I am generally skeptical of the value of behavioral economics, as the primary insight (that humans are irrational and rationalize their mistakes/failures) doesn't differentiate between economic systems that function productively for most participants (i.e. low rates of corruption and manipulation by elites, high levels of liberty and transparency) and those which fail most participants. Since all participants in both systems are prone to irrationality, how do beneficial systems arise?

Behavioral economics is silent on systems, and that severely limits its utility in my view. I also find little practical value in the insight that we overvalue ourselves when we succeed and discount our failures (we didn't have enough resources, etc.): yes, markets reflect the herd instinct that creates bubbles and manias, but other than avoiding the herd, how does this make me a more profitable investor?

The one insight of behavioral economics that is practical is the awareness that our will- power/self-discipline is a limited resource which we must invest wisely. In this sense it is a form of scarce capital--let's call it willpower capital. I liken it to a pool fed by a spring: when we exert our will or self-discipline, we drain the supply of willpower. Given time, the pool will replenish itself. But once we've drained our available self-discipline, tasks that require self-discipline become much more taxing.

This suggests several dynamics to me:

1. It requires a daily application of self-discipline to form a new habit or replace a destructive habit with a more positive one.

2. If we "spend" our available willpower on an array of projects rather than on developing one new habit, we are unlikely to be able to persevere long enough to cement that new habit to the point where it is part of our routine.

3. The earlier in the day we apply our self-discipline to forming a new habit, the more success we will have simply because our reserves of willpower are most abundant early in the day.

4. Setting goals is easy. What's difficult is developing a process to reach the goal, and making that process into a habit that becomes part of our routine.

5. Once a process becomes habit, we don't need to invest as much willpower capital in maintaining it.

As Aristotle is said to have observed, "We are what we repeatedly do" (or "We are what we do every day"). This explains the importance of habits, which are habits precisely because we do them every day or week, repeating the process again and again.

The power to shape what we repeatedly do is key to becoming a better investor, improving our productivity, becoming a more compassionate person--whatever we set as goals.

It's not surprising that many of the most productive people (artists, writers, scientists, etc.) often rise early and put in a solid morning of work without distraction. Given the nature of willpower and habit, that schedule makes good sense.

This entry was drawn from Musings Report 9. The Musings Reports are sent weekly to subscribers and major contributors.