FOOL ON THE HILL
Are You a Homo Moronicus?

Though the intricacies of money management can get complicated, the basic formula for increasing your net worth is simple: Spend less than you make and invest the difference. Yet most of us make less-than-ideal decisions about our money, at least occasionally. Is there a rational reason for our irrational behavior?

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By Robert Brokamp (TMF Bro)
February 3, 2003

Economics is the study of a lot of numbers: gross domestic products, interest rate fluctuations, stock market movements, and so on. Of course, behind all the numbers are people -- for example, the domestic folks who produce gross products. And economists don't ignore the human element. In fact, they've even given him a name: Homo Economicus. Seriously. Look 'em up in your economics textbook.

And what's good ol' H.E. like, in case you're thinking of inviting him over for a party or betrothing your daughter to him? He's a person of unbounded rationality, unbounded willpower, and unbounded selfishness. (Well, two out of three ain't bad for a son-in-law.)

Most economic theories assume that all people are like Homo Economicus (or "Hocus," as his friends call him). They assume that people make the best decisions, delay gratification, and act out of self-interest.

The problem is, most of us could be better characterized, at least occasionally, as Homo Moronicus: We often spend when we should save, consume when we should produce, and -- thankfully -- are not just looking out for No. 1.

Enter behavioral economics, which is "the combination of psychology and economics that investigates what happens in markets in which some of the agents display human limitations and complications," according to Sendhil Mullainathan and Richard Thaler, two of the field's practitioners. Behavioral economics studies all kinds of ways humans make curious financial decisions, such as why someone would drive 20 minutes to buy a $10 calculator instead of cruise around the block for a $15 calculator, yet wouldn't drive that far to pay $120 for a jacket instead of $125 (a quandary contemplated by Dr. Daniel Kahneman, one of two winners of last year's Nobel prize in economics).

I started looking into behavioral economics -- and I must acknowledge that I don't know much yet -- because I was perplexed. Why do people (myself included) make less-than-optimal financial decisions, even though they know better? Why, for instance, did I spend $7 yesterday on a lunch that I know had much more fat than I needed, when I had a can of chicken soup at my desk? Or why did a father buy a humongous large-screen TV but not life insurance, as did one victim of the Sept. 11 attacks? Why do a majority of Americans have too much in taxes taken out of their paychecks, and furthermore file their returns close to the April 15 deadline, letting the government keep their money for as long as possible?

Ask anyone the secret to accumulating wealth, and they'll tell you what to do: Spend less than you make and invest the rest. It's almost instinctual. Sure, some folks might be hazy on the details, such as whether a 401(k) or Roth IRA is the best place for retirement money. Most people know that spending more than they make is not good, yet the majority of Americans carry high-interest credit card debt.

Why don't we do what's right for us? I'm really curious, which is why I need your help.  I'd like to hear what you think. I'll get the conversation going by throwing out some of my reasons, and then give you an opportunity to join in.

Reason 1: People choose pleasure over pain, even if it results in greater pain later.
We'd rather eat, buy, and watch TV than exercise, abstain, and fill out IRA enrollment forms -- even though we may pay dearly down the road. If there's no immediate punishment for doing the less-favorable option, or instant gratification for making the better choice, then why be good?

Numerous studies have shown how people have trouble with short-term decisions. One of my favorites is the marshmallow test, in which the puffy treats were given to 4-year-olds. The kids were told they could have one, but if they waited until later, they could have two. Researcher Walter Mischel tracked the kids down years later, and it turns out the ones who were able to suppress their carnal desire for sugar in order to attain the greater prize (known as a m�nage-a-mallow) were more socially savvy, academically successful, and more popular around campfires.

Reason 2: People are money-drugged.
Perhaps this goes back to the old "hunters and gatherers" theory, but we like to acquire stuff. Researchers have been able to document a "buyer's high" that follows a successful retail kill.

I spent a good part of last winter looking for the perfect, fairly priced outdoor fireplace (which is essentially a grill that can accommodate logs). I had visions of friends in our yard on cool nights, telling stories and, of course, roasting marshmallows. I found great satisfaction in ignoring work and household duties in order to drive from store to store looking for the right model. Then I moved in for the purchase.

How many times have I actually used this outdoor fireplace? Let's just say the thrill was in the hunt, and all our marshmallows are still among the living.

Reason 3: People are haunted by the past.
I'm not suggesting that analysis of the Freudian variety is necessary to manage money well, but family history is an important reason some folks overspend or avoid dealing with money issues. We all know money figures into most divorces. It should be no surprise that it also figures into a lot of childhood neuroses, which then turn into adulthood financial difficulties. 

Reason 4: People don't like to be told "No."
Abnegation is un-American. We're going to drive the vehicle we want, wear what we want, consume as much as necessary, worship whomever we choose, and show as much cleavage as possible in beer commercials. Recognizing that there's a limit to how much we can possess would be admitting defeat. Words like "thrift" and "frugality" haven't been part of the national lexicon since Benjamin Franklin.

We've all seen the credit card commercials suggesting we can buy voraciously and travel the globe, and we don't have to worry about paying for it because we have a "no-hassle" card. Wouldn't it be funny to see a bank promote its savings account by showing happy, beautiful people opening their account statements and celebrating their increasing net worth? Well, probably not. Saving just isn't sexy.

Reason 5: Your team wins the Super Bowl.
Leading up to the Tampa Bay Buccaneers' Super Bowl triumph, do you remember all those flashbacks to the 0-26 Bucs, the team that had the misfortune to have a uniform designed in the '70s (the decade that good taste forgot)? Well, if you looked up in the stands, you may have seen me sporting a Lee Roy Selmon jersey. If you saw any clips from the Sam Wyche era (head coach, 1991-1995), you may have seen me parading around Tampa Stadium, painted orange, wearing nothing but a "Buc Naked" placard. Even now, I still come to work wearing an old orange jacket with a big logo of Bucco Bruce on the back.

So, I can't express how much it meant to me, and to the Tampa Bay area, that the Bucs made the Super Bowl. I now live in Virginia, but I flew to my hometown two weekends ago to be among the Buc faithful. And to be in Raymond James Stadium for the victorious homecoming. And to get blurry pictures of Warren Sapp during the parade. And to do my part to inflate players' salaries by buying way too much memorabilia.

How does this factor into personal finances? When it comes down to it, many of our decisions are emotional, not rational. I don't even want to contemplate how much Super Bowl weekend cost me, but it was worth it to be able to drive around Tampa till 3 a.m., honking my horn and high-fiving strangers, celebrating a victory in a game between people I'll never meet. Makes a lot of sense, doesn't it?

Your thoughts
So that's a start, but I'd really like to hear what others think. Why do you (or a really close friend of yours -- we'll call him "You") make less-than-ideal decisions about money? And better yet, what are the remedies? I'll report the findings in a follow-up article. So drop by the Fool on the Hill discussion board, or email me at robertb@fool.com. Then give yourself two marshmallows. You deserve it.

Robert Brokamp is the co-author of The Motley Fool Personal Finance Workbook. The Motley Fool has a disclosure policy.