Interesting story determining the measure of how well or how poorly the economy is doing, courtesy the reporters from the New York Times.
Not only is the lipstick theory plausible, “it’s perfectly consistent with all kinds of economic theory,” said Richard DeKaser, the chief economist with National City Corporation, a financial holding company and bank in Cleveland.
Have you ever seen those polls where John Q. Public is asked about questions of a general economic nature? How many of them have, at the very least, a basic understanding of economics?
Yeah, me too; I think such an exercise is akin to asking a medical doctor about auto repair, an auto repair technician about quantum physics, or a particle physicist about literature: It makes about as much sense as, well, insert a colorful metaphor here.
Before Warren Buffet was interviewed that one Monday morning on CNBC and said that we practically have a recession, though we may not be in one technically, many people can only say as much when they’re asked about the “R-word.” In addition, I’ve noticed that the public tends to insert more emotion into their economic analysis than such things warrant.
Let me say this first: There is room for emotion in economics. When, however, a person’s opinion regarding the nation’s current economic state is based more on emotion than well-founded rational thought. Henceforth, my point: John Q. and Jane Public don’t know enough of a darned thing about economics to offer their opinion; at least not enough for it to be meaningful. In the spirit of that I’m going to point out a couple of economic concepts that might help to alleviate the problem.
Gross Domestic Product, otherwise GDP, once taught as Gross National Product, or GNP, is the number that sums all of the products and services rendered in the United States (or any country, for that matter). Right now GDP is around $13 Trillion or so, give or take a few hundred billion dollars. GDP is calculated as a combination of many things:
GDP = consumption + gross investment + government spending + (exports − imports)
While there are several nuances associated with each variable, there are a few things to point out.
· Consumption is the largest driver of the economy; essentially that is all of the dollars that you and I spend.
· Investment is nearly as powerful as consumption
· Government spending is relatively valued at one quarter the effect of investment spending.
This illustrates exactly the reason why it would be great for government to curtail spending, lower taxes, and help the marketplace—government spending doesn’t do nearly enough for the economy, lowering taxes allows for individuals to have the option to save or consume more (marginal propensity to save or marginal propensity to consume, respectively) –driving consumption and, perhaps, helping investments.
This makes sense to me, but I consider myself a fiscal conservative.
There will be the contingent out there that says that paying taxes is good because it funds essential services that the government must supply to people, and there’s the whole debate about which rights one has in regards to healthcare and such—that is not within the scope of this article—but if government were forced to act like business in their daily management then we would be able to get a lot more value from our investment in government than not. Put another way, we allow government to spend too much and, I think everyone can agree, that we get too little from it. Wasteful government spending becomes something four times as bad when you have this understanding.
So, in an ideal world there is a happy medium between extreme government spending and extreme tax breaks for everyone. We don’t live in an ideal world, however, and economics works in cycles. The best thing to remember is the economy will go up most of the time, but will go down every now and again. Panic is not something that needs to happen when it goes down. Markets correct, stocks fluctuate, and indexes do the same. It’s nothing to worry about.
Why do I say this? I say this largely because of my believe that our most recent economic downturn in 2008 has been worse than it needed to be because people tend to overreact to what they feel are negative changing market conditions. If they understood the underlying dynamics of the market and the philosophy that “this, too, shall pass,” it wouldn’t have been as bad as it was.
My tone about “was?” There are multiple indicators that are pointing towards the worst of the current downturn being over, and us being on our way back up. The recent rallies in the stock market, the change in CPI and labor numbers all point towards an increasing economy.
So, in light of whatever the market is doing, irrationality rarely does the market good in the long run. In fact, if it did well with it then we wouldn’t have had the downturn in the market which we have had.
Home economics is a dying discipline. When I went through school the classroom existed, but not the corresponding class. Much like civics it is being relegated to a niche of society in such a manner that it is being forgotten…at a price.
For years I have lived by the philosophy that I manage my life like I manage a business. On the surface it may seem cold, perhaps even callous—but that isn’t necessarily the case at all. In fact, improved efficiency and effectiveness makes for a better life. A few examples:
1. The Budget. Face it—you stand to get rich if you suddenly run into a large sum of money, but the chances of that happening aren’t such that you should count on it. Instead, the world of finance stresses the time value of money and leveraging your current assets. Your income is the best wealth-building tool which you have and by reducing your debt obligations you effectively increase the power of your income to produce wealth. You do this most efficiently by producing a budget and watching and managing every dollar that flows through your household. By taking this approach you can “make every dollar scream.” What to do after you get to the point where your debt is paid off and you have extra money lying around? Invest!
