Dollars and Sense

If you think you spend money rationally and that businesses can’t manipulate you into spending more than you should, you probably haven’t read a recent book by Dan Ariely and Jeff Kreisler, Dollars and Sense: How We Misthink Money and How to Spend Smarter. The authors explain many of our financial “quirks” and offer ways to compensate for or even harness our irrational tendencies.

One of our common errors is to make spending decisions based on irrelevant comparisons. A good example is sale prices. Just because a crappy shirt has a $100 price tag on it and is marked down to $60 doesn’t mean it’s worth $100 or that anyone ever paid that price. It may still be a terrible deal at $60, and you definitely aren’t saving $40 by buying it.

The comparison we really should be making is whether owning the shirt is better than the other things we could buy for $60. But that’s harder than looking at the $100 “regular price” and deciding we’re getting a deal. “When we can’t evaluate something directly, as is often the case, we associate price with value.”

Some other mistakes we make are spending more when the method of payment is easier, overvaluing things because we own them, and giving in to the temptations of the present. The authors explain each of these and more with entertaining examples.

In an example of mental accounting, the authors explain that “people who feel guilty about how they got money will often donate part of it to charity.” This means that “How we spend money depends upon how we feel about the money.” Presumably, donating some of the money somehow cleans the rest of it in our minds.

The authors make an observation that I think applies far more generally than just financial decisions: “There is no limit to the effort people will make just to avoid thinking.”

The genius of credit cards is that because the real payment will be made at some point in the future, “they lessen our current pain of paying.” But then when the credit card bill comes, “we feel like we already paid at the restaurant.”

In an interesting experiment, employees in a company savings program were given the company matching amount up front each month, and then if the employee didn’t make a full contribution, they were given a statement saying “We prefunded the account with $500, you contributed $100, and the company took back $400.” This is an interesting way to harness loss aversion to get people to save more.

Over very short time periods, stocks are down almost as often as they are up. But we feel losses about twice as strongly as gains, so watching your portfolio daily will make you feel bad. The authors’ remedy is to look at your investments infrequently because the longer the time period, the more likely it is that stocks are up. Of course, this works best if you have a portfolio that doesn’t require monitoring, such as indexed investments.

We have a tendency of overvalue effort over experience. We’re happy to pay a tradesperson who takes a long time and seems to work hard. But if a highly skilled person finishes a job quickly and with high quality, we balk at paying what seems like a high price for the (apparently) low effort required.

“If we have a root canal coming in a week, it can ruin every day leading up to it.” Anticipation can multiply the impact of both positive and negative experiences. This is why when my son was having surgery and the hospital called to offer a nearer date, I jumped at the chance to end the family misery sooner.

An unfortunate example of expectations affecting performance is that “When you remind women that they are women, they expect to perform worse on mathematics tasks and they actually do perform worse on those tasks.”

In experiments involving brain scanning, researchers found that “branding doesn’t just make people say they enjoyed things more; it actually makes these things more enjoyable inside their brains.”

In the shake-your-head department, a survey found that “46 percent of financial planners didn’t have financial plans themselves.”

When it comes to big financial decisions, it’s hard to decide based on some big numbers. The authors suggest working out what you’re giving up in non-financial terms. For example, when deciding whether to buy a bigger house, we might think “the bigger house costs me the same as the smaller house plus one yearly vacation, a semester of college for each of my children, and an additional three years of working before retirement.”

On the importance of understanding the issues discussed in this book: “the struggle to improve our financial decision-making isn’t just a struggle against our personal flaws; it’s also against systems designed to exacerbate those flaws and take advantage of our shortcomings.” So, businesses know how to push our buttons and get us to spend more.

In conclusion, this book explains our many decision-making flaws and offers suggestions for making better choices in realistic ways. I find the writing clear and entertaining. It’s definitely worth a read.