Monday, September 14, 2009

Caring More About Keeping What I Have: Bias Or Preference?

This is going to have to be short because it's the first day of school and I haven't got my lunchbox ready or my shoes shined and I don't know where my classroom is or who my homeroom teacher is going to be.

Fortunately, today's topic is pretty simple. It's often pointed out that people generally don't think the same way about losses and gains. We tend to care more about losing what we have; we tend to think the status quo is somehow standard. We think about income and spending completely differently.

For example, the amount I'd pay to have someone clean my house is totally different from the amount you'd have to pay me to make me think cleaning someone else's house is worth my time. But why? It's not like the amount of housecleaning to be done is set in stone; both choices involve a trade of housecleaning for money. And yet the two feel totally different. In the same way, I wouldn't place a bet of any substantial amount of money, even if I thought the odds of winning were really really good.

Essentially, I care more about keeping what I have than about getting more. Is this a bias? Or a just preference? Sometimes you hear it suggested that there's something vaguely irrational about it. Writing (about other things) in the Times recently, Paul Krugman says,
"Behavioral finance, drawing on the broader movement known as behavioral economics, tries to answer that question by relating the apparent irrationality of investors to known biases in human cognition, like the tendency to care more about small losses than small gains or the tendency to extrapolate too readily from small samples (e.g., assuming that because home prices rose in the past few years, they’ll keep on rising)."
OK, fine, but why is "the tendency to care more about small losses than small gains" a bias, and why is it irrational?

I mean, I see why it's wrong to extrapolate too readily from small samples -- if you do, you'll make an incorrect prediction about what's going to happen and you'll act accordingly and you won't get what you want. But there's nothing analogous about caring more about small losses than small gains.

I care more about small losses than small gains because:

1) Part of the pleasure of enjoying the things I spend money on is the feeling that they are going to continue, and small losses often mean they won't. I like to drink wine, but I would be far unhappier to have to stop because I can't afford it than I would be happy to be able to afford fancier brands. Sure, fancier brands would be nice, but I feel only tiny amounts of frustration at not being able to afford them. Nothing like I would feel at having to downgrade, or give it up. Looking forward to next time is a big deal, and you don't really look forward to stuff you've never had. Or not that often, anyway.

2) Like most people, my financial life involve a range of money committments: a mortgage, ongoing bills, a cellphone contract, internet for my home. Other people have even more complex committments: kids' tuition, say, or insurance for expensive things they own. The impact of a small loss on these is great: I have to figure out some plan, change things around, lose things I've gotten used to (see 1). The impact of a small gain -- especially a one-time gain -- is somewhat significant, but it's not big in the same sort of way.

With respect to 2), I remember once when I was a graduate student, a faculty member told me they couldn't live on 80 percent of their current salaray (which is what they'd get if they did a year sabbatical or something). At the time I thought, Really? But thinking it over it makes sense: when you have any regular income, you structure your life according to it. Small losses are a huge deal.

So my answer is: Caring more about keeping what I have seems a preference, a legitimate one, and not a bias.

1 comment:

chris said...

Hmm, has the blogger stopped blogging?