2. Buy Like a Business. Once upon a time we’re all financially struggling people—whether that be as a poor college student or in a period of personal financial contraction—but we’re not in that position forever. It is rarely a static condition, however, and we progress onto better financial times. At this point in time we can move from buying-to-survive towards purchasing-to-thrive. We learn to buy in bulk—and start to think like an accountant. Price items on a per-unit basis, for instance. When I worked in a grocery store, once upon a time, I noticed that the tags that accompanied stock on the shelves would always have a “price per ounce” or related entry on the tag. By making some observations a person notices where the “sweet spot” is for purchase of a particular item: To buy the smaller box of cereal or the larger, “value-sized?” The larger the package—think bulk— usually the better value per unit. Take this concept one step further and develop a product mix of products that are economical and meet your personal utility or that of your family. For instance—I purchased the specific Rubbermaid containers meant for cereal and have no problems with purchasing the “bag cereals” which are often very close to the recipe of the corresponding name brand “box cereals.” On the other hand, I am very picky about the hot dogs which I purchase.
Another step in which to take this notion relies upon you realizing that sometimes you pay more in up-front costs to save money across the lifespan of a particular item; a concept which accountants like to refer to as “total cost of ownership.” A good example is the typical inkjet printer: Cheap and comes with some ink; it may or may not come with a USB cable, and certainly comes with a notorious “power brick.” Sure, you may spend $30 on the machine, but you will likely end up purchasing a lot of ink cartridges—just black and color, if you’re lucky—over the course of your time with the printer. On top of this these ink cartridges are fickle in such a way that the printheads can easily become non-working if they aren’t treated right or used correctly. Although they can have great resolution—past 1200x1200 dots per inch—they do so by spitting small ink blobs onto the paper; this makes for a very dirty process. By contrast—if you can do without resolutions higher than 1200x1200 dpi then a laser (or LED) printer is for you. They are much cleaner, have longer lives, and are generally more efficient. Of course, there are makes and models that are better or worse than others, but a little research or stop by your local printer service shop will give you a leg up.
One project which I’m planning is to replace my cans-of-soda drinking ways with a fountain soda machine. Although the initial costs are high (several hundred dollars for the initial setup), the cost of consumables—the soda syrup itself—can be less than half the cost of a serving of its canned alternative.
While this is merely the tip of the iceberg, it is a starting point for to get you to thinking about how you, too, could make your life better!
Scientists examine the circumstances under which chimpanzees, our closest relatives, will exchange one inherently valuable commodity (an apple slice) for another (a grape), which is what early humans must have somehow learned to do. The researchers found that chimpanzees often did not spontaneously barter food items, but needed to be trained to engage in commodity barter.
Hope: An expectation and wish; “a belief in a positive outcome related to events and circumstances in one's life. Hope implies a certain amount of — i.e. believing that a positive outcome is possible even when there is some evidence to the contrary.”
As part of my job I routinely travel between Grand Junction, CO and Vail and Aspen, CO. To pass the time between stops I often find myself listening to talk radio. My talk radio of choice between the hours of 10 a.m. and 1 p.m. in the Mountain Time Zone is Rush Limbaugh, conservative radio talk show host extraordinaire.
Firstly, before I go any further, I’ll mention something that I’ve said in the past: I’m not bringing this up as a political conversation; frankly, a person’s politics are akin to their religious or spiritual beliefs—they are personal and don’t have any bearing on any discussion in this forum; they merely act as a filter with which each of us process the world around us.
With that said, Rush had a monolog this week which depicted hope in a light different than I had ever looked at it before. It was very interesting in how it helped to re-shape my interpretation of the behavioral phenomenon. Let’s set the stage; from the transcript of the Rush Limbaugh Program on 5 February 2008:
“Hope is the logical extension of people who think they don't matter to anything, and a lot of people don't like not mattering. Everybody wants to have meaning in their lives. So if you hope for good things, if you hope for a better country, "I matter, because I care, because I hope for a better country."”
