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Why people make dumb financial decisions on purpose

• Hippocrates 4y ago
  Given this choice I would press the green button. If I was flat broke, living on the street, or in debt even, I would find investors to pay, say 5 @ 200k each, for me to press the green button and reward them 1mm each in case of payout.
• codefreeordie 4y ago
  It's a catchy headline, but the "decisions" used as examples, aren't really "dumb" under the complete set of facts. Really, what this is about is that the typical mathematics used to discuss a certain type of financial decision (mostly things like investments) uses an incomplete model that doesn't consider appropriately the actual values involved -- for example, failing to consider the wildly nonlinear curve of the marginal value of one dollar.
  • pid-1 4y ago
    I think you just repeated the article's main argument.
    • kwhitefoot 4y ago
      Why would anyone bother reading the article when the title and pretty much the first line are falsehoods.
  • Ozzie_osman 4y ago
    It's just a bad title. Choosing a guaranteed 1M instead of a 50% chance at 25M isn't particularly dumb. "Dumb" decisions might be playing the lottery, or spending a windfall instead of saving it. But even those dumb decisions have reasonable psychological underpinnings for the person doing them.
    • slfnflctd 4y ago
      > psychological underpinnings Another example of a 'dumb' decision: torpedoing a career to preserve relationships. My prospects are abysmal, my savings insufficient and I'm still dysfunctional, but I'm better off than I would've been in many ways if I had not decided to give my loved ones (and my mental health) higher priority. I like to think I can make a comeback one day, but it's okay if I don't.
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• k2enemy 4y ago
  I don't know how that article is written without mentioning utility theory in economics and the concept of diminishing marginal utility of money and the risk aversion it implies. No need to even bring in behavioral economics. https://en.wikipedia.org/wiki/Risk_aversion https://en.wikipedia.org/wiki/Risk_aversion
  • tehsauce 4y ago
    Agreed. The article claims the scenario is “mathematics vs circumstance”, but really it’s really naive math vs math which takes into account the nonlinear utility.
• gardenhedge 4y ago
  "A 50% chance of winning $50 million would equate to an expected value of $25 million." If you hit the green button you either get $50 million or 0$. Hitting the red button gives $1 million. Unless you don't want $1 million or don't need it, you're going to hit the red button and not the green button.
  • id 4y ago
    If you have $100 million to your name, it'd be smarter to hit the green button. It really depends on what you're starting with.
    • CrazyStat 4y ago
      I'd go for the green button if I had $5 million to my name. Another $1 million isn't going to make a huge difference in my life, $50 million would. Somewhere around $3 million is probably where I'd switch buttons.
  • BeetleB 4y ago
    Serious question: There are 20 people in line ahead of you. Each one of them hits the green button, and you physically see that half of them made $25 million. Would you not be tempted to hit the green button? $1 million will make a big difference to me, but in many cities it's not enough to retire on - especially with children. While $25M isn't worth 25x more to me, it's certainly worth a heck of a lot more than $1M.
• dazc 4y ago
  You can witness people buying lotery scratch cards every day in the UK and wonder why people are so dumb given the odds of actually winning a big prize. But then bear in mind that this person maybe has a big bill to pay and only £5 to their name, do they keep the £5 knowing that it isn't going make any difference or take a wild chance that will?
  • Mezzie 4y ago
    I buy scratchy lottos sometimes (the cheap 1-2 dollar ones) because I find the act of scratching them to be tactilely pleasing. $1-2 for a couple minutes of fun and the possibility of winning enough to get myself some candy for 'free' is nice.
  • JasonFruit 4y ago
    I once was down to my last dollar, and I bought my one and only lottery ticket ever. What could it hurt? I couldn't do anything to help myself with one dollar. I lost.
  • tester756 4y ago
    I call it a small price for a dream / what if mood
    • dazc 4y ago
      Indeed, I have an ongoing subscription with zero expectation of winning but I do sometimes enjoy thinking 'what if'. Considering how much money I throw away on streaming subscriptions I barely use, books I never get beyond the first chapter of, food I buy that ends up in the trash, etc, it represents quite good value for money.
