WEBVTT

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Imagine a person who always 
makes the right financial decisions.

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Let's call her
"Penny."

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Penny approaches every money 
problem with perfect logic and reason.

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She never gets emotional
or impulsive

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and always knows 
what's in her own best interests.

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You're probably thinking that Penny sounds
imaginary (and kind of obnoxious).

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But for over
a hundred years,

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most economists believed that 
the world was made up entirely of Pennys.

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That you and I 
and everyone you know

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always made the best decisions
to maximize our happiness.

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As crazy as that sounds, 
that was the conventional wisdom...

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until a small group of economists
and psychologists

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started to question whether
Penny actually existed at all.

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One of them, Richard Thaler,
won the Nobel Prize last year

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for showing that not only
do humans make financial mistakes,

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they make 
predictable mistakes.

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He joked about calling his research 
"Dumb Stuff People Do,"

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but today it's called 
"Behavioral Economics",

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and it has changed public
policy across the world.

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Thaler showed that humans can't
quite remove their emotions

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from the decision-making
process,

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but being able to predict these money
mistakes might help YOU avoid them.

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Let's say you're helping
your mom clean out the garage

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and you find a pack of
Pokémon cards

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that you must've bought when
you were a kid and forgot to open.

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So you go through them
and HOLY COW

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there's a first edition 
Charizard in mint condition!

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Even though you could easily
get $3,000 on eBay for it,

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you decide to buy a frame 
and keep it on a shelf in your apartment.

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Okay, let's rewind and consider
a different scenario:

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Instead of helping your mom
clean out the garage,

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you decide to go to the comic
book store.

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There in a glass case you see a first
edition Charizard card priced at $3,000.

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Even though you 
used to love Pokémon,

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you would never dream of 
shelling out that kind of dough

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for a playing card, 
and you leave the store.

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This may seem like understandable
behavior, but it's completely irrational.

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In the first 
scenario,

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you're deciding that a Charizard
card is worth giving up $3,000 for,

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but in the second 
scenario,

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you're deciding a Charizard card 
is not worth giving up $3,000 for.

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To a perfectly rational
being like Penny,

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whether or not 
you already own the card

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should be irrelevant
when judging its value,

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but clearly to humans 
like you and me, it's very relevant.

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Thaler called this 
the "endowment effect,"

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our tendency to assign more value
to the things we already own

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than the things 
we could own.

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Any time you refuse to sell
something for an amount

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that's more than
you'd pay for it,

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you are experiencing 
the endowment effect.

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Ugh, this movie is awful!

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I know.

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Why don't we watch something else?

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We can't.

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Why not?

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I paid 6 bucks to rent this movie!

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We can't just throw that money away!

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Ugh!

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You burned the popcorn!

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We have to finish it.

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That bag cost us 89¢.

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Have you ever watched a movie 
you hated all the way to the end

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or finished a meal 
you weren't enjoying,

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just because you paid for it and
you wanted to get "your money's worth"?

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If so, you have fallen victim
to the SUNK COST FALLACY.

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It's not like sitting through
the Emoji Movie

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will magically refund
the rental price -

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that money is sunk, 
and it's not coming back,

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so why put yourself 
through the extra pain?

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Most of us keep an emotional
balance sheet in our head,

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which is less concerned with
actual gains and losses

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than the feeling
of gains and losses.

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Even though watching
the movie makes you less happy,

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at least if you sit through it 
you don't have to count that $6

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as a loss in your
mental checkbook.

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Our fear of 
sunk costs is so great

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that businesses can use it
to squeeze even more money out of us.

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Many retailers sell
"memberships"

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that include perks like 
discounts and free shipping.

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They know that some
people will buy extra stuff

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they don't
really need,

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just to make sure they get 
"their money's worth".

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Imagine that you're shopping
for some headphones

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and you're about 
to buy some for $15,

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when you find out that 
the store down the street

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is selling the exact
same pair for $10.

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It's just 
a ten-minute walk.

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Would you do it?

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Now, same scenario, but this
time you're shopping for a laptop.

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The first store has the model
you want for $675.

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The second store $670.

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Now do you take the walk?

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Many people will answer
these two questions differently,

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even though they are 
essentially the same question:

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Is it worth $5 to take
a 10-minute walk?

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All other context 
should be irrelevant.

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Yet people are more likely
to say yes to the first scenario,

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because it feels like 
you're getting a better deal.

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This is called 
transaction utility,

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the amount of mental
pleasure or pain

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we get from feeling like we paid less
or more than something's really worth,

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and it's often totally
disconnected

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from the happiness 
you get from the thing itself.

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Stores have been exploiting transaction
utility from time immemorial,

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like the notoriously inflated
"manufacturer's suggested retail price,"

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which makes it look like 
every item is always on sale.

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And some shoppers are
so addicted to transaction utility

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that they'll fill their houses
with stuff they don't need

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and will never use
just to chase that bargain high.

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Of course, it's always important
to shop around and find the best deal,

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but remember that when 
considering any purchase,

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the only thing that matters
is what it's worth to you.

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If you won $100 on a lottery scratcher,
what would you do with the money?

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Buy an expensive pair of shoes?

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Go out for a fancy dinner?

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Most people say that they're more
likely to spend unexpected income

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on something indulgent
or frivolous,

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because hey, it's not like
I worked for that money.

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It was free!

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Thaler called this kind of thinking
mental accounting,

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which means separating money
into imaginary categories in your mind.

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Mental accounting violates
the rule that money is fungible

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- that is, totally 
interchangeable.

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Once you own a dollar, 
it's the same as any other

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and it shouldn't be treated differently
just because of where it came from.

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For Penny, that pair of shoes is either
worth giving up $100 for, or it's not.

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Just because some money
unexpectedly showed up

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doesn't make 
the shoes worth more.

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Mental accounting can be helpful in making
monthly budgets and sticking to them,

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but even then it can lead us
down irrational roads.

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One study focused on how
consumers reacted to a drop in gas prices

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from 4 to 2 dollars a gallon.

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This was at the beginning of
the 2008 financial crisis,

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so you'd think that most families
would've had a lot of use

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for that extra
40 bucks a week.

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Instead, researchers found that
people were surprisingly likely

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to squander those savings
on a higher grade of gas!

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It's as if 
in their minds

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they had budgeted
a certain amount to gas,

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so it had to be
spent on gas.

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They couldn't treat
the money as fungible.

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Mental accounting exists for
the same reason a lot of fallacies do:

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because our brains 
aren't perfect supercomputers

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and we use a lot of mental shortcuts
and emotional instincts just to get by.

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But knowing what 
those shortcuts are

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will make you less likely
to rely on them in the future.

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You may not ever be as wise as Penny…
but being pennywise is pretty good, too.

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And that's our two cents!

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If you want to hear more 
examples of "dumb stuff people do,"

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check out Richard Thaler's Misbehaving:
The Making of Behavioral Economics.

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It's a funny and fascinating
history of Thaler's research,

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full of surprising studies
that will inspire you

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to think differently
about money.