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Judging by the size of the book signing line for Professor Richard Thaler at the CFA (Chartered Financial Analyst) Annual Conference a few months ago, it was clear that he had made an impact. Not only was he now famous for having a cameo in The Big Short movie with Selena Gomez, advising NFL teams on draft strategy, and teaching at the prestigious University of Chicago, but he was recently awarded the 2017 Nobel Prize in Economics.

The Nobel Prize announcement mentioned his contributions to behavioral economics, specifically such concepts as limited rationality, social preferences, and lack of self-control. These theories help explain why an individual may not always act in a perfectly rational, long-term-planning, wealth-maximizing fashion.

According to National Public Radio1, when Thaler was asked about the most important impact of his work he replied, “the recognition that economic agents are human.”

I’m sure we can all picture times in our own lives when we’ve acted in financially irrational ways. For example, this week at lunch I gasped at the $2.10 price for guacamole while at Chipotle, but a week before while on vacation I shrugged off paying $30 for a room service cheeseburger. Even though both costs were coming out of the same bank account — and the incremental joy of guacamole far outweighs a mediocre burger — my mind rejected the first while accepting the second.

Many articles on Professor Thaler mentioned this is a seminal moment bringing Behavioral Economics to the forefront. Yet that downplays the recent prominence many other leaders in the field have received, such the Nobel Prize for Robert Shiller in 2014 and Daniel Kahneman in 2002.

Behavioral finance pioneer Professor Meir Statman won the IMCA’s 2015 Matthew R McArthur Industry Pioneer Award. As a member of Loring Ward’s Investment Committee Professor Statman has helped us create a robust risk tolerance questionnaire drawing in real life situations to help steer clients in the right direction, most recently blogging on the topic of investment risk and how a client may not always need to act in a wealth-maximizing fashion.

As any practicing advisor already knows, real life clients behave much differently than the perfectly rational decision-making robots of economic books. As financial author Nick Murray has said, “The dominant determinant of long-term, real-life return is not investment performance but investor behavior.” We discussed the options of accommodating or educating investor biases in a recent blog.  The better job that we as an industry can do in recognizing and addressing behavioral biases and helping our clients overcome them, the better off their financial outcomes are likely to be.

When asked how he would spend the $1.1 million prize, Thaler responded, “I will say that I will try to spend it irrationally as possible.”

Load up the guac.

 

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1 Nobel Goes To American Richard Thaler For Work in Behavioral Economics, Oct 9, 2017, NPR.

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