Companies whose earnings are out of sync with the rest of their industry are more likely to misreport them.
By James P. Weston and Erik Dane
How To Decide Whether To Stay And Rebuild Or Sell And Move Away If Flooding Has Damaged Your Home
Flooding in your home can be as psychologically traumatic as the death of a loved one or grave illness. Unfortunately, it’s also a demanding time when important financial decisions need to be made. Should you buy flood insurance? Should you stay and rebuild, renovate, or sell and move away? These are especially tough decisions because we are all prone to biased thought patterns, even without the added stress of a disaster. Fortunately, there are ways we can become aware of and overcome these patterns.
Rebuilding in a flood zone is risky, so it’s natural to consider whether and when Houston will flood again. Although we can’t predict when another catastrophe will happen, it’s important not to assume that because we flooded recently, flooding will happen again soon. Research shows that when people are planning for the future, they give too much weight to recent events. Sales of insurance policies soar after floods, but homeowners tend to cancel the policies after a year or two if their houses don’t flood again.
Considering these common reactions, try not to over-insure — but don’t be lulled into a false sense of safety, either. Houston has seen three “one-in-500-year” floods over the past three years. There’s a one-in-125-million chance of that happening, so the term “one-in-500-year” is clearly inaccurate. But if you’re not on the flood plain, and your house flooded for the first time in, say, 50 years, it might not be that far off.
We also tend to overestimate risks to our personal safety, but this danger is far more imagined than real. During a storm, if you don’t live where ocean surge is a risk, and you stay off the roads, it’s very unlikely that you’ll suffer critical injuries. Research shows that the more clearly we envision a life-threatening event, the more we believe it can occur. Hurricanes evoke threatening images, which may lead us to overestimate the personal risks that storms pose.
So how should we make level-headed decisions about what to do with a flooded house? Every house and homeowner is unique, but some general principles apply. It may help to consider all your options as a monthly expenditure, like a car payment. How much would you pay per month to avoid the risk of a flood? Are you anxious about flooding, or do you take it in stride? These factors can guide your decision.
One approach is to simply live in a house that floods frequently, but pay a large insurance premium and the costs of repair. The upside to this is lower mortgage payments and property taxes. The downside is the emotional toll of repeated flooding. For some, this might be too much to bear, but others seem to shrug it off. Many coastal residents repair staunchly after every hurricane, and are drywall magicians.
Raising the foundation can also be an option. Let’s say it would cost $100,000 to raise your foundation. If you borrowed $100,000 at 5 percent interest for 30 years, it would cost about $500 per month. This might be worth your while. Now, if you could move a mile away to a neighborhood that doesn’t flood for an extra $300 monthly mortgage payment, is it really worth it to keep your present house, with a raised foundation? You might think you would spend anything not to leave you neighborhood, or school, but comparing the monthly costs puts things in perspective. For example, could you tear down and rebuild on the same property with those same funds?
It might seem like these questions could be solved easily enough with a formula that could spit out a tidy answer. It’s not that simple — many of the factors in play are psychological and emotional. But to help you arrive at these decisions, the costs can be at least roughly monetized. You might not want to leave your neighborhood, but is it worth an extra $400 a month to stay? Thinking about decisions in this way can help us surmount biased patterns of thinking. One main takeaway from behavioral economics is that if we become aware of our cognitive biases, we can often mitigate their effects and make better decisions in times of uncertainty.
James Weston is the Harmon Whittington Professor of Finance at the Jones Graduate School of Business at Rice University.
Erik Dane is a Jones School Distinguished Associate Professor of Management (organizational behavior) at the Jones Graduate School of Business at Rice University.