Duke University Professor Dan Ariely ~ Don’t Try to Be Rational About Money | The Six Forces That Shape Every Purchase You Make

Almost everyone knows the particular sting of waking up the morning after a purchase and wishing the money were still in the account.

What makes it stranger is that the same people who dissect data and argue a case flawlessly at work seem to lose that faculty the moment their own wallet enters the picture.

We spoke with Dr. Dan Ariely — Professor of Psychology and Behavioral Economics and the author of Dollars and Sense — about what it would actually take to handle money better.

Money Arrived Too Recently for Evolution to Prepare Us

Financial Academic Journal (hereafter, FAJ):

Could you offer some examples of moments when people fail to reason clearly about what they are paying for?

Mr. Dan Ariely:

The errors I catalogued in Dollars and Sense concern us in our role as consumers. Before turning to the errors themselves, though, it is worth pausing on why they happen at all. Our species spent an immense stretch of time evolving. Picture the human mind as a kit of instruments assembled to handle sight, sound, language, walking, breathing and countless other demands. Money, however, showed up only a moment ago in evolutionary terms, so no dedicated instrument for it exists. We are obliged to reach for the tools already in the kit, none of which was built for this purpose, and the result is a mismatch between our cognitive equipment and the thing we are trying to reason about.

You might reasonably hope that our mental equipment will eventually catch up with money.

Technology, unfortunately, moves at a blistering pace. Cast your mind back a decade and the shift from cash to digital is nearly complete. Touchless interfaces are everywhere. Cryptocurrency exists. Not one of these developments is something we were equipped for. Where money is concerned, human invention runs far ahead of human evolution.

FAJ:

The gap you describe between technological speed and human adaptation does seem to make money harder to manage.

Mr. Dan Ariely:

That is exactly it. The surroundings grow more intricate by the year, and they were never arranged with us in mind. Deciding rationally about money therefore means working out which of the available options genuinely deserves our money.

Opportunity Cost: The Calculation Nobody Actually Runs

FAJ:

What makes that comparison between options so difficult in practice?

Mr. Dan Ariely:

Money buys an extraordinary range of things — a car, a home, meals, entertainment, music — and it can even buy back time when you hire a babysitter. So where should an extra $10 go?

Everything about money reduces to opportunity cost. Choose one purchase and another becomes unavailable to you; those trades are unavoidable. Yet in practice, reckoning the opportunity cost is genuinely hard. Ask yourself when you last stood in a coffee shop and wondered what this money might otherwise have accomplished had you skipped the cup.

FAJ:

When I am on the verge of buying something, the alternative uses for that money rarely cross my mind.

Mr. Dan Ariely:

Quite so — hardly anyone has trained themselves to think that way. The larger purchases are no different: phones, computers, cars all escape the same scrutiny. And as I mentioned, technology compounds the difficulty. Suppose I handed you ￥10,000 in banknotes at the start of every day. Under those conditions you would grasp your opportunity cost readily enough. A lavish breakfast puts dinner at risk; a taxi ride leaves less for whatever comes next. Cash covering a single day makes the trade-off legible — more here means less there.

Now change the interval. Rather than ￥10,000 daily, I hand you ￥70,000 once a week. Monday morning you feel no constraint whatsoever, and by the closing days you find yourself short. Extend the interval to a month and the effect deepens. Layer on a savings account, car payments, a mortgage — and the trade-off disappears from view entirely.

FAJ:

Now that you mention it, I seldom have a clear picture of what I am spending from day to day.

Mr. Dan Ariely:

Awareness of one’s own financial decisions is missing far more often than people assume. Ask someone what their monthly subscriptions add up to and the answer usually lands nowhere near the truth. The total is a mystery to them. Some cannot even recall every subscription they hold, and the figure they venture bears little resemblance to what leaves the account. Supermarkets produce the same pattern — we walk out having spent well past what we intended. Attachment to a particular item is another route to overspending. The catalogue could run on indefinitely, but the underlying point is that we were never built for money, and the marvellous complexity of contemporary life sharpens the problem. To be clear, I am an enthusiast for modern life and glad to be living now.

What we do need to accept is that our surroundings were not constructed to steer us toward good decisions. In places, they were constructed to steer us toward poor ones.

Factor 1: Emotions — Why Willpower Loses at the Shop Window

FAJ:

Thank you. In Dollars and Sense you identify six forces behind irrational judgments about money. Could you introduce each of them for our readers?

Mr. Dan Ariely:

Gladly. Heading the list, and arguably the weightiest of them, are emotions. You could frame this as a question of self-control, though let us stay with emotions for the moment. The concept rests on our having two modes of thought. One is cognitive, weighing drawbacks against advantages with some care. The other is emotional, and considerably less deliberate. The truth about financial decisions is that emotion frequently wins. This is the same mechanism behind skipping exercise, eating past fullness and spending past our means. We may hold a clear intention, and then a shop window presents a good hat, a sweater, a piece of hardware, and the intention evaporates at the till. Emotions, in short, are what push us into conduct that is neither rational nor good for us.

