FOOL ON THE HILL

Rational Choices

The D.C.-area snipers caused locals to change their routines. But let's look carefully at the odds to see if people changed the right routines. Behavioral economics can teach us how to be more rational with our money -- and our lives.

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By Selena Maranjian (TMF Selena)
October 28, 2002

Greetings from Sniper Central! You may or may not realize it, but Fool Intergalactic Headquarters is situated in Virginia, near Washington, D.C., just a mile from the Beltway. Living through these past few weeks with a sniper on the loose, I noticed a few interesting things -- things with implications for investing.

For example, many who live in the area changed our routines -- or they were changed for us. If we used to stop by a supermarket a few times a week, we would try to go just once a week, minimizing the times we're out and about. Calling for a pizza delivery instead of eating out suddenly seemed more appealing. We were on the alert as we filled our gas tanks. Outdoor after-school activities were cancelled indefinitely. Tours and vacations to our nation's capital were cancelled or postponed. Local businesses suffered.

Why all this change? It's simple. Obvious, even. We didn't want to be felled by a sniper.

That seems reasonable and sensible, but it merits a review of some numbers. For starters, know that D.C. has a population of almost 600,000, and the entire Washington metropolitan area, including parts of Virginia and Maryland, is home to about five million people.

So in a general sense, a local's odds of being "sniped" (have I just coined a new word?) at any point in time were one in five million. An article in a Virginia paper examined the odds more closely, and noted, "Three weeks ago, any one person in the Washington area had a near-zero chance of being shot by a sniper. Today, any one person in the Washington area has a near-zero chance of being shot by a sniper."

True enough. But still... why take chances, right? That's clearly how many folks felt. It's instructive to look at other relevant odds, though. I planned to dig up a bunch of numbers, but Laura Moyer, of The Free Lance-Star, did it for me, in the article cited above. She noted that in Virginia:

  • 935 people died in traffic accidents in 2001 (358 were alcohol-related).

  • 146 people experienced (non-Sept. 11) work-related deaths in 2001.

  • 66 people died due to accidental drownings in 2000.

  • 58 people succumbed to complications from medical/surgical care in 2000.

  • 85 lives were snuffed by current or former loved ones in 2000.

As I began to write this article, nine people had been killed by the snipers. It was very possible that the number would increase, but it wasn't likely to exceed the numbers above. (The more often a killer kills, the more likely it is that he or she gets caught.) So yes, the sniper was deadly, and dangerous. But locals were still at a higher risk of a fatal traffic accident.

Behavioral economics
Thinking about these grisly topics brings to mind a fascinating field of study, behavioral economics, which was recently recognized when pioneers in the field -- Daniel Kahneman, a professor of psychology and public affairs at Princeton University, and Vernon L. Smith, a professor of economics and law at George Mason University -- were awarded this year's Nobel Prize in economics. (Hear an interview with Prof. Smith on the Fool Radio Show.)

Behavioral economics mixes psychology and economics, as it explores how we don't often act in economically rational ways. For example, in Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics, authors Gary Belsky and Thomas Gilovich present this scenario: You're in a furniture store and you want to buy a lamp. It costs $100, but at a store five blocks away, it's on sale for $75. Do you walk the five blocks to save $25? You also want to buy a dining room set priced at $1,775. Five blocks away, it's selling for $1,750. Do you walk the five blocks to save $25? Oddly enough, even though the same amount of savings is at stake, people are more likely to walk five blocks for the lamp than the dining room set. (Another book on the subject: The Winner's Curse by Richard H. Thaler.)

The same kind of principles apply to investing. For example, we often leave our money invested in a fallen stock, rather than move what remains into a more promising stock. We want to "get our money back," or something like that. But if you're down $1,000 on a so-so investment, why wait to make $1,000 on that stock, when you could shift that money into another stock where you'd be more likely to make $1,000?

Similarly, when the market swoons, as it has over the past few years, we often think more about selling, when for our long-term money, buying is probably the best thing to do. After all, the silver lining of market downswings is that they present buying opportunities. Warren Buffett described the rational way to think about this in his 1986 letter to shareholders: "Our goal is more modest: We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful."

Monsters in our portfolios
In a recent New York Times article (free registration required), best-selling crime novelist Patricia Cornwell discussed the sniper, noting: "Someone reading this article may know one of the killers and refuse to make the connection for the simple reason that we believe only in monsters. We call the sniper a cold-blooded monster. We call the Baton Rouge serial killer a monster. We fear monsters, not ordinary people. We read about monsters in novels and watch them in movies. We are confident that we will be able to peer out the window and recognize a monster immediately."

It's often the same in investing. We look at the familiar names in our portfolio, and we don't think any of them will implode. None of our CEOs will spend $6,000 of our dollars on a shower curtain. Our mild-mannered, always-polite holdings couldn't possibly be diluting our ownership stakes through massive stock options granting. Similarly, Enron and Tyco (NYSE: TYC) shareholders didn't realize there were monsters in their portfolios.

Perspective
Returning to the sniper, I have a few final thoughts. Both the sniper and the Sept. 11 terrorist attacks should remind us how good we have it in America, despite the awfulness of these events. Too many other countries have lived with (and are still living with!) the fear -- and reality -- of imminent terrorist acts for a long, long time. We have lived with it for a long time; most of us just didn't realize it until recently.

Similar to, but worse than, the sniper is living in the midst of a war -- as so many do the world over. Think of places like Beirut not so long ago, where people spent years living with the omnipresent threat of sniper bullets and bombs. We were rather lucky -- the snipers' career appears to have been cut short, and things should pretty much go back to normal. Our horror lasted about three weeks, and about a dozen lives were lost. Elsewhere, thousands of innocents die over many years, while millions live in fear.

It was reasonable for those of us living in the sniper's target zone to take some precautions until the spree stopped. If it didn't derail our lives too much to do so, then why not? But we should have done so with the proper perspective. Yes, we were more likely to be shot by the sniper than to win a big lottery jackpot (hey -- perhaps, if nothing else, that will drive home the unlikelihood of winning the lottery). But we need to remember that much more dangerous to us (then and now) are drunk drivers, heart disease, and out-of-control domestic situations. If we took action and changed our lives because of the sniper, it seems only rational to reduce our exposure to other risks by dieting and exercising, not driving drunk or letting friends drive drunk, and working to resolve tensions with those close to us.

In sum, add a little more math to your life, and some more rational thinking, and your portfolio and lifespan might benefit!

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Selena Maranjian is smarter than a speeding bullet and faster than a tall building. For more about her, view her profile. You might also be interested in books she has written or co-written: The Motley Fool Money Guide and The Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools