Welcome back to Mind Over Money. I’m Kevin Cook, your field guide and story teller for the fascinating arena of Behavioral Economics.
“I began to have deviant thoughts about economic theory while I was a graduate student in the economics department at the University of Rochester located in upstate NY.” -- Richard Thaler, Misbehaving
This past weekend brought some excitement to our favorite arena when the Nobel Prize in Economics was awarded to Richard Thaler.
I talked about Thaler in episode #3 of the MindOverMoney podcast, Big Economic Shifts Challenge Your Decision-Making.
In that episode, I shared a story from Thaler’s 2015 book Misbehaving: The Making of Behavioral Economics. The story involved his friend, mentor, and collaborator the psychologist Daniel Kahneman, who also won a Nobel Prize in Economics in 2002 for his work on the psychology of judgment and decision-making. The story will explain why I call him “lazy” in my title.
First, some background on Thaler and Kahneman’s relationship. In Misbehaving, Thaler describes first coming across the psychology work of Daniel Kahneman & Amos Tversky in a Rochester library in mid-1970s.
Thaler, trained as an economist, had been compiling a list—The List, as he would come to call it—of all the irrational decisions people make, especially those involving money, risk, and uncertainty. But he was struggling with what direction to take his research ideas.
New Meaning for The List
As Thaler says “Dumb Stuff People Do” is not a satisfactory title for an academic paper.
But then he read Kahneman and Tversky’s landmark paper “Judgment Under Uncertainty: Heuristics and Biases.” At the time, Thaler said he wasn’t sure what a “heuristic” was.
(If you listened to episode #1 of the MindOverMoney podcast, Your Brain Wasn't Made to Trade, you already know that a heuristic is a mental rule of thumb, a decision-making shortcut. I list several of them there and in this blog post.)
Thaler describes reading Kahneman and Tversky’s work: “my heart was pounding... the paper took me 30 minutes to read, but my life had changed forever.”
With new insights about how people use heuristics on a daily basis for decisions big and small, Thaler said his hands were shaking with excitement.
Once he saw that heuristics were the cause of “predictable errors” Thaler realized he had found meaning for his Dumb Stuff People Do list.
He says in Misbehaving, “The concept of predictable biases offered a framework for my heretofore helter-skelter set of ideas.”
To hear the story about why Kahneman calls Thaler "lazy," check out the podcast attached to this article.
Been Caught Stealing
As much as Thaler has achieved in his work to bring the irrational human element to the forefront of economic theory, he remains humble amidst it all.
In an AP video clip at the University of Chicago award ceremony, Thaler is on stage saying “What have I done? I basically have made a career stealing ideas from psychologists. And you save the trouble of learning from the psychologists directly, just by looking at what I’ve stolen.”
These off-hand remarks were, of course, tongue in cheek. I don't believe Thaler wants to put any psychologists out of work. He’s trying to give credit where it’s due and he's highlighting his real contribution of bringing some of their most important work into the field of economics.
This is the real battle that has always intrigued Thaler: What Economists Think They Know (Economic players are always rational and markets are efficient) vs What Psychologists Really Do Know.
What Traders and Active Investors Already Know
This fusion between economics and psychology won a Nobel prize. But to any trader or active investor who has survived the emotional ups and downs for many years, this fusion is our daily experience.
We know that most market players do not act rationally every day. In fact, we count on this fact to make money and enhance our returns.
Trading is hard, and without lots of training, lots of mistakes, and lots more learning from those mistakes, most won’t become any good at it. It takes systems, rules, routines and the discipline to follow them. It also takes a good amount of emotional and psychological resilience, for even if you do everything right, you still might have to deal with a 50% failure rate on your trades over any given time period.
Your Brain Wasn’t Made to Trade
In my 2008 article Mental Models of Financial Sabotage my main thesis was “your brain wasn’t made to trade.” I used a psychological examination of rogue traders to help explain how we tend to make our money go away from us.
I described the emotional and cognitive biases and blind-spots, besides pure greed, that would make financial sabotage happen over and again. This was six months before we discovered Bernie Madoff and his spectacular Ponzi scheme which ripped-off hundreds of trusting investors for many billions of dollars.
In the podcast, I also share some of the top press coverage of Thaler's Nobel award.
Some of the best coverage from Bloomberg and the Financial Times focus on Thaler's contribution to public policy via research in his 2008 book Nudge: Improving Decisions about Health, Wealth, & Happiness.
