by Scott Ronalds

One of the core assumptions of economics is that people behave rationally. But they don’t. People are consistently, predictably, irrational.

I’m paraphrasing Richard Thaler, Daniel Kahneman and Amos Tversky here, the pioneers of behavioural economics. The trio has uncovered numerous ways in which people make dumb financial decisions without knowing it. I recently listened to a great podcast where Thaler tells a number of stories that bring the topic (behavioural economics) to life.

By exposing our “self-sabotaging” tendencies, Thaler’s hope is that once we realize we’re imperfect, we can do things to help ourselves. Tom discusses some common behavioural biases as they relate to investing and suggests tips for neutralizing them in his latest Financial Post article.

What I want to highlight in this post, though, is one of the stories that Thaler tells in the podcast about a bottle of wine.

It starts with an economics professor who was also a wine collector. The professor had a stiff rule that he wouldn’t pay over $30 for a bottle. He’d built a nice collection over the years and discovered that a few of the bottles he bought for around $10 were now worth $100. Further, there was a wine store nearby that was happy to buy these bottles from him for their new value. The professor wouldn’t sell the wine, however, but rather drank the bottles himself on special occasions.

This may seem reasonable. A wine lover simply decided to enjoy a few really good bottles rather then sell them.

But it didn’t make sense to Thaler, who concluded that the professor’s actions violated a basic economic rule: if he wasn’t willing to pay $100 for a bottle, then he should have sold the wine rather than drink it. Because there was a liquid market for the wine (pardon the pun), he’s “effectively paying $100 to drink it” in Thaler’s words. An irrational financial move, by an economics professor, no less.

Don’t feel too bad if you would’ve drank the wine too (I know I would’ve drank at least one bottle). But if we can all be a little more aware of some of our irrational tendencies, it can help improve our financial situation. And that’s worth raising a glass to.