Money is part of our lives from morning to night and, if we are earning interest, even while we sleep, writes John Hope Bryant in his book, The Memo: Five Rules for Your Economic Liberation. All the things and services in our lives cost money, and we don't have any control over the prices charged for everything we need and use.
But, you say, we do control what things and services we choose to buy. After examining human behavior, Nobel-prize-winning economist Richard H. Thaler challenges that idea. What Thaler has to say in Nudge, the book he co-authored with Cass R. Sunstein, expands on the financial literacy both he and Bryant see as a valuable foundation for happiness in every child, woman, and man in the world.
Financial literacy, like literacy itself, can begin at an early age, when a child learns it's dumb to take two quarters for one dollar. Thaler also used a Halloween trick-or-treater example to show how the investment choices people are given can affect their decisions. If children were to visit two adjacent homes that both offered Three Musketeer and Milky Way candy bars on Halloween, each child might select a different bar at each home. In another situation, if these children could visit only one home that offered the same two different bars and were allowed to each select two bars, they might choose two of the kind they liked best. What would happen if investors were given a choice of putting their retirement money in a fund composed of all stocks and one composed of all, more conservative and less risky, bonds? Most would split their funds half and half, just like the children visiting two homes. Another group of investors could put their money in an all-stock fund and a "balanced" fund that was invested half in stocks and half in bonds. Although they split their money half and half, their retirement depended on the performance of 3/4 stocks, more like the result of the children who took two of the same kind of candy bars.
Thaler cautions everyone about human failings. He cites a distinction between rapid, instinctive automatic thinking and reflective, rational thinking and presents a problem to demonstrate.
A bat and ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much does the ball cost?
Cost of ball = x
Cost of bat = $1.00 + x
Cost of ball and bat = $1.10
x + $1.00 + x = $1.10
2x = $1.10 - $1.00
2x = .10
x = .05 NOT .10
In Nudge, Thaler suggests the world could design slight nudges that, like a friend, could help our automatic thoughts make better choices and avoid the bad ones. Students would see the fruit and yogurt before the cookies and ice cream in the school lunch line. Best choices would be the default options offered by manufacturers, insurers, sales people, mortgage brokers, and credit card companies. But Thaler knows our best interests are not everyone's objectives. Reflective, rational thinking really needs to come into play, when there are many options and/or humans have little experience, poor information, and delayed or infrequent feedback about mistakes or success. Firms have a great incentive to cater to irrational beliefs. Suggesting everyone is doing something, like paying for a warranty on a small appliance, can provide a kind of peer pressure. The financial aid staff at colleges and doctors, for example, may be receiving gifts to recommend certain private lenders and expensive new drugs.
Humans tend to cling to the status quo, the monetary decisions they have made in the past, such as buying a new bathing suit every year even if they rarely go swimming. If we choose the TV show we want to watch on NBC at 7 pm, we'll be watching NBC shows until we go to bed. If our first vote for President was a Republican candidate, we may never change political parties. Thaler suggests, "Sometimes it's good to learn what people unlike us like....If you're a Democrat,...you might want to see what Republicans think; no party can possibly have a monopoly on wisdom." He also recommends diversifying investment portfolios.
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