January 15th, 2018

Dan Ariely on Why the Way We Spend Our Dollars Makes No Sense

Reading Time: 3 minutes

You’re at the grocery store and you need to buy potatoes. When you arrive in the produce department, you see that bags of potatoes come in two sizes: Five-pound bags and ten-pound bags. The smaller bag is closer to the amount that you need and cheaper overall, but the bigger bag is cheaper by the pound and, wouldn’t you know it, it’s also on sale! Which bag do you buy?

If you chose the latter, behavioral economist Dan Ariely wouldn’t be surprised. Even though we don’t need those extra potatoes, even if we run the risk of taking a monetary loss when the potatoes we don’t use go bad and have to be thrown out, seeing a good deal flicks a switch inside us, compelling us to buy, buy, buy!
Why are we like this? In Dollars and Sense, Ariely attempts to shed some light on our irrational spending behaviors.

How we assess value has almost nothing to do with actual market value

Ariely outlines ten different ways we assess value that have nothing to do with the object’s value:

We forget that everything is relative.

What’s the difference between buying an extra $100 concert tickets because you lost one, and buying one $100 concert ticket, but losing $100 from your wallet on the way to the show? From an economic standpoint, absolutely nothing, but the human perspective sees the two as apples and oranges.

We compartmentalize.

Categorizing our money instills false values upon it. No matter what we spend it on—bills, morning coffee, or a trip to the Bahamas—a dollar is still a dollar. But we treat the money we earn from salaries very differently from money we inherit, win, or are gifted.

We avoid pain.

It’s a very natural and necessary instinct for us to want to avoid pain, but we often do this at our own expense. When spending money causes us pain, we want to avoid it, and we do so by creating distance between ourselves and the act of spending money, via credit cards and online purchases.

We trust ourselves.

Often completely unconsciously, we let our own experiences and knowledge cloud our judgement even when it shouldn’t. Ariely calls this anchoring; using often irrelevant information to help us make decisions. For example, if we’ve paid $4 for a latte before, we likely won’t mind doing it again, even if we can get a $2 latte of equal quality somewhere else.

We overvalue what we have.

If I asked you to guess the value of something, like a purebred dog or pair of shoes, you’d probably give me a reasonable estimate based on your own experiences. But what if I asked you to assess the value of your dog, or your favorite pair of shoes? Suddenly, they seem worth much more, don’t they!

We worry about fairness and effort.

Consider this: You get caught in a rain storm and run to the nearest convenience store. You see a display of umbrellas for $5 but before you can get to them, a clerk removes the $5 sign and replaces it with a $10 one. Economically, it’s a sensible move, but on a human level? Not so much.

We believe in the magic of language and rituals.

Language is a powerful tool and marketing experts know this better than anyone. For an example of how businesses use language to sway us, we need look no further than the world-famous McDonald’s. Which would you rather have: A burger, or “Two all-beef patties, special sauce, lettuce, cheese, pickles, onions on a sesame seed bun”?

We overvalue expectations.

Our expectations of an item we’re buying can completely color our perception of it. It’s why brand loyalty exists; instead of generic acetaminophen containing the same exact ingredients, people will almost always fork over the extra few dollars for the same pills with the Tylenol label on them.

We lose control.

We’ve talked more than once about the pitfalls of trusting our own self-control here at the Fabulous, and no example of this is more famous than the Stanford marshmallow experiment, which we’ve referenced here before. Instant gratification will always beat the benefits that may be reaped in the distant future. It’s one of many reasons why people don’t save for retirement.

We overemphasize money.

If you needed heart surgery, would you choose the expensive surgeon, or the surgeon offering a 40% discount? We tend to associate discounts and lower prices with lower quality, or “you get what you pay for,” but it’s not always true.

The Takeaway

When we make financial decisions, we can be very easily swayed by information that is irrelevant or even false if we’re not careful. Our psychological relationship with money is a complicated one, but money management is much easier when you go at it knowing your own cognitive biases.