Thursday, January 14, 2010

Why So Many Americans Are Broke

According to classical economics, human beings are logical when it comes to money. If given sufficient information, they will make the most of their dollars. But four experiments—administered on students at some of the finest universities in the world—reveal that smart people make mistakes when it comes to handling money.

Read more here.


At 1/14/2010 10:58 AM, Blogger stevedp86 said...

I always use my credit card (rewards, convienence etc...) but by the end of the month my balance is always zero (why? well I'm not stupid). I'm only 23 and a lot of the people I know don't comprehend the interest and just do the minimum payment.

And yes, I do buy too much stuff with my CC but I don't care.

And automatic payments definitely work, only way I'll save.

At 1/14/2010 11:13 AM, Blogger jamused said...

I suspect that the results are overstated. When the test subjects are students at Cornell, Harvard, Stanford, and MIT you're studying a population that almost certainly has never held a full-time job or had to budget their money in order to cover necessities in their lives.

At 1/14/2010 12:26 PM, Anonymous Anonymous said...

Stories like this nearly always reveal as much about the irrationality of economists as they do about consumers. The idea that saving $5 is the same for both high and low cost items is absurd.

For a limited monthly total expenditure, there will be a mix of both a few high cost items and a lot of low cost items. It should be obvious to anyone but an economist that saving 33% on several low cost items results in a higher net purchasing power than saving 4% on one or two high cost items even if the absolute savings per item is the same.

Just about every day presents opportunities to get 33% bargains on low cost items, unless you've already spent all of your monthly allowance on one or two high priced items for no larger absolute savings ( but much lower percentage savings).

Regards, Don

At 1/14/2010 1:33 PM, Anonymous Lyle said...

The article just echos the discovery of behavioral economics that humans are human, not economic calculating machines. The whole financial crisis shows the serious fundamental error in modern economics, the assumption humans always make the best economic decision. The sorts of experiments suggested here are ones show the sorts of behaviors that exhibit the humanness of our responses, among those being following the crowd. The marketers and Madison avenue types all know how to influence people to behave in ways that are not in their long term interest. See Predictably Irrational or other books on behavioral economics. Interestingly Adam Smith humans did not always behave rationally, but in their zeal to make economics a mathematical discipline like physics, the economics profession assumed this away to make the math work.

At 1/14/2010 2:05 PM, Blogger OA said...

Anonymous said...
Stories like this nearly always reveal as much about the irrationality of economists as they do about consumers. The idea that saving $5 is the same for both high and low cost items is absurd.

You're actually supporting the researcher's claim that people are irrational. You're saying people's willingness to drive 20 minutes to save $5 should depend on how it's presented to them.

So if a 3rd group were told that at another store 20 minutes away if you buy the jacket for $135, they give the calculator for free, they'd have a different amount of takers.

In all cases, the only difference is the 20 minutes of time and the $5 saved. Just the apparent savings is different.

This is why you see 40% off sales with the small print saying the goods may never have been offered at the higher price.

At 1/14/2010 2:19 PM, Blogger Michael said...

OMG, the comments you are getting on this post provide further proof of the point!

I've had full time jobs for 22 years, 30 years if you consider I was paid a stipend while in gradual school and had no other job. I am susceptible to every one of the cited problems.

And $5 saved is $5 saved, whether on the purchase of a pencil, a beer, a car, or a house. When your employer starts setting your hourly wage as a fixed percentage of the next purchase you want to make, let me know and I will revise my opinion.

At 1/14/2010 3:16 PM, Blogger Adam Freund said...

This is another retread of the absurd (and obvious) findings of behavioral economics. There is no such thing as rationality outside of human beings. By definition what people choose to do is rational and the only way to state it isn't, is to claim someone universal rationality that exists outside the realm of human actions. It can't be done and because we don't know (or more importantly agree with) the reasons for someone's actions does not imply they are irrational. Economics does not prescribe nor require that everyone behave according to some universal economic calculator.

In addition, there are other benefits and costs which don't involve money and no outside observer can determine those other than by observing how people actual behave.

At 1/14/2010 3:51 PM, Blogger QT said...

Isn't this relative? The title of the piece is as irrational as the experiment involving the $5.00 savings on a calculator vs. the coat.

An excellent example of what "broke" or "poor" looks like is on CNN as we speak...Haiti.

While one can agree that many Americans make poor spending and personal financial decisions, describing the results as "impairment" or "loss" is stetching it. The decisions rather reflect the wealth of American society...we spend because we can.

