November 12, 2007

The Rationale for Irrational Behaviour

When I get logical, and I don't trust my instincts — that's when I get in trouble.
— Angelina Jolie

By studying investor behavior, Professor Meir Statman has insights into why we're not rational. Investments and many other items have two components
  1. utilitarian: practical, tangible, measurable
  2. expressive: emotional, intangible
Using a car as an example, the utilitarian elements are gas mileage, reliability and safety. The expressive elements are style, status and social responsibility. Our purchases are based on both.

In the US, the 2007 Hyundai Sonata surpasses the BMW 525i
  • 19 more horsepower
  • superior acceleration
  • more interior room
  • same number of airbags
  • half the price ($20K vs $40K)
That's according to a commercial. So it must be true ;)

No, no, you're not thinking; you're just being logical. — Niels Bohr
Buying the Sonata looks the logical choice. Let's look at 2007 car sales to Oct 31st from The Wall Street Journal. Hyundai sales dropped 12.1% to 250,885 cars. In contrast, BMW sales increased 9.2% to 188,845 cars. In October, why did Hyundai sell only 19,214 cars vs 19,084 for BMW, a difference of only 130 cars? There must be plenty of expressive drivers.

The same goes for investors. Statman would like a hedge fund, for example, listed as follows: 6% expected returns, 2% hope, 2% cachet.

The same article is published on Nov 7, 2007 with two different titles:
Strange. Different titles must grab different readers. Whatever the title, the article's worth a read.

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