Tim Harford writing for the Financial Times, titled his piece "Thaler’s Nobel is a well-deserved nudge for behavioural economics" with the subtitle "The master of deceptively simple observations of human nature ensured the field is taken seriously."
The title of Harford’s article is a subtle play on words, but the subtitle is a brilliant summary of how Thaler’s “List” turned into a set of powerful ideas and research that will continue to shape economic theory and practice.
Harford also captioned a photo of the man "Richard Thaler's insight is that such trivia as the 'Dumb Stuff People Do' might lead to important analytical and policy insights."
Jeanna Smialek wrote an excellent resource for Bloomberg Read These Five Papers to Understand Thaler's Nobel-Winning Work.
She sums up his 2015 memoir/manifesto Misbehaving thus...
Thaler clearly states the crux of his career-long argument: economics needs to take human behavior into account. People give into biases when making decisions, and that human miscalculation can come with serious consequences. Both economic forecasters and policy-setting governments need to take the fact that actors are human into account, he argues. "The primary reason for adding Humans to economic theories is to improve the accuracy of the predictions made with those theories,” he writes, quipping that behavioral economics comes with the added benefit of being more interesting and more fun. “It is the un-dismal science.”
In the podcast, I also read from Dan Ariely's 2008 book Predictably Irrational because it offers unique insight into Thaler's work. Ariely probably didn't know that Nudge was being published the same year, but he referenced Thaler's 2004 published research with the title "Save More Tomorrow" which became an important study in the new book.
Jeanna Smialek in her Bloomberg piece described it thus...
“Save More Tomorrow” is important because it brings a real-world experiment to bear on one of Thaler’s big ideas: “libertarian paternalism." The idea is that society should design institutions that help people to make better decisions, but without impinging their freedom to choose.
While Nudge and its ideas may be the lasting Nobel legacy of Richard Thaler, I recommend anyone read or listen to Misbehaving first and foremost because it gives life, history, and humor to the fascinating arena of behavioral economics.
Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the TAZR Trader service.
Image: Bigstock
Thaler's Nobel: Brilliant, Lazy, Humble
Welcome back to Mind Over Money. I’m Kevin Cook, your field guide and story teller for the fascinating arena of Behavioral Economics.
“I began to have deviant thoughts about economic theory while I was a graduate student in the economics department at the University of Rochester located in upstate NY.” -- Richard Thaler, Misbehaving
This past weekend brought some excitement to our favorite arena when the Nobel Prize in Economics was awarded to Richard Thaler.
I talked about Thaler in episode #3 of the MindOverMoney podcast, Big Economic Shifts Challenge Your Decision-Making.
In that episode, I shared a story from Thaler’s 2015 book Misbehaving: The Making of Behavioral Economics. The story involved his friend, mentor, and collaborator the psychologist Daniel Kahneman, who also won a Nobel Prize in Economics in 2002 for his work on the psychology of judgment and decision-making. The story will explain why I call him “lazy” in my title.
First, some background on Thaler and Kahneman’s relationship. In Misbehaving, Thaler describes first coming across the psychology work of Daniel Kahneman & Amos Tversky in a Rochester library in mid-1970s.
Thaler, trained as an economist, had been compiling a list—The List, as he would come to call it—of all the irrational decisions people make, especially those involving money, risk, and uncertainty. But he was struggling with what direction to take his research ideas.
New Meaning for The List
As Thaler says “Dumb Stuff People Do” is not a satisfactory title for an academic paper.
But then he read Kahneman and Tversky’s landmark paper “Judgment Under Uncertainty: Heuristics and Biases.” At the time, Thaler said he wasn’t sure what a “heuristic” was.
(If you listened to episode #1 of the MindOverMoney podcast, Your Brain Wasn't Made to Trade, you already know that a heuristic is a mental rule of thumb, a decision-making shortcut. I list several of them there and in this blog post.)
Thaler describes reading Kahneman and Tversky’s work: “my heart was pounding... the paper took me 30 minutes to read, but my life had changed forever.”
With new insights about how people use heuristics on a daily basis for decisions big and small, Thaler said his hands were shaking with excitement.
Once he saw that heuristics were the cause of “predictable errors” Thaler realized he had found meaning for his Dumb Stuff People Do list.
