ECON Chapter 1-4 Vocab

Loss aversion

The tendency to care more about avoiding losses than about achieving equal-size gains. People won't take an uncompensated risk over gains, but will over losses to give themselves a chance at avoiding the loss

Reference point

A place or object used for comparison to determine whether the person is deciding between losses or gains

Mental accounting

A theory developed by Richard Thaler that claims that people treat money differently depending on its source and/or intended use

Rule #1

Save significant amounts regularly

Rule #2

Invest using long-term strategies you understand

Rule #3

Reduce (or defer) your taxes

Rule #4

Take on good debt and avoid bad debt

Rule #5

Build a strong credit score

Rule #6

Insure against the losses you can't afford

Exponential discounting

Discounting each future time period by the same percentage. People discount the future when comparing it to the present

Time consistent preferences

Preferences shared across all selves, so that future selves will not alter a plan that a previous self found optimal. The point in time at which you ask someone whether they want a smaller payoff or a larger one later will not affect their decision

Immediacy effect

People tend to choose to be patient when both of the option are far into the future. But to choose the immediate option when it is closer.

Hyperbolic discounting

The tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time

Commitment devices

Mechanisms that prevent you from changing your long-term decision by making a different choice in the moment. Ex. Signing up for a class with a friend

Payroll deductions

Possible commitment device. Deduction from your check that guarantees that your money is saved... not spent

Hard inquiry

An inquiry into your credit history, typically in advance of applying for a loan or a credit card. Can negatively affect your credit for 12 months and remain on your credit history for two years.

Equity

The difference between property value and what one owes on it

Index funds

Mutual funds that mirror the composition of a particular market or index. No active management and you get the average return of the assets that are at the core of your fund = low management fees.

Traditional economics

An approach to economics that emphasizes utility, profit maximization, market efficiency and determination of equilibrium; assumes people are rational

Behavioral economics

Study of psychological factors in economic decision-making.

Financial self-awareness

A conscious knowledge of one's values, beliefs, emotions, and behaviors relating to money

Prospect Theory

A model of how people feel about risk, developed by Daniel Kahneman and Amos Tversky. Someone's willingness to take risk is affected by whether they perceive the potential outcomes as gains or losses

The process of automating your contributions

Setting an automatic transfer from your checking account into your savings and investment account