For the better part of the past decade, Paul Sullivan has written about and lived a
mong some of the wealthiest people in America. He has learned how they save, spend, and invest their money; how they work and rest; how they use their wealth to give their children educational advantages but not strip them of motivation. He has also seen how they make horrendous mistakes.
In The Thin Green Line: The Money Secrets of the Super Wealthy
, Sullivan explains why some people, even “rich” people, never find true wealth, and why other people, even those who have far less are much wealthier.
How much a person’s life is worth
As a graduate student at the University of Rochester, he was trying to calculate how much a person’s life was worth, in the same way someone might try to value a used car.
He was asking these questions without thinking about any of the fuzzier things humans think about when they think about valuing themselves and others–such as love, compassion, humor, kindness, greed, selfishness, or lethargy. He was looking at life as if a person were a refrigerator with a replacement cost. His way of quantifying the price was to measure how much more someone would ask to be paid to do a risky job, such as being a miner.
“I realized people were not behaving how they were supposed to behave,” Thaler said. “They weren’t behaving like rational economic agents.”
How much would you pay to eliminate a one-in-a-thousand risk of immediate death, and how much would you have to be paid to accept the same risk?
He came up with these two questions and the answers astonished him. They made no sense.
The typical answer for how much people would pay to get rid of the risk was about $200, while they would need to be paid $50,000 to accept the risk.
This disparity was illogical or, in the parlance of economists, irrational. It was the same risk, just phrased differently. People were tallying up costs and benefits in their head, but their answers differed based on how he asked the question.
Once Thaler grasped the ramifications of our flawed reasoning, he started thinking about how those biases skewed our thinking about money. That’s when he came up with bucketing.
“Putting labels on these buckets is a charade but a helpful one.”
He oulined an example.
Someone worth $10 million with $1 million of that in a home might put $3 million in an emergency fund in case something goes wrong. A different person could also ask that her portfolio be invested 10 percent in real estate, 30 percent in cash, and the rest in equities. It’s the same allocation.
“Just putting a label on that cash as emergency money doesn’t make any difference. But at some level it makes all the difference. It calms them down.”
Mental accounting shows that the stories we tell ourselves about money matter
Decades after Thaler first came up with this, advisers are latching onto the idea of bucketing.
For wealthier people, an adviser can put the living expenses in cash, the vacationing money in something a little riskier, and the money that won’t be needed anytime soon into the riskiest investments.
Budgeting makes perfect sense: it ensures that you can pay your bills or afford something before you buy it. But talking about budget is dreary.
Mental accounting certainly violates the basic principle of economics that money is fungible, that it flows like water. But our behavior also violates those same principles. If we were rational, we’d never buy a home we couldn’t afford or save too little for college or fail to put away enough for retirement. But we worry about all these things, and for good reason: if we haven’t screwed them up, one of our friends has.
Complement The Thin Green Line: The Money Secrets of the Super Wealthy with 7 Lessons in Wealth-building from the richest man in Babylon, “Babylonian parables” that have become a modern inspirational classic.