Back in the old days, economists were trained to make financial decisions based upon rational analyses of concrete facts and well documented, irrefutable data. No opinions, no best guesses, no unanticipated upheavals such as tsunamis or hurricanes or terrorists attacks. As Joe Friday used to say on Dragnet, “Nothing but the facts, ma’am.”
It turns out that financial decisions, any decisions really, are based upon many elements. Facts and rational analyses are just two of those elements. Take, for example, your intention to set up a savings or market account designated specifically to pay for your daughter’s college educational costs because you know “it’s the right thing to do” in a world of uncertainty and escalating costs.
You could name that account “College Fund” or you could name that account “Rosie’s College Fund.” Which account do you think would likely be successful in actually paying for your daughter’s college expenses?
Even though the intention, the goal, the premise, the rationale for both these accounts is the same, how each account is named will determine the success or failure of each account. On the one hand, the name “College Fund” is generic…it could be any college fund…it isn’t specific…it isn’t meaningful. On the other, “Rosie’s College Fund” is. It means Rosie. It means your daughter. It means that every time money goes into that account, there will be more money for Rosie. It means that every time money doesn’t go into that account, money is being taken away from Rosie.
Clearly, the emotion associated with the name “Rosie” is what matters here. You wouldn’t forget to transfer money into that account and you wouldn’t transfer money out of that account for some other purpose. Why? Because that’s Rosie’s money. You as Rosie’s parent are making an emotional financial decision that meets your intention of providing your daughter with the funds to pay for her college costs.
Dr. Richard Thaler is one of the first thinkers to research what is today known as Behavioral Finance. Behavioral Finance registers the impactful influence that emotions have on making financial decisions. In his book, Misbehaving,” Thayer documents the fact that “…sometimes, we make financial decisions based on emotions…” Thayer asserts that “…humans (consumers and investors)do not act rationally but economists have pretended that we do.”
Thaler encourages consumers, investors and companies to “nudge” themselves towards making financial decisions that are “good for them” based upon sensible, middle of the ground elements; elements that take into account and blend fact based or analytic financial data with behavioral or emotional financial circumstances in order to make smart, well rounded financial investments.