If you’ve ever taken an economics class, you’ve studied the “rational consumer.” But who is the rational consumer? Does one exist? This is the first interview in a series that will examine the financial behavior of grown-ups on campus in an aim to promote financial literacy and openness. Money remains an unusually taboo subject in our culture, and communicating more openly about it can be only helpful. In the future, I’ll talk to philosophers and sociologists, finding out whether their work has affected their financial behavior. But what better place to begin than with an economist?
Originally from Russia, professor Katerina Simons received her master’s in Economics from Yale in 1984, followed by a doctorate in 1986. She went on to work as an economist for the Federal Reserve Bank of Boston for 12 years before teaching at Dartmouth and now Yale. If a rational consumer exists, Simons should fit the bill.
Before I can come up with an opening question, she has taken a strong stance against insurance. “I never buy extended warranties … a type of insurance against your vacuum cleaner or whatever. I think insurance should be for possible losses that you can’t afford. If you buy an appliance, you can afford to have it repaired. So, the amount of money you pay in insurance costs does not justify the probability of the thing actually breaking.”
That seems about as rational as one can get. Simons essentially considers herself to be her own insurance policy. “If the thing is really poorly made, it will probably break during its normal warranty period. If it is well made, it will last for a long time. You don’t need a three-year warranty.” So, where’s the threshold for needing insurance? For Simons, at least, it’s high. She voluntarily insures herself against huge losses due to floods or fires, for example. But she notes that most people don’t buy insurance unless they’re required to, yet they are often convinced to buy extended warranties.
She also tries, sometimes successfully, to think formulaically about getting the most “bang for the buck.” She considers experiences “like travel, tango classes, personal trainers” to be more valuable than material possessions. “Experiences are generally better because they stay with you or are related to something you do with friends or family. The pleasure that we get from new things we often overestimate — not necessarily the pleasure itself but how long it lasts.”
And if those experiences don’t turn out to be very rewarding? Upon finding herself bored in a lecture or performance that she has paid for, Simons tells herself, “Sunk costs, sunk costs, sunk costs, get out of here!” Sunk costs reflect payments that aren’t refundable. Economists agree, at least in theory, that they should be ignored in favor of choosing what will make you happy now over suffering through the experience you paid for.
Simons is clearly a deliberate consumer. But surely no one is perfectly rational. What behaviors does she have that others might find strange?
“I am a child of Russia and I have a neurotic reluctance to throw out food. It’s bad to throw out a lot of food, but one must throw out some.” She laughs, “Actually, understanding sunk costs would mean throwing out food!” When it comes to clothing, she is similarly loss-averse. Out of fear she would damage them, she left her cashmere sweaters untouched for so long that moths ate them in the closet.
Like everyone, Simons isn’t perfectly rational. But her constant exposure to economic theories has left her with the habit of weighing the happiness (in economics, “utility”) of each purchase. But rather than calculate utility, Simons finds it easier to apply “marginal analysis.”
Every consumer should spend so that the final dollar spent brings as much (not more) utility as any previous dollar spent. But Simons doesn’t claim to “have a good grasp” on her utility function, “if such a thing really exists.” And while she would like to apply marginal analysis, “it requires way too much discipline and awareness of all the possibilities at the same time.”
Professor Simons once unsuccessfully tried to explain marginal analysis to her 9-year-old daughter during a discussion about buying a million dollars’ worth of candy. But some lessons must have stuck, as Simons’ daughter now writes for one of the most popular financial sites among young people: NerdWallet. So, what advice does professor Simons hope that her children and, by extension, Yale undergraduates will take to heart?
For one, she’s a strong advocate of steady, regular investments. “Try to save [or invest] 10 percent of your income and pay off your credit cards.” And investing doesn’t need to be complicated. (I was happy to hear Simons echo the themes of my Sept. 19 op-ed in the News). Invest passively, diversify your investments and do not attempt to time the stock market or pick stocks.
Paying off credit cards does not mean avoiding them all together, though. “Use credit cards as cash rather than debit cards because they’re more secure. There seems to be more protection and less fraud. Use them but don’t use them for credit, just use them for transactions.” Simons takes advantage of credit cards that offer points for each dollar spent, as they provide a small discount on everything you buy with them — on top of their other perks.
After all the talk of sunk costs, marginal utility and credit card debt, I optimistically ask Simons whether economists are more rational than the rest of us. “Yes, I think they may be more rational. I don’t think many economists would buy product warranties.” Again, with the extended warranties! Other than avoiding vacuum cleaner insurance, does she have any other parting advice? “Invest, wear sunscreen and don’t smoke.” Spoken like a true rational consumer.
Louis DeFelice is a junior in Jonathan Edwards College and the creator of the financial website wonderlearninvest.com. Contact him at email@example.com.