Lessons From The New Science Of Behavioral Economics
Gary Belsky, Thomas Gilovich
For this book, I decided to hand-write (and later digitize) notes. These are not very detailed but enough for my personal reference. This is an experiment and I may or may not continue taking notes for other books.
Read my review of the book on Goodreads.
I'm trying something new. Taking notes on a real paper with a real pen (will digitize later). Maybe this will help retain. pic.twitter.com/YQHkhoWyqE— Karan Goel (@karangoel) December 27, 2016
- humans = rational
- humans = efficient with money
Counterexample - tipping. (we do it because of social heuristics and rules of thumb)
Statistical regression = As n increases, sample measure moves closer to average
Study by Epler: “rebate” (people don’t spend) vs “bonus” (easy to spend)
Bigger bonus = harder to spend
- Credit cards - makes us spend $ we otherwise won’t, and often spend more.
- Ditch credit card
- Every dollar is the same
- Wait before spending the bonus (weeks or months)
- “All income is earned income”
- When decision is to make a preference, people look at the positive qualities
- Conversely, when decision is to choose worse option, people look at the negative qualities
- We assign value to gains or losses in absolute terms and not as a % of net worth. Losing $500 for someone with $1,000 vs someone worth $100,000. Remember, every dollar is the same.
- We feel more strongly about losses than gains = loss aversion.
Disposition effect - Sell winners early, hold losers too long.
- Drive in snow to attend a game for which we bought the ticket even if it means risking life
- Don’t want to appear wasteful
- 1 good choice = easy decision
- 2 good choices = no decision
- decision under conflict
2 types of people:
- Maximisers: find out everything about all choices before making a decision
- Satisficers: find out enough about the choices + use gut instinct + “trusted screeners”
- Too many choices when it comes to investing; causes high level of bank deposits
- The longer we defer a decision, the less likely we make it ever (tight deadlines are helpful)
“Trade-off conttast” - Choices are enhanced or hindered by the trade-offs between choices.
- If A is better than B => A.
- If B is better than C (in ways different from what makes it worse than A) => N
- B’s appearance is enhanced
- “extremeness aversion” - people are more likely to choose an intermediate choice.
Status quo bias: Resistance to change.
- People tend to overvalue what they have
- “endowment effect”
- another manifestation of loss aversion
Regret aversion: people want to avoid the pain of regret and responsibility for negative outcomes.
- Keeping money in checking/savings and not investing
- Keeping low-paying job rather than make the switch
- Net selling a losing investment
- Narrow the choices down to fewer
- Deciding not to decide is a decision
- Put decisions on autopilot. Write and follow rules = make less decisions.
- Set deadlines for decisions.
- Pretend like you are deciding from a neutral position. Or flip the perspective (“should I sell this stock” becomes “am I comfortable buying this stock today”)
Nominal change (actual dollars) vs real change (in buying power)
When home prices rise, so do other prices.
“Neglecting the base rate” - disregard or discount the overall odds (lottery).
Insurance (wedding, flight etc)
Play the averages because change plays a greater role
- View and seek information in a way that supports our existing beliefs.
- First impressions matter. Eg advertising.
- Anchoring: Latching onto an idea or fact as a reference point
- Particularly prone to anchoring when swimming in unfamiliar waters
- Useful (don’t eat random berries - could be poison)
- Have a person board of directors and seek a second opinion
- If you have less knowledge about something, seek more information
- Be humble and know when you’re wrong
- Over rate one’s abilities.
- Helps in some cases. For example, when people start businesses, overconfidence that you can beat the competition is useful.
- Different from conscious arrogance.
- Buying expensive things without research
- FSBO (fizzbo) = For Sale By Owner (For Sale By Overconfidence)
- People tend to remember successes, and repress failures.
- “Heads I win, tails it’s chance”
- People think they caused success, but something else caused failure.
- Following the trend often doesn’t work (plenty of research)
- Causes bubbles and crashes
- How fads begin
- Ignore private information and focus on others’ actions.
- Avoid hot stocks
- Tune out the noise
- Set and follow your own rules
Neuroeconomics - How brain affects financial decisions
- Reflexive system: Fear, disgust, greed
- Reflective system: Reasoned, analytical
Financials: People tend to use reflexive and not enough reflective when investing.
- Voice your reasons
- Have checklists
- Make a pros and cons list
- Every dollar spends the same
- Losses hurt more than gains please
- Spent money doesn’t matter (sunk-cost)
- Too many choices are bad
Steps to take:
- Raise insurance deductible (playing the averages)
- Self-insure and cover the cost of small losses
- Pay off credit card debt with emergency fund (interest rate high enough to justify)
- Buy index funds
- Diversify investments
- Keep track (budgeting)