Book Review: Why Smart People Make Big Money Mistakes by Belsky and Gilovich

Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the Life-Changing Science of Behavioral Economics
is a fascinating book in the relatively new field of behavioral economics. This area has been of interest to me for a while now since I try to understand the often very irrational decisions people make. Below I’ve written out s about the biggest fallacies that people do on routine basis. Do you recognize some of the tendencies you have in them?

  • People make wrong conclusions. In the Israeli Navy the commanders discovered that most of the times a trainee was praised after a very good performance, they tend to perform worse the next time. And vice versa, if the trainee was critizised, he tend to perform better the next time. The conclusion that critizising motivates better than praise is obviously wrong – due to probability, it is not very likely to outperform already a very good performance the next time or do worse than a already low level performance.
  • People have money in the different mind categories – think about having a super-bowl ticket worth 150€ and discovering it’s lost at the stadium would you buy a new one? Most people would not. However, if they had lost 150€ cash for the ticket instead, they would actually buy a new ticket.
  • Statistics – you know that 2/3 of the red balls in one bag are red and in the other bag 1/3 of the balls are red. You don’t know which bag is which. You take 5 balls from bag A and 30 from bag B. Of those 5, 4 are red and of those 30, 20 are red. Which bag is the one with 2/3 of red balls? Well, it is most likely B, due to the much larger sample size.
  • If a cash is framed as “bonus” people are more loose in spending it. If it is framed as “rebate” they are much more conservative.
  • You are in the store to buy a lamp which costs 100€. You find out that there’s another store 5 blocks away where the same lamp costs €75. Would you go there insted? Most people would.
  • On the other hand. You want to by a dining set which costs €1775. You find out there’s the same dining set for €1750 in the store just 5 blocks away. Would you go there to buy it? Most people won’t. When we incur a loss or expense, we prefer to hide it from ourselves within a bigger loss or expense.
  • This makes upselling or additional feature selling much more rewarding – people are willing to pay much more for features when buying something bigger than to buy them later on separately (think buying a car+accessories).
  • Credit card money is cheapened because there is no loss at the moment of purchase, at least on a visceral level. Not only will you BUY more, but you will also PAY more.
  • Availability Bias – people make decisions based on the information that comes most quickly to mind – often the most recent and remarkable information around.
  • People are more willing to take more risk if it means avoiding losses and be more conservative if you can lock in sure profits. This means that if you frame something as a gamble to win vs sure win, people tend to prefer sure win but if you define it as sure loss vs gamble to avoid loss, people tend to prefer gamble. NB! Judgements are constructed “on the spot” in response to specific tasks and are therefore very sensitive to how the problems arise or the way in which they are framed.
  • When people view a decision as one of preference, they focus on the positive quilities of the options. If they view a decision which option to dismiss, they focus on the negative qualities of they option.
  • The more choices people have, the less likely they are to choose. Also, the more time you have to do a task – any task – the less pressure you feel to get with it, and the frequent result is you never get to it at all.
  • Endowement effect: what’s mine is mine and what’s yours isn’t worth as much. People value more the things they already possess. That’s why merchants offer trial periods and money-back guarantees.
  • Decision paralysis: people tend to prefer status quo. NB! Although: remember: research suggests that most people’s biggest regrets in life center around the things they failed to do. People experience more regret over their mistakes in action in the short term, while regrets inaction in the long run.
  • People tend to neglect the base rate. There is a HUGE difference whether you pay 1% or 2% of management fee in a mutual fund. Over the years the difference mounts. Rule: do not invest in anything where the management fee exceeds 1%. When buying insurance, raise the deductible and lower your fee. Remember the base rate. Is a mild and quiet person more probably a salesman or a librarian? Well, there are 80 times more salesmen in the US.
  • Confirmation bias – tendency to search for, treat kindly, or be overly impressed by information that confirms your initial impressions or preferences. This also makes people avoid asking questions that may challenge your preconceptions. This means that once the person develop preferences – even small ones – he tends to view new information in such a way that it supports those preferences. Or, barring that, they tend to discount any new information that doesn’t fit their preconceived opinions and feelings. This is used on sales and marketing so that a customer must be “programmed” to favor a product or a service based on the initial impression.
  • Meremeasurement effect: simply asking someone if they’re planning to do something increases the likelihood they will do it.
  • Anchoring: First give whichever number anchor in whichever context, then ask a specific question and the answer the subject gives, is greatly influenced by the anchor. This is why six-packs and “4 cans for 2 bucks” make people buy much more. If asked from people, how much they are willing to spend in restaurant “Studio97” or “Studio17”, sure enough, they are willing to spend much more at Studio97.
  • Mood influences behaviour. A lot. When people are afraid, they estimate much higher percentage probability of terrorist attacks happening than those who are happy or even angry. Also, the NAME of the company listed on the stock market has a great effect on the returns of that stock in short period after it’s listing: the easier the name is to pronounce, the better it will perform. Anger leads to the feeling of certainty. The more certain a person is, the less probable he sees risks.
  • People are herd animals. Imagine if you bought a new Lexus for $100K. The week after somebody comes to you and offers to buy it for 80K, then somebody else comes to you and offers to buy it for 75K, etc. Finally somebody offers you 50K, two months after you bought it. Would you sell? Well, if you wouldn’t, why would you sell a stock you believe in that has dropped in price?
  • Sadness makes you buy more expensive things, disgust makes you value things less
  • How to avoid these traps? Make checklists like Warren Buffet, make pro and con lists, do NOT decide on first instinct, because perceived crises exceed actual crises in this world.
  • Small tweaks can have big results. Students were communicated the importance of getting a tentanus shot. Half of the students were also given a map of the campus and asked to plan their route to the health center and pick a date and time to go. The other half had 3% of students who get the shot finally, this half had 28%.
  • It’s hard to prove yourself wrong. When you believe in something, you tend to find arguments to support that belief and not see the arguments which disprove it. Speak with others. Do not only seek specific advice, but also critique of your decision-making process.
Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s