0:00:02.738,0:00:07.050
Imagine a person who always [br]makes the right financial decisions.

0:00:07.050,0:00:09.020
Let's call her[br]"Penny."

0:00:09.020,0:00:13.360
Penny approaches every money [br]problem with perfect logic and reason.

0:00:13.360,0:00:15.960
She never gets emotional[br]or impulsive

0:00:15.960,0:00:19.300
and always knows [br]what's in her own best interests.

0:00:19.300,0:00:23.350
You're probably thinking that Penny sounds[br]imaginary (and kind of obnoxious).

0:00:23.350,0:00:25.010
But for over[br]a hundred years,

0:00:25.010,0:00:29.630
most economists believed that [br]the world was made up entirely of Pennys.

0:00:29.630,0:00:31.910
That you and I [br]and everyone you know

0:00:31.910,0:00:35.980
always made the best decisions[br]to maximize our happiness.

0:00:35.980,0:00:39.290
As crazy as that sounds, [br]that was the conventional wisdom...

0:00:39.290,0:00:42.675
until a small group of economists[br]and psychologists

0:00:42.675,0:00:46.350
started to question whether[br]Penny actually existed at all.

0:00:46.350,0:00:49.805
One of them, Richard Thaler,[br]won the Nobel Prize last year

0:00:49.805,0:00:53.155
for showing that not only[br]do humans make financial mistakes,

0:00:53.155,0:00:55.340
they make [br]predictable mistakes.

0:00:55.340,0:00:59.140
He joked about calling his research [br]"Dumb Stuff People Do,"

0:00:59.140,0:01:01.808
but today it's called [br]"Behavioral Economics",

0:01:01.808,0:01:04.839
and it has changed public[br]policy across the world.

0:01:04.839,0:01:08.140
Thaler showed that humans can't[br]quite remove their emotions

0:01:08.140,0:01:09.710
from the decision-making[br]process,

0:01:09.710,0:01:15.653
but being able to predict these money[br]mistakes might help YOU avoid them.

0:01:23.630,0:01:26.231
Let's say you're helping[br]your mom clean out the garage

0:01:26.231,0:01:28.261
and you find a pack of[br]Pokémon cards

0:01:28.261,0:01:30.943
that you must've bought when[br]you were a kid and forgot to open.

0:01:30.943,0:01:33.449
So you go through them[br]and HOLY COW

0:01:33.449,0:01:36.809
there's a first edition [br]Charizard in mint condition!

0:01:36.809,0:01:40.239
Even though you could easily[br]get $3,000 on eBay for it,

0:01:40.239,0:01:44.749
you decide to buy a frame [br]and keep it on a shelf in your apartment.

0:01:44.749,0:01:48.064
Okay, let's rewind and consider[br]a different scenario:

0:01:48.064,0:01:50.412
Instead of helping your mom[br]clean out the garage,

0:01:50.412,0:01:52.700
you decide to go to the comic[br]book store.

0:01:52.700,0:01:58.082
There in a glass case you see a first[br]edition Charizard card priced at $3,000.

0:01:58.082,0:01:59.790
Even though you [br]used to love Pokémon,

0:01:59.790,0:02:02.360
you would never dream of [br]shelling out that kind of dough

0:02:02.360,0:02:04.960
for a playing card, [br]and you leave the store.

0:02:04.960,0:02:09.619
This may seem like understandable[br]behavior, but it's completely irrational.

0:02:09.619,0:02:10.780
In the first [br]scenario,

0:02:10.780,0:02:15.330
you're deciding that a Charizard[br]card is worth giving up $3,000 for,

0:02:15.330,0:02:16.710
but in the second [br]scenario,

0:02:16.710,0:02:21.330
you're deciding a Charizard card [br]is not worth giving up $3,000 for.

0:02:21.330,0:02:24.140
To a perfectly rational[br]being like Penny,

0:02:24.140,0:02:26.220
whether or not [br]you already own the card

0:02:26.220,0:02:28.640
should be irrelevant[br]when judging its value,

0:02:28.640,0:02:32.809
but clearly to humans [br]like you and me, it's very relevant.

0:02:32.809,0:02:35.800
Thaler called this [br]the "endowment effect,"

0:02:35.800,0:02:40.080
our tendency to assign more value[br]to the things we already own

0:02:40.080,0:02:42.380
than the things [br]we could own.

0:02:42.380,0:02:45.210
Any time you refuse to sell[br]something for an amount

0:02:45.210,0:02:47.370
that's more than[br]you'd pay for it,

0:02:47.370,0:02:50.705
you are experiencing [br]the endowment effect.

