Reasons We’re Bad At Money Explained

Dr. Pete LunnIf you ever feel you are bad with money, perhaps you should look to psychology rather than book keeping as the source of your problems.

Inconsistencies and anomalies in our thinking mean we view financial transactions differently based on how they are framed, according to Dr. Pete Lunn.

To prove his point, the neuroscientist, turned behavioral economist and author of Basic Instinct: Human Nature and the New Economics, ran a series of simple experiments on the audience at the Cornflakes & Commerce breakfast at the NCI this week.

His first question proved the point well: In scenario 1, you are given €30 and told you would get another €10 for sure. But then a coin toss will determine if you lose €20 of that total or keep the full amount. Asked to pick, a majority of the audience put their hands up.

The second scenario sees you given €50 and told you will lose €10 of it straight away. You then toss a coin to see if you lose another €20 or keep it. A lot of hands went down.

Yet, the odds of making the same amount of money are the same, Lunn said. “The only real difference is how they are framed,” he said.

These anomalies have been exploited by marketers for years. Behavioral economists started studying these patterns relatively recently and, in the process, upended a number of long-cherished economic beliefs, Lunn said. One of the principle casualties was the belief that people are fundamentally rational with money.

Another experiment on the audience involved an imaginary visit to Lunn’s place of work, the ESRI, where the visitor is given a company-branded mug on arrival. Showing a slide of the pretend mug, Lunn asked if he offered to buy it back on the visitor’s departure how much people would be willing to sell it for. The consensus seemed to be around €5.

He then turned the problem on its head, and asked how much people would pay if they were offered the mug to buy on their arrival at the ESRI. People started laughing but few were willing to offer the €5.

“It’s as if, once we own it, it takes on added value,” Lunn said.”People are really very uncertain about what stuff is worth to them.”

Another experiment saw him ask the audience if they saw a calculator for €15 in a store and knew the same model was in a different store a 15-minute walk away would they go get the cheaper  model. Most said they would.

Lunn then asked if a jacket cost €135 in one shop, and the same one cost €130 in a shop 15 minutes away, would they do the same walk. Most said they would not. “Why are people pricing a 15-minute walk differently?” he asked.

“Uncertainty about what things are worth to us has quite a big impact on our trading behavior,” Lunn said. The result is that people will stick with what they know and avoid uncertainty.

Another experiment pointed to discrepancies in how people value time. Asked if they would take €100 today or €105 tomorrow, around half opted for the money today. Lunn then asked if people would take €100 in 30 days time or €105 in 31 days, the proportion opting for the quick pay out dropped dramatically.

People value the immediate higer, Lunn said, and will not price a day’s delay consistently. “This is one of the reasons why ‘buy now, pay later’ works,” he said. It is also a reason why people “massively under-invest” in their pensionfunds, he said.

Another very interesting experiment showed how people will turn down fairly hefty cash if they perceive the bargain to be unfair.

This “trust game” involves two players who may not even know or see each other. IN one version of the game, a proposer has €10 but has to split it with a responder. The responder can chose to accept or reject the offer. If he accepts, both parties keep the cash.

When first done in 1980, the results shocked orthodox economists who argued that people are rational and that any offer, regardless of how small, would be accepted by the responder. They “got very upset about this one,” Lunn said.

The most common offer was €5, he said. The mean was around €4.40 but offers below €3 were usually rejected. Even in studies in developing countries where large amounts were offered, people would reject the equivalent of two or three weeks’ pay, Lunn said.

“This should give any one in business pause for thought. Fairness is a very powerful driver,” he said.

 

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