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← 5 Ways People Are Dumb With Money

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Showing Revision 39 created 05/22/2019 by Alexandre Clemente.

  1. Imagine a person who always
    makes the right financial decisions.
  2. Let's call her
  3. Penny approaches every money
    problem with perfect logic and reason.
  4. She never gets emotional
    or impulsive
  5. and always knows
    what's in her own best interests.
  6. You're probably thinking that Penny sounds
    imaginary (and kind of obnoxious).
  7. But for over
    a hundred years,
  8. most economists believed that
    the world was made up entirely of Pennys.
  9. That you and I
    and everyone you know
  10. always made the best decisions
    to maximize our happiness.
  11. As crazy as that sounds,
    that was the conventional wisdom...
  12. until a small group of economists
    and psychologists
  13. started to question whether
    Penny actually existed at all.
  14. One of them, Richard Thaler,
    won the Nobel Prize last year
  15. for showing that not only
    do humans make financial mistakes,
  16. they make
    predictable mistakes.
  17. He joked about calling his research
    "Dumb Stuff People Do,"
  18. but today it's called
    "Behavioral Economics",
  19. and it has changed public
    policy across the world.
  20. Thaler showed that humans can't
    quite remove their emotions
  21. from the decision-making
  22. but being able to predict these money
    mistakes might help YOU avoid them.
  23. Let's say you're helping
    your mom clean out the garage
  24. and you find a pack of
    Pokémon cards
  25. that you must've bought when
    you were a kid and forgot to open.
  26. So you go through them
    and HOLY COW
  27. there's a first edition
    Charizard in mint condition!
  28. Even though you could easily
    get $3,000 on eBay for it,
  29. you decide to buy a frame
    and keep it on a shelf in your apartment.
  30. Okay, let's rewind and consider
    a different scenario:
  31. Instead of helping your mom
    clean out the garage,
  32. you decide to go to the comic
    book store.
  33. There in a glass case you see a first
    edition Charizard card priced at $3,000.
  34. Even though you
    used to love Pokémon,
  35. you would never dream of
    shelling out that kind of dough
  36. for a playing card,
    and you leave the store.
  37. This may seem like understandable
    behavior, but it's completely irrational.
  38. In the first
  39. you're deciding that a Charizard
    card is worth giving up $3,000 for,
  40. but in the second
  41. you're deciding a Charizard card
    is not worth giving up $3,000 for.
  42. To a perfectly rational
    being like Penny,
  43. whether or not
    you already own the card
  44. should be irrelevant
    when judging its value,
  45. but clearly to humans
    like you and me, it's very relevant.
  46. Thaler called this
    the "endowment effect,"
  47. our tendency to assign more value
    to the things we already own
  48. than the things
    we could own.
  49. Any time you refuse to sell
    something for an amount
  50. that's more than
    you'd pay for it,
  51. you are experiencing
    the endowment effect.
  52. Ugh, this movie is awful!
  53. I know.
  54. Why don't we watch something else?
  55. We can't.
  56. Why not?
  57. I paid 6 bucks to rent this movie!
  58. We can't just throw that money away!
  59. Ugh!
  60. You burned the popcorn!
  61. We have to finish it.
  62. That bag cost us 89¢.
  63. Have you ever watched a movie
    you hated all the way to the end
  64. or finished a meal
    you weren't enjoying,
  65. just because you paid for it and
    you wanted to get "your money's worth"?
  66. If so, you have fallen victim
  67. It's not like sitting through
    the Emoji Movie
  68. will magically refund
    the rental price -
  69. that money is sunk,
    and it's not coming back,
  70. so why put yourself
    through the extra pain?
  71. Most of us keep an emotional
    balance sheet in our head,
  72. which is less concerned with
    actual gains and losses
  73. than the feeling
    of gains and losses.
  74. Even though watching
    the movie makes you less happy,
  75. at least if you sit through it
    you don't have to count that $6
  76. as a loss in your
    mental checkbook.
  77. Our fear of
    sunk costs is so great
  78. that businesses can use it
    to squeeze even more money out of us.
