Hacker News Board Hacker News, browsed like a classic message board
Live data from Hacker News

Why people make dumb financial decisions on purpose

awealthofcommonsense.com

Post reply on HN
Print view View original

101–110 of 170 posts

Re: Why people make dumb financial decisions on purpose

#101

Post by ghaff »

UKR_anon wrote: post #87
phao wrote: post #80

Earlier quoted context omitted.

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?

Everytime you book additional insurances that cover small amounts of money. Like a airplane ticket insurance (that only covers the fee of the ticket if you cancel). Or a additional rental car insurance. Assuming that Insurance companies are not stupid and only offer an Insurance that is +ev for them, that means its -ev for you. If you are in the financial situation that 1-5k$ wont ruin you its rational to NOT take th…

Investing has a degree of this as well. And, in practice, most rational investors will diversify based on a number of factors into fairly safe but low return assets and into potentially higher return but riskier ones.

Re: Why people make dumb financial decisions on purpose

#102

Post by petercooper »

UncleMeat wrote: post #72
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.

Rory Sutherland (behavioural science chap) made a similar point on travel. He says that when he must get to the airport on time, he takes the back roads that get him there in a guaranteed 30 minutes rather than take the freeway that will take 15 minutes 95% of the time but could be heavily congested (and inescapable) otherwise. Sometimes urgency and efficiency are at odds!

Re: Why people make dumb financial decisions on purpose

#103

Post by randcraw »

All the classic economic models for choice that I've seen fail to consider that the perception of not only risk but reward are BOTH nonlinear. IMO, this has been an Achilles heel of classic price and game theory. The rise of behavioral economics in recent decades would seem to agree with this iconoclysm.

If I need $1 million right now or else a loved one dies, then it doesn't matter how big the reward of a riskier alternative choice may be. I take the million NOW. If the additional reward is a victim of decreasing value as that offer rises, it's only rational for the decider to show diminished interest in choosing the greater reward (even if the marginal odds are only a tiny amount less likely).

Disregarding the reward curve of the individual is going to consistently misjudge economic choice and will surely be a poor basis for any economic model.

Re: Why people make dumb financial decisions on purpose

#104

Post by mgraczyk »

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…

The problem with the analysis in the article and with your analysis is that the expected utility of the player is not the same as the expected amount of money. Different people have different "utilities of money" reflecting their different risk tolerances, incomes, satiation rates (diminishing marginal utility), etc. The expected value analysis is the correct one if you use the right "value".

If you are only playing the game once, then any rational agent should attempt to maximize expected utility. Here "rational" just means that preferences are consistent in a particular way. For the purposes of this game played just once, almost all humans are rational. When humans play multiple times, they quickly lose the ability to calculate and make rational decisions.

Re: Why people make dumb financial decisions on purpose

#105

Post by BeetleB »

cromd wrote: post #90
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…

Well, life doesn’t always give many chances to play a game. You can only work at so many failed startups, or have so many failed long-term romantic relationships before you’ve used your best years! Someone else already made the point about the risk of walking away empty handed, but I’m just pointing out that some domains allow for many retries and some don’t.

> Well, life doesn’t always give many chances to play a game.

Disagree. Sure - you don't get many games involving millions of dollars, but you do get many for smaller amounts.

I could put all my extra money into paying off a low interest mortgage (guaranteed return), or I could put it in an index fund (higher average return, with no guarantees, and a potential for a loss).

And working at startups: Not sure the expected value is high there. May be higher than working at a FAANG. I doubt it.

Re: Why people make dumb financial decisions on purpose

#106

Post by mrwh »

rblatz wrote: post #96
mrwh wrote: post #67

Earlier quoted context omitted.

Agreed. And well, if everyone played the game, then the population at large would still be better off taking the million. I can well imagine there being fewer social problems if we all get a million fun bucks versus half of us getting fifty million. But then that's a different effect kicking in. Personally, a million would affect my life positively (I'd buy a house), 50 million negatively (I'd stop working).

Would you stop working? Or would you take a break until you found something you truly wanted to work on?

My job is what I want to work on. But I'm lazy, and I know myself well enough to know that if I didn't have to go through the things I dislike about my job (hello doing performance reviews), I'd stop doing it all. And it would ultimately be to my detriment. I wish it were otherwise, but there we go.

