Does Studying Behavioral Economics Improve Your Financial Decisions?
I hate behavioral economics. Not because I disagree with its’ theories or findings, but because it consistently reminds me of how stupid I am. I think I choose optimally – nope. I think I weigh all the options equally – nope. I think I am rational – nope. You get the idea, and if you’re familiar with behavioral economics, then perhaps you feel my pain.
I’ve been studying behavioral economics for a few years now. It started back in college with Dan Ariely’s Predictably Irrational, a book that really made me rethink a few things, and progressed with a few academic papers and blog posts. What exactly have I learned? Simple: we think about money relatively, not absolutely.
For example. Let’s say you are buying a stereo for $400 when someone tells you that across town is the same stereo for $300. If you’re like most people, you’ll drive across town and save the 100 bucks. Now, suppose you are buying a car for $30,000 when someone tells you that across town is the same car for $29,900. If you’re like most people, you’ll forgo the $100 discount and buy the car at $30,000. But given that each scenario is financially identical – a trip across town saves $100 – shouldn’t you respond the same? If you were rational, yes. But you aren’t, for some reason you feel that the $100 saved in the car scenario is less that the $100 saved in the stereo scenario.
Here’s one more example. Let’s say you are on your way to the theater with a ticket worth $20 and a $20 bill in your wallet. When you arrive at the theater you find that you’ve lost the ticket. The question is: Do you buy another ticket with your $20 bill? Most say no. Now take the same scenario but instead of having a ticket worth $20 and a $20 bill, you have two $20 bills. You arrive at the theater, but this time you’ve lost a $20 bill. Same question: Do you buy another ticket? Most say yes. Like the previous example, this make no financial sense because twenty dollars is lost in both scenarios. However, for some reason people feel that the lost ticket is worth more than the lost twenty. Point is, when it comes to money, we understand things relatively instead of absolutely.
Back to my hatred.
Here’s the worst part. Even though I’ve spent years reading about behavioral economics and studying scenarios like the ones I just outlined, I’m no better at deciding. So I keep asking myself: Does learning about behavioral economics improve financial decision-making?
Maybe a little bit, but in general, I think absolutely not. I know I should assess dollars absolutely, but I still assess them relatively. Put differently, I would never travel across town to save $100 on a $30,000 car because it just wouldn’t feel right. No matter what I learn, I just can’t seem to shake my irrationalities. There is a great quote, one I have used before, by Nassim Taleb that captures my point of view on evolutionary terms. He explains:
What are our minds made for? It looks as if we have the wrong user’s manual. Our minds do not seem made to think and introspect; if they were, things would be easier for us today, but then we would not be here today and I would not have been here to talk about it – my counterfactual, introspective, and hard-thinking ancestor would have been eaten by a lion while his nonthinking but faster-reacting cousin would have run for cover.
Taleb’s position is that when it comes to deciding rationally, our brains just aren’t up for the task. True, humans have the most sophisticated minds on the plant. But the mental mechanisms that biologically separate us from other species, those cognitive parts which permit us to assess the pros and cons of buying a stereo, new cars, or theater tickets are brand new; and like any first generation technology, they are prone to several systematic errors. As Jonah Lehrer says, “when it comes to the new parts of the brain, evolution just hasn’t had time to work out the kinks.”
This is precisely why I don’t think learning about behavioral economics, or the psychology of decision-making in general, helps me decide. No matter how much I learn, and no matter how educated I am, my brain will make the same mistakes over and over again because it just wasn’t designed with cars, stereos, and movie tickets in mind.
Tversky, A., & Kahneman, D. (1981). The framing of decisions and the psychology of choice Science, 211 (4481), 453-458 DOI: 10.1126/science.7455683