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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

8 Comments Post a comment
  1. jay #

    Interesting

    August 27, 2011
  2. Dennis #

    Do you think you are more rational / make better decisions now when you were a kid or a teen or in your early 20s? If so then you obviously learned how to make some decisions better. Just because you arent an emotionless optimized decision engine doesnt mean that your decision making cant be improved.

    August 28, 2011
  3. sammcnerney #

    I do think I am more rational and I make better decisions now compared to when I was younger. But I won’t attribute my increased rationality or decision making ability to learning about behavioral economics/psychology. To be honest, I don’t know where the attribution would go to. Schooling? Parenting? This is a much much bigger question.

    And I do think people can improve decision making – but only to a very small degree

    August 28, 2011
  4. I would argue the contrary – that it does help.

    Training in the field – and perhaps more importantly, applying it to design my own pricing and discounting techniques – has given me a lot of insight into the tricks that we can be led into, deliberately or accidentally. It helps me see how my preferences can be biased by the framing of prices and choices. And in fact, it helps me see that there aren’t clear, well-defined underlying preferences and my “optimal” choices change from day to day.

    In your example of driving across town to save money on a stereo, I do apply a “rational” rule: what is my time worth, and how long will it take me to get this discount?

    The result of this might indeed be that I don’t go across town to save $100 on the car; but in fact I might also not bother making the same trip to save money on the stereo! That $100 sounds tempting but we tend to be willing to go to an irrational amount of trouble to avoid the feeling of being overcharged, when we could instead just recognise that feeling as a subjective attitude which we can easily change inside our heads.

    I would certainly not say that behavioural economics has made me a perfect or rational decision-maker, but I think it’s improved me. I would also not claim that it’s worth the time I’ve spent studying it, just for that small benefit – but fortunately I had other reasons to do it.

    August 29, 2011
  5. sammcnerney #

    Leigh,

    I don’t deny that learning about the cognitive biases stuff/behavioral economic principles can and does help. But I only think it helps “a little”

    So what do I mean by “a little.” Well, that’s a bit difficult to define. By little I mean that it can only help with (and this is just a ballpark estimate) 1% of your decisions. Keep in mind, I am thinking about every decision made throughout everyday. When you add all of them up, suddenly you realize that you make thousands, maybe tens of thousands of decision everyday. Almost all of them – 99% – are made out of our control, by our unconscious brain, and we don’t even realize we’ve made them, as if we were on autopilot.

    But there certainly are times in the day when we can think critically, snap out of autopilot, and choose optimally.

    Here is the important part. Whereas most of our daily decisions are non consequential (say, walking across the street, or drinking water, or getting dressed) a small portion are highly consequential (closing a million dollar deal, proposing). If we can use knowledge of behavioral economics on the decisions that are highly consequential then we are in good shape. It is like we are hedging our knowledge of cognitive biases in situations where they matter most.

    So, I am a fan of behavioral economic studies that help people in high-risk/consequential situations. But I am not a fan of studies that try and improve our everyday decisions.

    August 29, 2011
  6. sammcnerney #

    But i’m pessimistic at the end of the day….

    August 29, 2011
  7. Agreed that human beings make strange decisions regarding purchases and money. If we were all good at it, we would all be financially better off than we currently are.

    September 19, 2011
  8. thanks for nice sharing

    October 23, 2014

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