0:02:50.825,0:02:53.135
Ugh, this movie is awful!

0:02:53.135,0:02:54.030
I know.

0:02:54.030,0:02:55.349
Why don't we watch something else?

0:02:55.349,0:02:56.289
We can't.

0:02:56.289,0:02:57.219
Why not?

0:02:57.219,0:02:59.179
I paid 6 bucks to rent this movie!

0:02:59.179,0:03:00.820
We can't just throw that money away!

0:03:00.820,0:03:01.730
Ugh!

0:03:01.730,0:03:02.820
You burned the popcorn!

0:03:02.820,0:03:04.230
We have to finish it.

0:03:04.230,0:03:07.096
That bag cost us 89¢.

0:03:07.359,0:03:10.490
Have you ever watched a movie [br]you hated all the way to the end

0:03:10.490,0:03:12.510
or finished a meal [br]you weren't enjoying,

0:03:12.510,0:03:16.080
just because you paid for it and[br]you wanted to get "your money's worth"?

0:03:16.080,0:03:20.379
If so, you have fallen victim[br]to the SUNK COST FALLACY.

0:03:20.379,0:03:22.890
It's not like sitting through[br]the Emoji Movie

0:03:22.890,0:03:25.340
will magically refund[br]the rental price -

0:03:25.340,0:03:28.130
that money is sunk, [br]and it's not coming back,

0:03:28.130,0:03:30.520
so why put yourself [br]through the extra pain?

0:03:30.520,0:03:34.119
Most of us keep an emotional[br]balance sheet in our head,

0:03:34.119,0:03:36.919
which is less concerned with[br]actual gains and losses

0:03:36.919,0:03:39.359
than the feeling[br]of gains and losses.

0:03:39.359,0:03:41.809
Even though watching[br]the movie makes you less happy,

0:03:41.809,0:03:44.688
at least if you sit through it [br]you don't have to count that $6

0:03:44.688,0:03:46.998
as a loss in your[br]mental checkbook.

0:03:46.998,0:03:49.960
Our fear of [br]sunk costs is so great

0:03:49.960,0:03:53.750
that businesses can use it[br]to squeeze even more money out of us.

0:03:53.750,0:03:56.188
Many retailers sell[br]"memberships"

0:03:56.188,0:03:59.318
that include perks like [br]discounts and free shipping.

0:03:59.318,0:04:02.499
They know that some[br]people will buy extra stuff

0:04:02.499,0:04:04.039
they don't[br]really need,

0:04:04.039,0:04:07.559
just to make sure they get [br]"their money's worth".

0:04:07.559,0:04:09.609
Imagine that you're shopping[br]for some headphones

0:04:09.609,0:04:11.479
and you're about [br]to buy some for $15,

0:04:11.479,0:04:13.460
when you find out that [br]the store down the street

0:04:13.460,0:04:16.120
is selling the exact[br]same pair for $10.

0:04:16.120,0:04:17.759
It's just [br]a ten-minute walk.

0:04:17.759,0:04:18.759
Would you do it?

0:04:18.759,0:04:22.400
Now, same scenario, but this[br]time you're shopping for a laptop.

0:04:22.400,0:04:24.870
The first store has the model[br]you want for $675.

0:04:24.870,0:04:26.640
The second store $670.

0:04:26.640,0:04:28.260
Now do you take the walk?

0:04:28.260,0:04:31.472
Many people will answer[br]these two questions differently,

0:04:31.472,0:04:34.375
even though they are [br]essentially the same question:

0:04:34.375,0:04:37.520
Is it worth $5 to take[br]a 10-minute walk?

0:04:37.520,0:04:39.840
All other context [br]should be irrelevant.

0:04:39.840,0:04:43.300
Yet people are more likely[br]to say yes to the first scenario,

0:04:43.300,0:04:45.470
because it feels like [br]you're getting a better deal.

0:04:45.470,0:04:48.260
This is called [br]transaction utility,

0:04:48.260,0:04:50.430
the amount of mental[br]pleasure or pain

0:04:50.430,0:04:54.360
we get from feeling like we paid less[br]or more than something's really worth,

0:04:54.360,0:04:56.605
and it's often totally[br]disconnected

0:04:56.605,0:04:59.595
from the happiness [br]you get from the thing itself.

