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What's going on?
Economics should take human behavior into account. This is a seemingly simple concept, but in a world dominated by the assumption that everyone will act rationally, its revolutionary! One of its chief researchers, Richard Thaler, earned himself a Nobel Prize on Monday by quantifying the effect that certain human behavior has on economics.
What does this mean?
Thalers research shows that economics must take humans inherent characteristics into account in order to better predict the (economic) future. A basic historical tenet of economics had been to assume that humans would act in their own best interest but, as we probably know from our own experiences, that is often not the case (e.g. humans tend to settle for the status quo even when change is a good idea).
Why should I care?
The bigger picture: According to Thaler, we would all benefit if we were nudged to make optimal financial decisions.
In one study, employees who werent saving much for retirement were given the opportunity to allocate future pay rises to their retirement savings accounts which they took and ended up saving lots more as a result. In short, without the nudge, they werent acting in their own best interest. More broadly, Thalers arguments have been expanded to say that, while people should always have a choice, society can create better economic outcomes for everyone by nudging people in the right direction.
For you personally: Your behavior may be having a detrimental effect on your finances.
Thalers work helps illuminate how people often create separate accounts in their minds for their finances (a.k.a. mental accounting). For example, you may enjoy trading around stocks in a small account, but have you thought about how your pension is invested? By focusing narrowly on single accounts, individuals may be missing out on beneficial strategies that would become apparent if they were to view their finances more holistically. The good news is that if you identify your own failings you can rectify them and reap the benefits.
Originally posted as part of the Finimize daily email.
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