People do some crazy things with money. But no one is crazy. Everyone makes financial decisions based on their own unique experiences that make sense to them in the moment. Your personal history with money shapes approximately 80% of how you think the world works, even though it represents only 0.00000001% of what has actually happened.
This is why a person born into poverty thinks about risk and reward differently than a trust fund child. Neither is right or wrongâtheyâre just working with different mental models formed by vastly different experiences.
A person who grew up in poverty, one who grew up during a time of high inflation, one who grew up during a stock market boom, and one who grew up during a recession will all have fundamentally different views about money. And all of their views will be completely rational to them based on their experiences.
Economists Ulrike Malmendier and Stefan Nagel studied how people invest based on their generational experiences. They found that peopleâs lifetime investment decisions are heavily tied to the experiences they had in their own generationâespecially early in their adult lives.
If you grew up when inflation was high, youâre less likely to invest in bonds as an adult. If you grew up during a stock market boom, youâre more likely to invest in stocks. This isnât irrationalâitâs deeply human.
Low-income households spend on average $400 per year on lottery ticketsâfour times the amount of the highest-income groups. Is this crazy? Not when you understand that for many, a lottery ticket is the only ticket to a dream that feels out of reach any other way. In a world where you canât imagine saving enough to change your circumstances, a lottery ticket represents hope.
Consider the vastly different experiences people have had with the stock market:
Born in 1970: The S&P 500 increased almost 10-fold (adjusted for inflation) during your teenage years and twenties. Stocks seem like amazing wealth builders.
Born in 1950: The market went almost nowhere during your teenage and early adult years. You might view stocks with skepticism.
Born in 1930s: You lived through the Great Depression. The very idea of stocks might terrify you.
Understanding that no one is crazy has profound implications:
Itâs easy to say âyou should do Xâ with money. But we often donât know what experiences shaped someoneâs relationship with money. A person who seems irrationally conservative might have watched their parents lose everything. A person who seems recklessly aggressive might have never experienced a market crash. Neither is crazyâtheyâre just human.
Spreadsheets are good at calculating the optimal financial strategy. But spreadsheets donât have feelings, families, or histories. Real people do. And real people make decisions based on what lets them sleep at night, which is often very different from what maximizes returns on paper.