  • tpmx 4y ago
    These two situations (the linked one and the one you're describing) aren't really comparable in terms of probabilities.
    • dazc 4y ago
• imtringued 4y ago
  The rational behaviour is to make everyone press the green button and then give away a million dollars to anyone who didn't get a prize but the obvious problem is that no such thing happens. Instead of cooperating some people insist on getting the full 50 million dollars as if they deserve it and were destined to get the money while the plebs who didn't get anything also deserve to stay poor. In other words, the problem is that humans are cruel to each other and peace of mind vs other cruel people is worth more than a higher reward.
  • majkinetor 4y ago
    Co-op is definitelly best outcome. Find 20 people to each press green and divide equally total amount. U r then in worst case scenario better then taking 1m
• _Algernon_ 4y ago
  There's diminishing returns on the utility of money. If you're living paycheck to paycheck that guaranteed million is gonna give you a higher expected return of utility than the next 49 million combined. I disagree with the title calling it a "dumb" financial decision. It can be perfectly rational to take the million.
  • crazygringo 4y ago
    Exactly. The fact that this article doesn't even mention the concept of marginal utility, and acknowledge that it's mathematical rather than "psychological", is borderline irresponsible. [1] https://en.wikipedia.org/wiki/Marginal_utility https://en.wikipedia.org/wiki/Marginal_utility
    • burntalmonds 4y ago
      It does mention it. "If you don’t have a dime to your name you should take the guaranteed million dollars all day, every day. But what if you have some money? What if you’re already a millionaire? At that level of wealth taking the 50/50 shot at $50 million might be far more tempting."
      • baobabKoodaa 4y ago
        No, it doesn't mention it, and in fact the quote you copypasted does not contain any mention of it. The author is oblivious to the concept and is erroneously concluding it to be merely a psychological effect.
      • bluetomcat 4y ago
        The takeaway is that a wealthier person can take greater risks without endangering their livelihood. A wealthy person, could, for example risk buying an older used car that would potentially need costly repairs. In case it needs these repairs, they will suffer some financial losses but would still be able to derive utility from the car. In case it doesn’t need them, they get rewarded for the risk with a functional car that costs considerably less than a new one. For a broke person the same decision is much harder. Not being able to repair the car would unlock undesirable 2-nd and 3-rd order effects, like, not being able to go to work.
• MontyCarloHall 4y ago
  This is a nice concrete refutation of the fallacious reasoning in Pascal’s Mugging [0]. You can take this argument to its absurd conclusion by setting probability p arbitrarily small and the payout X arbitrarily large, such that p*X is arbitrarily greater than $1M, e.g. a 1/100000 chance of winning 100 trillion dollars. [0] https://en.m.wikipedia.org/wiki/Pascal%27s_mugging https://en.m.wikipedia.org/wiki/Pascal%27s_mugging
• Cloudef 4y ago
  Because people dont care about money if their life has no happiness or purpose in the first place
• agentwiggles 4y ago
  Honestly I'd hit the red button. I'd rather take a guaranteed payoff of my mortgage and all other debt, with plenty left over for a few neat toys, than chance walking away with nothing.
  • selfhoster11 4y ago
    Exactly. I’m also quite puzzled that nobody mentioned yet that if you were offered a chance like this in real life, it would likely be the only time in your life that you get a chance like that. Unless you get a repeat, or you are rich, it would be foolish to not press the red button.
  • BeetleB 4y ago
    I wouldn't, because I can likely pay off my mortgage without it and still have money left over for some toys. My mortgage isn't a big burden. But I can understand it for folks who can't save much due to a mortgage. The problem with the scenario is that the disparity is so high: $1M vs expected value of $25M. 50% is high enough that for people like me, it's clearly a green button option. But how about this: Guaranteed $1M vs a 4% chance of winning $50M. Now the expected value is $2M - still a lot higher than $1M. But ... 4% chance? Suddenly the guaranteed $1M is a lot more attractive.
