What role does money play in our lives and how does it affect us? And why is so much going wrong in everyday life around the money? Why do we buy the wrong thing so often and why do we often overpay?. In this article, I will talk about the common mistakes of money spending and psychological reasons for overspending.
I will use practical examples to show which mistakes we make as consumers over and over again and why this happens. A consideration of the different types of money should help to get our financial mistakes on the loose.
Why Money Determines Our Lives
Why does money take such a special place in our heads? Money is something so new in the history of human development that we can not automatically handle it properly, but first have to laboriously learn how to deal with it.
When you give a hammer to a small child, it quickly knows how to touch it and what to do with it: hit it somewhere. But this child could not handle money yet. We encounter money everywhere and in different forms.
From an economic point of view, money is nothing special. It is a means of payment, more precisely an intermediary, which allows us to provide or acquire goods and services without the need for direct bartering. Buying money is much easier than trading goods and getting to the actual destination after many stops.
An exchange-oriented economy based on needs or desires would not work today. Our society is too complex with its division of labor. The money should not necessarily consist of notes and coins. And in cashless payments, it exists anyway only as a number sequence in the computer.
Even payback collection points, webmails or other value symbols that we have agreed upon are a kind of money.
Money is also an arithmetic unit and a generally binding standard of value. However, it has a nominal and a real value, which we often do not consider. Economically, money is also a kind of storage. We can save money and create a supply of purchasing power. All we have to do is be careful that inflation does not eat up purchasing power.
Read Also, How to build your savings fast
Money is better than sex
Money is better than sex, brain researcher Brian Knutson has already stated. He showed his subjects in functional magnetic resonance pictures of sex scenes and dollar bills, observing the activities of the reward system. The strongest reactions were seen when the subjects saw the cash.
When it comes to money, mind is gone
When it comes to money, it is not the brain regions responsible for rational thinking that take the lead, but the old archaic realm responsible for emotions and instinctual gratification.
In a Neuroeconomics Laboratory of Bonn University professor Armin Falk was able to prove that a higher nominal value activates the reward system more and gives the brain more satisfaction, even if the real purchasing power does not change.
People were offered a certain amount of money to meet their weekly needs. They should decide whether they wanted this amount or twice as high, but then all prices would double if they chose a high amount. That is, the real purchasing power remained absolutely the same.
Nevertheless, the majority of people chose a higher nominal amount, which obviously produced a better feeling and satisfaction.
The brain succumbs to the illusion of money
Our reward system just cannot handle money. It estimates the nominal value higher than the real one, so it succumbs to the illusion of money. Economics generally talks about money illusion when inflation is not perceived. That is, when people assume their money has the same value over time.
This effect is particularly common in financial products. When the customer takes out a life insurance policy, his brain is happy about the high sum insured and he does not consider what purchasing power that amount will have in 30 years.
It is the same with all other investment products, whether short-term or for old-age provision. Even real estate owners succumb to the illusion of money, if they assume that the value of their property will rise steadily.
Not only when investing the money illusion comes to fruition, but also when borrowing. Who really knows about the difference between the effective and the nominal interest rate?
The nominal interest rate is calculated on the basis of the nominal loan amount and indicates the interest cost alone. In contrast, the effective interest rate also includes the ancillary costs of the loan, ie the loan fees and the processing fees, as well as the nature and timing of the repayment, grace-free start-up years and the amount of the disbursement amount. If you want to compare different loan offers, you have to look at the respective effective interest rate.
Our reward system does not know the difference between the nominal interest rate and the effective interest rate.
In addition, the reward system is not made to calculate specifically, but rather to make more or less fuzzy estimates. Prices are therefore felt and not counted.
Money does affect the people
Many of our choices and behaviors are unconsciously influenced by previous thought processes or perceptions that have nothing to do with the actual topic. This so-called priming can be deliberately used to guide people in their buying behavior.
Mostly it’s numbers that make us happy, but it’s also possible to do something different.
