We suck at buying things, we’re literally wired this way. According to psychological science, there are 2 common things about human nature:
- We don’t always act in our best interests
- We’re easily manipulated
We may not even realize it, but these 2 small little character traits affects the decisions we make everyday. Even if we’re good with our finances, we can still make mistakes, it just who we are.
Dan Gilbert, author of “Stumbling on Happiness” took a look at these character traits and applied it to the way we spend money and some of his findings were spot on.
To simplify things, Gilbert uses the example of wine shopping. You’re at the LCBO and you have 3 options for wine; $8, $27, and $33? Which one do you choose? The majority of us will choose the $27 bottle since we don’t want the most expensive one, nor do we want the cheapest.
Retailers are well aware of how we think; they strategically place items on the shelf to force our hands. Let’s replace that $27 bottle of wine with a $100 bottle. Our choices are now $8, $33, and $100; all of a sudden that $33 seems like a deal, but in the earlier situation most of us wouldn’t have even considered it.
I learned a long time ago that more expensive doesn’t mean better, but in these situation, I for sure would fall into the majority. Who knew that buying things was such a mind bender.
This same psychology applies to travel deals. Let’s say there’s are 2 similar package deals to the Bahamas, one is on sale for $700, while the other is $1,200. Both sound great so after a few days of research you’re ready to book the $700 package, here’s the thing it’s now sold out, but the $1,200 deal is still available, do you take it? Most people won’t since we’re comparing past prices to the prices of today, as a result we lost out on some great deals, but that’s the psychology doing it’s thing.
This exact scenario happened to me when I was booking my accommodations for Japan. I found a decent price on a hotel but decided to wait a few days, when I was ready to book the price had gone up $50. I was pretty annoyed so I explored my other options and decided to book via Airbnb. I made an emotional decision based on a past price which was an emotional mistake.
When it comes to investing, we’re no different, for most of us it actually resembles the herd mentality. The herd mentality or mob mentality is when people follow certain trends. Take a look how the stock markets are doing and it’s not hard to see why many of us are a bunch of sheep.
When markets are doing well, everyone is buying in, trying to get in on the action. But when markets start to decline, the average person will start to sell off their investments due to fear. That makes us emotional investors since we’re buying high and selling low.
Long term investors know to do the exact opposite. They buy low and sell high. As long as it fits with their overall financial plan / asset allocation, there’s no need to make any emotional decisions.
As an index investor, I have no emotional attachment to the decision I make, yet I can totally become manipulated when it comes to buying things on a daily basis. Sure I have budgets in place that keep me in check, but in hindsight I haven’t always made money decisions in my best interest. I need to pick up Gilbert’s book and find out what else I’ve been doing wrong all this time.
Image courtesy: Jing / Flickr