    • ghaff 4y ago
      The utility function, and to some degree, attitude towards risk is going to differ a lot among individuals. And I imagine that among those reading this here, some are probably going "A million is a nice sum but it's not really life changing whereas $50 million would let me retire right now." And you can scale the numbers up or down and at some point almost everyone will choose red or choose green respectively.
      • im3w1l 4y ago
        Ironically 50 million would make me want to hire people to realize my visions, pulling me out of retirement.
• rotexo 4y ago
  The response I saw on Twitter that made the most sense: “sell your button press for $5 or 10 million to a person who has $100 million”
  • rwmj 4y ago
    Now I'm wondering what the expected value is if you were to auction this button pressing opportunity. Intuitively it seems to be over $1m (and less than $25m) so if I'm right then that's better than pressing the red button.
    • ghaff 4y ago
      Assuming there's no risk to payouts being made/no fraud/etc. then presumably yes. It's probably related to hedges against commodity price increases/ foreign exchange fluctuation, etc. Not quite the same thing but somewhat similar in principle.
    • rotexo 4y ago
      Also made me think of the parallel universe to the show “Silicon Valley” where Richard Hendricks sells Pied Piper to Gavin Belson for like $10 million and happily retires in La Veta, Colorado.
  • rotexo 4y ago
    On a tangent, and I’m just spitballing here, how is this for a business idea. I: have a PhD (which is not to say I’m smart, it is just to say I have been exposed to lots of facts that other people may not have been exposed to), and I have a bunch of ideas that may or may not be good ones, but I’m too risk-averse to act on any of them and start a business. You: have a bunch of money and are open to ideas. So you pay me, say, $100 bucks to just vomit my ideas out during a 15 minute phone call. Like a cheap loot box of ideas, most of which have a low probability of success, but there may be a nugget of gold in there.
    • rwmj 4y ago
      The thing you learn from start-ups is that ideas are worth nothing. It's execution that matters. But ... if you were an oracle (religious, not database) who sometimes foretold the future, would there be a marketplace for your ideas? In 2003 if you described a social network would that be valuable information? I tend to think no since there were social networks before Facebook but FB were lucky and executed very well.
• subsuboptimal 4y ago
  I constantly run into situations where I spend money in ways that are financially non optimal, but socially good (in my mind). An easy to understand example is, I believe I should pay more in taxes and everyone as wealthy as I am should too. I rent an apartment, but I rent it out at the cost it takes to maintain it in good condition, because I think profiting off rent is unethical. This means I'm generally renting much much cheaper than local rents, and my tenants can therefore build savings.
  • WalterBright 4y ago
    If you want to may more in taxes, the IRS accepts donations. There can also be good business reasons to charge below market rent. Having a lower vacancy rate, for one.
    • subsuboptimal 4y ago
      No, I don't think you understand. I'm not charging below market rate, I'm charging at cost. Whatever it takes to maintain the building and provide utilities, etc. The space is worth, perhaps, $2400 a month. My last tenant paid $600 a month. She needed a place to stay for a year while she built up a down payment. Being able to stay with us meant she could save tens of thousands and she was able to embark on her own. Could I have charged $1000 and pocketed a little profit? Of course. But it would have come directly at her ability to succeed. I think that's deeply unethical. I think it's morally repugnant to profit from housing.
    • subsuboptimal 4y ago
      The IRS does not, in fact, accept donations. But the point is that I believe we should all chip in more to help each other out. If you make, eg, $750k a year like I do an increase in taxes isn't really going to hurt your ability to live comfortably. I'm confident I could travel anywhere in the world, buy a second home, etc. I could still do those things if I payed more in taxes. Just... Not as often.
• 10000truths 4y ago
  Other commenters have mentioned marginal utility, but this article is basically explaining minimax [0] decision making - people (and chess AIs) tend to pick the option that minimizes worst case losses. [0] https://en.wikipedia.org/wiki/Minimax https://en.wikipedia.org/wiki/Minimax
• kwhitefoot 4y ago
  > A 50% chance of winning $50 million would equate to an expected value of $25 million. No it doesn't. Statistics is the science of populations of events, expected value applies only if you have a sufficiently large population.