He says in Misbehaving, “The concept of predictable biases offered a framework for my heretofore helter-skelter set of ideas.”
To hear the story about why Kahneman calls Thaler "lazy," check out the podcast attached to this article.
Been Caught Stealing
As much as Thaler has achieved in his work to bring the irrational human element to the forefront of economic theory, he remains humble amidst it all.
In an AP video clip at the University of Chicago award ceremony, Thaler is on stage saying “What have I done? I basically have made a career stealing ideas from psychologists. And you save the trouble of learning from the psychologists directly, just by looking at what I’ve stolen.”
These off-hand remarks were, of course, tongue in cheek. I don't believe Thaler wants to put any psychologists out of work. He’s trying to give credit where it’s due and he's highlighting his real contribution of bringing some of their most important work into the field of economics.
This is the real battle that has always intrigued Thaler: What Economists Think They Know (Economic players are always rational and markets are efficient) vs What Psychologists Really Do Know.
What Traders and Active Investors Already Know
This fusion between economics and psychology won a Nobel prize. But to any trader or active investor who has survived the emotional ups and downs for many years, this fusion is our daily experience.
We know that most market players do not act rationally every day. In fact, we count on this fact to make money and enhance our returns.
Trading is hard, and without lots of training, lots of mistakes, and lots more learning from those mistakes, most won’t become any good at it. It takes systems, rules, routines and the discipline to follow them. It also takes a good amount of emotional and psychological resilience, for even if you do everything right, you still might have to deal with a 50% failure rate on your trades over any given time period.
Your Brain Wasn’t Made to Trade
In my 2008 article Mental Models of Financial Sabotage my main thesis was “your brain wasn’t made to trade.” I used a psychological examination of rogue traders to help explain how we tend to make our money go away from us.
I described the emotional and cognitive biases and blind-spots, besides pure greed, that would make financial sabotage happen over and again. This was six months before we discovered Bernie Madoff and his spectacular Ponzi scheme which ripped-off hundreds of trusting investors for many billions of dollars.
In the podcast, I also share some of the top press coverage of Thaler's Nobel award.
Some of the best coverage from Bloomberg and the Financial Times focus on Thaler's contribution to public policy via research in his 2008 book Nudge: Improving Decisions about Health, Wealth, & Happiness.
Tim Harford writing for the Financial Times, titled his piece "Thaler’s Nobel is a well-deserved nudge for behavioural economics" with the subtitle "The master of deceptively simple observations of human nature ensured the field is taken seriously."
The title of Harford’s article is a subtle play on words, but the subtitle is a brilliant summary of how Thaler’s “List” turned into a set of powerful ideas and research that will continue to shape economic theory and practice.
Harford also captioned a photo of the man "Richard Thaler's insight is that such trivia as the 'Dumb Stuff People Do' might lead to important analytical and policy insights."
Jeanna Smialek wrote an excellent resource for Bloomberg Read These Five Papers to Understand Thaler's Nobel-Winning Work.
She sums up his 2015 memoir/manifesto Misbehaving thus...
Thaler clearly states the crux of his career-long argument: economics needs to take human behavior into account. People give into biases when making decisions, and that human miscalculation can come with serious consequences. Both economic forecasters and policy-setting governments need to take the fact that actors are human into account, he argues. "The primary reason for adding Humans to economic theories is to improve the accuracy of the predictions made with those theories,” he writes, quipping that behavioral economics comes with the added benefit of being more interesting and more fun. “It is the un-dismal science.”
In the podcast, I also read from Dan Ariely's 2008 book Predictably Irrational because it offers unique insight into Thaler's work. Ariely probably didn't know that Nudge was being published the same year, but he referenced Thaler's 2004 published research with the title "Save More Tomorrow" which became an important study in the new book.
Jeanna Smialek in her Bloomberg piece described it thus...
“Save More Tomorrow” is important because it brings a real-world experiment to bear on one of Thaler’s big ideas: “libertarian paternalism." The idea is that society should design institutions that help people to make better decisions, but without impinging their freedom to choose.
While Nudge and its ideas may be the lasting Nobel legacy of Richard Thaler, I recommend anyone read or listen to Misbehaving first and foremost because it gives life, history, and humor to the fascinating arena of behavioral economics.
Kevin Cook is a Senior Stock Strategist for Zacks Investment Research where he runs the TAZR Trader service.