When it comes to handling money, most of us aren't as rational and logical as we think. As with losing weight, we know what we need to do -- eat less (spend less) and exercise more (save more), but somehow we can't bring ourselves to do it. Or we buy a hot stock that really doesn't fit our investing needs and later wonder, "What the heck was I thinking?"
You needn't beat yourself up about your seemingly irrational money choices, though -- it turns out there's a lot of psychology and evolutionary history involved in why and how we do dumb things with money.
In fact, there are now entire fields -- neuroeconomics and behavioral economics -- dedicated to how and why we behave certain ways with money. The good news is that researchers in these fields have pinpointed ways we can actually outsmart our brains when it comes to money. We simply need to understand the most typical financial/psychological traps, then shift the way we make certain investing and purchasing decisions.
1. The lure of 'free'
No matter how smart you are, that one little word can lure you to make purchases you wouldn't have otherwise. In fact, it happened to Dan Ariely, the James B. Duke Professor of Behavioral Economics at Duke University and author of "Predictably Irrational: The Hidden Forces That Shape Our Decisions." Ariely confesses that he uses his own mistakes to inspire his research.
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Not long ago, Ariely says, he passed up buying a much-needed minivan in favor of a sporty Audi. Why? There were a few other factors, but a big influence was that the Audi came with free oil changes for the next three years. "In fact, those services were only worth about $200, but the promise of 'free' anything was very appealing," he says. "They could have offered me a $2,000 discount on the minivan and I still would have bought the wrong car (the Audi) because the free-oil-change offer was so tempting in the heat of the moment."
According to Ariely, that simple word "free" also explains why consumers will choose a "free" credit card (no annual fee) with an annual interest rate of 15 percent over a card with a $100 annual charge but a lower interest rate of 12 percent.
How to outsmart your brain: "Whenever you see the term 'free,' consider it a warning to slow down and consider your choice very carefully," says Ariely. Do the math and always consider what you are giving up when you choose the item attached to something "free." Usually -- but not always -- there is a real cost to something touted as "free."
2. The 'anchor-price' persuasion
Have you ever lusted after an expensive piece of jewelry, only to discover later a comparable item that was much cheaper? You were probably thrilled by your "bargain" find -- even if the cheaper jewelry still cost several thousand bucks, and was possibly out of your price range.
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