Freakonomics By Stephen J. Dubner and Steven Levitt

Author Steven Levitt begins Freakonomics by brushing over some of the stories, questions, and ideas he will cover in the rest of the book, such as the 1990s crime drop, information asymmetry, real estate agents, correlation vs. causation, and, most importantly, incentives. From then on, each chapter centers on an unusual question.

The first chapter's main message is about incentives. Incentives are the basic building blocks of economics: according to economists, nearly every decision can be explained through incentives. Because of incentives, people are sometimes driven to cheat. Because of high-stakes testing, schoolteachers in Chicago public schools were incentivized to change their students' answers on test answer sheets so that they(i.e. the teachers) would not be fired or penalized for the poor test scores. Similarly, sumo wrestlers in Japan are incentivized through bribes and social incentives to cheat and throw certain important matches (i.e. to allow other wrestlers to win) so other wrestlers do not drop in the rankings. 

Chapter 2 asks how the Ku Klux Klan is similar to real estate agents. It tells the story of Stetson Kennedy, a man who infiltrated the 1940s KKK and published much of their secret information, thereby erasing the informational advantage they had that made people fear them. Real estate agents also have an informational advantage over their clients, and they often use this to their advantage, selling houses for less than they are worth so that they can close a deal quickly because they have less to gain from a higher sale than the sellers do. Experts often abuse information asymmetry between themselves and consumers, but things like the internet are working to erase this information imbalance by providing more information to everyday people. 

Chapter 3 debunks the myth that drug dealers are all rich by telling the story of a man who studied the organization of the Black Disciples crack gang in Chicago. In reality, crack gangs are very similar in structure to any business in corporate America, with a small number of people on the top making big money and hundreds of people on the bottom barely scraping by at all. These people stay in the business because of the prospect of potentially moving up and making it big one day, which is the mentality that drives people like athletes and entertainers trying to move up as well. 

Chapter 4 asks, "where have all the criminals gone?" It first tells the story of Romania, a country that experienced a huge rise in crime after its dictator banned abortion. The chapter then turns to the United States in the mid-1990s: while crime had been rapidly rising in the year prior, the trend suddenly reversed, leaving many experts puzzled and attempting to explain it. None of the explanations they proposed were correct—instead, according to Levitt, the crime drop was heavily linked to the Roe vs. Wade Supreme Court decision nearly twenty years before. When abortion was legalized, many low-income, low-education, teenage mothers were able to take advantage of it. This meant that many babies who would have grown up unwanted and impoverished—and, by this trend, more likely to become criminals as they neared adulthood—were not being born. Nearly two decades later, this generation of potential criminals would have been teenagers; however, they had never been born, and so there was a sudden drop in crime. 

Chapter 5 talks about parenting, and the obsession that many parents have over making sure they do exactly the right thing so their children will turn out successful. Levitt points out that many parents are misguided, and the things they do matter much less than the things they are. Parents who are highly educated with a high income are most likely to have successful children; these factors are determined before the child is even born. 

This same truth applies to naming children, as discussed in Chapter 6. The name given to a child does not cause their success or failure; rather, it is a reflection of the status and circumstances of the parents. Names also move down through society: high-income parents begin to use a name, and then, over time, it trickles down to low-income parents until it becomes less popular. 

The epilogue tells readers that, while there is no single unifying theme to this book, the main takeaway is a new way of thinking, looking at, and interpreting the world according to the tools of economics discussed in the book's chapters. 

MONEY Master the Game 

“You have to make the shift from being a consumer in the economy to becoming an owner— and you do it by becoming an investor.” 

“Information without execution is poverty. Remember: we’re drowning in information, but we’re starving for wisdom.” 

Step 1: Welcome to the Jungle 

“What percentage works for you? Is it 10%? Or 15%? Maybe 20%? There’s no right answer here— only your answer. What does your gut tell you? What about your heart?” 

“But here’s the key to success: you have to make your savings automatic.” 