FAJ:

I recognize that. Impulse gets the better of me now and then, and I come home with things I had no business buying.

Factor 2: Relativity — The Same $8 Is Never the Same $8

Mr. Dan Ariely:

Second on the list is relativity, and it is a fascinating one, because it operates as a general-purpose routine the brain applies to virtually everything. What this routine does is direct our attention to how things compare against one another instead of registering their absolute magnitude.

Return to childhood for a second and recall your mother pouring juice for you and your siblings. Even a slight discrepancy in the levels mattered to you, didn’t it? The quantity of juice in absolute terms was never the issue — the gap was. In numerous respects the human apparatus is arranged to register relative differences and ignore absolute ones.

Money behaves identically. Picture a shop selling inexpensive reading glasses at $15. You then discover that a ten-minute walk will bring you to another shop offering the same pair for $7. Most people make that walk to save $8 on a $15 item, since the reduction exceeds half the price.

Now switch the merchandise to expensive VR goggles priced at $1,015. Again a ten-minute walk secures a discount, this time bringing the price to $1,007. The saving is $8, exactly as before. What happens? Almost nobody walks. Your bank balance registers $8 and remains entirely indifferent to whether it came off $15 or $1,015. In the first case our intuition frames $8 as a discount north of 50 percent. In the second we frame it as a negligible fraction, unworthy of the detour. Our psychology insists on relative differences and disregards absolute ones.

FAJ:

That follows. Your illustration involved discounts — would optional add-ons and special offers fall under the same principle?

Mr. Dan Ariely:

Without question. Buying a new car, you will be asked by the dealer whether an upgraded stereo for another $2,000 appeals to you, and the answer arrives easily enough. With $40,000 already committed, $42,000 registers as a modest step up. Approached cold, however, that same stereo would never be bought — starting from zero, $2,000 is a serious sum. Home renovation supplies a parallel case. A great many people report that money slips away more easily during a renovation. Once a large budget is already in motion and the contractor raises the possibility of a TOTO bidet toilet for $2,000, the figure sounds reasonable. That is relativity at work, with people reasoning entirely in relative terms.

FAJ:

Being conscious of that routine would seem valuable on both sides of a transaction.

Factor 3: The Pain of Paying — What the Taxi Meter Did That Uber Doesn’t

Mr. Dan Ariely:

Third comes the pain of paying. The premise here is that a payment is not defined by its amount alone but by how conspicuous it is to us. Take an example from my own classroom. When I teach the psychology of money I bring pizza and charge 25 cents for every bite. What do you suppose follows? Enormous bites. Salience produces that behaviour: the payment sits so prominently in view that the students set out to make it efficient, and they cram the pizza in. The pain of paying holds that any expenditure can be rendered more or less conspicuous, and that heavy salience drains the pleasure out of whatever we are doing.

FAJ:

Overall satisfaction with the meal would presumably suffer once efficiency takes over — though ideally one would want both affordability and enjoyment.

Mr. Dan Ariely:

Let us stay inside the restaurant, then. Imagine the place belongs to me and I have established that diners take roughly 100 bites per $100 of bill. I approach your table with an offer: 50 cents a bite, when the going rate works out to a dollar, so you are getting half off. Your dish arrives, I settle back, and each time your fork moves I record a small tick in my notebook. When you finish I bill you 50 cents per tick. How pleasant was that dinner? Fairly dreadful — the salience was overwhelming.

Taxis offer another version. Meters used to sit in plain sight with the fare climbing in front of you. Caught in traffic, passengers would occasionally decide to get out and cover the rest on foot. Then Uber arrived, the money vanished from view, and that behaviour vanished along with it.

What all this points to is salience and the pain that accompanies paying. Money, under this account, is never merely the sum changing hands — it is how visible that sum is made. Neither state is inherently good or bad; the question is which one we build. Raise the pain of paying and people naturally do less of the activity. Lower it and they do more. Making sound financial decisions means attending not only to amounts but to how conspicuous those amounts have been made.

FAJ:

Thinking back, the meter certainly kept me conscious of the sum I was about to hand over. Holding these ideas in mind day to day would sharpen anyone’s decisions.

Factor 4: Mental Accounting — Why a Year-End Bonus Buys Different Things

Mr. Dan Ariely:

Fourth is mental accounting — the notion that how money reaches us shapes how we feel about parting with it.

Hand someone $1,000 as a gift card and it will be spent quickly, with very little hesitation.

Draw the same amount from a checking account and reluctance sets in. Or picture winnings from gambling: they leave your hands far more readily than anything sitting in a savings account.