In this context, Rush sets up hope as being a manifestation of “one of those emotions which make one feel better about themselves,” a self-serving emotion, in other words. “Hope is the stepchild of sympathy. It's like sympathy. You can have sympathy for somebody.” Sympathy for the position of one’s self in the events of a greater scheme of things, sympathy for those in the path of the events which are part of such a greater scheme of things? Don’t get me wrong—no emotion is wrong or invalid; judging an emotion is outside the scope of this text or, even, my interest. What is within the boundaries of my interest and this text, however, is the effectiveness of such a feeling. What is the economics of hope?
A famous U.S. Senator and 2008 Presidential Candidate, Barack Obama, rose to fame in the Democrat political party in the United States, in part, by a 20-minute keynote at the 2004 Democratic Convention, which turned into a book by the same name, “The Audacity of Hope.”
Audacity: “Courage, resolution, boldness.”
“The courage of hope,” “the resolution of hope,” “the boldness of hope;” yes, all are good things…but as a principle which produces anything…hope can only go so far. The man behind the audacity of this hope was one that triumphed over his surroundings by conquering them, by besting his circumstances, exploiting opportunities, and staying true to the notion that action needed to be coupled with such hope.
Politicians, the consummate marketers which they are, try and sway our actions via votes and other support by trying to sway our emotions—in their view, a person will go to where their heart takes them. We are all constantly wooed by images of presidential candidates crafted by the individual campaigns themselves and by the media which reports (and also attempts to sway opinion) on the various players involved. The Democrats like to offer change. People hope for change, and so they vote for the Democrat which they feel will bring the most change. The Republicans, on the other hand, offer everything from a war hero to a master of the business world to a former governor in favor of the Fair Tax Plan and a minor contender which offers a strict Libertarian view on pretty much everything. Just about everyone is trying to appeal to our emotions in some form or another. Mostly, they’re trying to appeal to our emotion of hope, the courageous thing which it is.
However, hope is just that: An emotion which can satisfy that we’re a part of the process; because as long as we can hope for a better solution, we’re a part of that solution, right?
From the perspective of the 2008 race for candidates for U.S. President, in the words of Rush Limbaugh: “The discussion of hope from a political leader is pure poppycock. It's empty; it's transparent; there's nothing there. It is totally devoid of substance.”
Let’s take a step back, into a perspective more personal to you and me: Each of us have, at some point in time or in our lives currently, had hope; we have had hope for a good outcome to be realized, for our New Year’s Resolutions to take hold, or just to make it through the next day. Hope, however, is a short-term thing in these instances. Sooner or later, by itself, hope fizzles and the outcome which you had hoped to realize can quickly turn into worse, even less productive emotions: Self-inflicted suffering. Because hope didn’t allow you to realize the outcome which you had in mind, a person can quickly turn to loathing and lose hope.
“[N]one of us can predict the outcomes in our lives, and so many of us use hope as a bridge to the eventual outcome we hope for from event to event or circumstance to circumstance…"Gosh, I hope I don't get fired next week." Start thinking I'm going to get fired or whatever it is, you generally end up thinking the negative. Now, people mistakenly place hope as the sentiment or the emotional state that will lead to the outcome of things, "Oh, gosh I really so hope this happens." But that's basically an excuse for not doing anything, for not trying, and so what you're doing is you're setting yourself up to have to deal with whatever happens, probably negatively, because you're not allowing yourself to be part of the equation to get the result that you want.”
Rush pegged the remedy as well: “[I]n my experience…my hoping for something never made it happen. My desire for something did.”
Desire: “Want strongly.”Have you ever wanted something? Have you ever wanted something a lot? If you were to place degrees of “want” onto a specific outcome, the greater the degree of your desire for that outcome to happen, the more effort which you would likely put into achieving that desired outcome. The key is so easy: Actively make yourself a part of the equation which makes something happen.
I love real-world examples, perhaps you do, also:
“"What's hope ever accomplished? Did Bill Gates hope when he was in school that he'd find the secrecy to the MS-DOS system getting on every freaking computer, or did he go do it?"
In and of itself, hope is not very useful past the warm and fuzzy feelings which it gives you. The more productive emotion, the more economical one, is that of desire…especially the sort which leads to action.
Everyone, to some degree, cares what other people think about them. Sure, there are those out there that have the “I am who I am, and all others be damned!” mentality, but even they must come to the stark realization one day that their success relies, to some degree, on the decisions of others. Sooner or later, everyone worries about their reputation.
So, what is it about this phenomenon of reputation?
