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How Money Messes With Our Minds

Science confirms that money makes our brains short circuit. Here's how to fight back

Take out your wallet and pull out a wad of cash. Now count the bills, slowly. Rub your fingers over Washington's face. Feel better?

person in chicken suit handing out flyers

Photo by Jeff Minton

Our brains get faked out by marketing ploys and pricing tricks.

See also: The high cost of 'free' trials

More than likely, the answer is yes. The reason, research shows, is that money can act like a drug on our brains. Just the ritual of counting your money, says University of Minnesota marketing professor Kathleen Vohs, can raise your pain threshold. In one experiment she and her colleagues took two groups of students and had one count bills; the other, blank pieces of paper. Then both groups stuck their fingers in hot water. The students who counted real money reported feeling significantly less discomfort.

Vohs's study, published in the journal Psychological Science in 2009, is part of a field called behavioral economics, which explores how money plays tricks with our heads. Turns out, it happens a lot. The mind's financial guidance systems can go haywire when we order at a restaurant, when we sell our homes, or when we try to save for retirement. "I'm sure every time I go to the supermarket, in small ways I'm fooled," says William Poundstone, who writes about behavioral economics in his new book, Priceless: The Myth of Fair Value (and How to Take Advantage of It).

When we don't have a feel for what something should cost, our brains flail about for a reference point. The old expression goes that you can't compare apples and oranges, but we're actually fine at this. "You never see anyone baffled by the fruit plate," says Duke University behavioral economics professor Dan Ariely, who wrote Predictably Irrational: The Hidden Forces That Shape Our Decisions. "What is difficult is to compare an apple and 50 cents, or $1.20."

Companies exploit these brain-scrambling effects to get us to buy things we don't need. The good news: If you see them coming, you can use the same tricks to save money — and make money. Be aware of the following five traps:

The Trick: a high price makes a lower price seem reasonable, even if it isn't.

You sit down to eat at a restaurant. The most expensive steak on the menu costs $50. But there's another one for $25. "Ah," you think. "Just right." Deciding on the $25 steak feels rational. You weighed the options; you made your choice. But your selection was swayed by the mere existence of the $50 steak.

Economists call this effect anchoring. That $50 steak anchors our expectations of what a steak could cost. By comparison, a $25 steak looks cheap. Anchoring is rampant on wine lists, says Richard Thaler, an economist at the University of Chicago Booth School of Business and co  author ofNudge: Improving Decisions About Health, Wealth, and Happiness. "Suppose the most expensive bottle on the list is $100 and nobody wants to buy it," he says. To boost sales, the restaurant adds a $200 bottle. "They could keep just one of them around. Nobody will order it."

Eric Johnson, codirector of the Center for Decision Sciences at Columbia University, has done experiments with actual bottles of wine. Students are told a random number, then asked to put a price on the bottle. The students who were told higher numbers — even though they know this number has nothing to do with the wine — picked higher prices. "It is really quite shocking," Johnson says. "The more you do this, the more you realize we are really imperfect decision makers."

The Fix: Shaking an anchor is difficult. Put a number in our heads and it tends to stick. Even telling people to ignore it rarely helps. "It's like saying, ' Don't think about an elephant,' " says Poundstone. "You can't do it."

One solution: Establish personal anchors in your mind, says Duke's Ariely. Pick something and set its value. Maybe $25 is the price of a theater ticket. Before ordering a $25 wine, ask yourself if it's worth a show.

If you're eating out, stick to the menu's more affordable neighborhoods. Self-described "menu engineer" Gregg Rapp, who has advised major restaurant chains, recommends finding deals at the bottom or the back of the menu, where cheaper items tend to hide. And if you're wondering whether a menu has been "engineered," see if it uses dollar signs — they make us think about money. "I've been taking dollar signs off menus for 29 years," Rapp says.

The Trick: Our fear of losing makes us pass up winning moves

Eric Johnson often conducts an experiment in his Columbia Business School class. He divides the class into two groups and asks one group how much they would pay for a mug. The typical response is $4. He gives the other group a mug for free, then asks, "How much would I have to pay you to part with it?" It's basically the same question — how much is the mug worth to you? Except this group gives an average response of $8.

Researchers call this the endowment effect. Johnson still finds it amazing — two randomly selected groups disagree dramatically over the value of a mug they hadn't seen moments before. "It's one of the most telling demonstrations in behavioral economics," he says. "Simply owning something increases its value."

Why? Because we really don't like losing something once we have it: The pain of losing outweighs the joy of winning. It's called loss aversion, and one consequence, says Richard Thaler, is that we tend to prefer "flat-rate" plans, in which, for instance, we pay a fixed amount for a cell phone plan, rather than being billed by the minute. "Nobody likes to hear the meter running," he says.

That principle can make us buy more than we need. Take cars: Many two-car households don't need the second car — they'd save money by owning one and renting a car or taking a taxi when needed. But if we own the second car, we feel as if each trip is free, even though it isn't. We forget about the vehicle's purchase price and its ongoing expenses.

