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Why people make dumb financial decisions on purpose

awealthofcommonsense.com

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Re: Why people make dumb financial decisions on purpose

#51

Post by WalterBright »

subsuboptimal wrote: post #24

I constantly run into situations where I spend money in ways that are financially non optimal, but socially good (in my mind). An easy to understand example is, I believe I should pay more in taxes and everyone as wealthy as I am should too. I rent an apartment, but I rent it out at the cost it takes to maintain it in good condition, because I think profiting off rent is unethical. This means I'm generally renting mu…

If you want to may more in taxes, the IRS accepts donations.

There can also be good business reasons to charge below market rent. Having a lower vacancy rate, for one.

Re: Why people make dumb financial decisions on purpose

#52

Post by Bootvis »

jstanley wrote: post #50
horsawlarway wrote: post #47

Expected value doesn't mean jack shit if the game can only be played once. > Expected value (also known as EV, expectation, average, or mean value) is a long-run average value of random variables. If you can only press a button once - you should take the guaranteed money in almost all circumstances (assuming you have finances that look like most Americans - if you're already a millionaire... do what you want, this ga…

> that first million is far more impactful than the next 49. This is in fact the reason you should take the million. How many times you get to play the game is irrelevant. Your whole life is filled with potential but uncertain payoffs, and you should maximise expected utility every time (where utility is not the same as dollars).

No it’s not, if you play the game 20 times you’re almost certain to win 50 million and probably a lot more. Unless your utility function is flat after 20 million it does matter.

Re: Why people make dumb financial decisions on purpose

#53

Post by BeetleB »

horsawlarway wrote: post #47

Expected value doesn't mean jack shit if the game can only be played once. > Expected value (also known as EV, expectation, average, or mean value) is a long-run average value of random variables. If you can only press a button once - you should take the guaranteed money in almost all circumstances (assuming you have finances that look like most Americans - if you're already a millionaire... do what you want, this ga…

> Expected value doesn't mean jack shit if the game can only be played once.

Thinking like this was the mistake I've made.

While you can play a given game only once, your life will have plenty of such games. So there definitely is a relevance to "expected value". And this is easily to simulate with a program. The expected value of the wealth for those who take the chance when the "local expected value" is better than the certain outcome does tend to be higher.

Re: Why people make dumb financial decisions on purpose

#54

Post by roenxi »

_Algernon_ wrote: post #11

There's diminishing returns on the utility of money. If you're living paycheck to paycheck that guaranteed million is gonna give you a higher expected return of utility than the next 49 million combined. I disagree with the title calling it a "dumb" financial decision. It can be perfectly rational to take the million.

A useful formula is the Kelly Criterion [0]. I'm abusing the logic and probably going to apply this wrong, but...

I think this counts as a 24:1 bet (we notionally have $1 million, we can gamble to get another $24). The Kelly bet is 0.5 - 0.5/24 ~= 0.5. So we would want to put about half our wealth into this gamble and that implies it starts becoming attractive around the time we have $2 million to invest. Up till then we might take the gamble but we don't have enough money to really feel comfortable.

[0] https://en.wikipedia.org/wiki/Kelly_criterion

Re: Why people make dumb financial decisions on purpose

#55

Post by BeetleB »

agentwiggles wrote: post #21

Honestly I'd hit the red button. I'd rather take a guaranteed payoff of my mortgage and all other debt, with plenty left over for a few neat toys, than chance walking away with nothing.

I wouldn't, because I can likely pay off my mortgage without it and still have money left over for some toys. My mortgage isn't a big burden. But I can understand it for folks who can't save much due to a mortgage.

The problem with the scenario is that the disparity is so high: $1M vs expected value of $25M. 50% is high enough that for people like me, it's clearly a green button option.

But how about this:

Guaranteed $1M vs a 4% chance of winning $50M. Now the expected value is $2M - still a lot higher than $1M. But ... 4% chance? Suddenly the guaranteed $1M is a lot more attractive.

Re: Why people make dumb financial decisions on purpose

#56

Post by Tade0 »

> The mathematical answer is you hit green every time.

Nope. There's a whole field of research about this - decision theory - which doesn't agree with this decision.

Most people appear to go with the Minmax approach - they minimize potential losses(or in this example: maximize minimal payouts).

For one-time events it's a sound strategy.

Re: Why people make dumb financial decisions on purpose

#57

Post by BeetleB »

gardenhedge wrote: post #6

"A 50% chance of winning $50 million would equate to an expected value of $25 million." If you hit the green button you either get $50 million or 0$. Hitting the red button gives $1 million. Unless you don't want $1 million or don't need it, you're going to hit the red button and not the green button.

Serious question:

There are 20 people in line ahead of you. Each one of them hits the green button, and you physically see that half of them made $25 million.

Would you not be tempted to hit the green button?

$1 million will make a big difference to me, but in many cities it's not enough to retire on - especially with children. While $25M isn't worth 25x more to me, it's certainly worth a heck of a lot more than $1M.

Re: Why people make dumb financial decisions on purpose

#58

Post by rwmj »

rotexo wrote: post #23

The response I saw on Twitter that made the most sense: “sell your button press for $5 or 10 million to a person who has $100 million”

Now I'm wondering what the expected value is if you were to auction this button pressing opportunity. Intuitively it seems to be over $1m (and less than $25m) so if I'm right then that's better than pressing the red button.

Re: Why people make dumb financial decisions on purpose

#59

Post by BeetleB »

kwhitefoot wrote: post #26

> A 50% chance of winning $50 million would equate to an expected value of $25 million. No it doesn't. Statistics is the science of populations of events, expected value applies only if you have a sufficiently large population.

It is the expected value if multiple people play the game. As I posted in another comment:

There are 20 people in line ahead of you. Each one of them hits the green button, and you physically see that half of them made $25 million.

Would you not be tempted to hit the green button?

Re: Why people make dumb financial decisions on purpose

#60

Post by drewg123 »

horsawlarway wrote: post #47

Expected value doesn't mean jack shit if the game can only be played once. > Expected value (also known as EV, expectation, average, or mean value) is a long-run average value of random variables. If you can only press a button once - you should take the guaranteed money in almost all circumstances (assuming you have finances that look like most Americans - if you're already a millionaire... do what you want, this ga…

Why not form a "company" with 10 friends, and pool the winnings?
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