April 2, 2018 / 1:05 PM / 7 months ago

Your money: Game theory for your financial life

NEW YORK (Reuters) - The term “game theory” probably makes you think of really hard math - the kind pioneered by U.S. mathematician John Nash, the troubled genius who inspired the Oscar-winning film “A Beautiful Mind.”

U.S. mathematician and Nobel Laureate John Nash in 2011. REUTERS/Bobby Yip

But game theory actually has some very real applications in everyday life, which you are probably already doing without an enormous white board and advanced calculus. Think about some of the biggest financial decisions you make: Buying or selling a home, bidding on a car, negotiating a salary, or weighing job offers.

Game theory is thinking strategically about what matters to you, and what matters to the other party; what you can ask for, and what you can likely get; what move you can make next, what their response will be, and how you can counter.

“It comes up in people’s financial lives all the time,” said Kevin Zollman, an associate professor at Carnegie Mellon University who applied these theories in the real world in his recent book “The Game Theorist’s Guide to Parenting.”

Here are few big life moments when game theory comes in handy:

* Buying a car

When you are on the lot, step one in game theory is to know what is motivating the other person. Does the salesperson have monthly sales targets? Are the new models coming in? And what is motivating the buyer?

Think in particular about what is easy for the dealer to give you and what is not. For instance, if there is a garage on-site, it is relatively easy for the dealer to add on discounted inspections and repairs. You can increase your negotiating leverage with prior research, so you can compare offers on the fly.

When Zollman was shopping for a used car recently, he was armed with a printout of a cheaper model that was sitting at a dealership three hours away. If he didn’t get favorable terms, he was ready to walk. But what he really wanted was an extended warranty that came with certification. When the dealer gave him that, he made the deal.

* Buying a home

This is classic game - multiple potential players, who often do not know what the others are bidding.

The more information you possess, the greater your strategic advantage. What pressures are the sellers under, in what kind of time frame – and how can you outmaneuver your ‘opponents’?

When financial planner William Brancaccio, of White Plains, New York, helped clients buy a home recently, they knew the chess pieces were positioned in their favor because it was a bad time of year to sell and the house was priced higher than the competition.

His clients secured financing pre-approvals and did their research by digging up the original sale price, tacking on the costs of subsequent renovation work, so they could guesstimate an acceptable break-even point for the seller.

“Then we found out the sale was due to a divorce – they had to sell, and nobody was currently living in the home,” said Brancaccio.

Result: The clients got the house for under the asking price.

* Salary and job offers

This particular game requires delicacy. Unlike a car dealer you may never see again, your boss is still going to be there on Monday morning.

“Trying to extract every last dollar now may harm your reputation within your company. In the long run you may do better by leaving the other side enough of a ‘profit share’ in the deal,” said Avinash Dixit, an economist at Princeton University and co-author of “The Art of Strategy: A Game Theorist’s Guide to Success in Business and Life.”

That said, you are certainly entitled to ask your worth. Some useful backup: The stats compiled by sites like Salary.com and PayScale.com, which should indicate whether you are underpaid for your job title. And even more close to home, the pay levels of your co-workers, which may or may not be publicly available.

Got another job offer? In these games it is beneficial to be “open and honest,” rather than sneaky and subversive, said Zollman. In other words, if a competing claim for your services is on the table, tell your boss or potential employer exactly what the situation is – and what they need to do to keep you.

Keep in mind that games are not always win-lose propositions. Win-win is the ideal you are striving for. Said Zollman: “Game theory can help you figure out outcomes that everyone is happy with.”

Editing by Beth Pinsker and David Gregorio

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