0:04:59.595,0:05:03.830
Stores have been exploiting transaction[br]utility from time immemorial,

0:05:03.830,0:05:09.120
like the notoriously inflated[br]"manufacturer's suggested retail price,"

0:05:09.120,0:05:12.280
which makes it look like [br]every item is always on sale.

0:05:12.280,0:05:15.800
And some shoppers are[br]so addicted to transaction utility

0:05:15.800,0:05:18.650
that they'll fill their houses[br]with stuff they don't need

0:05:18.650,0:05:21.850
and will never use[br]just to chase that bargain high.

0:05:21.850,0:05:25.884
Of course, it's always important[br]to shop around and find the best deal,

0:05:25.884,0:05:28.806
but remember that when [br]considering any purchase,

0:05:28.806,0:05:32.089
the only thing that matters[br]is what it's worth to you.

0:05:32.089,0:05:36.780
If you won $100 on a lottery scratcher,[br]what would you do with the money?

0:05:36.780,0:05:38.260
Buy an expensive pair of shoes?

0:05:38.260,0:05:40.010
Go out for a fancy dinner?

0:05:40.010,0:05:43.089
Most people say that they're more[br]likely to spend unexpected income

0:05:43.089,0:05:45.330
on something indulgent[br]or frivolous,

0:05:45.330,0:05:47.800
because hey, it's not like[br]I worked for that money.

0:05:47.800,0:05:48.820
It was free!

0:05:48.820,0:05:52.320
Thaler called this kind of thinking[br]mental accounting,

0:05:52.320,0:05:56.809
which means separating money[br]into imaginary categories in your mind.

0:05:56.809,0:06:00.839
Mental accounting violates[br]the rule that money is fungible

0:06:00.839,0:06:02.689
- that is, totally [br]interchangeable.

0:06:02.689,0:06:05.420
Once you own a dollar, [br]it's the same as any other

0:06:05.420,0:06:09.520
and it shouldn't be treated differently[br]just because of where it came from.

0:06:09.520,0:06:15.030
For Penny, that pair of shoes is either[br]worth giving up $100 for, or it's not.

0:06:15.030,0:06:17.740
Just because some money[br]unexpectedly showed up

0:06:17.740,0:06:19.800
doesn't make [br]the shoes worth more.

0:06:19.800,0:06:23.749
Mental accounting can be helpful in making[br]monthly budgets and sticking to them,

0:06:23.749,0:06:27.040
but even then it can lead us[br]down irrational roads.

0:06:27.040,0:06:30.869
One study focused on how[br]consumers reacted to a drop in gas prices

0:06:30.869,0:06:33.230
from 4 to 2 dollars a gallon.

0:06:33.230,0:06:36.030
This was at the beginning of[br]the 2008 financial crisis,

0:06:36.030,0:06:38.830
so you'd think that most families[br]would've had a lot of use

0:06:38.830,0:06:40.570
for that extra[br]40 bucks a week.

0:06:40.570,0:06:44.299
Instead, researchers found that[br]people were surprisingly likely

0:06:44.299,0:06:47.756
to squander those savings[br]on a higher grade of gas!

0:06:47.756,0:06:49.192
It's as if [br]in their minds

0:06:49.192,0:06:51.392
they had budgeted[br]a certain amount to gas,

0:06:51.392,0:06:54.025
so it had to be[br]spent on gas.

0:06:54.025,0:06:56.460
They couldn't treat[br]the money as fungible.

0:06:56.460,0:07:00.109
Mental accounting exists for[br]the same reason a lot of fallacies do:

0:07:00.109,0:07:03.070
because our brains [br]aren't perfect supercomputers

0:07:03.070,0:07:07.159
and we use a lot of mental shortcuts[br]and emotional instincts just to get by.

0:07:07.159,0:07:09.150
But knowing what [br]those shortcuts are

0:07:09.150,0:07:12.429
will make you less likely[br]to rely on them in the future.

0:07:12.429,0:07:19.120
You may not ever be as wise as Penny…[br]but being pennywise is pretty good, too.

0:07:19.120,0:07:20.930
And that's our two cents!

0:07:20.930,0:07:24.490
If you want to hear more [br]examples of "dumb stuff people do,"

0:07:24.490,0:07:29.320
check out Richard Thaler's Misbehaving:[br]The Making of Behavioral Economics.

0:07:29.320,0:07:32.699
It's a funny and fascinating[br]history of Thaler's research,

0:07:32.699,0:07:35.651
full of surprising studies[br]that will inspire you

0:07:35.651,0:07:38.802
to think differently[br]about money.