Have you ever done something and then afterwards scratched your head and thought, “what on earth was I thinking!?”  Welcome to the world of being human.  We are not rational and despite our best intentions, there are going to be times when we do odd things.

So, what influences our decisions?  Well, there is a wealth of research into ‘Why We do Dumb Stuff’ – technically called Behavioural Economics.  As Dan Ariely (Prof of Psychology and Behavioral Economics at Duke University) says, “we’re Predictably Irrational!

In this series of four blogs, we are going to look at a few of the concepts from the field of ‘Why we do Dumb Stuff’ and then relate it back to your everyday finances.

What we’ll look at today is RELATIVITY.

We don’t know what we want until we see it in context.  For example, you don’t know what size TV screen you want until you compare them.

Where relativity trips us up is when we try comparing things that are dis-similar.  For example, your real estate agent has three properties to show you all in a similar price range.  Two of them are similar brick houses, although one needs a new kitchen.  The third is a new modern concrete and glass home.

The chances are you’ll eliminate the modern new home as you don’t have anything to compare it to (in the selection).  And you won’t choose the home that needs a new kitchen, you will choose the other brick house that needs no work.  Why?  The house that needed a new kitchen is the decoy (remember this little ‘decoy’ trick, it is used in many of other situations).

Relativity helps us make decisions but it can also make us miserable.  We can’t help comparing ourselves with others and feeling envious of those we perceive are doing ‘better’ than us.

So, how do we manage Relativity?  Being aware of it is a good starting point.  Once we are aware we can make choices that move us away from comparing.

What happens when that word FREE is added to the equation?

Free or zero is an emotional hot button.  There is no doubt that when you get something for free, it feels good.

we are not rational

But here’s the kicker… there is always a downside to FREE.  We can find ourselves making bad decisions because we have been swayed by the attraction of the Free option.  How many times have you bought something you didn’t want because you got swayed by the FREE offer?

So why do we go for the Free option?  Because we hate to lose money.

In fact, we hate to lose money much more than winning money!  So, if something is FREE, there is (seemingly!) nothing to lose.

The concept of Free applies to our time as well as our money.  How often long have you waited in line for the free sample, or have stood for ages at a free open day at a museum or event?

Before you leap in and take up the FREE offer, look hard at the option.  What was the Need you were wanting to fulfil?  And will the Free option meet that need?

Social and Market Norms

Imagine this scenario.  You are at a dinner party, the food is delicious, the wine is a perfect match, the conversation flows and people have complemented you on your dress.  It’s a perfect evening.  At the end of the evening, you thank your host for the superb time and ask how much you owe for all their hard work?  Will $100 cover it?

Now, in real life you’d never do that!  But if you did, what has happened here?  Besides having brain fade, what you have done is breached a SOCIAL NORM.  These are the friendly requests we make to each other like, “can you feed my cat while I am away?” or “could you pick up the kids after school?”

These are usually warm and fuzzy and make us feel part of a community, it gives both parties pleasure and you know the favour will be reciprocated.

There are also MARKET NORMS.  These are very black and white.  This is all about paying and getting what you pay for.  The two norms run very nicely side by side.  However, when you mix the two, as our dinner guest did, the balance gets upset.

Here is an example.  A group of lawyers were asked if they would drop their fees to $50 per hour to help elderly retirees.  The lawyers said no.  Another group of lawyers were asked if they would help the same group of retirees for free and they overwhelmingly said yes.

As soon as money is mentioned you shift from a SOCIAL to a MARKET NORM and Comparison and Relativity kicks in.  The lawyers in the first group applied Market Norms and found the offer too low.  The second group used Social Norms and were happy to volunteer.  Once we start thinking about market norms, the social ones disappear.

Here’s a dating tip.  When you’re out at a romantic dinner, don’t mention the menu prices (even though they can see them)!  This will shift your relationship from the Social to the Market Norm and the evening may not end up the way you had planned…

These three examples of how we are not RATIONAL are just the tip of the ice berg but they do give us a very good starting point to understanding our own behaviours and why we do what we do with not just our finances but our lives as well.

We’ve produced a video series on ‘Why we do Dumb Stuff’, check it out.

If you would like to know more about why you’re ‘doing dumb stuff’ or you just want to chat about how you can do better with what you’ve got, give us a call or drop us an email.