Most personal finance literature focuses on the numbers. How much you need to save, where to find the best deals, which investments earn the highest return, why you should pay off your high interest debt first. But there’s a growing body of work exploring our financial behaviour and why certain decisions about money are made with our emotions rather than our heads.

At the forefront of that research is Duke University professor Dan Ariely, best-selling author of Predictably Irrational: The Hidden Forces That Shape Our Decisions.

Dollars and Sense: Book Review

Dan has teamed up with comedian Jeff Kreisler to write a new book about money called Dollars and Sense: How We Misthink Money and How to Spend Smarter. It’s a fascinating take on how we think about money, what makes us happy (or miserable) when we spend it, and how we can change our decision-making for the better.

Part one explains some of the psychological mistakes we make with money and how businesses such as casinos have perfected the art of separating us from our money. You’ll learn about mental accounting, or how we feel differently about two types of spending; the price of free, where free items like parking or drinks cost us in other unexpected ways; and relativity, where we can drive out of our way to save a few pennies per litre on gas, but won’t go across town to save $20 on a winter jacket.

Part two looks at how we assess value in ways that have little to do with value. The authors share the story of when, in 2012, new JCPenney CEO Ron Johnson scrapped the retailer’s traditional, yet slightly deceptive practice of marking products up and then marking them back down as a bargain deal. In the name of transparency, JCPenney would now offer fair and square pricing with no coupons, sales, or bargaining.

Customers revolted. They preferred the old way with sales and discounts. It made them feel like they were getting a more value with a perceived deal, even though prices were relatively the same either way. Within a year, JCPenney lost $985 million and Johnson was out of a job.

Then there’s the example at a car dealership when we get offered add-ons such as rust-proofing, fabric protection, DVD players, or, ahem, even sunroofs.

“Car dealers – perhaps the most devious group of amateur psychologists this side of mattress salesmen – know that when we’re spending $25,000, additional purchases, like a $200 CD changer, seem cheap, even inconsequential. Would we ever buy a $200 CD changer? Does anyone even listen to CDs anymore? No and no. But at just 0.8 percent of the total purchase price, we hardly shrug.”

The Pain of Paying

The most interesting psychological concept, to me, was the pain of paying, which Dan and Jeff explore throughout Dollars and Sense.

Studies show that we’re willing to spend more when we pay by credit card instead of cash. If you don’t think that’s true, the next time you go out to a restaurant leave your credit cards at home and just bring cash.

The pain of paying is the idea that we experience some version of mental pain when we pay for things. It’s the result of two distinct factors:

1. The gap between the time when our money leaves our wallet and the time we consume the good for which we’ve paid.
2. The attention we give to the payment itself.

The formula is: Pain of paying = Time + Attention.

We can avoid the pain by increasing the amount of time between payment and consumption. That’s why saving up and paying for a vacation in advance can make a trip more enjoyable then if you pay as you go, or worse, are faced with a hefty credit card bill at the end of your holiday.

Here’s Dan Ariely speaking with CBC’s On The Money host Peter Armstrong about why we spend so much:

So How Should We Think About Money?

In Dollars and Sense, Dan says we can’t simply ‘fix’ our brains and automatically make better financial choices every time. Our primitive lizard brain is hard-wired to make irrational decisions. That’s why the first 200 pages of this book focus on all the head-scratching money moves we make – and why we make them – while only the last 40 pages deal with how to avoid those bad decisions and make better spending choices in the future.

The point of the book isn’t to make you question every financial decision, always, in every way possible. That would be psychologically overwhelming. Pick your spots and question those things that are most likely to cause long-term financial harm.

“There’s a reason why we’ve decided to show you why we make foolish money decisions, rather than telling you what to do in any situation. For one, we just don’t know what is the right thing to do in every situation. No one knows. But we also don’t want to give you fish; we want to show you how you’ve been fishing so you may approach future fishing in a better way, if you so choose.”

Some ways we can stop and think differently about the way we approach money is to:

• Recognize opportunity costs – Consider what we’re sacrificing for what we’re getting
• Remember everything is relative – Buying a $60 shirt marked down from $100 isn’t “saving $40”; it is “spending $60.”
• Don’t compartmentalize – Pause, think, and remind yourself that money is fungible. Every dollar is the same. Your money.
• Feel “some” pain when you spend – It won’t be long before blinking in a certain way will be a payment option. Don’t sign up for that.
• Don’t trust your gut – Stop and question your long-term habits, whether that latte is worth $4 to you, or if a cable bundle is worth $140 per month.
• Don’t overvalue what you own or what you might lose – Sunk costs cannot be recovered. If an amount is spent, it’s spent. When making financial decisions, consider only where you are now and where you will be in the future.

In general, though, when you don’t have any specific idea of an item’s value, do some research. Go online, investigate, ask around. Not for every day decisions like the price of chewing gum, but you should probably dig around for a few hours before going to a car dealership.

Final Thoughts

Dan Ariely is a behavioural economist who has done some incredible research about the human mind and how we make decisions. He doesn’t offer finger-wagging rules for us to follow, or chastise our bad choices. Instead he shows us why we make irrational decisions and how, with a little more thought, we can overcome our own emotions and the psychological tricks others use to separate us from our money.

In his latest book, Dollars and Sense, Dan trades on-and-off with financial comedian (is that really a thing?) Jeff Kreisler to deliver quite possibly the most entertaining and insightful personal finance book I’ve ever read.

Dollars and Sense is financial literacy at its finest. It aims to educate readers to be aware of their own cognitive limitations, design personal systems to correct themselves, and take control of their financial decisions. If you don’t learn something about yourself and how even the most sophisticated consumer can fall victim to his or her own mental mistakes, then congratulations – you’re a robot!

Time for a Giveaway!

The book publisher, HarperCollins, was kind enough to send us a copy of Dollars and Sense to give away on the blog. To enter, simply leave a comment below and tell us about one of your own irrational spending habits.

Do you carry credit card debt, yet also have money set aside in a savings account? Do you spend $7 on a greeting card at a grocery store when you could get one for $1 at the Dollar Store? Do you drive all over town to save a few bucks on groceries or gas, yet fail to put the same effort into negotiating your car loan or mortgage?

We’ll pick one entry and announce the winner in the next edition of weekend reading. Good luck!