Mental Accounting Is Irrational

 Or 5 Things I Learned From ‘Dollars and Sense, How we Misthink Money and How to Spend Smarter’ by Dan Ariely and Jeff Kreisler

1. Mental Accounting Is Irrational –

When we mentally categorize money into separate pots, we also separate that money from being actual money. It becomes the same as having a stack of poker chips to one casino, we feel justified in either 1) spending all that money on anything we can rationalize to fit into that category, or 2) we move it into another category when we over draw from one pot. This can lead us to mislabeling unaccounted-for-money, such as game winnings or money found on the street, as “fun money” and blow it all without thinking twice, when in fact it is still money, and we can use it for all the things we need money for on a regular basis (bills, debt, investing). Instead of relying on our internal accountant, we should lay out a physical or digital budget where we can see where our money is going and stick to it. This will help us when an impulse purchase opportunity arises, we can simply refer to our budget and ask ‘what category does this belong in and does it make sense for my budget.’ This momentary pause, every time and over time, can be all we need to save us from blowing up our budget and sticking to our financial goals

2. Our Brains Love Descriptive Language -

The language used to describe items can persuade us to spend an exorbitant amount on items that we would never spend on. For example, we are more likely to spend $20 on a “grass-fed organic beef patty burger with homemade pickles made from the finest cucumbers in our organic small-batch garden” rather than the $2.80 we would spend at In-n-Out for a “cheeseburger”. Two items can be the exact same product but if one is described in eloquent language then we are more likely to spend significantly more on the descriptive item than on the non-descriptive item. In a world of artisanal everything from grilled cheese sandwiches to donuts, it is important to take a step back and consider if we are getting something special, or if what we want just has a fancier hairdo than what we usually purchase.

3. Sales and discounts hijack our ability to rationalize purchases.

When we see a $100 shirt on sale as “Now only $60!” we are convinced that we are saving $40 by buying that shirt. When in fact the arbitrary value of that shirt was never actually $100 but, sales people know that anyone is much more likely to buy a shirt for $60 if the consumer believes they are getting a deal rather than buying an overpriced blouse. For example, in this interesting article from the Atlantic from 2013, the author found that prices actually increased by an average of 8% just before Thanksgiving. When Black Friday rolled around, everyone had the increased price in mind for when they considered the ‘steep discounts’ they would be getting on that wonderous retail holiday. There is a common anecdote from a past CEO of JC Penny who attempted to do away with the characteristic ‘sales’ that JC Penny has been known for. This CEO did away with the sales and tried to transition to an ‘everyday low price’ image. Consumers were furious and refused to buy items that were not ‘on sale’ despite the prices being similar but without the initial high price to compare the discounted prices to. JC Penny lost a lot of money during this experiment and the pioneering CEO lost his job quickly.

4. Opportunity cost is a helpful contemplation tool when used in larger blocks of time. Attempting to ponder how many morning coffees it would take to pay off that new car you want, the amount of ice cream those new shoes could fetch you or how many hours of your labor it will cost to see the new blockbuster (with accompanying popcorn and drinks); all these calculations can be incredibly time and energy consuming to figure for each transaction we make. However, when reviewing our monthly expenses, we can use opportunity cost to reflect on the regular purchases we think we ‘can’t live without’ and recognize what we are losing or gaining by buying that daily latte over time. By taking the time at the end of each month to review our financial track record, we can see exactly where we are putting our money and decide if that new gaming habit is as financially innocent as we thought. In our reflection space, we can hash out exactly how many hours of work we have spent on things that are not a priority and, we can organize our intentions and goals for the upcoming month. By taking the time to be consistently aware of our spending and opportunity costs, we can achieve our financial goals! 

5. Fairness and effort – When we see somebody working hard for us – we want to pay them well. When we see a skilled professional complete a task that they make look easy and only takes a few seconds to complete, we do not want to pay them nearly as much. For example, if you lose the key to your office and hire the best local locksmith, they pop the door open in under two minutes, turn to you and say “That’ll be $200”, we might be reluctant to see the minute-to-dollar ratio as fair. Instead, if you hire the second-best locksmith and they pop the door open after an hour of fiddling around and they turn to you and say “That’ll be $200”, that hourly rate sounds fair! But, when it comes down to it, would it not have been better to have access to your office after two minutes, or an hour? Regardless of how fair we judge the time and effort we see the locksmiths exerting on the same job. Although we do not perceive the years of effort, learning, and tribulations that has led a professional to the ability to perform a complex task with ease, we should pay them their fee for their accumulated experience. This also informs us on how we can better present ourselves to our customers in order to avoid any negatively tinged-conversations around fairness in our own business transactions. If we have arrived at a place in our skill where there is minimal perceived effort which thereby arouses feelings of ‘unfairness’ within our customers, it would be wise to include some showmanship that can serve to bridge the gap between the perceived effort and the years of experience that have led you to your expertise.

 

Final Words:

This was the first book I have read about the psychology behind money and I am quite intrigued. What are some of your favorite ways you mentally frame money in your life? Leave a comment!