Psychology of Money

This Is Your Brain On Money – Part Two

My previous post about your brain on money covered various scientific experiments. Here are some of the findings reported:

  • Making money activates the same parts of the brain as cocaine.
  • Counting cash relieves pain.
  • Higher levels of testosterone cause worse financial decisions.
  • Most of us will pay to punish strangers who we deem unfair.
  • Money makes people meaner, more dangerous, and less ethical.
  • Credit cards cause some people to spend more.

Okay, that last one seems like common sense — no research required, right? On the other hand, you might be surprised by what science has discovered about the “money illusion” and the odd influence of prices ending in the number “9.”

You’ll read about those findings below, as we continue our look at your brain on money, starting with…

The Inescapable Drag of an Anchor

I saw a good pair of running shoes on sale for $120 the other day.

Okay, now that I’ve thrown a number out there, I’ve influenced your thinking.

If I showed you a pair of shoes and asked you to estimate their value, your estimate would probably be higher than if I had written, “I saw a good pair of running shoes on sale for $60 the other day.”

In the field of behavioral economics that’s called an “anchor.” Researcher Adam Galinsky explains, “Even when people know that a particular anchor should not influence their judgments, they are often incapable of resisting its influence.

As a result, they insufficiently adjust their valuations away from the anchor.”

Consider an experiment in which mechanics were asked to estimate car values…

Actors, pretending to be customers, first mentioned a possible price to a mechanic. That was the anchor. Then they asked the mechanic what the car was worth.

When a high anchor value had been suggested, the estimates averaged about $700 higher than when a lower anchor was used.

Yes, a mere mention of a price affected the thought process of the mechanics.

And it’s really tough to escape this anchoring effect.

For example, in another study real estate agents were asked to estimate the value of a home, after being given various asking prices. Galinsky reports that, “All of the agents’ estimates were influenced by the list price, yet they denied factoring the list price into their decisions, instead citing features of the property that would justify their estimates.”

Now you understand the power of those silly tags in discount stores that tell you a “comparable price.” Even though you know the suggested value is unrealistically high, and know it’s meant to influence you, it probably still does the job.

Behold the Power of the Money Illusion

We tend to focus more on the nominal value of money, and less on what it can actually buy, even though, objectively, the latter is what matters.

Economists call this the “money illusion.” The Independent reports that, thanks to fMRI machines, we can now measure this effect in the brain.

In an experiment using fMRI brain scans, subjects were paid a “salary” for completing tasks on a computer, but had to spend their “earnings,” on items in a specific catalog they were shown. Some subjects were given 50% higher salaries, but also given a catalog with prices that were 50% higher.

In other words, both groups had the exact same spending power.

But the participants’ brains didn’t seem to get that. The fMRI scans showed that the “reward centers” of the brains of those who received more money were much more active.

This was despite the fact that couldn’t actually buy more than the other lower-pay participants.

Because of this effect researchers speculate that workers may be happier getting higher pay raises during inflationary times, even if their spending power declines in real terms versus times when prices are going up more slowly, but raises are smaller.

So someday, when we’re all millionaires, we might feel better about our earnings, even while we complain about bread that cost $300 per loaf.

Who Needs Love When You Have Money?

A research article titled, “The Symbolic Power of Money” suggests that money can take the place of social acceptance and reduce the psychological pain of social discomfort.

The effect was seen in simple experiments where participants counted money.

And maybe counting cash can do more than just relieve the pain of general social discomfort. Lead researcher Xinyue Zhou, of Sun Yat-Sen University in China, says, “We think money works as a substitute for another pain buffer — love.”

Lift Money, Not Weights

That same research article reports on experiments in which volunteers stuck their hands in very hot water. Those who had previously counted money felt less pain, and also reported that they felt stronger.

Apparently handling money can make you feel better psychologically and physically. And the effect works the other way around as well.

Specifically, the article reports that, “Interpersonal rejection and physical pain caused desire for money to increase.”

