Buzz
Money can be a difficult and abstract concept, made even more complex by the constant influx of financial products like mortgages, credit cards, and student loans. So how can you make the most of your finances?
The truth is, you probably can't. At least not all the time, as explained in Dollars and Sense: How We Misthink Money and How to Spend Smarter, a book by Dan Ariely and Jeff Kreisler.
“Spending a lot of time thinking about money might seem useful if it led to better financial decisions. But that’s not what happens,” the book states. “In reality, making poor financial choices is part of being human. We’re really good at messing up our financial lives.”
So, how do you improve your money habits, even slightly? One step is acknowledging our flaws and understanding the irrational ways we behave.
Relativity
Ariely and Kreisler explain that relativity is “one of the most potent forces that cause us to assess value in ways that are often disconnected from its true worth.” For instance, you might feel more compelled to purchase a $40 shirt if its original price is marked at $60, even though the shirt costs the same as one that’s always priced at $40. In our minds, the first shirt seems like a better deal because it’s been discounted, even though that’s not accurate. The pre-sale price is no longer relevant, so why consider the $60 at all?
The authors note that purchasing “bargains,” like the $40 discounted shirt, gives us a sense of accomplishment and makes decisions simpler. However, rather than focusing on the amount we think we're saving—$60 in this case—we should focus on the actual amount we’re still spending.
A similar example is when you’re upsold at a car dealership. If you’re already spending tens of thousands on a new car, adding $2,000 for leather seats might not seem like a big deal. Compared to the car’s total price, that extra cost feels small (especially when financing is involved).
This is because we often focus on the percentage of the total spending rather than the exact amount. This explains why you might spend an extra $2,000 on leather seats but hesitate to spend $4 on a cup of coffee during your commute. Relative to zero, that $4 feels much more significant.
Mental Accounting
Mental accounting refers to how we organize our spending into mental categories. Although all dollars are theoretically the same, we often perceive them differently based on the category we've placed them in or the emotional response they trigger.
For instance, you might have set up strict spending categories with monthly limits: $250 for loan payments, $200 for groceries, $100 for vacations, $100 for entertainment, and $50 for utilities, similar to the envelope system. When the money in one category runs out, you stop spending, even though you could easily shift funds from another category. After all, it’s all your money.
This approach isn’t inherently bad; in fact, it can serve as a useful mental shortcut. According to the authors, it allows us to avoid considering every potential trade-off every time we make a purchase. For example, instead of seeing your avocado toast as money you could have saved for a future mortgage, you view it as money you won’t spend on other meals that week. While not a rational approach, it helps prevent mental overload.
However, we don’t always stick to these boundaries. We often engage in malleable mental accounting to justify our spending and avoid feeling guilty. We bend our own rules with flimsy excuses. For example, even though we know eating out isn’t part of the plan, we might allow ourselves “just this once” because we feel we’ve earned it after a tough week, and that $60 dinner might come from the “entertainment” fund instead of the “food” fund.
Then there’s how we emotionally perceive money from different sources, a concept known as emotional accounting. For instance, we might allocate our paycheck to “necessary” expenses like rent and groceries, while spending Christmas money from Mom on “fun” purchases like a new TV. This pattern holds for work bonuses or tax refunds as well—these feel like “bonus” funds that we don’t have to treat with the same level of responsibility.
Anchoring
Anchoring happens, the authors explain, when we allow irrelevant information to influence our decision-making, using that unrelated starting point as a reference for future decisions.
For example, you might not have any idea of a car’s value until you see the Manufacturer’s Suggested Retail Price (MSRP). That provides an anchor, even though it may not reflect the true value of the car.
A key reason anchoring occurs is because we tend to trust our own judgment—our sense of value—far more than we should. We base both current and future financial choices on previous ones. As the authors note, “We trust that we’ve made a specific value decision repeatedly, and we assume it was the right one.”
After spending $4 on a latte and $50 for an oil change, we’re more inclined to repeat those choices in the future because we’ve made those decisions before, we remember them, and we naturally favor our own decisions—even if it means spending more than necessary. This happens even when a place offers free coffee while we wait for a $25 oil change.
Another instance of anchoring that can impact your financial decisions is salary negotiations. In these situations, the first number stated carries a lot of weight. There are many articles advising you not to give the first figure to avoid undervaluing yourself (especially for women), or suggesting you offer an inflated figure first to take control of the conversation before your potential employer does.
However, anchoring isn’t as strong when you have some knowledge of what you’re buying. For example, a real estate expert is less likely to be influenced by the listing price of a house compared to someone who isn’t an expert. On the flip side, we can also trust ourselves less.
What You Can Do About It
Ariely and Kreisler’s book suggests that self-control is a key factor in managing our finances, a concept they admit is easier to talk about than to put into practice.
Managing our personal finances “responsibly” is meant to set up our future selves for success. However, that future self can often feel distant and unfamiliar—making it easier to indulge in the present or delay enrolling in your company’s 401(k) plan.
To help make future you feel more like yourself, you need to make this future person “defined, vivid, and detailed.” One approach is to have conversations with your future self. Another is to set a specific retirement date (if that’s the goal you’re struggling to work toward), such as January 12, 2058, instead of simply saying “in 40 years.” The authors also recommend “meeting” a computerized version of your older self to create empathy.
This may seem a bit unconventional, but they suggest other methods as well. One is automation, provided you have the financial means. Guilt can also be effective (the book references a study by Dilip Soman and Amar Cheema from the Rotman School of Management, which found that people spent less when envelopes of money were labeled with their children’s names, as it triggered feelings of guilt).
Another tactic you could try is reward substitution. Rather than constantly focusing on your future self, consider a small immediate reward you could give yourself after completing necessary tasks. For example,
Some states are doing just that by offering “lotteries” to people who deposit money into savings accounts. Each deposit earns a ticket with a small chance of winning an additional sum of money. These lottery-based savings plans are proving effective.
For you, this could mean rewarding yourself with a movie after making a payment on your credit card debt, or a similar treat.
Clearly, these strategies won’t fix everything—much of our financial situation is influenced not only by our own behaviors but also by a system designed to be complex and difficult to navigate. However, it does offer a valuable lesson in how we can begin training ourselves to make smarter financial decisions.
