by Michael Silicz
Ho ho ho – the holiday season is finally here! And you know what that means… It’s that time of year where, rather than relax with family and reconnect with old friends, we’re likely scrambling to purchase last minute gifts for those we care about. Collectively, many of us are trying desperately to show our love to friends and family by purchasing this holiday season’s must have holiday trend, gadget or gizmo for them.
So, what is the must have gift this year? Is it new Star Wars memorabilia? What about Elf on the Shelf? Or could it be organic beard balm for your hipster husband?
Well, these gifts may very well be the it gifts of the year, but as a financial guy, I really have no idea.
What I do know is economics, finance and policy. (Maybe this is why I am often seated at the end of the table during the holidays… hmm.) And when it “Streetnomics” (you know, the kind of ideas you learn in the real world on the street, as opposed to the abstract stuff we’re taught in university), the people out there can’t stop but talking about the latest craze: behavioural finance.
Behavioural finance is the “it” (for economists) this holiday season. It’s the Saint Kardashian of the economic world. It is, in terms of growing followers, the Khole of Instagram. Here’s the Coles notes of what you need to know to impress your family and friends this holiday season.
First though, it’s important to be reminded quickly of last (century’s) trend. In a nutshell, holiday pun intended, “rational expectation” economics of the past assumes that you and I are like the Architect in the Matrix, able to perfectly know what’s in our best interest all of the time. From deciding between buying a Big Mac or Teen Burger, or whether to invest in a bank stock or ETF, this theory assumes we are always making the best decision possible with all information available to us.
Well friends, the coolest, hippest economists out there are calling this theory into question. They believe that it’s about as real as Santa Clause. Enter behavioural economics.
Out of American university thought (hence the incorrect spelling) comes behavioural economics. It seeks to study the effects of psychological, social, cognitive, and emotional factors on the economic decisions of people and the consequences of them on market prices, returns, and resource allocation. Whereas traditional economic models of the past have assume markets to be efficient and always right, behavioural economics assumes that knowledge is imperfect, that said perfect information is not available, and that humans are ultimately bound to make mistakes. Putting it in street terms, people are not rational like machines, and will often make obvious economic mistakes that are contrary to their own self-interest.
This is big, exciting and powerful news for so many reasons! This new theory argues that people are more emotional than rational, hence leading to all sort of “biases” that introduce poor decisions into our lives. Rather than think like a computer, in this modern day where we are overwhelmed with choice and information, this theory argues that we make emotional decisions first, and then use rationality to justify them. How cool is that?
Behavioural economics has three main themes. First, people often make decisions based on approximate rules of thumb and not strict logic. This means that rather than compute things like Data in The Next Generation, people rely things they already believe that may or may not be true. Second, people “frame” their decisions through a collection of anecdotes and stereotypes that make up the mental emotional filters which they rely on to understand and respond to events. Last, and the most geeky, behavioural finance’s most important point relates to financial markets and how these biases create mis-pricings and non-rational decision making. In streetnomics, that means people in the market make all kinds of mistakes, leading to opportunities to profit. But more on that another day…
Bottom line, with so much information (and more importantly, misinformation), it is impossible to be rational and hence market irrationality is introduced into the system. Going back to The Matrix Reload, to quote the Architect, “as you so adequately put, the problem is choice.” Because of choice, behavioural economics and finance is the in topic this year – aren’t you glad you’re now in the know?
So, this holiday season, when you see people freaking out for some creepy shelf elf or spending hundreds of dollars on Star Wars Lego at higher than market price, you’ll now be able to understand, using streetnomics, why they’re being so irrational! By knowing the latest and greatest (economic) trend of the 2015 holiday season, you can now relax, unwind, and be the one in the know at your next holiday gathering.
Michael Silicz helps people separate the signal from the noise. He has experience in finance, law and public policy. If you have any column ideas or would like to see Michael write about a specific topic, email him at firstname.lastname@example.org