  • synu 4y ago
    I see this is being downvoted for some reason, but I have the same question. I get that if you keep replaying the game the expected value materialises over averages, but if you have one chance it doesn’t sound right that you should expect 25M if the two outcomes are zero or 50M? And that this is so true and obvious that it is dumb to take the 1M?
  • shapefrog 4y ago
    Schrodingers cat is half alive.
  • BeetleB 4y ago
    It is the expected value if multiple people play the game. As I posted in another comment: There are 20 people in line ahead of you. Each one of them hits the green button, and you physically see that half of them made $25 million. Would you not be tempted to hit the green button?
    • kwhitefoot 4y ago
      No because each event is independent.
      • stale2002 4y ago
        But the point is, that we can collect data, based on the information that we observed. The fact that we observed this data, means that this would effect our estimation of the situation.
        • kwhitefoot 4y ago
          Only if you have reason to believe that the events are not independent. And anyway the way the original scenario is phrased suggests that it is a one off.
• FunnyBadger 4y ago
  It think they misstated the actual problem which should have an equal EXPECTED value: Expected Value = Value x Probability.
• egypturnash 4y ago
  Surprise surprise, people are not perfect emotionless economic units! I don’t think it’s a good look for the “Director of Institutional Asset Management at Ritholtz Wealth Management” to call perfectly sensible decisions by people whose net worth is many orders of magnitude smaller than his “dumb” just because he can afford to pass up a guaranteed million.
  • compiler-guy 4y ago
    He didn’t call them dumb. He called them wise, in spite of their decisions going against a simplistic expected value analysis.
• LorenPechtel 4y ago
  The dumb is in the author thinking these are dumb decisions. $50M is nowhere near 50x as valuable as $1M, thus the green button is nowhere near 25x the value of the red button. For most people pushing red is the smart decision, not the dumb one.
• Kalanos 4y ago
  seriously flawed perspective. it's a 50% chance of nothing versus a 100% chance of a life-changing amount of money. if it was $1K:$25K or $100K:$2.5M then you'd take the risk.
  • ghaff 4y ago
    Totally depends on an individual. You can't generalize that $1M is life-changing for everyone and $100K is not for anyone.
    • Kalanos 4y ago
      statistics
• horsawlarway 4y ago
  Expected value doesn't mean jack shit if the game can only be played once. > Expected value (also known as EV, expectation, average, or mean value) is a long-run average value of random variables. If you can only press a button once - you should take the guaranteed money in almost all circumstances (assuming you have finances that look like most Americans - if you're already a millionaire... do what you want, this game doesn't matter much to you). Basically - This is a dire misunderstanding of how statistics works in general. The population at large might be better off pressing the 50% at 50 million button (because then you are running this game many times and you will likely achieve the expected value) - but as an individual, who can only roll the dice once, you are much better off just taking the immediate and guaranteed win. And that's not even accounting for the drop off in marginal value of each dollar as you accumulate them - that first million is far more impactful than the next 49.
  • jstanley 4y ago
    > that first million is far more impactful than the next 49. This is in fact the reason you should take the million. How many times you get to play the game is irrelevant. Your whole life is filled with potential but uncertain payoffs, and you should maximise expected utility every time (where utility is not the same as dollars).
    • Bootvis 4y ago
      No it’s not, if you play the game 20 times you’re almost certain to win 50 million and probably a lot more. Unless your utility function is flat after 20 million it does matter.
      • orlp 4y ago
        If you play the game 20 games you'll still be better off pressing the 1 million button 5-10 times, at the start if you don't know in advance how many presses you get, or at the end if you do and haven't won big yet.
        • 4y ago
• WalterBright 4y ago
  What people say they will do on a hypothetical is not the same thing as what they will do if actually faced with the decision. The way I've been able to deal with this personally is by thinking "what would I do if this was Monopoly money?" and then reconcile that with my emotional decision.
