Are You A Predictably Irrational Investor?

Are You A Predictably Irrational Investor?

            by: Brendan Magee

I don't know too many people who would not object or defend themselves if when it came to handling their money, savings, and investments were defined as being "predictably irrational," but Richard H. Thaler, Professor of Economics from the University of Chicago was just awarded the Nobel Prize in Economics for his research in determining how peoples' behavior affects how successful or unsuccessful they are in saving money.

The Nobel Prize committe's position in awarding Thaler the Nobel Prize is detailed below:

The Nobel committee, announcing the award in Stockholm, said that it was honoring Professor Thaler for his pioneering work in establishing that people are predictably irrational — that they consistently behave in ways that defy economic theory. People will refuse to pay more for an umbrella during a rainstorm; they will use the savings from lower gas prices to buy premium gasoline; they will offer to buy a coffee mug for $3 and refuse to sell it for $6.

I think a good way to determine if you fall under Thaler's theory is to ask yourself two questions:

1. When it comes to saving and investing, have you ever done something you said you weren't going to do?

2. When it comes to saving and investing, have you not done something you said that you were going to do?

Take an honest look at your decisions. During the crash of 2008, did you take money out of the stock market? In the early 2000's did you pull the trigger on a tech stock after seeing how well that sector of the market was performing? Now most of us know and agree that you don't sell low nor buy high, but if you answered yes to any of these questions you were behaving in a destructive manner. It may bruise the ego a little in owning up to mistakes that you have made in the past, but the only way to take ownership of your American Dream is to take ownership of bad behavior that you are responsible for.

So if the answer is yes that your behavior has been in conflict with what you are ultimately trying to accomplish, why is that? You are a smart individual. You have achieved a high school diploma, a college degree, a masters, etc. You are raising children, own a home, and have been successful enough to start saving and investing money. You are intelligent.

The problem is and this is what Thaler bases his research on is that you are human, and there is no escaping that fact. As human beings we do not have one bit of control over the thoughts and impulses that come into our heads and that we act upon. Sure there are areas where we do a good job of self control. We usually don't say every little thought we have about our boss to his or her face, but what about the times when there is no one else involved but ourselves? The popcorn at the movie theater, the pepperoni pizza, the gym, etc. How successful are you in controlling what goes into your mouth and what your body is engaging in?

Perhaps the thing that we need to come grips with is that there are certain areas of life where we are way better off engaging in or avoiding, but  living up to those agreements we are incapable of doing them  to the level or as consistently as we need to in order to be successful. How many of us would be 25 pounds lighter if we joined Weight Watchers? How much more money would you have if in 2008 your coach talked you out of getting out of the market or stopped you from loading up on tech stocks? 

So you turn to a coach whose job isn't to sell you products, but rather make sure that you do not "ever" engage in behavior that sets you up for failure.

Eating less and moving more are easy concepts to understand in losing weight. Own equities/stocks, diversify, buy low/sell high are easy concepts to understand when it comes to building wealth. Both concepts are easy to understand but awfully difficult to stick to over long periods of time. If they were everyone you meet, including yourself, would have a size 32 waist with a million dollars in their retirement accounts. Unfortunately, those people are the exception. Why? It's because we are human.

Sorry to run but my fitness instructor is waiting on me.

Brendan Magee is the founder and president of Inevitable Wealth Coaching. With comments or questions e-mail brendan@coachgee.com or call 610-446-4322