Misbehaving Ch. 1: Econs and Humans

"The core premise of economic theory is that people choose by optimising. In reality, people are not super-rational calculating machines." — Richard Thaler

Investment Context

Nobel laureate Richard Thaler recounts the formation of behavioural economics. He opens by attacking classical economics' foundational assumption: a world populated by Econs.

An Econ is a fiction — computing probabilities perfectly, feeling no emotion, possessing unlimited willpower, optimising every decision. Thaler observes that the real world is populated by Humans — emotional, limited in self-control, and making predictable irrational errors.

"Predictable" is the book's key word. If errors were random they would cancel out and the classical model would survive. It is precisely because errors have a systematic direction that they leave traces in market prices.

The Wall Street Translation

1. The Crack in Efficient Markets

The efficient market hypothesis presumes markets driven by Econs. If that held, bubbles and crashes should not exist. Markets are driven by Humans, so prices routinely diverge from fundamental value through fear, greed, and herding.

2. The List of Anomalies

Thaler's career began by simply keeping a list of anomalies — things Humans do that an Econ never would.

His most famous example: people will drive across town to save $10 on a $20 radio but not to save the same $10 on a $1,000 television. To an Econ, $10 is $10 regardless of what fraction of the total it represents.

The example matters not because it is amusing but because it replicates. Thaler's contribution was demonstrating that these departures are not noise but stable, measurable regularities.

3. Accepting That You Are Human

The first step to investing better is admitting you are Human: you will panic, anchor on past prices, and hate realising losses.

This converges with Your Money and Your Brain elsewhere in this library — Zweig from neuroscience, Thaler from economic experiments, both concluding that designing the environment beats relying on willpower.

Actionable Trading Rules

1. Design the environment instead of relying on willpower: Build structure through hard rules and automatic investing that protects you from your own emotions.
2. Distinguish rational repricing from human panic: When a mildly disappointing earnings report drops a stock 30%, ask whether cash flows were rationally reassessed or people simply panicked.
3. Write the thesis down in advance: Humans habitually revise the narrative to justify a losing position. If the thesis you originally wrote has been falsified, sell.

Relevance to a Retirement Portfolio

For retirees this chapter's value is reducing moral self-judgment.

Wanting to flee during a decline does not make you weak or stupid; it makes you Human, and the reaction is predictable and universal. Recognising that, the right response is not self-blame or a vow to do better next time, but accepting the tendency will always be there and designing a plan that does not require you to overcome it.