• moviewise 4y ago
  There is a documentary about the psychology of financial decisions (behavioral economics): Mind Over Money: Nova (2010) https://moviewise.wordpress.com/2013/01/14/mind-over-money-nova/ https://moviewise.wordpress.com/2013/01/14/mind-over-money-n... "Emotion may lead you to make bad financial decisions. For example, people who feel sad will pay more, sometimes four times more, for a consumer product than those who do not feel sad." The "Nash equilibrium" also delves a bit into the psychology of decision making: https://www.reddit.com/r/math/comments/1tc80g/is_the_explanation_of_nashs_equilibrium_in_the/ https://www.reddit.com/r/math/comments/1tc80g/is_the_explana...
• Tade0 4y ago
  > The mathematical answer is you hit green every time. Nope. There's a whole field of research about this - decision theory - which doesn't agree with this decision. Most people appear to go with the Minmax approach - they minimize potential losses(or in this example: maximize minimal payouts). For one-time events it's a sound strategy.
  • remram 4y ago
    Yeah this is really weird. The author knows one "mathematical" measure, 'expected value', and calls that "mathematics". Ignoring the fact that mathematics have given us way more measures such as variance and the other moments that are just as important and "mathematical". Then microeconomics have given us 'utility' etc. Finding one mathematical concept and saying "mathematics say this" is so strange.
• scarmig 4y ago
  Isn't the best solution here to find a wealthy investor and sell him the option to press the green button priced at $20M? You get $20M, and they get an instrument with an EV of $25M at the cost of $20M.
  • robocat 4y ago
    You would need an auction to get a good payout. If you only find one smart wealthy investor, they can offer you a take-it-or-leave-it $2 million. Your choice then becomes take $1 million from the red button, or sell the green button for $2 million. I imagine most people would take the 2 million, especially because I suspect most people are poor at negotiating when life-changing amounts of money are involved. I have seen many naive people do silly house trades (or missing out on good trades).
• BiteCode_dev 4y ago
  Nassim Taleb famously destroys those lines of reasoning in his books: game theory is unpractical for most people, because it almost always ignore variables that don't exist in a lab but are crucial IRL. Comments have been explaining which ones already apply to this article, I'm not going to repeat them. But there is an another example from Taleb that always makes me smile: - If the other player tosses a coin and gets 9 tail in a row, what are the chances of getting tail on the next toss? - 50%! - No, 100%. The other player is cheating.
• paganel 4y ago
  I still don’t get it how hitting the green button (50% at 50 mullion) is the “rational” choice, it isn’t. 1 million in your pocket, no matter what, is exponentially and life-changing (for the majority of us) better than a 50% of getting nothing. Maybe if the value behind the red button would have been smaller (let’s say $1000 or even $100) then things would have been different, but, again an $1 million in one’s pocket no matter what is life-changing for most of us.
  • compiler-guy 4y ago
    On a pure, simplistic, naive, reading of expected value it is the “rational” choice because $25 million is more than $1 million. The author’s point is that the simplistic understanding of expected value isn’t always wise. The audience is economists who use the economic equivalent of perfectly spherical cows and then wonder why their model isn’t all that good.
• TheAceOfHearts 4y ago
  If there's multiple players with these buttons the optimal strategy is to pool your resources and distribute the winnings evenly. Teamwork makes the dream work.
  • wizofaus 4y ago
    If you could get 10 friends to agree on such an arrangement would you still have one press the red button to ensure everyone at least gets something? Or take the 1/1024 chance of getting nothing at all in return for the likelihood of everyone getting 25 million?
• bcrosby95 4y ago
  Given my current financial situation, 1 million would let me retire immediately. What I see when I look at those buttons are: 100% chance of being able to retire early vs 50% chance of being able to retire early.
  • pcthrowaway 4y ago
    Unless you're expecting to less than maybe 10 years to live, I wonder how anyone can assume $1 million would be enough to retire, given the uncertainty about the rate of inflation in the next few years.
    • bcrosby95 4y ago
      I already have 1.5 and own my home.