Think about The effect which you have onto the world around you. Not just to your immediate family, close friends, and co-workers, but onto the circles of individuals belonging to more outlying portions of your friends and family. How about your acquaintances, lesser acquaintances, and people whom you don’t even really know, but with whom you still occasionally come into contact? The point is that we often have more impact on our own world, more than we realize. How often, however, do we take a moment to think about how we impact the lives around us, or if that impact is particularly positive or negative?
Think about the sum total of each of these groups, then think about the positive or negative impact which you have on them. Think about the degree of this impact: Just a bit good, just a bit bad, a whole lot good or a whole lot bad; or somewhere in between? In a psychological-economic sense and parlance of “Seven Habits of Highly Effective People” it is essentially the net imports and net exports of the emotional capital, both deposits and withdrawals, with other people.
Yes, people remember the impacts which you have on them. Some may let you know; some may not say a thing…but remember nonetheless. People tend to criticize when a need of theirs is not being met, but others will just let the ill will fester inside of them.
For the uninitiated, the concept of emotional deposits and withdrawals: Each time you interact with someone you will affect their emotions—if you do so positively, you make an “emotional deposit.” If you do so negatively, you make a withdrawal. Of course, you want to maximize the deposits which are made with each person in your life and minimize the chance that you will withdraw too much with a person. If you have enough emotional deposits with a person, you can certainly run a line of credit, so to speak. However…run a negative balance for too long and it becomes possible that you’re go into emotional default with a person and they’ll eventually write you off.
In an economic sense—a grander one—you must be aware of the aggregate of impacts which you have on other people. The net of the deposits and withdrawals which you make is ultimately the reputation which you have. In this sense, it is wise to be actively aware, monitor, and manage the impacts which you have with other people as to increase the value of your reputation and make you more famous than infamous.
The Greeks used the words oikos for house and nomos for law which would eventually be combined to reflect philosophies which would evolve from the writings in the Muqaddimah, written by the Arab historian Ibn Khaldun in 1377. Mercantilists and physiocrats would eventually arise in Europe, becoming known as economists, studying the separate discipline of economics with the publishing of Adam Smith’s quintessential work The Wealth of Nations in 1776. A discipline falling within the purview of the larger study of business, it is formally considered a social science studying production, distribution, and consumption of goods.
When I was previously in school for one of my business degrees I categorized the three business sub-disciplines of accounting, finance, and economics into what I dubbed “Matthew’s Levels of Money” such that each of the fields dealt with money at different levels: Accounting deals with the simple “accounting” of funds inasmuch as making sure what money is where; economics deals with the greater movements of such things through groups of businesses, industries, markets, national economies, and larger systems. Finance deals with money flowing in intermediate systems, between the scales which accounting and economics covers. Lastly, I posed that there were areas in which accounting merged with finance and where finance and economics merged as fields of study.
While finance and accounting are all well and good, economics, at least to me, is the physics of the business world. Physics is the study of the relationship between matter and energy, one of the fundamental sciences on which everything else in the universe can be understood and is built upon. Economics is a business and social field of study which can shed immense amounts of light onto many things, not just those that involve money, distribution, or production.
For instance, when observing behaviors of others, the economist understands that people are apt to do one of two things: Seek pleasure and avoid pain. Put another way, one needs to find the incentive in the actions of individuals or groups thereof to understand their stated or unstated intentions. People speed in their cars along their route between points A and B because there is a perceived incentive that they would rather be at point B rather than either of the other alternatives. People cheat on their taxes because there is the perceived incentive that they will not have to pay as much money to the Internal Revenue Service or that they will get more money in tax refunds. They may be honest because that makes them feel good, or they may tell lies because they feel that there is an incentive in being perceived a different way than what reality would otherwise dictate: People chasing the incentive is a powerful tool.
A concept in economics which is closely related to a person’s incentive to do something is one that is old as the science itself: Utility. It is essentially defined as the degree of usefulness which a person assesses to a situation, product, or anything involving choice; classical economics dictates that each person should be maximizing utility in any situation involving choice. While practicality is often what textbooks teach in regards to how utility is measured, this can vary based on culture or any one of a multitude of other factors. For instance, companies have a tendency to use Canada as a test market, as opposed to the United States, because Canadians tend to attach more practicality to their measure of utility and Americans tend to attach more status or prestige to their perceived utility in a decision, such as one to purchase a product. Put another way, Canadians will buy the test pizza at a fast food chain restaurant because they find it convenient or tasty. Americans will purchase the pizza because it is the cool thing to do that week.
