converts your retirement savings into fixed cash flow stream for life? Chances are you would be content, if not happy, receiving fixed cash flows every month. You may even compare yourself with your friends who have stock-bond portfolio and feel blessed that you do not have to worry about the stock market fluctuations to sustain your living. But why would you like the fixed cash flow product if your employer gives you and yet not buy it yourself?
To answer this question, consider an experiment conducted by Harvard psychologists. Participants in two groups were told that they could take home a painting of their choice. One group was told that their choice was final. The other group was told that they could exchange the painting for another within a certain time period.
The study found that the participants who were not given a choice liked their paintings much more than the group that was given the choice.
Freedom of choice can typically cause anxiety and lead to discontentment. We, however, adapt to constraints. We suffer less regret when we are forced to accept choices. That is why you liked the retirement-income product compulsorily provided to you by your employer. When we cannot change our circumstances, we often change the way we think about those circumstances. And that is better for our emotional well-being.
(The author is the founder of Navera Consulting. Feedback may be sent to knowledge@thehindu.co.in )