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November 10, 2017

Editor's Choice: Dollars and Sense: How We Misthink Money and How to Spend Smarter

By: Dylan Schleicher @ 12:27 PM – Filed under: Big Ideas & New Perspectives, Personal Development & Human Behavior

Dollarssense

Dollars and Sense: How We Misthink Money and How to Spend Smarter by Dr. Dan Ariely & Jeff Kreisler, Harper, 288 pages, Hardcover, November 2017, ISBN 9780062651204 

The image of the human being as homo economicus—a rational actor that optimizes his own economic self-interest in a free market—is one that the field of economics was built upon. It has not only taken a hit in recent years, it is now seen as almost absurd—akin to a geologist believing the Earth is flat. Behavioral economist Dan Ariely’s previous books, especially Predictable Irrational, have been a popular counter to that view of economics. His new book, Dollars and Sense, authored with comedian Jeff Kreisler, makes it more personal. He explains why we—yes, you and I, and everyone—are not rational when it comes to managing our own money. And it all begins with the very simple fact that:

 

Whenever money is added to any decision, it gets more complex.

 

Dan Ariely and Jeff Kreisler open their book with the mistakes we make when gambling in a casino. They include issues of Mental Accounting, The Price of Free, The Pain of Paying, Relativity, Expectations, and Self-Control. It is, they admit, perhaps unfair in how extreme an example it is. But:

  

All of these mistakes may seem like they’re unique to a casino, but in truth, the whole world is a lot more like a casino than we’d like to admit: In 2016, America even elected a casino owner as president, after all.

 

I think the accounting may have been a little off on that one, but it is a fair point. We walk around with the same mental shortcomings that casinos take advantage of in our everyday lives, as well—and act just as irrationally as we do in a casino because of them. If anything, most of us are at least aware of the fact that the odds are against us in a casino. We like to think we’re more savvy outside of it. But consider the story of JCPenney CEO Ron Johnson, who instituted a “fair and square” pricing system in stores, ending the long-time practice of artificially raising list prices so they could “discount” them to an “on sale” or “bargain” price. How did customers react to this honesty in pricing, when the company essentially decided to stop deceiving them? They revolted. Sales collapsed when the “sales” ended, and Ron Johnson was fired.

 

Ron Johnson’s JCPenney offered products at more honest prices and was rejected in favor of gimmicks. … Think about that: JCPenney’s customers voted with their wallets and elected to be manipulated. They wanted deals, bargains, and sales, even if it meant bringing back inflated regular prices—which is exactly what JCPenney eventually did.

 

“Almost immediately after his firing,” the authors tell us, “the list price of most items at JCPenney rose by 60 percent or more.” And everyone celebrated the return of bargains and coupons. This is a problem of relativity. We compare the cost to what we think it used to cost to determine the value, when if we were thinking rationally, what it used to cost shouldn’t matter. All that should matter is what it costs now, because that is what we’re paying for it. There’s another story about one of the authors that illustrates this point perfectly:

 

Jeff recently had an interesting experience while shopping. For years, his favorite cereal was Optimum Slim. For a man of soft, round middle, advancing years, and limited exercise ambition, it promised just the right amount of slim. The optimum amount.

 

Yes, the book is more than a little punny, but the point of the story is that, on one visit, he couldn’t find his favorite cereal. It turned out the cereal he had always paid $3.99 a box for had a new box, a new name, and a new price: “Nature’s Path Organic Optimum Slim—Regular $6.69. SALE $3.99.” Nothing had changed about he cereal, and the new price was actually the same as the old, but the way it was presented had changed drastically. The authors explain what happened:

 

It’s one thing if the company introduced new packaging as a way to raise the price. It’s another thing if the store pretended the regular price was a sale in order to boost orders. But to do both at the same time—that’s using a certain amount of relativity. The optimum amount.

 

Yeah. Methinks the authors had a certain amount of fun writing this book. The optimum amount. And it can be a bit much at times, but the humor does make the complex psychology around the most anxiety inducing element of our lives—our money—and the way it leads us into irrational decisions go down easier by a certain amount. Just a small amount. Because once we stop laughing at how irrational people are, we realize that those people are us. The good thing is there’s always another laugh around the corner, and something we can do about it. And the first thing we can do is make ourselves aware of it, which is why the book itself is such a good investment.

The authors explain why mental accounting, even the simple act of budgeting, is inherently irrational (a dollar is a dollar is a dollar), but why “just like corporate accounting, [it] can be useful if used judiciously.” They also explain how we can use it to deceive ourselves, how it can lead to a “self-contained Enron” accounting scandal if our mental balance of accounts gets too creative. They inform us that paying for something triggers the same receptors in our brains as those that cause physical pain, and how companies are making paying easier to reduce that pain and more easily separate us from our money. They explain that, basically, when our humanity intervenes, “The invisible hand of the market gets smacked away.” How our experiences are anchored and framed can (and do) affect how much we think they’re worth. Ownership, or our own sense of fairness affects our perception of value. Language and ritual, as well as our own expectations, change the real value of our experience. There are great stories ranging from locksmiths to Picasso to illustrate these points, and a potentially alarming number of anecdotes about wine. They wrap it up with some ideas of what we can do, and what is being done in different places, to “turn our mental shortcomings into tools that work in the service of our financial success.”

Books about personal finance almost always elicit a mixture of boredom, discomfort, and depression. Dollars and Sense is fun, (maybe a little too) funny, and a really easy read. And, in the end, it is also a profound one, because the decisions we make about money are ultimately decisions we make about our life. And that brings it back to the most fundamental, human level of existence: the amount of time we have and the choices we make on this Earth. And to get to that core, Ariely and Kreisler believe that, “a useful financial decision-making strategy is to pretend money doesn’t exist.” Huh?

 

What if, instead of looking at a vacation [in terms of how much money it costs], we quantified the amount that this vacation would cost us in terms of movies we could attend or wine we could drink? What if we looked at the wardrobe we were going to replace for the winter and we calculated how many tanks of gas or bicycle repairs or days off work it would cost? What if, rather than considering the difference in price between big-screen TVs, we were to think about the difference as a dinner out with friends and fourteen hours of overtime and then decide if it’s worth the upgrade?

 

In short, instead of what it cost, we should consider the opportunity costs. “This direct-comparison method is not necessarily the most efficient,” they tell us, “or even the most rational, approach.” But we are not homo economicus, and especially with big financial decisions, it is probably the right approach:

 

No matter our station in life, we believe it is important that instead of thinking about life decisions in terms of money, we think about them in terms of life.

 

We are all irrational about money. The sooner we realize that, the more rational—or at least reasonably irrational—we can become about life.


 

About Dylan Schleicher


Dylan Schleicher has been a part of the 800-CEO-READ claque since 2003. Even though he's stayed on at the company, he has not stayed put. After beginning in shipping & receiving, he joined customer service and accounting before moving into his current, highly elliptical orbit of duties overseeing the ChangeThis and In the Books websites, the company's annual review of books and in-house design. He lives with his wife and two children in the Washington Heights neighborhood on Milwaukee's West Side.