In addition to this active priming, there is also passive priming due to special circumstances, such as the weather and various coincidences. So bad weather, a missed bus or a spot of breakfast coffee on the white blouse can affect our decisions and behavior all day long.
In exploring how people can be influenced, one has also studied the effect of money on behavior. The main finding was that money signals promote selfish and egocentric behavior. Students who had looked for a while at a picture with coins of different currencies needed up to 70 percent longer in the subsequent experiment to ask for help in solving a complicated problem, and spent half as much time helping others, if they asked for help.
Buying the wrong: future expectations determine the present
Why do we always have the experience of having bought the wrong one? It does not always have to be toys for 5000 euros. Often a cold pizza for three euros is enough to be disappointed with taste and appearance.
The main reason is that one of the essential functions of the brain is to make predictions about what will happen and what we will experience and feel. Without this ability, we would not even be able to decide whether to drink a cup of coffee or a cup of tea. All of these predictions, like most decisions, are completely unconscious.
Psychological Reasons For Overspending
How money disappears by itself hidden price increases?. I did not buy anything unusual, but my money is gone again. Why is that? “Surely you have heard such and similar sentences from friends or relatives. Maybe you have just made this experience after a normal shopping.
The psychological reasons for this overspending because the hidden price increases, which we do not even notice. For their problem-free enforcement, the economy applies the laws of psychophysics.
The term “psychophysics” does not sound old-fashioned. In the middle of the 19th century, the first psychologists began to explore the interrelations between the measurable physical stimuli and the subjective experience of a human being. When a stimulus is actually perceived and when are two stimuli perceived as different?
To translate these questions into practice, please imagine that you hold a coffee pod in your hand. How many grams does the coffee contain weigh? Let’s say: seven grams. And now you take a coffee pod of the same brand from a newer pack. Feel a difference? In the new pad are only 6.5 grams of coffee.
Since the price has remained the same, the pad with the 0.5 grams smaller filling but 7.7 percent more expensive. You probably can not feel the weight difference, and you can not taste it either.
For the manufacturer and the trade but calculated well, solely by the mass of the sold pads. This is not a fictitious example, but one finds it in the information of the consumer center.
For many decades, the findings of psychophysics were considered as the basic wisdom of perceptual psychology, but seemed to have no practical value. Until the economy rediscovered them and began to use them in order to be able to carry out price increases as unnoticed as possible.
The brain loves quick rewards
The reward system loves quick rewards, even if they are small, while the decision making system likes big rewards, even if they happen later. In the brain, therefore, a temporal preference and a size preference are anchored, which repeatedly compete against each other. This fact has been demonstrated in a wide variety of experiments and in a variety of situations.
Whether students offered a free meal today or two free meals in a week, or whether they wanted to either put money into retirement or prefer to go on vacation, people always chose the situation should consider only abstractly and theoretically, for the long-term variant with the greater benefit.
However, when placed in the concrete decision-making situation, rapid gratification was predominantly preferred.
In one experiment, the subjects could choose between a small and immediate reward and a later higher reward.
Almost all opted for the $ 5 voucher, which could be redeemed immediately, and not for the $ 40 voucher, which was valid after six weeks.
Why we pay more with small bills than with big
When we pay small sums with small bills, we have the subjective impression of spending less money than if we pay with a large bill and then receive change back.
If you pay with small change or small bills, you spend your money more easily. This has been confirmed in experiments.
The behavioral economists speak of the denomination effect (nominal value effect). They recommend department stores or stores in shopping centers to give their customers as much as possible change. Because this would be spent more quickly at another cash register or in another store.
If someone pays a price of 24.90 euros with a 50-euro note, you should not give him back a 20-euro note, a 5-euro note, and ten cents, but better four 5-euro notes, five individual euro pieces, and ten cents.
Of course, it is even better if the customer pays by debit card or credit card. Then he feels the payment pain even less.
Conversely, it means to the customer that he should buy the largest possible bills for shopping, because then he automatically thinks more about whether he wants to split with his big bills, and less buys.