Sometime back, we discussed in another column (‘Keep returns expectations moderate’ in Knowledge Arbitrage dated August 10, 2013) that it is good to aim for mediocre returns. Our objective was to help you moderate your regret. But will you be happy earning mediocre returns?

To answer this question, consider long-distance air travel. Suppose you frequently fly business class to the US. While business class is good, you desire to travel first class.

What if your airline upgrades you to first class on one of your return-legs from the US? You would, no doubt enjoy the rich experience of first class travel. But your subsequent travel to the US would most likely be miserable! Why? You will compare the business class travel to your first class experience and feel unhappy about the facilities that the former does not offer.

So, what should you do to enhance your business class experience? Perverse as it may seem, you should travel economy class at least once every year! That way, you would be able to appreciate your business class experience!

In other words, your experience is much better and feeling of regret much less if you occasionally travel economy and frequently fly business class than if you occasionally fly first class and frequently travel business class!

Now, consider your investments. When you aim for mediocre returns, your objective would be to buy index funds.

Comparative happiness Yet, two factors could make you happy with your index fund investments. One, the occasional losses on your equity portfolio would make your more frequent average-returns experience appear better!

And two, you will be occasionally tempted to invest in high-risk investments that “promise” high returns, e.g., farm land investments and quant-based trading strategies. And when such investments yield losses, your index fund returns appear better!

We are not suggesting that you should never experience luxury services such as first class air travel. Neither are we encouraging you to suffer losses to appreciate mediocre returns on your investments.

Rather, what we are suggesting is that a mediocre outcome will appear good when compared to a bad outcome, whereas a good outcome will appear mediocre when compared to a better outcome. Your happiness will depend on your frame of comparison, not necessarily on the actual returns earned.

In fact, evidence suggests that happiness does not typically increase with wealth after you provide for your basic needs.

This does not mean you should stop aspiring for more wealth. But it may be worthwhile to shift your frame of reference, especially if you fail to acquire more wealth.

If nothing else, it would reduce regret and make you feel happy.

(The author is the founder of Navera Consulting. Feedback may be sent to >knowledge@thehindu.co.in )

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