Even where the source is identical — a paycheck, say — the schedule on which it arrives creates psychological differences of its own. Suppose you worked for me and I offered a choice: an additional $1,000 every month, or $12,000 in a lump at year’s end. Which strikes you as preferable? Reason favours the monthly arrangement, since the money reaches you sooner. Yet the manner of arrival transforms the spending. Monthly recipients direct the money toward bills, electricity, groceries and the like. Annual recipients do something out of the ordinary for themselves — a trip, perhaps, or a new bicycle. The lump sum evidently grants psychological permission for expenditures they would deny themselves under a monthly rhythm.

So we carry psychological biases tied to how money was obtained and how it was delivered, and those biases govern our spending. Handling money better begins with acknowledging that the tendency is there.

FAJ:

The salary example matches my own experience. I can recall making decisions along precisely those lines.

Factor 5: The Magic of Free — Zero Is Never Actually Zero

Mr. Dan Ariely:

The fifth force I want to expand on is the magic of free. Something priced at zero excites us to a degree quite out of proportion. Consider the hours people pour into free news of indifferent quality. Or ask how many of us would remain on Facebook at $10 a month. The instant a thing costs nothing it becomes irresistible, and that is how we end up surrendering staggering quantities of time to it.

Still, the old line about there being no free lunch holds. A price of zero does not mean an absence of cost. It happens routinely that we sink more hours and more effort into something acquired for nothing than we ever intended, and often more than whatever we gained was worth.

FAJ:

And what is the final force behind illogical financial choices?

Factor 6: Expectations — The Locksmith Who Got Worse Reviews as He Got Better

Mr. Dan Ariely:

The remaining element is expectations. The premise is that experience does not arrive through the senses alone — the mind participates in it. Wine illustrates this neatly. Drink a glass while knowing its origin, the character of the ground it grew in, the method behind it, and compare that with drinking the identical wine in total ignorance. The two are not the same, because part of what we experience is experienced mentally.

Effort belongs inside this same subject. Something that happened to me makes the point. A few years ago I locked myself out of my house and called a locksmith. He arrived, had the door open inside a minute, and charged me $125. I paid, then asked him how he set his prices. Back when he was starting out, he told me, the work took him ages, he occasionally destroyed the lock, and he had to bill people for both his hours and a replacement. Customers paid happily in those days and sometimes added a tip. As his skill improved and locks stopped breaking, however, people grew more indignant about his fee. Had he stood there perspiring for half an hour or an hour, they would have handed over the money without complaint. Everyone is better served by his being quick rather than slow, and yet that is plainly not how we register it.

When we pay, part of what we are paying for is fairness, and the worth of a service need not track its price at all. Our sense of what is fair is what determines the sum we will willingly hand over. Because expectations can badly distort which figures strike us as reasonable, stepping back to think before money leaves your hands is worth the pause. That habit keeps unnecessary expenditure in check.

A Message to Readers: Perfect Rationality Is the Wrong Goal

FAJ:

Thank you very much. To close, would you leave our readers with a message?

Mr. Dan Ariely:

My answer is that no genuine route to perfect rationality exists — and that we ought not to be chasing one. Imagine some new mode of thinking descended overnight and everybody began reasoning about money with complete rigour. Behaviour would look entirely different. Saving would rise and spending would fall, because advertising would lose its grip and so would whatever the supermarket has positioned at eye level.

Even so, irrationality is a component of what makes us human. Leaving a tip in a town you will never set foot in again is irrational. So is buying flowers for the person you love, and so is giving money to a charity. Some of the beauty in being human lies in exactly those irrational acts, which reach toward other people and find joy in the connection.

That is why striving for rationality strikes me as the wrong project. The better task is examining which of our economic behaviours actually deliver joy and which fall short of delivering enough of it.

My suggestion is to sit down once a year with your credit card statement, work through the categories, and put two questions to yourself: which of these brought me real pleasure and deserves more of my money, and which of them did I get about right? Ultimately I believe we could spend less and generate more pleasure than we currently do. The starting point is understanding the relationship between the money we spend and the happiness it is supposed to produce.

Editor’s Note

Six forces, and not one of them is a failure of intelligence. A brain that evolved for sight, sound and movement was handed cryptocurrency and touchless payment, and it is doing what it can with the instruments available. Seen that way, the morning-after regret looks less like weakness than like a predictable outcome of the mismatch Dr. Ariely describes.

What stayed with us most, though, was his refusal to prescribe rationality as the cure. Tips left in towns we will never revisit, flowers, donations — the irrational column of the ledger is where much of a life’s meaning sits. The annual review he recommends is not an audit for eliminating waste. It is a question about which expenditures earned their place.

Interview and text: Financial Academic Journal