  79. Many retailers sell
  80. that include perks like
    discounts and free shipping.
  81. They know that some
    people will buy extra stuff
  82. they don't
    really need,
  83. just to make sure they get
    "their money's worth".
  84. Imagine that you're shopping
    for some headphones
  85. and you're about
    to buy some for $15,
  86. when you find out that
    the store down the street
  87. is selling the exact
    same pair for $10.
  88. It's just
    a ten-minute walk.
  89. Would you do it?
  90. Now, same scenario, but this
    time you're shopping for a laptop.
  91. The first store has the model
    you want for $675.
  92. The second store $670.
  93. Now do you take the walk?
  94. Many people will answer
    these two questions differently,
  95. even though they are
    essentially the same question:
  96. Is it worth $5 to take
    a 10-minute walk?
  97. All other context
    should be irrelevant.
  98. Yet people are more likely
    to say yes to the first scenario,
  99. because it feels like
    you're getting a better deal.
  100. This is called
    transaction utility,
  101. the amount of mental
    pleasure or pain
  102. we get from feeling like we paid less
    or more than something's really worth,
  103. and it's often totally
  104. from the happiness
    you get from the thing itself.
  105. Stores have been exploiting transaction
    utility from time immemorial,
  106. like the notoriously inflated
    "manufacturer's suggested retail price,"
  107. which makes it look like
    every item is always on sale.
  108. And some shoppers are
    so addicted to transaction utility
  109. that they'll fill their houses
    with stuff they don't need
  110. and will never use
    just to chase that bargain high.
  111. Of course, it's always important
    to shop around and find the best deal,
  112. but remember that when
    considering any purchase,
  113. the only thing that matters
    is what it's worth to you.
  114. If you won $100 on a lottery scratcher,
    what would you do with the money?
  115. Buy an expensive pair of shoes?
  116. Go out for a fancy dinner?
  117. Most people say that they're more
    likely to spend unexpected income
  118. on something indulgent
    or frivolous,
  119. because hey, it's not like
    I worked for that money.
  120. It was free!
  121. Thaler called this kind of thinking
    mental accounting,
  122. which means separating money
    into imaginary categories in your mind.
  123. Mental accounting violates
    the rule that money is fungible
  124. - that is, totally
  125. Once you own a dollar,
    it's the same as any other
  126. and it shouldn't be treated differently
    just because of where it came from.
  127. For Penny, that pair of shoes is either
    worth giving up $100 for, or it's not.
  128. Just because some money
    unexpectedly showed up
  129. doesn't make
    the shoes worth more.
  130. Mental accounting can be helpful in making
    monthly budgets and sticking to them,
  131. but even then it can lead us
    down irrational roads.
  132. One study focused on how
    consumers reacted to a drop in gas prices
  133. from 4 to 2 dollars a gallon.
  134. This was at the beginning of
    the 2008 financial crisis,
  135. so you'd think that most families
    would've had a lot of use
  136. for that extra
    40 bucks a week.
  137. Instead, researchers found that
    people were surprisingly likely
  138. to squander those savings
    on a higher grade of gas!
  139. It's as if
    in their minds
  140. they had budgeted
    a certain amount to gas,
  141. so it had to be
    spent on gas.
  142. They couldn't treat
    the money as fungible.
  143. Mental accounting exists for
    the same reason a lot of fallacies do:
  144. because our brains
    aren't perfect supercomputers
  145. and we use a lot of mental shortcuts
    and emotional instincts just to get by.
  146. But knowing what
    those shortcuts are
  147. will make you less likely
    to rely on them in the future.
  148. You may not ever be as wise as Penny…
    but being pennywise is pretty good, too.
  149. And that's our two cents!
  150. If you want to hear more
    examples of "dumb stuff people do,"
  151. check out Richard Thaler's Misbehaving:
    The Making of Behavioral Economics.
  152. It's a funny and fascinating
    history of Thaler's research,
  153. full of surprising studies
    that will inspire you
  154. to think differently
    about money.