Economics is a versatile science which allows the practitioner to look at the details of a given situation or the big picture. From the intelligent interactions between agents to the dynamics of national economies, economists rely on data and an understanding of the geometry of a given situation. Calculated, the economist is an effective decision maker that can sort through and process large amounts of information and think effectively on their feet.
In the art of corporate warfare, the economist is an able participant and a lethal combatant. Even in the hands of any other member of the business team, a firm understanding of economics will make one’s effectiveness that much more potent.
Following World War II America went through a period in which the government, or the public sector, was growing poorer in relation to the private sector which was becoming wealthier. This is the outline offered by Harvard economist John Galbraith in his book The Affluent Society. It is also the origin of the term “conventional wisdom.”
We’ve all heard it: Conventional wisdom, rules of thumb, and urban legends. What is the problem with such “wisdom?” Not only is it “easy” wisdom but it also tends not to be true, just accepted by enough people in order for it to seem true. It acts as an obstacle to the truth, to new ideas, and is only fueled by the inertia of so many people believing in such bad information. This inertia is fueled by convenience, emotion, and assumption.
Common sense, on the other hand, is largely practical: Less of the abstract and more of the “collection of prejudices acquired by age eighteen,” according to Albert Einstein. In the same train of thought such practicality can have its limits when it comes to the progression of society: “Similarly, common sense has been invoked in opposition to many scientific and technological advancements. Such misuse of the notion of common sense is fallacious, being a form of the argumentum ad populum (appeal to the masses) fallacy.”
So, we return to our original premise: If so many people believe in it, it must be true, right? Logic dictates otherwise with a concept known as Argumentum ad populum. Translated from Latin it is “appeal to the people;” placed into a more concise context “if many believe so,” or “if many find it acceptable, then it is (acceptable or so).”
Alright, let’s test it.
It has been reported in the mainstream media that more than 1/3 of Americans believe there was a government conspiracy surrounding the attacks on the World Trade Center in New York City on September 11, 2001. As of 1 July 2007 the population was about 301 million individuals in the United States; 36 percent of 301 million people equals about 108.3 million people. More than 100 million people believe that the U.S. government was complicit—either actively or through negligence—in the horrible attacks of 9/11. Certainly more than 100 million people, statistically, can’t be wrong! Right?
I can’t help but look at the world from the perspective of an economist, believing in some bits of logic. Sociology teaches us that while the person might be intelligent, rational, and calculated, putting many of them together and their behaviors tend to move towards the irrational. Additionally, just because the many believe something…it doesn’t mean that it’s true.
How about looking at it this way: Have you ever voted in an election? Did the person whom you voted for win or lose? Doesn’t matter, because the majority of individuals voted for the person who got into the office; that means that he or she was good in their elected position by virtue of most people voting for them! Politicians are good by virtue of how many people voted for them…right? How about at any certain time when most people think that a particular company whose stock is a good place to invest? History and your favorite Internet finance site can tell you how this is a failed notion.
So, in the end the masses aren’t necessarily correct, conventional wisdom isn’t necessarily wisdom and tends to be more convenient than possessing any utility and your own experiences should be all that draws you towards a more thorough wisdom about the world.
Ever get a spam email? Does the below sound like promises that they throw around frequently?
“Men will have symmetrical facial features, deeper voices and bigger penises, according to Curry in a report commissioned for men's satellite TV channel Bravo.
Women will all have glossy hair, smooth hairless skin, large eyes and pert breasts, according to Curry.”
According to an evolutionary theorist from the London School of Economics…in several thousand years, this could be you! That is, unless, you end up being part of that other race.
Recently I posted a story here about complex algorithms being used to predict acts of terrorism and advise military and state leadership in the conduct of matters of diplomacy. An obvious extension of using such sets of mathematical formulas would be to predict how to win the lottery, as I mentioned in that post.
My view of the lottery, though, has changed since I devised my original concept on the matter: The lottery is a tax on poor people and those with a lesser amount of economic and financial knowledge.
What the lottery-winning seeking public should do, instead, is to use the stock market.
So, without further ado…who is better in the game of investments: A computer or a person?
Let’s start by defining a couple types of investing: There are those that believe in and practice the fundamentals: Observing P/E ratios and, essentially, applying a series of formulas to a company, an industry, their stock picks, etc. Fundamentals’ investing is in my opinion, just that: The fundamentals of investing.
