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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

#71

Post by orlp »

Bootvis wrote: post #52
jstanley wrote: post #50

Earlier quoted context omitted.

> 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.

If you play the game 20 games you'll still be better off pressing the 1 million button 5-10 times, at the start if you don't know in advance how many presses you get, or at the end if you do and haven't won big yet.

Re: Why people make dumb financial decisions on purpose

#72

Post by UncleMeat »

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…

This is a key observation in more practical concerns like retirement planning. Often, maximizing expected value isn't actually what you want. For somebody with a comfortable retirement portfolio you care a lot more about not running out of money than ending up with a huge amount when you die. So you'll choose strategies that might have worse expected values but limit the frequency of worst case scenarios.

Re: Why people make dumb financial decisions on purpose

#73

Post by Kranar »

BeetleB wrote: post #53
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…

This is a much more profound statement than it seems at first and I wholeheartedly agree with it. Not only that but the gains compound over time.

It's not about the expected value of any one opportunity, it's about the expected value among every opportunity you will encounter in your life. This also implies that one should do what they can to expose themselves to said opportunities especially while they're young.

Re: Why people make dumb financial decisions on purpose

#74

Post by UncleMeat »

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).

Not so. It can be throughly reasonable to make a choice that has lower expected value but has a distribution that fits your needs more closely.

Re: Why people make dumb financial decisions on purpose

#75

Post by thfuran »

phao wrote: post #65
BeetleB wrote: post #53

Earlier quoted context omitted.

> 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…

> your life will have plenty of such games What are you talking about? Which life will have plenty of such games? In what way is that true?

In the way that these are analogies for actual situations, not just pure whiteroom thought experiments.

Re: Why people make dumb financial decisions on purpose

#76

Post by ghaff »

crazygringo wrote: post #16
_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.

Exactly. The fact that this article doesn't even mention the concept of marginal utility, and acknowledge that it's mathematical rather than "psychological", is borderline irresponsible. [1] https://en.wikipedia.org/wiki/Marginal_utility

Marginal utility does let you view the pressing of the red button as an action a rational actor could take. That said, when you get into concepts like prospect theory in behavioral economics, there is definitely a psychological aspect as well.

Re: Why people make dumb financial decisions on purpose

#78

Post by jimmysnuka »

Admittedly, I'm not an expert at this stuff, but it seems like strictly using expected values to calculate optimum decisions can get you into some strange situations, like infinite expected value [1]. For some reason the author brings up lump sums vs annuities, which I don't think is at all comparable to betting (annuities from the US govt are guaranteed payments). That aside, a number of people have already mentioned Kelly criterion [2]. This strategy would tell you that you should take the guaranteed $1 million, but this is a long-run strategy. I personally would take the $1 million because it is guaranteed. I'm also not sure if relying on math for a one-off event like this makes sense.

[1] https://en.wikipedia.org/wiki/St._Petersburg_paradox [2] https://en.wikipedia.org/wiki/Kelly_criterion

Re: Why people make dumb financial decisions on purpose

#79

Post by rotexo »

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”

On a tangent, and I’m just spitballing here, how is this for a business idea. I: have a PhD (which is not to say I’m smart, it is just to say I have been exposed to lots of facts that other people may not have been exposed to), and I have a bunch of ideas that may or may not be good ones, but I’m too risk-averse to act on any of them and start a business. You: have a bunch of money and are open to ideas. So you pay me, say, $100 bucks to just vomit my ideas out during a 15 minute phone call. Like a cheap loot box of ideas, most of which have a low probability of success, but there may be a nugget of gold in there.

Re: Why people make dumb financial decisions on purpose

#80

Post by phao »

thfuran wrote: post #75
phao wrote: post #65

Earlier quoted context omitted.

> your life will have plenty of such games What are you talking about? Which life will have plenty of such games? In what way is that true?

In the way that these are analogies for actual situations, not just pure whiteroom thought experiments.

I suspected that much (that it was an analogy for some kind of actual situation).

But what situation? How is it that a person's life has many of these chances in large enough volumes to make expected values worth it?

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