Behavioral finance has become widely accepted in financial planning circles as the industry recognizes that sometimes perfectly intelligent clients do very stupid things. In endeavoring to learn why that is and prevent it as much as possible, there may be no more respected thinker than Daniel Kahneman.
Kahneman is the Eugene Higgins Professor of Psychology Emeritus and Professor of Psychology and Public Affairs Emeritus at Princeton University, positions he’s held since 2007. He’s also a fellow at the Center for Rationality at the Hebrew University in Jerusalem, which studies the rational basis of decision making.
Steven Pinker, a psychology professor at Harvard University, called Kahneman “the world’s most influential living psychologist.” In an article for The Guardian, he said, “He pretty much created the field of behavioral economics and has revolutionized large parts of cognitive psychology and social psychology.”
Kahneman received the Nobel Memorial Prize for economics in 2002. British economist Richard Layard said that that award “has made happiness respectable – not only as a subject of study but as a goal for society.”
Kahneman is still supporting advisors in their work with clients. He spoke at the IMCA New York Consultants Conference in February, telling attendees that clients are “more sensitive to loss than gain,” and that “people aren’t concerned about their level of wealth, but about changes in their wealth,” Jamie Green reported.
Furthermore, “people don’t like giving up things,” even if they’ve only had them for a little while, Kahneman said. He described an experiment he conducted with behavioral economist Richard Thaler where one group of people was given mugs and the others were given some money. The mug owners wanted an average of $7 to sell their recently acquired mugs; but the mug-less group was only willing to pay an average of $3.
That endowment effect, as it’s known, means “people often demand much more to give up an object than they would be willing to pay to acquire it.”
In an interview in 2002 after he was awarded the Nobel Prize, Kahneman said he “became interested in psychology as a substitute for philosophy, as a way of answering questions about the human condition but answering them by looking at facts rather than by discussing words.”
He said that the influence of his and his colleague Amos Tversky’s work on economics was “entirely accidental.” He said, “If we had published exactly the same paper, which is cited in the award prospect theory, if we’d published that word for word in Psychological Review, in the Journal of Psychological Theory there would have been no Nobel Prize for this work today. So it was because it happened to be published in Econometrica that this happened.”
The decision to publish the paper in Econometrica, he added, was because “We thought we had a good paper and so we sent it to the best journal that would publish it.”