The traditional economic model of homo economicus, depicting a perfectly rational decision-maker, faces significant scrutiny. Behavioral economics highlights substantial gaps between this ideal and actual marketplace behaviors. A notable case is the participation rates of employees in 401(k) plans. When individuals are given an opt-out choice instead of an opt-in, participation rates soar. This simple shift in framing drastically changes decision-making dynamics.
In his book, Irrational Together, Adam S.
Hayes critiques the behavioral economics approach, arguing that it fails to encompass the full range of influences on economic behavior. He emphasizes the substantial impact of social interactions and cultural contexts on our financial decisions. As a sociology professor at the University of Lucerne, Hayes merges his academic insights with his finance background, offering a unique view on the intersection of society and economics.
Table of Contents:
The impact of social norms on financial decisions
Hayes presents compelling evidence that social and cultural norms often lead individuals away from optimal financial choices. He cites a survey where participants considered downsizing their homes for financial reasons. Their decision-making was significantly influenced by perceptions of familial harmony, particularly regarding their mothers-in-law, rather than purely financial calculations. This example underscores how social dynamics can obscure clear economic reasoning.
In-group bias in investment choices
Investment professionals may believe they are insulated from these social influences. However, Hayes references research indicating that even experienced venture capitalists show in-group bias, favoring startups led by individuals with similar backgrounds and educational experiences. This tendency illustrates how entrenched social affiliations can affect investment decisions, potentially overlooking lucrative opportunities.
Exploring the implications of technology on economic behavior
One intriguing aspect of Hayes’s work is his examination of the rise of robo-advisors. Through detailed research, including regulatory filings and interviews with industry providers, he reveals how these automated systems may not fully account for the irrationalities influenced by social factors. For instance, he created accounts as both a thirty-five-year-old and a fifty-year-old, demonstrating how age-related biases could skew the advice provided by such platforms.
Hayes also addresses the potential drawbacks of applying modern portfolio theory through these technological channels. While these models aim to optimize returns, they may inadvertently reinforce societal norms that lead to suboptimal decision-making practices among investors.
Rethinking economic theories
Despite the complexities of human behavior, Hayes emphasizes the necessity of recognizing these social dimensions in economic theory. Invoking insights from the late baseball legend Yogi Berra, he acknowledges the difficulties in making accurate future predictions. However, he stresses that understanding these social influences is crucial for investment professionals seeking to improve their performance and navigate the complexities of client relationships.
Irrational Together serves as a vital resource for those in the financial sector, prompting a reevaluation of how social forces shape economic behavior. By acknowledging the effects of culture, religion, and ideology, investment professionals can better equip themselves to counteract the irrational decision-making rooted in social norms.