At 1/14/2010 3:56 PM, Blogger Jet Beagle said...

I agree with jamused. Why would economists make conclusions about American spending habits based on the stated or even revealed preferences of college students? Does anyone believe the campuses of Harvard, Stanford, and MIT represent real world environments? These kids may be intelligent, but they haven't yet acquired real smarts. Let the students work for a living and pay mortgages for a decade. Then discover whether they have acquired money sense.

At 1/14/2010 5:40 PM, Blogger PeakTrader said...

The article doesn't prove people are irrational or make "mistakes."

Mistake 1: Did the "wealthier" consumers really overspend? Did they get the tickets (unlike the poorer consumers)?

Mistake 2: Is a $20,000 wedding equal to a $20,000 auto purchase? Why do people tend to go overbudget for a wedding, but not for an auto purchase? The difference does matter.

Mistake 3: Consumers are more uncertain about a higher priced good than a lower priced good. So, when a cheaper good falls by $5 and an expensive good falls by $5, the consumer is more likely to buy the cheaper good.

Mistake 4: It's rational to assume beer is more expensive at a "fancy resort hotel" than "a run-down grocery store."

If you want to test if consumers are irrational or make mistakes, then you tell 100 people there are 100 tickets and you can each bid for one ticket. It's likely every bid will be not more than immaterial to each bidder.

At 1/14/2010 7:17 PM, Blogger OBloodyHell said...

> "The loss of cash is an immediate and very concrete event," Vyse concludes, "but placing an additional debt on a credit card is a more delayed and diminished form of loss," which makes it easier to accept.

I don't argue with possible accuracy of the claim, here, but there's a variable which isn't mentioned as being dealt with, and that is -- what percentage of the big spenders (credit-carders) ALWAYs paid more in general?

There's an assumption that anyone who pays with a CC will pay more, but it may well be that people who USE CCs are generally willing to pay more. I don't see this variable as adequately controlled by the description of "half and half".


I also agree with jamused's observation.

...And find Don/anon's rather pointless. $5 saving for the exact same effort is $5 saved for the exact same effort. The idea that there IS any difference is the problem, not "sensible", as you suggest. How often it occurs that one is able to do it is just totally irrelevant to the fact or not of the savings or the effort required to obtain it, and the decision to pursue that effort.

At 1/14/2010 8:02 PM, Anonymous Lyle said...

Other experiments have shown that people would rather avoid a loss than have a bigger gain. The marketing types know that its easier to get people to spend credit card money than real money, else why would they make it so easy to use credit cards, why the no signature required for less that $25, and the no swipe card. It is interesting that marketing types knew about a lot of the psychological issues but the economists living in their ivory towers did not. Actually politicians know about some of the behaviors as well.
Clearly the great number of college students with huge credit card bonuses would validate the credit card cash observations. Note of course that not all fell for the item, just the majority, whose behavior is consistent with other observations.

At 1/15/2010 3:29 AM, Blogger PeakTrader said...

More high schools should teach personal money management and basic economics. Moreover, human and professional development classes wouldn't hurt.

At 1/15/2010 10:07 PM, Anonymous Anonymous said...

If you don't like the frequency of purchase of high vs low priced items argument, then try this risk- based argument :

Assume that every item you purchase has a 5% probability of either being defective or just disappointing you when you get it home, as you suffer buyer's remorse.

When you spend $10 for a $15 calculator, you save $5 but you have an expected loss of 5% of $10, or - $0.50 for a net gain of $4.50.

When you buy the $125 jacket for $120 you gain $5 but have an expected loss of 5% of $120 or - $6
,for a net loss of -$1.

In an uncertain world, buying high priced items results in a higher level of risk to your achievable standard of living.

Regards, Don

At 1/16/2010 4:27 PM, Anonymous Anonymous said...

Now an irrefutable argument -

Replace the calculator with a $20 bottle of wine that can be purchased for $15, saving $5.

Replace the jacket with a $200 case of wine that can be purchased for $195, saving $5. The case of wine consists of 10 bottles of the same wine as the single bottle above.

Tell me again how $5 saved is always $5 saved.

Regards, Don

At 1/17/2010 5:07 AM, Anonymous Fligg said...

The operative word here is STUDENTS.

Don't confuse intelligence with wisdom and experience.

At 1/21/2010 9:53 AM, Blogger MADELYNN said...

This is exactly what we're learning in a class by Dave Ramsey's, "Financial Peace University." It seems we have to re-learn the, save, save! The class of 200 people--100 families,(not including mortgages)was over 6 million dollars!


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