How Money is Messing with our Mind

We tend to go around money a lot less rational than we might think. By using some practical examples, behavioural scientists Dan Ariely and Jeff Kreisler analysed those wrong thought-patterns we have about money. And now they explain what we can learn from it.

In their book, titled Dollars and Sense: How We Misthink Money and How to Spend Smarter, Dan Ariely and Jeff Kreisler analysed the latest psychological insights of money. By using examples from everyday life, both scientists investigated our rather irrational choices when it comes down to money. Furthermore, they explain how we can take advantage of the psychology of money.

A few examples from the book. If we have money problems, we tend to be worse at problem solving. The other way around, we become less empathic if we have more money. People also tend to overestimate the value of their house and have problems with estimating budgets. All good examples of how to make your own financial situation a complete mess.

The pain of paying

We feel pain when thinking about losing some of our hard earned cash. Salespeople will try and do everything to keep that pain as low as possible. A result of that is that we unintentionally consume even more.

Does it matter whether we use credit cards or cash to pay? In theory not because it’s the same amount of money. But research tells us that we are willing to spend more when we pay with a credit card. We buy more expensive products and give more tip. Chances are high that we underestimate how much we spend, or even completely ignore it.

Cash is tangible, which is why the level of pain we feel is higher. Because of that, casino’s exchange money for gaming chips or tokens. Or take mobile app games in which you can buy certain products so you can proceed quicker through the game. People do not feel like they’re playing with money and are willing to spend more.

Besides increasing or decreasing the pain, the exact moment of the money exchange itself is also important. For example, paying for your honeymoon or romantic cruise upfront with credit card will cause a lot less pain than paying afterwards. Just the thought that you still have to pay will spoil all the fun.

Think about the alternatives

We need to think more about what we’re giving up when making big expenses. About a year ago Ariely and a research assistant went to a Toyota dealer to ask people what they were willing to give up if they would buy a new car. Almost no one could answer that question, with one exception who answered… a different car.

According to Ariely that’s because money is so abstract and universal that it’s very difficult to think about the alternative costs. We almost never exceed at weighing the alternatives, such as traveling or paying off mortgage or studies early. Even if we do think about the alternative costs, chances are quite high that we still make the wrong decision in the end.

An example? Ariely describes an experiment in which 3 groups of consumers receive 3 different offers:

• Option 1: a Pioneer system of $1000.
• Option 2: a Sony system of $700, but receive $300 in cash additionally.
• Option 3: a Sony system of $700, plus $300 worth of cd’s.

In reality, each respondent had a choice in spending $1000. Looking at the results it was clear that option 2 (sony + cash) was less popular than option 3 (sony + cd’s) by far. That sounds rather odd. Think about it. Spending $300 as you see fit should sound more attractive and valuable than spending $300 on cd’s only. The reason is that with $300 of cash, you could spend it on anything you want, including on cd’s if you want to. But because $300 in cash is too abstract, people don’t have a clue on what to spend it on. When receiving cd’s, we know exactly what we get.

Be aware of smaller purchases

By adding bigger sums of money in a smart way, the smaller expenses become ‘relative’ to the bigger one. This tactic encourages us to buy even more. For example, car dealers pretty well know that when we spend $25000 on a car, an additional expense of a cd player of $200 seems pretty cheap relative to the price of the car. But would anyone buy a cd player of $200 any more? Do we even listen to cd’s in the car these days? No and no. But because $200 is only 0,8% of the total price, we don’t give it too much thought.

When you book an expensive resort for the upcoming holidays, you don’t care too much spending $6 for a simple coke, which is about double the amount you would normally pay elsewhere.

Playing around with prices is nothing new. Big companies, such as Apple, Microsoft, etc. use something called the decoy effect, in order to make their high-end products look more appealing than the somewhat cheaper ones. By applying the decoy effect, people tend to buy the more expensive iPhone model more over the cheaper one.

Your time is valuable

Are we spending our time efficiently when it comes down to money? Or are we spending more time driving around in circles looking for the cheapest gas station where we could save a few cents per litre, instead of looking for a cheaper mortgage with which we might save a few $1000 at once? “Set your priorities straight”, says Dan Ariely.