June 16, 2022
Joe Fairless

JF2844: Why Investors Lose Money — How to Stop Misbehaving | Actively Passive Investing Show ft. Travis Watts

In this episode, Travis discusses the highlights from Misbehaving: The Making of Behavioral Economics, a book written by Nobel Prize winner and author Richard H. Thaler. While we often assume most people are logical and rational with their money, Travis explains how Thaler disproves that theory with a number of examples.


1. JCPenney’s Bankruptcy

Years ago, JCPenney brought in a new CEO who decided to do away with the department store’s popular coupons, opting instead to lower prices in the store. Shortly after this decision was made, JCPenney nearly went bankrupt. While the CEO’s logic made sense, the fact of the matter is that humans are dopamine addicts. Just as social media can give us a quick rush of dopamine, JCPenney shoppers felt that same excitement every time they used a coupon to save $20 vs. purchasing items at regular price. When the coupons disappeared, the customers followed suit. 


2. Irrational Human Behavior in Casinos

In his book, Thaler uses this example to demonstrate how negativity bias can cause irrational behavior in casinos. Say you go to Las Vegas with $1,000. You gamble all of it and make $10,000. You receive a dopamine rush of excitement and decided to turn that $10,000 into $20,000. However, you lose half of it. You decide to cash out with your $5,000 and leave the casino feeling defeated. 

Even though in this example you walked into the casino with $1,000 and left with $5,000, you’re still unhappy. This is because you’re focused on the most recent loss of 50% — an example of a cognitive bias known as a negativity bias. 


3. The Depressed Billionaire

Thaler uses another example to demonstrate illogical thinking when it comes to money. Say a successful billionaire experiences a catastrophic event that causes them to lose 90% of their wealth. They still have $100 million, but the pain and negativity they experience from the loss are crushing. Meanwhile, someone who makes $100,000 per year that receives a massive raise to $200,000 a year might be overwhelmingly happier than the ex-billionaire with $100 million. 

“The point is that we as humans don’t rationalize by absolutes, we go by contrast,” Travis explains. “We have to rise above these animal instincts that we have. We need to gain a little bit of perspective, gratitude, and appreciation.”


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