Step 2: Become an Insider, Learn the Rules 

Mutual funds and institutional investing = bad. 

Index funds = good. 

Roth = good. 

Step 3: What’s the price of your dreams? 

“You can’t manage your health if you can’t measure it. And the same goes for your finances.” 

Dream levels: 

Dream 1: Financial Security 

Mortgage, utilities, insurance, food, transportation, all covered for the rest of your life. Calculate the cost of those things per month, multiply it by 12 to get your annual “Secure” income. That’s your “financial security” income, and the first dream is to save enough money to cover that.

 

Dream 3: Financial Independence (skip 2) 

What’s the cost of your complete lifestyle right now? That’s how much you need to be bringing in to be completely financially independent. To get an idea of how much an amount of income needs to be saved for, multiple it by 20. So if you spend $100,000 a year, you need to save 2,000,000.

Dream 4: Financial Freedom

The cost of the lifestyle you want and deserve, above and beyond what you’re at right now. Pick three things to start. Figure out whatever else you want and the annual cost of it, and add that amount to your current annual total.

Dream 5: Absolute Financial Freedom 

Anything you want any time you want it, never worry about money again "You don’t have to own the jet to have the lifestyle. You don’t have to own the sports team to sit in the sky box. And you don’t have to pay for the whole team to be an owner— you can be a partial owner and get all the privileges. "Write down everything you would want on this list, and figure out the cost of it.

Speeding it up 

Save more and invest the difference. Find big areas of spending you can cut back on to speed up your plan. 

Earn more and invest the difference. Make a rule to invest more of your income as it increases. 

Step 4: The Most Important Investment Decision 

“Rule 1: don’t lose money. Rule 2: see Rule 1. —WARREN BUFFETT’S RULES OF INVESTING” 

“Want to take the guesswork out of choosing the right bond mix for your portfolio? Vanguard founder Jack Bogle suggests buying into low-cost, low-fee bond index funds that spread out your risk because you’ll own every part of the bond market.” 

“How often should you rebalance? Most investors rebalance once or twice a year. Mary Callahan Erdoes of J.P. Morgan told me she believes rebalancing is such a powerful tool that she does it “constantly.” What does that mean? “That’s as often as your portfolio gets out of whack with the plan that you originally put in place, or the adjusted plan based on what’s happened in the world. And that shouldn’t be set. It should be a constant evaluation, but not an obsessive evaluation.” 

Just remember four things from this section of the book: 

Asset allocation is everything! So you want to diversify between your Security Bucket and your Risk/ Growth Bucket. You want to diversify across asset classes, markets, and time. 

You don’t want to hesitate to get in the market trying to have perfect timing; instead, use dollar-cost averaging and know that volatility can be your friend, providing opportunities to buy investments cheaply when the market is down. This technique will increase your portfolio’s value when the markets come back up.

Have a Dream Bucket that gives you emotional juice and excitement so you can experience the benefits of your investing prowess in the short term and midterm instead of just someday far in the future. 

Use rebalancing and tax harvesting to maximize your returns and minimize losses. 

Step 5: Upside without downside, a lifetime income plan 

“Ray is showing us that if your money is divided equally, yet your investments are not equal in their risk, you are not balanced!” 

He graciously proceeded to sketch out the following breakdown: 

30% in stocks (for instance, the S& P 500 or other indexes for further diversification in this basket). 

Fifteen percent in intermediate term [seven- to ten-year Treasuries] 

Forty percent in long-term bonds [20- to 25-year Treasuries]. 

7.5% in gold and 7.5% in commodities. 

Step 6: The Billionare’s Playbook 

Four rules: 

Don’t lose money 

Risk a little to earn a lot, risk one dollar to earn 5 

Anticipate and Diversify 

You’re never done. Keep learning, saving. 

Step 7: Taking action 

How to spend money to make yourself happy: 

Investing in new experiences 

Buying time for yourself 

Investing in others

AUTHOR

ANKIT VERMA

ASSISTANT PROFESSOR