Behavioral finance theory at work?

Personal finance

Flexo over at Consumerism Commentary has written about Bernanke’s recent comments, in which the Fed Chairman claimed that “US households overall have been managing their personal finances well.” Flexo thinks it would have been more beneficial (and perhaps more accurate) had the chairman stated the opposite.

This poses an interesting question. Is making positive or negative remarks about how the majority of people behave a more effective method for stirring us out of complacency?

Recently there’s been , a high-pitched mobile phone ringtone that children and teens have started using in classrooms because it’s inaudible to most adults. Technorati shows that posts on that topic have gone up 10-fold over the last day (it’s still too new a keyword for Google Trends to analyze), and knockoffs of the ringtone are everywhere. Everyone wants to see if they’re still young enough to hear the 17KHz sound. I’m guilty as well, having spent several minutes looking for the ringtone, and now adding this post to the burgeoning Technorati list. And no, I couldn’t hear it. So, telling people that they can’t do something, and if they can, they’re an exception, seems to be effective at getting people to try.

This probably has to do with a fun little bias we have about our abilities in relation to those of others. Call it the (my favorite) or the , but it describes the phenomenon where 80% of people think they’re above-average drivers. A similar concept, apparently called in the UK, describes managers’ consistent overconfidence in the estimation of project parameters. Picture a company planning a brand new product launch and who’s plotted out a positive project NPV based on expectations of gaining 50% market share in 6 months’ time! (And yes, this happened at a company I worked for previously.)

How does this apply to finance? Doesn’t telling someone that he can’t beat the market encourage that person to try?

I’d tend to agree with Flexo and believe that if Bernanke had said, “US households overall can’t seem overcome poor management of their personal finances,” this might have done more to encourage people to look at their own situations. (Of course, the market would have tanked another 2% upon hearing these words, too.) I have to also wonder if it had been Oprah who’d made the statement whether people would have paid more attention, since I doubt most young Americans know who Bernanke is if they .

In a related vein, ever since signing up for PFBlogs.org, I’ve also found myself wondering if readers are more drawn to blogs about debt, or getting out of debt, rather than ones about investing. And if so, is it more because (for lack of a better phrase) misery loves company, and we feel better about ourselves after seeing others in worse situations than ours, or simply because more people can relate to having debt than having money to invest. I’ve noticed that my posts on spending or making money attract far more readers than my other posts. But, I haven’t been motivated enough to truly test my hypotheses by counting clicks over a given week or figuring out how to normalize or exclude all the other factors that might enter into play into topic popularity.

I don’t know much beyond the basics of theory, but I’ve heard more and more about it from friends who work in the investment industry. The better question to ask is whether you can actually harness the ideas in this field and put them to real use in investing. But we humans definitely behave in funny ways when it comes to money.


As far as Bernanke is concerned, I doubt he made those comments with the intent of using reverse psychology to encourage people to take action. I saw that article too, and my first tongue-in-cheek reaction was to shoot an email to my husband, an economist by training, asking whether being out-of-touch with reality was a requirement for being a Fed chairman.

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2 Feedbacks on "Behavioral finance theory at work?"

Kira

God, that’s annoying. But I went around my office and got a couple other people to listen to it anyway, to see if they could hear it. =)



Ricemutt

My husband and a friend (both older than I) could hear it too. I guess I’m destined to become prematurely deaf!