186 THE WARREN BUFFETT WAY
change. We tend to mentally put money into different “accounts,” and
that determines how we think about using it.
A simple situation will illustrate. Let us imagine that you have just
returned home from an evening out with your spouse. You reach for
your wallet to pay the babysitter, but discover that the $20 bill you
thought was there, is not. So, when you drive the sitter home, you stop
by an ATM and get another $20. Then the next day, you discover the
original $20 bill in your jacket pocket.
If you’re like most people, you react with something like glee. The
$20 in the jacket is “found” money. Even though the f irst $20 and the
second $20 both came from your checking account, and both represent
money you worked hard for, the $20 bill you hold in your hand is money
you didn’t expect to have, and you feel free to spend it frivolously.
Once again, Richard Thaler provides an interesting academic ex-
periment to demonstrate this concept. In his study, he started with two
groups of people. People in the f irst group were given $30 in cash and
told they had two choices: (1) They could pocket the money and walk
away, or (2) they could gamble on a coin f lip. If they won they would
get $9 extra and if they lost they would have $9 deducted. Most (70
percent) took the gamble because they f igured at the very least they
would end up with $21 of found money. Those in the second group
were offered a different choice: (1) They could gamble on a coin toss—
if they won, they would get $39 and if they lost they would get $21; or
(2) they could get an even $30 with no coin toss. More than half (57
percent ) decided to take the sure money. Both groups of people stood
to win the exact same amount of money with the exact same odds, but
they perceived the situation differently.^12
Risk Tolerance
In the same way that a strong magnet pulls together all the nearby
pieces of metal, your level of risk tolerance pulls together all the ele-
ments of the psychology of f inance. The psychological concepts are ab-
stract; where they get real is in the day-to-day decisions that you make
about buying and selling. And the common thread in all those decisions
is how you feel about risk.
In the last dozen or so years, investment professionals have devoted
considerable energy to helping people assess their risk tolerance. At f irst,