Dollars and Sense is an enjoyable, non-technical overview of some of the ways we make bad money decisions and a few ways we can get better. The primary author, Dan Ariely, is a well-known behavioral economist who has written extensively about how predictably irrational we can be. The other author is a comedian (with a middle-aged white-guy sensibility), which at times provided a chuckle and other times, groans. The authors seem to share my worry that companies, especially technology, financial and other businesses, are getting better and better at manipulating our behaviors so that they can profit from our mistakes.
Here some of the most useful take-aways:
- We value things relative to other things because it’s hard work to measure value absolutely. For example, we should decide how much to eat based on how hungry we are, not relative to the size of our plate. We should ignore whether something is on sale and focus instead on the final price. And, we should consider what else we could spend the money on (the opportunity cost).
- We experience paying for things literally as a pain, which registers in brain scans. Companies do all they can to reduce the pain of paying by increasing the time between payment and consumption, reducing attention paid to paying or by using non-monetary payment methods e.g. frequent flier miles. We might want to retain some of this pain, for example by paying with cash rather than credit, because it keeps us mindful of our spending.
- Anchoring is most effective when we don’t know the value of something. “We cling to any starting point.” Even a random number can influence the value we assign to things. We are subject to “self-herding”, basing our future decisions on past choices so we achieve “arbitrary coherence.” I’ve always purchased my dress shirts at Brooks Brothers. Would buying them on eBay, make me feel like I had made a mistake all those years?
- I especially enjoyed the chapter on the endowment effect (chapter 8). The authors explain, “we value what we own more highly because we focus more on its positive attributes.” This is connected with loss aversion: we experience losses about twice as acutely as gains. This is why free trials are so effective. One way to even things out: combine our losses (so that they’re less salient overall) and split up our gains (so they’re more so). For example, maybe wealth managers should limit communication during market downturns, and talk to clients more during upturns.
- We may over-weight fairness in the prices we are willing to pay, especially with respect to effort. This could explain the controversy around surge pricing for ride sharing services. Is it really twice as much effort to drive in the rain versus the sunshine? And yet, this pricing policy helps get more cars on the road when we really need them. We should beware of “irrelevant effort heuristics”. Kayak.com slows down some of its calculations so you can get a sense of how much work it’s doing, which users will value more highly.
- Our expectations can significantly and viscerally change our experience. “Consumption vocabulary” e.g. add “the wine connoisseur’s “bouquet” and “nose” and “legs” can help us appreciate an experience better and value it more highly. We should try to pre-pay for experiences because we can build up our positive expectations and avoid the pain of paying while we could be enjoying it.
- We are biased to the present because the future has less emotion for us and we imagine our future selves to be entirely different people. The authors note that one-quarter of 50-64 year olds have saved nothing for retirement. We can address this by imagining our future selves doing “something wonderful” and using “binding self-control contracts” such as automatic 401(k) deferrals to “hide” the money from ourselves.
In sum, the authors exhort us to “stop and think”. This is clearly good advice, especially for important financial decision that happen rarely and for smaller decisions that happen frequently, and whose effects can add up. It’s clearly helpful to be aware of our weaknesses and how businesses (and I daresay governments) can exploit them.
On the other hand, there are cases where we can be very good at making decisions intuitively: such as when have had a lot of experience and have gotten good feedback and coaching (see Make any Decision). After a while, we learn that the best places to buy milk and juice are not necessarily going to be the best places for meat and fish. We can often tell at a glance whether a restaurant’s hygiene is up to par. We can build expertise in higher-stakes decisions like purchasing a home helping friends and family as they go through the process. I would have liked another chapter on the decisions we make well and how to expand that expertise.
I recommend this book for anyone interested in a non-technical introduction to the psychology of money and who wants to improve their financial decision-making.
Decision Fish is building a fun, online financial wellness program. We are looking for people willing to try it out early, even before it’s available to the public. Do you work at a company that still doesn’t offer a financial wellness benefit? Contact us or forward this to a friend using the share buttons below.