Take a man like Warren Buffet: He is the epitome of someone who believes in behavioral finance. When I was much younger I remember a commercial for some large Wall Street Trading firm which stressed that after they looked at a stock, they would go and investigate it in-depth: Interview managers, examine infrastructure, and perform other in-depth activities which filled in the blanks that a fundamental stock pick couldn’t do.
The comparison and contrast is a simple one: Fundamental investing is a very logical, linear, rational method of investing. Behavioral investing, on the other hand, has a million shades of human emotion involved and, therefore, is open to the irrationalities which we are prone to as humans.
And that’s it: A computer program which attempted to account for the human aspect a investing would need to be exceedingly complex.
The odd part of this whole stock market thing? The irrationalities which incite risk in the system is why the stock market goes up as much as it does over time and is why any money put into the stock market as a portion of Gross Domestic Product adds to GDP by factor of 400 percent; in other words, when constructing the value of GDP if you put $100 into it as a form of investments—anything in the stock market—it is calculated to increase as a portion of GDP at a rate of 4 to 1, making that $100 investment worth $400 in terms of GDP; contrast that against the 1:1 ratio of government spending.
John McCain made an interesting remark published today:
"If he's alive or dead it doesn't matter. If he's dead, just prop him up and put some dark glasses on him like, like 'Weekend at Bernie's,'" McCain joked. "Let's get the best minds in America together and fix this tax code."Having served for 18 1/2 years as Fed Chairman, Greenspan is considered at the top of his field of central banking. Obviously some politicians consider him in even much higher regard.
Smart Money magazine recently ran an article with the tagline “Emotions and poor judgment lead a lot of smart people to make dumb financial moves.” Given my interests in psychology and economics, I thought this a perfect opportunity to review a few insights about money and behavior through the scope of this article.
1. “Saving with the right hand, spending with the left.” Are you one of those people who fixate on the price of a new automobile, but don’t monitor your routine shopping habits, such as groceries and entertainment? Do you think that it is a rational—or even acceptable—decision to have a savings account with a 5 percent rate of return, while you still pay much more than that for your credit card interest rate? How about the IRS: Do you set your tax withholdings in a given year so that you receive a high return at the end of the year?
The article duly points out a few more logical methods for dealing with the above scenarios. For instance, the average credit card debt of an American is about $1800; an amount that most households have in savings to pay off. Paying it off increases the rate of return on the money remaining in savings by reducing the strain placed on it from other parts of your cash flows. How about the tax withholding situation? Why don’t you instead set it more accordingly—so the IRS does not get so much of your earnings—and you invest it in an account that earns you money throughout the year; instead of offering the government an interest-free loan, you can make that money work for you. Controlling your financial present and future is a lot about making every dollar “scream:” That is, the harder you make your money work for you, and the less you use it to consume now, the more you will have to consume later. Radio talk show host Dave Ramsey has a saying that he fondly recites on his radio program: “Today, live like no one else, so later, you can live like no one else.”
2. And 5…“Playing it too safe,” and “Throwing good money after bad.” People don’t like losing. As I’ve mentioned before, “people are more displeased by a loss than they are over a comparable gain: In America, at least, we typically need to offset an unexpected loss by a gain of 2.5 times that loss.” This loss aversion, obviously, extends to money. An example cited in the article is of the classic fuel-purchasing “penny pincher:” Driving miles out of their way to save as many cents per gallon when, in fact, the fuel consumption and the wear and tear on the person’s vehicle will cost about 6 times the amount that the person is saving. Individual investors, also, have the same attitude towards averting loss whereas they will be more apt to sell a winning stock than a losing one. The “sunk cost” bias tells us that we tend to feel that we’ve passed the “point of no return” and feel that cutting one’s losses would be a waste of resources—time, money, and otherwise. In fact, decisions about future investments should be made based on future possibilities and not biased by recent investments within the scope of the current scenario.
3. “Looking into a cloudy crystal ball.” While more than two thirds of Americans have life insurance, those in the 35 to 64 years old age bracket are six times more likely to be injured to such a degree that they would miss an extended amount of work—than they are to die. The upshot? Less than one third of us have disability coverage. People base their prediction of the frequency of an event or the proportion within a population based on how easily an example can be brought to mind—in other words, we tend to take “short cuts” to the conclusion that we want to draw with the information that is available to us, relying easily on images and experiences that come to mind more quickly than more logical alternatives. The article duly points out, via the words of University of Chicago researcher Cass Sunstein, a phenomenon known as “probability neglect:” “We tend to ask what’s the worst—or best—that could happen. Instead, we should be asking what’s likely to happen.”
