Don't Fall for Money Mind Tricks (Part 1)

By in Personal Finance | 9 comments

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With a Masters Degree in Counseling, a Bachelor’s in Economics, and an MBA in Finance, you’d think I would be smart enough not to fall prey to marketer’s (and my own mind’s) tricks. Turns out, not only do I make mental money mistakes but so do folks a lot smarter than I.

DO YOU REALLY NEED TO BUY THESE?

 Behavioral finance studies show just how easily our minds can be swayed to make poor economic decisions. This three part series introduces two money mind tricks with more to follow.

By increasing your awareness of the mind’s tricks, you can train yourself to be more mentally rational and make smarter financial decisions.

MENTAL ACCOUNTING

As a young girl, my aunt counseled me that when I got money as a gift, I should use part of it to SPLURGE. That was BAD ADVICE!

Spend only dividends and interest, not capital gains? This is a popular tactic used to preserve wealth in retirement. Is it sound? Many retirees use this approach, what about your relatives?

When buying a car for $25,000.00 many agree to the little extras because, after all, they are just a few bucks more. Well that extra $350.00 for paint protection is the exact same $350.00 that could be used to pay your grocery bill for a couple of weeks! Now that’s real money.

These are examples of mental accounting! Stick money in various mental pots and treat each pot differently.

Does the grocer care if your cash came from dividends or capital gains? Will the barber be concerned if you took his payment from account A or B?

 Money is the same, regardless of it’s source!

Solution

Create a sound financial plan with room for necessities, fun, and retirement regardless of the money’s origin.

Be aware of the trick of mental accounting and don’t let it cause you to spend more. Money is money. Treat it all as the limited resource that it is and not differently based on its origin! 

ANCHORING

Has this ever happened to you? You have a dinner planned at an upscale restaurant. There’s a steak listed for $50.00 and another one for $25.00. You remark to your companion, “What a great value, only $25.00 for a steak!”

What just happened? According to Richard Thaler, a foremost behavioral economist from the University of Chicago and author of Nudge, the $50.00 steak anchored our minds. We saw that high price and figured, $50.00 is what a steak costs. By comparison, the $25.00 steak appeared cheap!

If you’re an investor, I guarantee you’ve fallen for this one. You buy a stock for $20.00 per share and watch its price plummet. Instead of selling the investment which didn’t perform, you tell yourself, “I’ll sell it when it gets back up to $20.00.” Your mind is anchored at the $20.00 purchase price.

Wouldn’t you be better off selling the poor performer, chalking it up to experience and deploying your money on an investment with better prospects? Of course.

Marketers use this technique all the time.

Look at the price tags where the original $35.00 sweater is marked down to $25.00. You think you must buy because it’s such a great deal.

Is it really a great deal if you can buy a comparable sweater at the shop next door for $20.00? Use your own experience to determine a fair price.

In assets which fluctuate in value due to market forces, such as stocks or real estate, accept how the market values the asset NOW, not what it was when you bought it. Be dispassionate in your assessment and ignore its previous price.

Our home is currently on the market for the exact price my next door neighbor’s SOLD their identical home last year. The real estate market has fallen in price over the last year. Although it’s a bit painful, I accept that reality and am not anchored to last year’s value!

Solution

Combat this trick by KNOWING WHAT THINGS COST and determining what you are willing to pay.

Stop back for Part two and learn more strategies to combat mental money mistakes.

ACTION STEPS:

 Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

Before you pull out your wallet, check your mind and make sure it’s your decision to spend. Be alert to marketers ploys.

BEHAVIOR FINANCE RESOURCES

Check out these related sites:

What mental money mistakes have your made?

image credit; mypapercrane

    9 Comments

  1. I am pretty good at not letting mental accounting influence me, however I do find myself anchored at particular prices when it comes to stock. My solution is no individual stock will be more than 5% of the portfolio. Do I ever violate that principle? Yes, but it is profitable!

    krantcents

    May 20, 2011

  2. I’m always amused by high gas price discussions! There are bigger leaks than a 50c increase per gallon of gas, yet people think of cutting back only when they see gas at $4.00.

    $4 seems to be the anchor is this case! ($5 if you are in California!!)

    MoneyCone

    May 20, 2011

  3. @Krantcents-You seem to have this one well thought out. It helps to have a plan in advance!
    @Moneycone-Agreed- Cutting back with driving irregardless of the current gas prices makes sound environmental AND financial sense.

    Barb Friedberg

    May 20, 2011

  4. I love this post!! It’s true, money is the same no matter where it comes from, but anchoring a price in someone’s mind makes an alternative seem like a better/worse relative value.

    I knew a guy who ran a company who used to always offer his customers 3 options, knowing that in most cases, the customer would choose the middle option. Of course, he made sure the middle option was a high-margin one.

    Paula @ AffordAnything.org

    May 20, 2011

  5. Very insightful post, Barbara. A deal is not a deal if grounded (or anchored) in fantasy figures.
    This is one reason I recommend that people attend auctions and yard sales to figure out the intrinsic or residual value of “stuff”. Getting a can-you-believe-what-that-sold-for epiphany can save many a dollar down the road.

    101 Centavos

    May 21, 2011

  6. Great post Barb. Thanks for the wake up call.

    Miss T @ Prairie EcoThrifter

    May 22, 2011

  7. @Paula-Very clever use of anchoring for you friend’s business. Good idea to use it when selling to others!
    @101 Centavos-Another good idea, going to yard sales to seel what “stuff” is really worth. Sadly, more time than not, it’s not worth as much as you think.
    @Doable-It’s old, but it hangs around because it works!
    @Miss T-Glad I could help.

    Barb

    May 23, 2011

  8. People do tend to get trapped by this. You cited a great tip here. One should think about how much the difference on the price is, and try to figure out what other things they could buy with the price difference. This should give them an idea on whether or not they are actually getting the price at a discount.

    primelending dallas

    November 23, 2011

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