Look High or Low

A research article titled, “Brand Placement and Consumer Choice: An In-Store Experiment,” looks at where to put bags of potato chips (or anything else) to generate the most sales.

The conclusion: “Placement of potato chips on the middle shelf was associated with the highest percentage of purchases.”

It’s not a surprising finding, but it’s worth considering how easily such knowledge can be used to separate you from your money.

Grocery stores can simply put items that are more expensive (or those with the highest profit margins) on middle shelves.

I’ve covered sneaky tactics like that in a previous article on subliminal sales tricks.

Predictable Financial Biases

In their entry about Daniel Kahneman the Concise Encyclopedia of Economics explains how Kahneman and Amos Tversky demonstrated that people are biased in predictable ways.

Specifically, they showed that people misestimate probabilities consistently in the same ways.

If we simply made random errors we would sometimes overestimate the probability of an event and sometimes underestimate the probability. But that’s not what we do.

For example, suppose a mutual fund outperforms the stock market averages three years in a row.

Most investors then assume the managers are better than average, even though the time frame is too short to be statistically significant (just imagine a room full of people, each flipping a coin three times; several will get three heads in a row with no special skills).

This bias is called the the “law of small numbers” by Kahneman and Tversky. It’s the fallacious relative of the probability theorem known as “the law of large numbers.” You can forgo the math is you remember this simple takeaway: don’t make predictions from small samples.

The Amazing Number Nine

It’s time to take a look at your brain on the number “9.” Why do so many prices end with that digit, and does it really affect us that much?

My first reaction — and probably yours — when seeing a price like $29.99, is to think “Oh, it’s $30.” With that natural tendency to round up prices it seems unlikely that there would be any advantage from pricing things to end with “9.”

But consider the findings in the research paper titled, “Effects of $9 Price Endings on Retail Sales.” Several experiments are reviewed, all pointing to the power of that number.

For example, in one experiment researchers picked four dresses from a catalog, priced at $39, $49, $59, and $79.

For each of the four they raised the price by $5 in some catalogs and lowered the price by $5 in other catalogs. As a control group some catalogs kept the original prices.

The sales came in, and dresses with the original pricing (ending in $9), sold more than those with the price raised by $5 (which now ended in $4). That makes sense. Why would a dress sell better at $54 than $49, right?

However, in three of the four cases the dresses with the original pricing (ending in $9) sold better than those which had the price dropped by $5 (and in the case of the fourth dress, the sales were about the same).

For example, the dress originally priced at $79 had 60% more sales at that price than in the catalogs where it was priced at $74.

The authors of the paper say the experiments they reviewed provide “conclusive evidence that $9 price endings can increase demand.”

Despite the clear measurement of the effect, there is no good explanation it. We don’t know why we are affected by this “magic number.”

The authors did note that those $9 price endings were not as effective when retailers used the word “sale” or similar verbiage. Perhaps that reminds us that we’re being influenced, and so causes us to more carefully consider the value.

Maybe, if we stop for a moment before buying anything, and consider possible subconscious influences, we can break the spell of “9” and other subliminal tricks.

Money Causes and Possibly Relieves Stress

CNBC recently reported on surveys showing that “money is the leading cause of stress among Americans.” This is especially true among younger adults, those with children, and those who are poorer.

Whether or not money can also reduce stress depends on how you use it. Making more may not be the key, unless you are poor to begin with.

But one study found that spending money to save time reduces stress. In other words, if your stress is in part from a life that is too busy, it might make sense to pay someone to do your yard work, or to buy takeout instead of cooking your dinner.

In other words, when your life gets to busy and stressful, relax and let your money do some of the work for you.

Save or Make Money by Watching Your Brain at Work

Now that you’ve read about some of the research, start watching your own brain. See if you are falling for subliminal sale’s tricks, or if your investing decisions are being affected by irrational biases. Catching your subconscious reactions and correcting for them might make or save you a lot of money.

If you have your own stories about your brain on money, please share them with us below … and keep on frugaling!

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