Monday, March 08, 2010

5 Reasons to Read: Why Smart People Make Big Money Mistakes

You know you're a dork when you get excited because there's a new edition of a book being released. (Not a new book, mind you. A new edition of a book.)

So yeah, I'm a dork. And proud of it.

My reinforced dorkdom comes courtesy of the new, 2009 edition of my favorite behavioral-finance book: Why Smart People Make Big Money Mistakes ... And How to Correct Them. I first reviewed Why Smart People... back in 2003, and gave the book high ratings.

Did I throw a "new edition" party now that WSPMBMM has been updated and re-released? Well, no. But I did look forward (more than usual) to the book appearing on my doorstep. Which is kind of scary, given that I read the first edition, in full, probably four times.

5 Reasons to Read: Why Smart People Make Big Money Mistakes

  1. It's the best "Intro to Behavioral Finance" out there. Belsky and Gilovich did a superb job of making the biggest points of behavioral finance accessible to pretty much anyone — well, anyone willing to pick up the book, at least.

  2. If you thought anything that had to do with human behavior and economics would be boring as crap, well, you've been reading the wrong stuff. This is the book that'll make you change your mind.

  3. Mainstream gurus can only take you so far. Once you've read most of the stuff by Dave Ramsey, Suze Orman, and all the other mainstream faces of finance, you figure out that not much of their advice differs from one author to another. Most of it is basic, basic, basic.

    At that point, if you're like me, you're left wanting to "go deeper" into how people act and react with money. Turning to Why Smart People Make Big Money Mistakes is a fantastic "next step" in your money-maturity process. We've all heard Dave Ramsey rant about how you "spend more when you spend with credit cards," but it's in Why Smart People... that you learn where this factoid originates:

    But you may be surprised to learn that by using credit cards, you not only increase your chances of spending to begin with, you also increase the likelihood that you will pay more when you spend than you would if you were paying cash (or paying by check).

    Want proof? Consider this landmark experiment, conducted in the 1990s by marketing professors Drazen Prelec and Duncan Simester. They organized a real-life, sealed-bid auction for tickets to a Boston Celtics game. Half the auction participants were informed that the highest bidder would have to pay for hte tickets in cash (with a day to come up with the funds). The other half was told that the winning bidder would have to pay by credit card. Prelec and Simester then averaged the bids of those who thought they'd have to pay in cash and those who thought they could pay with a credit card. Incredibly, the average credit-card bid was roughly twice as large as the average cash bid. Simply because they were dealing with plastic — with money that was devalued in some way — the students became spendthrifts. Put another way, credit cards turn us into big spenders in more ways than one. We become poorer because we're more likely to spend, and more likely to spend poorly.

    What you'll learn in Why Smart People... forms the underpinnings of mainstream advice — and, on occasion, even runs counter to it. (Hint: Those nuggets are the ones I love most!)

  4. It doesn't read like an economics book. Co-author Gary Belsky, while a financial writer on occasion, is the editor-in-chief of ESPN The Magazine. That position, unless I'm completely out of the ESPN loop here, is not exactly conducive to churning out financial gibberish. I suspect that Belsky's non-economics-based Day Job has a large impact on why the book is far more readable, and far more enjoyable, than any other behavioral-finance book I've wrapped my brain around.

  5. In this regard, Why Smart People is similar to Charles Wheelan's Naked Economics. I loved that one, too. There you are, reading a nonfiction economics and/or finance book ... immersed in it, actually ... and you never feel like you're reading an economics book. It's too darn interesting.

  6. There's much new stuff in the revised edition. The 2009 printing of Why Smart People... contains roughly 50 more pages than did my 1999 copy. While I think some of this relates to a larger font, there is now an eighth chapter, titled "Emotional Baggage." (What? Human emotion and financial success often run in opposite directions? Since when?)

    There's also a new "Conclusion: Now What?" section to wrap things up. The publishers also added fifteen pages of index in this edition, a welcome gift for those of you disturbed enough to need such a thing. (And before you readers smart off, yes, I do use the index. I can admit it.)

    You'll also find that stats and figures (particularly market-related figures) have been revised to reflect changes since 1999. For instance, on page 44 of the 1999 edition, I read:

    ...Good for her, considering that stocks have offered the best average annual return of all the major savings and investment categories over the past seventy years — about 11 percent a year on average, versus 5 percent a year for bonds and 3 percent for cash in the bank.

