Why People Lose Their Life Savings

N E W   Y O R K, Feb. 13 -- You've probably heard it again and again: diversify your investments. So why do people — including thousands of Enron employees — get stuck with unbalanced 401(k) plans that become worthless when their company's stock craters?

For Enron employees who say they were misled by management about the health of the company, the short answer is that they never suspected a company in the top 10 of the Fortune 500, as Enron was last year, could crash and burn so quickly and completely.

But behavioral economists — a growing group in the ranks of academia — have a longer answer. They say employees, contrary to the assumptions of most economists, rarely think logically about their portfolios. Indeed, precisely because of the psychological attachment workers have for their employer, they find it difficult to make objective decisions about the company stock.

"You start thinking about all the good things you know about the company," says Terrence Odean, a professor at the University of California at Berkeley. "The inside view is one of the things that hurts people."

Who Says People Act Rationally?

This so-called "inside view" — a term popularized by Princeton University psychologist Daniel Kahneman — is just one of many phenomena behavioral economists have observed over the years that cast doubt on classical economic thinking, in which people are viewed as self-interested, rational thinkers shrewdly calculating the bottom line.

By contrast, behaviorists like to paint a picture of individuals full of quirks leading them to act in ways that don't make financial sense. The best-known of the breed is Richard Thaler of the University of Chicago, who for years has noted "anomalies" in people's economic decisions.

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An early example that helped shape Thaler's thinking: a friend who acknowledged he mowed his own lawn to save $10, but said he would never mow a neighbor's lawn to earn the same amount of money.