Frederic Mishkin was in a bind. In January 2008, his wife wanted to buy a house, but as we all know now, the housing market was in the midst of a crash. More than one person probably shared similar doubts with friends around the same time, but Mr. Mishkin is a little different. He told his story during a Federal Reserve meeting, as we learned when the minutes were released late last week.
At the time, Mr. Mishkin was a member of the Fed’s board of governors, a position that seemingly requires knowing a lot about the economy and how to make smart money decisions. Just take a look at the comments (on page 93, if you’re clicking that link) that preceded his house-buying story:
“Even though I have a scenario that looks O.K., I do want to point out that four very significant downside risks really worry me. We all talked about them. Of course, the first is housing. But I worry about a particular dynamic, which is that the negative price movements that we currently see could be getting worse. People could be expecting that they’re getting worse, and therefore, they want to hold off from buying a house because the effective cost of capital is higher. As somebody who stupidly is just going to contract on a new house because I have to please my wife, I actually thought exactly along these lines and was thinking about pulling out but then decided that my marriage was more important.”
Even though he understood the consequences, Mr. Mishkin decided his marriage was “more important.” Maybe he should have pushed back harder with this wife, but that suggestion would miss the point. Sometimes we make decisions that appear irrational when viewed in isolation, but they make complete sense when viewed as part of our overall life.
Buying houses at the wrong time isn’t the only decision that may look irrational. There are times when renting instead of buying may not make financial sense, but some people value the nonfinancial asset of flexibility that comes with renting. Then there are the more personal decisions, like opting to be a stay-at-home parent even if we could easily earn far more than the cost of child care. The value a parent places on being at home doesn’t fit on a balance sheet.
These decisions and many, many others illustrate that we have quantifiable and qualitative lines on the balance sheet of life. The key is to recognize when this is happening.
If we don’t recognize it, then we’re increasing the odds we’ll make irrational decisions unconsciously, which can lead to pain versus balanced fulfillment. Instead, we can pursue what I call conscious irrationality. By acknowledging there will be moments when we won’t act rationally, we can practice identifying when it’s fine to act irrationally despite reams of evidence that say we shouldn’t.
For instance, during Janet L. Yellen’s nomination process to become chairwoman of the Federal Reserve, her investments were made public. There was discussion about how much she had in cash. Was it too much? Should we read anything into her decision? But the only point that matters is that none of us are Janet Yellen. How much we have in cash, for example, needs to fit into the big scheme of our lives, not someone else’s. For Ms. Yellen, it probably works just fine.
We also need to test our irrationality. Have we given in because it’s easier or because it’s something that really matters to us? Mr. Mishkin put a house under contract because he knew it mattered to his wife, but he outlined in perfect detail the reasons he knew it might not prove to be the most rational decision.
Can you say the same about your irrationality? Do you know the exact reasons that you’re doing what you’re doing, or are you relying on excuses? Many of our financial decisions will come down to finding a balance between the quantifiable and the qualitative. The odds of us finding the right balance go up significantly the sooner we realize the numbers won’t always add up but might still make sense when we include the value of all the items on life’s balance sheet.
This commentary appeared February 24 on NYTimes.com.
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