    And in the 2009 edition, page 35:

    ...Good for her, considering that stocks have offered the best average annual return of all the major savings and investment categories over the past eighty years — about 9 percent a year on average — yes, even after the market gyrations of recent years — versus 5.5 percent a year for bonds and 3.7 percent for cash in the bank.

  7. Public Enemies #1 and #2: "Mental Accounting" and "Anchoring." For me, it's absolutely amazing to discuss money with other people and see just how often these two problems surface. Belsky and Gilovich spend a lot of time on these two money mistakes, and for good reason: They crop up everywhere.

  8. On the "sell side," anchoring can cause you to fix on a figure — say, your original purchase price — and cling to it irrationally. This is another factor behind the phenomenon we discussed earlier, whereby many people tend to hold on to losing investments longer than winning ones. If you buy a stock for $50 a share, that amount becomes your anchor when evaluating the worth of the stock down the road. In fact, it's not even necessary for you to have bought the stock to anchor on a price. In 2007, the stock of Garmin, which makes navigation devices, peaked at just under $78 a share. Subsequently, when the share price fell to below $66 in 2008, many investors thought the stock "looked cheap" compared with its all-time high, and they rushed to invest.

    They had anchored on that $78 price. Unfortunately the stock dropped to $15 later that year and at this writing is still priced at less than one-third of its all-time high (a performance much worse than the overall market). Mind you, it's hard not to sympathize with those investors who anchored on the stock's zenith. Even if the current finances or future prospects of the company have changed so that its shares have justifiably dropped in value, it's difficult to erase the orginal purchase price (or highest price) from memory. Pulling up anchor is harder than you might think.

    Want even more anchoring goodness? Yeah. Me, too:

    Tom and one of his graduate students, Clayton Critcher, recently performed a series of experiments in which they examined whether numbers embedded in a product's name might influence judgments people make about it. In one study, they gave participants information about a "P97" or "P17" smart phone and asked them to estimate the percentage of the phone's sales that would come from Europe. Those asked about the "P97" gave significantly higher estimates. In another study, participants were asked how much they would be willing to spend on a meal at restaurant "Studio 97" or "Studio 17." We're sure you can guess the results. On average, participants were willing to pay one-third more for a meal at Studio 97. Buyer beware, indeed.

    I'm pretty sure there's something wrong with me. I find this stuff to be way too fascinating. Seriously.


Why Smart People Make Big Money Mistakes is a fantastic book. It was fantastic when it first came out in 1999, and it's fantastic in its updated and revised 2009 edition. Is it worth purchasing the new edition if you already bought the old one?

I'd have to say: Probably so. (Well, maybe not at the cover price of $15, but the Amazon price of ten bucks and change ain't bad at all.)

In my mind, there's enough new material here to warrant a repurchase. Plus it's good to see the various stats and figures get updated after all the chaos of the last ten years.

On the other hand, if you've never read the book, you're missing out on a great read. You'll be flat-out amazed at all the "behavioral" money mistakes that you, and the folks around you, are set up to make each and every day — much of it encouraged by the advertisements you see and the shopping situations created by retailers and credit-purveyors alike.

Why Smart People Make Big Money Mistakes didn't make it onto my financial "must-read" list by accident!

Labels: ,

— Posted by Michael @ 8:07 AM


Its all about lifestyle. Make your lifestyle fit within your income and you'll be on the right path. Once you achieve these lifestyle changes you will be able to avoid debt, save and invest and be financially free.


Great summary! There are really good advices in this book. Strongly recommended.


I have read about some financial mistakes that people often do. The post also lets us know how to avoid these mistakes for example by making proper financial plan, diversifying our investments etc.


This book looks really interesting. I think I am going to go get it. I have read the Dave Ramsey and Suze Orman materials. And you are correct, it's very basic. Sometimes we need to master the basics, but once that is down, for many it is better to understand why we act the way we do. Then, we can change our financial habits and thinking! Great book review.

** Comments Closed on this Post **

Thoughts on my personal finances, goals, experiences, motivations, and accomplishments (or lack thereof).

My financial life began turning around when I took responsibility for it.
— Dave Ramsey


Start (2005-12): ~$21,900
Currently: $0
[About Our Debt Paydown]


Savings Goal: $15,000
Currently: ~$15,115
[About Our Liquid Savings Goal]