Money is a tricky topic. Some people make good financial decisions and others, well, sometimes not so good. Regardless, they still have something in common - they don't want to talk about it.
This probably has to due with the fact that human behavior and consumer psychology are so closely linked and studies have shown that we're aren't completely rational when making money decisions (or justifying them).
Would you consider yourself a rational or irrational decision maker? Let's find out!
Michael Shermer, a columnist for Scientific American and the author of "The Mind of the Market: Compassionate Apes, Competitive Humans, and Lessons from Evolutionary Economics" detailed how humans make illogical financial decisions because emotions get in the way. Our behavior can be blamed on evolutionary traits from primates.
According to Shermer, there are three questions used by scientists to measure your rationality with respect to money. Let's take a closer look at them.
Question 1: How much money would you rather make?
a. $50,000 a year while other people earn $25,000
b. $100,000 a year while other people earn $250,000
If you chose 'a', $50,000, you are not alone.
In fact, most people choose this option because it makes them feel like they're "doing better" than others. As good as that sounds, it's not quite logical.
Would you say you let your emotions get in the way of answering the question? I don't blame you! What about earning $100,000 vs $50,000 even if others make more than you? It's twice as much money!
Question 2: Will you accept my proposal?
Let's say your neighbor, Lucy, gives me $100 to split between you and me.
Lucy tells me it's my decision how to split the money up.
The catch: If you accept the division of money I propose, we both get to keep our share.
If you reject my proposal, Lucy will take the money back and we both walk away with nothing.
My proposal: I propose splitting it 90/10 - I keep $90 and you get $10.
Would you accept or reject my proposal?
I guess the question is, is $10 enough?
If you accepted my proposal, you are the minority.
If you rejected my proposal, you chose what most other people choose. This doesn't make rational sense.
Consider this: if you had accepted my proposal, you would've received $10 for free! Not bad, right?
However, if you rejected my proposal, you get nothing. Thinking logically, wouldn't you rather pocket the $10?
According to scientists, most people don't accept any proposal that's less than $30 of the $100 up for grabs.
Researchers say it's because humans have "reciprocal altruism" which demands fairness from our negotiating partners. Most people think the 90/10 split is unfair and are likely to reject it no matter what! That's pretty illogical.
Question 3: Who would you rather be?
Adam (A) is waiting in line for the movies. He gets to the ticket booth and the cashier exclaims, "Congratulations! You are our 100,000th customer. You've just won $100!"
Ben (B) is waiting in line at a different theater. The man in front of him just won $1,000 for being the one-millionth customer of the theater.
Ben gets to the ticket booth and the cashier says, "Congrats! You win a consolation prize of $150."
Who would you rather be, Adam (A) or Ben (B) in this instance?
Ironically, most people would rather be Adam (A) in this situation.
They'd rather forgo $50 in order to alleviate the feeling of regret that occurs with not winning the $1,000.
According to Schermer, this is a trait that humans inherent from primates. We are essentially willing to pay $50 for regret therapy or "loss aversion."
Consider loss aversion when it comes to investments. Studies have shown that before humans risk an investment, we need to feel assured that the potential gain is 2X what the possible loss might be.
Not because the potential gain might be larger, but because we usually think a loss feels 2X as bad as any gain feels.
Strange but true!
This research tells us a lot about one of the biggest myths in consumer psychology and economics, known as "Homo economicus."
The theory says that an "economic man" is rational, self-maximizing, and efficient in making choices.
But we know that humans make irrational choices in other aspects of life - romance, relationships, time, diets.
So why should money choices like investing or shopping be any different?
The important thing to remember when it comes to money is to analyze your emotions and feelings before making a big financial decision.