Ever Wonder Why Frequent Flyer Miles Seem So Valuable?

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Ever Wonder Why Frequent Flyer Miles Seem So Valuable?

By Justin A. Reckers

People often focus on near-term concrete goals in financial decision-making. While trying to maximize these immediate and clear goals they forget or discount the real reason for the actions. This is called Medium Maximization. Having something measurable within reach can redirect our motivation. Immediate and concrete goals by which to measure ourselves give a sense of progress. Plus it just seems an easier decision to make.

When an airline offers a frequent-flyer program it allows members to accumulate miles. The miles begin to obtain value to the program member despite being only a medium you can trade for free travel. The member doesn’t truly care about the miles. He cares about the benefit of accumulating those miles, free travel. The medium, in this case, frequent flyer miles, truly has no value yet still draws the concentration of the program member. “The money we earn from work is also a medium. Thus, the potential implication of research on medium is not medium; it is extra large.” Christopher Hsee, Journal of Consumer Research, June 2003 

The tenet of Medium Maximization says people often fail to fully skip over the medium (frequent flyer miles) in favor of the benefit (free travel). For example, consider the opening scene to the film Wedding Crashers. The scene concentrates on a divorcing couple in the midst of a Divorce Mediation session. They begin arguing over who should be awarded the frequent flyer miles. Frequent flyer miles and other frequent buyer or cash back rewards programs are considered by family law courts to be a community asset in California. The husband says “I earned those miles”, the wife seems to agree but believes he earned them on trips to see his -insert expletive- girlfriend. The miles are the medium to this couples’ financial decision-making process (dispute). By focusing on the medium (frequent flyer miles) rather than the benefit (free travel) of owning the medium, they have both failed to consider the decision at hand from a rational perspective. The real decision at hand is who will be awarded the right to free travel in the future not who gets the frequent flyer miles. The value of this free travel can be estimated fairly easily. Twenty-five thousand (25,000) miles might earn a one way ticket from Los Angeles to New York while the same ticket would actually cost $300. The wife lost sight of the benefit of the miles immediately when she associated the medium with the outcome in her mind, her cheating husband. She has missed the point by concentrating on the medium rather than the benefit.

The wife is very clearly upset by the situation and allows her emotions into the decision making process. I don’t blame her. The point of the illustration is to realize that economic theory tells us people will never concentrate on the medium because it has no value. The emotional turmoil of the dispute in the movie tells us humans often place a value on the medium and may ultimately make emotional decisions because of their tendency for medium maximization. Understanding Behavioral Finance can help mitigate emotion but we can never hope to completely remove it making Behavioral Economics vital to appreciating real life financial decision-making especially in Divorce Financial Planning.

The Theory of Relativity and your Divorce Decision-Making

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The Theory of Relativity and your Divorce Decision-Making

By Justin A. Reckers

Humans tend to make decisions influenced heavily by relativity. We compare one option relative to another. You may decide a grande latte is a good deal relative to the cost of a tall latte. You may think a BMW including complete scheduled maintenance for 1 year is a better deal than a one year old BMW at a cheaper price. Markets are full of options. There are thirty different brands of salsa all with a different price. You may not be conscious of it but you decide which to purchase by comparing one relative to another.

Economic modeling is based entirely on the premise that the entity making financial decisions is armed with all available information, free of emotion and interested only in the most ”rational“ economic outcome of the decision. If economic modeling held true every consumer would consider the cost per ounce of the tall versus the grande and then make their decision based on which was the better value. Every car shopper will factor the value of included service plans versus expected depreciation in value into their decision making process. Consumers do not operate this way. Humans have social, cognitive and emotional barriers we must navigate during a decision making process. Deadlines keep us from collecting all available information. Emotions keep us from seeing it clearly. Social norms tell us to judge the quality and success of our lives relative to others.

Marketing gurus know this and use it to sell products. Ever wonder why the movie theatre or baseball concession always suggest you spend twenty five cents more on a larger size soda? Why not go for the grande latte? It really isn’t that much more expensive compared to the tall. It is time we use it to learn to make better financial decisions.

For most people, divorce will be the largest financial transaction in their lives. It may also be the most emotionally chaotic or traumatic transition. Economic theory tells us that there should be no emotion in the equation when making financial decisions and all available information should be at our disposal. So how can you hope to make good decisions about the financial health of your family in the midst of emotional chaos? What happens when you don’t have all of the information?

Lack of information is one of the most common barriers to good financial decisions in divorce proceedings. One party usually has the edge having managed the family finances or been a business person. They may completely understand the family financial picture while their spouse has delegated the responsibility without question. This is natural. It would be a waste of valuable time to balance the check book twice every month so one party takes the responsibility.

In divorce proceedings financial knowledge can be power. High quality decisions need high quality information from which to judge the options. The party without the knowledge must spend time and money collecting documents, reconstructing the balance sheet and income statement and trying to level the playing field. This is the most important part of your divorce financial planning and building a good decision making process in your dissolution proceedings. Remember we make decisions based on choosing one option relative to another. If you are confronted with a decision you must make based on limited information you run the risk of reaching a poor conclusion. In the absence of options you must choose from what you know. The human propensity for choosing one option relative to another will leave you open to making irrational financial decisions.

The cliche financial decision in divorce is trading the house for retirement plans. Mom wants the house and dad wants the retirement plan. It is rarely a good deal for both parties. If you do not know the cost of purchasing a new home or renting a comparable home, your default decision will be to keep what you have now. Choosing to keep the family residence as part of your divorce settlement means you must forego other assets. It may mean you have to work a job you do not like in order to pay the bills. You may have to give up retirement accounts or other assets in order to offset the value in your asset division. It may mean you have no emergency cash in the bank in case you lose your job or become ill.

There is nothing wrong with ultimately choosing to retain the family residence as long as the decision was made after gathering the necessary information and considering your options. The natural human aversion to ambiguity will point you towards the status quo in the absence of options. That is fine when it comes to lattes and salsa. Financial decisions in divorce will affect the rest of your life and the lives of your children.

Start thinking about new places to live. The equity in your home is priceless at this stage in your life. In the house it is not liquid and may not be working for you as well as it could in other investments. Decide what kind of home you could see yourself living comfortably now and when your children are grown. To get you thinking and hone your expectations, start looking at local newspaper ads and visit websites like Realtor.com to seek information about current listings. Keep your finger on the pulse of the neighborhood so you can be sure to know when a good deal becomes available. Consider downsizing to a more affordable home that you will be able to care for on your own. You will be surprised how quickly a large home can overwhelm you with maintenance demands. Talk to your family. It is important to discuss expectations with your children. Tell the kids you cannot afford to keep the house and still do the things you all love to do and you would prefer to do fun things with them given the choice. Chances are good that those same children when given the choice will choose to see their mother happy and comfortable in a smaller, more affordable home, over watching her rip up floor boards to heat the McMansion. Consider renting for a year while you transition into post divorce life. There are plenty of homes available to rent while you take time to recover financially from the attorney fees and other divorce related costs.

When you include these considerations in your decision making process you will be judging your options from an informed position. The status quo may be overcome by the excitement of new options or the comfort of safety. These are the biggest financial decisions you may ever make. Prepare yourself with self awareness, information, negotiation skills and trustworthy advisors and you will transition successfully into post divorce life.

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