• jimmysnuka 4y ago
  Admittedly, I'm not an expert at this stuff, but it seems like strictly using expected values to calculate optimum decisions can get you into some strange situations, like infinite expected value [1]. For some reason the author brings up lump sums vs annuities, which I don't think is at all comparable to betting (annuities from the US govt are guaranteed payments). That aside, a number of people have already mentioned Kelly criterion [2]. This strategy would tell you that you should take the guaranteed $1 million, but this is a long-run strategy. I personally would take the $1 million because it is guaranteed. I'm also not sure if relying on math for a one-off event like this makes sense. [1] https://en.wikipedia.org/wiki/St._Petersburg_paradox https://en.wikipedia.org/wiki/St._Petersburg_paradox [2] https://en.wikipedia.org/wiki/Kelly_criterion https://en.wikipedia.org/wiki/Kelly_criterion
• fegu 4y ago
  This is similar to the choice between a salary (quite predictable) and a startup (maybe a lot, might just as well be zero). Or, in a company, between doing consulting or in-house product development.
• jawns 4y ago
  For those who say they would press the red button ... * Imagine the payout on the red button were not $1M but $100K or $50K or $10K. Is there any point as it diminishes toward zero that would make you switch buttons? * Imagine the payout on the green button were not $50M but $100M or $500M or $1B. Is there any point as it increases toward infinity that would make you switch buttons? For those who say they would press the green button ... * Imagine the payout on the red button were not $1M but $2M or $5M or $10M. Is there any point as it increases toward $50M that would make you switch buttons? * Imagine the odds on the green button were not 1:2 but 1:3 or 1:5 or 1:10. At what point, as the odds diminish, would you switch buttons?
  • ghaff 4y ago
    You can certainly fiddle with numbers to the point where you can basically force a given person to go with green or go with red. In general, as you get into certain payouts that aren't a big deal for an individual they'll tend to go with higher expected value at least up to a point. But as the odds get longer, most people will tend to go with certainty as long as it's a reasonable amount.
• randcraw 4y ago
  All the classic economic models for choice that I've seen fail to consider that the perception of not only risk but reward are BOTH nonlinear. IMO, this has been an Achilles heel of classic price and game theory. The rise of behavioral economics in recent decades would seem to agree with this iconoclysm. If I need $1 million right now or else a loved one dies, then it doesn't matter how big the reward of a riskier alternative choice may be. I take the million NOW. If the additional reward is a victim of decreasing value as that offer rises, it's only rational for the decider to show diminished interest in choosing the greater reward (even if the marginal odds are only a tiny amount less likely). Disregarding the reward curve of the individual is going to consistently misjudge economic choice and will surely be a poor basis for any economic model.
  • mgraczyk 4y ago
    Not sure what you mean by this. Even in the most basic rational choice analysis, where the players are agents seeking to maximize a utility function, the "reward" can be nonlinear. I'm not familiar with any economic model that unintentionally restricts the agent's utility to be linear. Sometimes you assume that agents have a linear "utility of money", but everyone in economics knows that this is a taylor expansion around a small region where the linearity assumption is reasonable, and not an actual fact about human preferences.
• danielmarkbruce 4y ago
  https://en.wikipedia.org/wiki/Expected_utility_hypothesis https://en.wikipedia.org/wiki/Expected_utility_hypothesis
• plorg 4y ago
  The discussion here seems to be whether, if we can capture all of the relevant details, a certain person is making a rationally optimal decision. Taking this to its logical conclusion we're fitting math to a process of decision making and adjudicating which criteria are considered rational and which are not. Sure there is mathematics involved here, but it reads a lot more like a question of who is our isn't allowed agency, in this case in their economic and financial decisions.
• t_mann 4y ago
  Fyi, an imho more illustrative example why we should think in terms of expected utility than expected cash flows: https://en.wikipedia.org/wiki/St._Petersburg_paradox https://en.wikipedia.org/wiki/St._Petersburg_paradox tl;dr: doubling winnings on each throw of heads and paying out on the first tail is a game with expected winnings diverging to positive infinity, yet probably no one would pay more than a few bucks to enter
• deleted 4y ago
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