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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

#121

Post by cromd »

BeetleB wrote: post #105
cromd wrote: post #90

Earlier quoted context omitted.

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 expect…

I assume you agree that some kinds of opportunities are limited. Not trying new foods because you're afraid of wasting your money would be silly, or not saying hi to your neighbor because they might ignore you would be silly, but some things are very complicated. I'm thinking of: surgeries, mate selection, college degrees, white-collar crime, etc. I'm just saying that utility and loss aversion come into play, and "life is long" can't always save the day.

On startups, I think there are people who have been in situations where they have an expected value greater than something like a FAANG $300k/year over 3 years scenario (e.g. they own a large stake in a close-to-IPO company). And they should maybe still walk away, if the 50% chance of a tiny IPO payout would destroy their self esteem and make them feel even further behind their high-salary peers. (Also keep in mind that not everyone lands jobs at FAANG companies, so it shouldn't be super hard to find people who lucked into a startup where their EV is higher than their market salary over a few years). In other words: even if a startup somehow has higher EV, you may want to ignore the EV.

Re: Why people make dumb financial decisions on purpose

#122

Post by pnutjam »

ghaff wrote: post #66
pnutjam wrote: post #43

Earlier quoted context omitted.

It's a classic spherical cow model. It has no bearing on reality, although this pay structure is becoming more and more common; albeit with less then 50% odds. How many companies have you seen with "contests" to get ideas or content. The vast majority of people end up with nothing.

>How many companies have you seen with "contests" to get ideas or content. The vast majority of people end up with nothing. Yeah, but you see the same thing with giveaways at trade shows, for example. Even for a fixed giveaway budget, there's an argument to be made for having a drawing for a nice prize, rather than giving everyone some cheap swag.

I'm talking about contests like, design our logo OR build the next rocket to the moon.

Re: Why people make dumb financial decisions on purpose

#123

Post by im3w1l »

ghaff wrote: post #84
BeetleB wrote: post #55

Earlier quoted context omitted.

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…

The utility function, and to some degree, attitude towards risk is going to differ a lot among individuals. And I imagine that among those reading this here, some are probably going "A million is a nice sum but it's not really life changing whereas $50 million would let me retire right now ." And you can scale the numbers up or down and at some point almost everyone will choose red or choose green respectively.

Ironically 50 million would make me want to hire people to realize my visions, pulling me out of retirement.

Re: Why people make dumb financial decisions on purpose

#124

Post by chmod600 »

petercooper wrote: post #102
UncleMeat wrote: post #72

Earlier quoted context omitted.

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!

Depends a lot on what the back roads are like, though. The freeway can be more reliable a lot of the time.

Re: Why people make dumb financial decisions on purpose

#125

Post by t_mann »

Fyi, an imho more illustrative example why we should think in terms of expected utility than expected cash flows:

https://en.wikipedia.org/wiki/St._Petersburg_paradox

tl;dr: doubling winnings on each throw of heads and paying out on the first tail is a game with expected winnings diverging to positive infinity, yet probably no one would pay more than a few bucks to enter

Re: Why people make dumb financial decisions on purpose

#126

Post by rwmj »

rotexo wrote: post #79
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 m…

The thing you learn from start-ups is that ideas are worth nothing. It's execution that matters.

But ... if you were an oracle (religious, not database) who sometimes foretold the future, would there be a marketplace for your ideas? In 2003 if you described a social network would that be valuable information? I tend to think no since there were social networks before Facebook but FB were lucky and executed very well.

Re: Why people make dumb financial decisions on purpose

#127

Post by stale2002 »

kwhitefoot wrote: post #117
BeetleB wrote: post #59

Earlier quoted context omitted.

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?

No because each event is independent.

But the point is, that we can collect data, based on the information that we observed.

The fact that we observed this data, means that this would effect our estimation of the situation.

Re: Why people make dumb financial decisions on purpose

#128

Post by aloisklink »

dazc wrote: post #8

You can witness people buying lotery scratch cards every day in the UK and wonder why people are so dumb given the odds of actually winning a big prize. But then bear in mind that this person maybe has a big bill to pay and only £5 to their name, do they keep the £5 knowing that it isn't going make any difference or take a wild chance that will?

If you think about it, isn't buying insurance pretty similar (especially if you pay extra for really rare insurance policies, like lightning strike insurance).

You're essentially making a bet with your insurance company that xxxx will happen. Just like with the lottery, the expected monetary value of insurance is always negative (it has to be, otherwise the insurance company won't make money), but the utility value of that insurance is different for each person.

E.g. for me, insurance on a phone doesn't make sense, since I easily buy a another cheap phone if mine breaks. But for somebody with less money, those few hundred dollars might have a much higher utility.

Re: Why people make dumb financial decisions on purpose

#129

Post by divbzero »

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.

Isn’t it expected utility that matters, not expected value? From that standpoint taking $1 million guaranteed is rational unless you already have high net worth.

Re: Why people make dumb financial decisions on purpose

#130

Post by ghaff »

phao wrote: post #108
UKR_anon wrote: post #87

Earlier quoted context omitted.

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 c…

>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. T

Extended warranty which is basically insurance. Leaving aside the fact that some credit cards provide it for you anyway and things like that. Yes, for most purchases, this is a bad deal because the expected value is almost certainly negative and--probably--if something does break you can replace it.

Here we're talking about losses rather than gains. The certainty of small losses (extended warranty purchases) vs. the chance of a relatively large loss. But it's the same idea with a negative sign.

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