There is a Nobel Prize given for the dismal science — economics. Since prevailing economic theories seem to change with the weather, it may seem pointless to award a prize in the field. The recent award to Richard Thaler, however, is spot on.
Thaler’s work is in the area of behavioral economics. Simply put, he studies the irrational behavior of humans in the way they handle their finances.
For example: You have $10,000 in a savings account earning virtually nothing. Say you have $7,000 in credit card debt charging 18% interest. Logic would indicate you should tap the former to pay off the latter. Many, if not most, people do not. Why?
Thaler found that people place a higher value on what they have than what they do not, therefore it seems more important to keep the cash than to part with it, even though there is future expense involved.
He found that when the price of gasoline drops, many drivers switch to premium rather than save the difference. He learned that if a cab driver is having a slow day, he will work longer hours to try to make up for it; conversely, if he is having a busy day, he will quit early, even though the exact reverse would make better economic sense. You can read more here.
It is well documented that when employees are offered a default choice to opt into a retirement savings plan rather than to opt out, many more join the plan, though the number should logically be identical.
People are not always rational when it comes to money. This is why there was tulip mania in Seventeenth Century Holland, why you can buy a cup of coffee for $55 in New York today and why one Bitcoin sells for more than $5,200.
Being a good custodian of wealth requires attention and planning. This is especially true as you prepare for retirement and the preservation of family wealth. If you’d like to learn more about our view of this process, give us a call or email us for our free guide to retirement planning.