4. “Living in the moment.” People like to procrastinate. Watching your favorite television program (or any television program at all, for that matter) instead of cleaning the garage or the attic is often more appealing and offers a more immediate reward than the alternatives. Instead of looking at the non-linear benefit or the delayed costs and rewards, people tend to look at the immediacy of them instead.
“Letting your ego get in the way.” Overconfident investors tend to have good experience and think they are skilled, while in reality luck may play a larger factor than skill. Because it is easiest to think about, focus, and analyze ourselves and our ability we will tend to take a shortcut back to ourselves and our own abilities and skills. Confidence is good; and a healthy dose of overconfidence (despite the definition and connotations otherwise) is good: Without it, we wouldn’t have a propensity to strive for what’s better, what’s next. An unhealthy amount of confidence when dealing with the stock market, it is pointed out in the article, trend towards high risk investments, overtrading, and under-diversification, and, ultimately, smaller rewards over the long term. Investing for all but the die-hard day trader, is like making a burger in that you get the fundamental essence of what you want and continue to play with it less, only moving it such that it doesn’t get burned, taking it off the grill when it’s ready to eat.
7. “Following the crowd.” Just because everyone else is doing it means that you should, too, 
right? The Bandwagon effect, or following the herd, is essentially the observation that people often do or believe things because many other people do or believe the same. Funny enough, a Yale study entitled “Dumb Money” by researchers Owen Lamont and Andrea Frazzini pointed out that poor sentiment was actually indicative of good future returns in both stocks and funds: Those who bought and held S&P 500 index after Black Monday have made eight times their investment; on the other side of the coin the more popular investments have been shown to underperform. The company that developed the ever-popular iPod and iPhone, Apple, has skyrocketed in the last year or so: Stock that I started monitoring at $117.98 is now worth 106.88 percent more than the price I began monitoring at. Some industry experts, however, have predicted that after the buzz of the iPhone wears off, the stock may finally start to deflate—if not plummet. Time will tell if these predictions are correct, however.
I’ve mentioned before that personal finance is more about a person’s behaviors than it is a function of their ability with crunching numbers. Taking this to its logical conclusion, a corollary would become that emotions and poor judgment lead a lot of people, exceptionally bright or not, to make, simply put, dumb financial moves. Historically, psychology has played an integral role in economics. For example, when Adam Smith wrote The Theory of Moral Sentiments it included “the ethical, philosophical, psychological and methodological underpinnings to Smith's later works, including The Wealth of Nations (1776), A Treatise on Public Opulence (1764) (first published in 1937), Essays on Philosophical Subjects (1795), and Lectures on Justice, Police, Revenue, and Arms (1763) (first published in 1896).”
Hersh Shefrin, in his 2002 work “Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing,” listed three main themes for behavioral economics:
· Heuristics: Using “rules of thumb” that are, at best, approximated, instead of strict rational analyses, people tend to make bad decisions.
· Framing: The context of the problem or the way it is presented to the decision maker will often affect his or her action; which can result in a bad decision.
· Market inefficiencies: Examples such as mis-pricings, return anomalies, and non-rational decision-making can explained observed market outcomes that are contrary to otherwise rational expectations of market dynamics.
College macroeconomics courses teach a concept of “utility,” a fundamental concept in neoclassical economics which depicts perceived value in a good or service. Prospect theory, as part of behavioral economics, describes decision processes as consisting of two stages: Editing and evaluation. Editing consists of possible outcomes of the decision are ordered following some heuristic. Specifically, people decide which outcomes they see as basically identical, setting a reference point and consider lower outcomes as losses and larger as gains. In the evaluation phase, people behave as if they would compute a value, or utility, based on the potential outcomes and their respective probabilities, and then choose the alternative having a higher utility.
Keep in mind, however, while all this theory is good for a foundation of understanding the basis for the mistakes—and successes—we will inevitably have when it comes to our finances, note that these models can fail to predict outcomes in real world contexts for one reason or another. As in the science of profiling, establishing patterns and trends are keys in determining if a particular model will accurately predict a desired outcome. On the other side of the token, it is argued that while behavioral insights can be used to update economic and financial theories that we’ve come to rely upon, they also offer greater depth into these two disciplines: Not only reaching the same (correct) predictions as traditional models, but also correctly predicting outcomes where traditional models have failed in the past.
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