Buying a house is also a kind of flat-rate plan, given that paying rent feels like tossing money out the window every month. Sometimes it is. But it might make sense to rent your home, especially if you don't plan on living there for a long time. (To see if you'd save money by renting, use AARP's online calculator at

The Fix: Once you understand loss aversion, you'll see it everywhere. In the stock market it affects how we feel about a stock we own. We tend to hold losers too long and sell winners too early. When a stock tanks, we don't want to sell for a loss, so we hang on, hoping it will recover. And when a stock is rising, we try to lock in the wins, often too early. Thaler's advice? Pick a sensible strategy — and stick with it. (Consider an automatic investment plan that results in dollar-cost averaging: You invest a fixed amount in certain funds at set intervals, so you'll buy more when prices are low — and you won't be tempted to yank your money in and out as prices go up and down.)

Ariely has a tip for fighting loss aversion: If you go out regularly for meals with someone, alternate paying the bill. The person who pays will feel a little more pain, but not twice as much. When you split the check, you both suffer. In taking turns, the person who doesn't pay is freed from the pain of loss. Assuming the bills are about the same, you'll spend the same amount of money, but you'll cut the number of spending transactions in half. "These are the tricks we can play with ourselves to make ourselves feel better," he says.

The Trick: We can't tell how long that long shot really is

From a financial perspective, playing the lottery is a bad bet. But millions of us do it anyway, even though we usually lose money. This is the flip side of the loss-aversion principle: The lure of a huge payoff overcomes our resistance to drop a few bucks on a ( probably) worthless ticket. As economists put it, we "overweight low probabilities." That's also why we buy insurance for things like flight accidents, even though the average American's annual risk of dying in a commercial-airline crash is about one in 11 million.

The Fix: Our brains aren't really wired to intuitively grasp the insignificance of very small odds. But there are ways to turn the urge to gamble on long shots to our advantage.

Harvard Business School economist Peter Tufano recently studied a savings plan called Prize-Linked Savings (PLS), which uses a lottery to encourage people to save money. Here's how it works: Credit-union members open savings accounts that pay less interest than normal accounts, but each time members make a deposit, they are enrolled in a lottery where they stand a small chance of winning a much larger sum. And, unlike in a conventional lottery, they never lose money. A group of Michigan credit unions started a PLS program called Save to Win in 2009, but other states currently don't allow PLS-type plans, which are seen as competitors to existing state-run lotteries.

The Trick: We want it now, not tomorrow

Quick! Would you rather have $50 today or $52 in a week? Studies show that most people take the money now. But getting $52 a week later is the equivalent of earning 200 percent interest annually. If your bank offered that rate, you'd surely take it.

Researchers have conducted this now-or-later experiment with real money and with pieces of chocolate (the latter study was published last year in the journal Economics Letters) with the same results: Our guts tend to be impatient. Economists call that hyperbolic discounting, and it explains everything from drug addiction to the slow response to global warming. "One of the classic examples of this is people not saving enough for retirement," says Eric Johnson. Shortsightedness might have made sense to our ancestors, who lived in a world of immediate threats. But it complicates our long-term planning today.

The Fix: Just reverse the question: "Imagine you could have $52 in a week. Would you rather have $50 now?" Johnson asks. Phrasing it that way harnesses loss aversion: Now it feels like we're losing $2.

In 2004 Richard Thaler helped devise Save More Tomorrow, a plan that lets workers direct part of their future raises into retirement savings instead of taking cash out of their current paychecks. The raise hasn't happened yet, so participants don't feel loss aversion or hyperbolic discounting. In an early implementation, the savings rate of participants more than tripled.

The Trick: Too many choices lead to bad decisions — or no decisions.

In 2000, social psychologist Sheena Iyengar, who now teaches at Columbia and wrote the 2010 book The Art of Choosing, published a groundbreaking study on choice. In one experiment she offered free samples of jam to shoppers. Almost one-third of those who chose from six kinds of jam bought a jar, compared with only 3 percent of those faced with 24 varieties. In another experiment she showed that those who chose from more options were less happy with their purchase.

That effect, dubbed the paradox of choice, changed a lot of assumptions about what consumers want. It also explains why we make — and fail to make — many spending decisions. Faced with too many choices, we develop habits. We pick one jam, one restaurant, one credit card company. And because we rarely examine those habits, we don't get the best deals.

The Fix: Dan Ariely recommends taking time once a year to see if our habits make financial sense. Do we really need the $100-a-month cable-TV plan? Think of it as resetting your financial compass to shake off the mind-altering effects of buying stuff.

And finally, relax. Some money decisions do have right and wrong answers. But what something is worth to you is ultimately subjective. "It's a general problem with life," says Richard Thaler. Is a $40,000 car better than a $30,000 one? Probably. "But how much better?"

There's only one answer, and your brain won't find it very satisfying — $10,000 better.

David Kestenbaum is an economics correspondent with National Public Radio. You can also hear him on the Planet Money podcast, at

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