Re: Why people make dumb financial decisions on purpose

#107

Post by mgraczyk »

randcraw wrote: post #103

All the classic economic models for choice that I've seen fail to consider that the perception of not only risk but reward are BOTH nonlinear. IMO, this has been an Achilles heel of classic price and game theory. The rise of behavioral economics in recent decades would seem to agree with this iconoclysm. If I need $1 million right now or else a loved one dies, then it doesn't matter how big the reward of a riskier al…

Not sure what you mean by this. Even in the most basic rational choice analysis, where the players are agents seeking to maximize a utility function, the "reward" can be nonlinear. I'm not familiar with any economic model that unintentionally restricts the agent's utility to be linear. Sometimes you assume that agents have a linear "utility of money", but everyone in economics knows that this is a taylor expansion around a small region where the linearity assumption is reasonable, and not an actual fact about human preferences.

Re: Why people make dumb financial decisions on purpose

#108

Post by phao »

UKR_anon wrote: post #87
phao wrote: post #80

Earlier quoted context omitted.

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?

Everytime you book additional insurances that cover small amounts of money. Like a airplane ticket insurance (that only covers the fee of the ticket if you cancel). Or a additional rental car insurance. Assuming that Insurance companies are not stupid and only offer an Insurance that is +ev for them, that means its -ev for you. If you are in the financial situation that 1-5k$ wont ruin you its rational to NOT take th…

I think I get it, but I'm not so sure I'm convinced. Those examples, however, don't resonate with me (don't have a car, nor a license to drive one; nor I own a house; I've been inside an airplane only once).

However, I believe I've done similar things with used electronics. I tend to favor buying a really cheap used ones for [sometimes] 1/5 of the price instead of a new one. It could break or be of low quality, but chances of that are small and thus (over time -- making an EV-ish calculation), I spend less money on electronics.

I also believe I do this in buying new products. In many situations, I can pay extra for an extra year or two of 'guarantee' (not sure if the right term is 'guarantee' or 'insurance'). However, very often, the first 6 months or 1 year of guarantee is given and has its cost embedded in the price of the product. The question becomes: how likely it is for the product to fail given it hasn't failed for the first year. I believe the chances are small so I don't buy it. I guess it's also an EV kind of calculation (just like you gave as an example).

However, those don't seem that common, really. Maybe it's just the kind of life that I live.

Is the situation 100%1M vs. 50%50M supposed to exemplify these ones? These not-so-frequent ones for small amount of money?

Another thing is that expected value has to do with a limit in this situation:

(1/n) x SUM [j = 1 to n] outcome(j) -> E for n -> oo

(there is an ergodicity assumption going on here -- which doesn't always hold in practice). That limit can be E while the first idk how many hundreds of values of outcome(j) be very distinct from E.

How many times will things like that happen in your lifetime? Some dozen? What if you separate away the large-scale ones (like the 100%1M vs 50%50M)? The small-scale ones will be more frequent and you just blindly follow the EV approach to them. The large scale ones will be extremely rare, and maybe another approach is better. No?

Re: Why people make dumb financial decisions on purpose

#109

Post by ghaff »

jawns wrote: post #100

For those who say they would press the red button ... * Imagine the payout on the red button were not $1M but $100K or $50K or $10K. Is there any point as it diminishes toward zero that would make you switch buttons? * Imagine the payout on the green button were not $50M but $100M or $500M or $1B. Is there any point as it increases toward infinity that would make you switch buttons? For those who say they would press…

You can certainly fiddle with numbers to the point where you can basically force a given person to go with green or go with red. In general, as you get into certain payouts that aren't a big deal for an individual they'll tend to go with higher expected value at least up to a point. But as the odds get longer, most people will tend to go with certainty as long as it's a reasonable amount.

Re: Why people make dumb financial decisions on purpose

#110

Post by BeetleB »

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?

A very common one: You have a debt to pay off (typically mortgage). Should you put all your extra money to pay it off early or should you pay the minimum and invest the rest?

As another commenter pointed out: Most investments involve this. In the RE circles you often have the same dilemma: Buy a house for rental in a LCOL area where you get (mostly) guaranteed net income, or buy in a place like California where the rent income won't cover all the expenses, but you feel you can pay the difference and rely on profiting off the hoped appreciation.

Insurance is also a good example someone else pointed out.

Even: Get a guaranteed low paying job as a relatively unskilled worker, or get into deep debt to go into medical school, do a residency, and earn a lot. The latter can have significant risk: Some people don't do well enough to get a residency. Others get the residency but don't have what it takes to complete it. In both cases you're left with a huge amount of debt.

Post reply on HN