Ariely discusses the psychology of money

Chautauqua can’t get enough of behavioral economist Dan Ariely.

Ariely returned to the Amphitheater stage Thursday for his second morning lecture to speak on Week Four’s topic “Irrationality.” He last spoke on Monday, discussing irrational decision-making and how to combat it. Thursday morning, he focused instead on the psychology of money.

“Money is a really interesting domain. We deal with it all the time, and because of that, we think that we actually understand money,” he said. “The reality is that it’s very complex and strange. When we think about it deeply, we realize all the things that we don’t do or think well about money.”

In basic terms, Ariely equated money with opportunity cost, or what he referred to as a “common good.” Opportunity cost is the price of the potential gains from an alternative when a choice is made. But Ariely said people have difficulty thinking in these economic terms, for a variety of reasons.

For example, when a person buying a Toyota was asked about the opportunity cost of buying said car, the answer wasn’t in terms of vacations that may be taken or books that could be bought. The person said the opportunity cost of buying a Toyota was not buying a Honda.

Ariely said people sometimes have a hard time substituting across products and time. Another reason opportunity cost is downplayed is because of the complexity of modern finance. The environment is changing dramatically with digital payment set to only increase in usage in the future.

“If I gave you $40 for a day, the tradeoffs would be quite easy to figure out,” he said. “But what if I gave it to you for the whole week? For the month or year? And added credit cards, student loans, mortgages and retirement accounts? Now it becomes incredibly hard to figure out what is the opportunity cost of any particular spending.”

When financial decisions are immediate and in front of us, they are easier to judge and make, Ariely said.

He pointed out three concepts that obfuscate the reality of money. They are relativity, pain of payment and fairness.

Relativity is the idea that saving $7 on a $15 purchase is somehow better than saving $7 on a $1,500 purchase. To the banks and checking accounts, there is no difference. But because of the comparative relativity, the savings seems less in the second case, and people are less likely to care about it, Ariely said.

This is a trick that car dealers use. After selling a car, they will often add accessories and bills to the receipt because, by relative comparison, the additional cost seems negligible, he explained.

Pain of paying can best be described as the difference between paying with cash and paying with a credit card, according to Ariely. The reason is because cash is concrete and tangible while credit is ethereal; when the actual payment will come is a nebulous future event.

“It’s all about timing,” he said.

While paying cash is more “painful,” it is more helpful to an individual’s bottom line.

Payment pain can actually be turned to economic and social benefit. Cigarettes are consumed less if bought individually or in smaller packs. The same goes for reducing energy consumption.

“One of the elements of money is how much attention we pay to it,” he said. “Imagine if your gas meter was in the middle of your house.”

With the momentum of society moving payments online, Ariely is concerned people will pay less attention to them, citing Apple and Android Pay initiatives. These may enable easier payments, but that is not always to the benefit of the consumer, he said.

The last concept is fairness. Ariely related the story of a locksmith. Early in his career, he would spend hours trying to fix locks for people, sweating over the project. When he would finish, he would often get a thanks and a tip. Years of experience later, fixing locks was of no trouble. But both the thanks and tips have disappeared.

“Why? Because we don’t see the sweat and effort,” Ariely said. “We’re essentially willing to pay more for incompetence.”

Setting a scenario where a person finds a parking spot but doesn’t have a quarter for the meter, Ariely asked the audience how many would pay him a dollar for a quarter to pay the meter. Naturally, no one raised their hands. However, when the scenario changed to include an offer to run to the bank, exchange a dollar for quarters, and return, the exchange suddenly seems more equitable. This is because people see payment as a function of fairness.

He said the two biggest areas where this is an issue is banking and the Internet. People assume ATMs are easy money machines. But Ariely argued that’s because banks do a poor job of showing the amount of effort and expense it takes to maintain them, as with the rest of its services. The same goes for the Internet. Google does not lead us through the steps of each search. The only two industries that make an effort to explain their processes are wine and food.

“When [a company or website] shows what they do for you, appreciation comes in,” he said.

In an experiment conducted with Intel, the computer chip manufacturing company, they tested the company’s policy of rewarding employees with $25 one workday a week if they produced a certain number of chips. They contrasted this procedure with a control group, who got nothing, a second group, who got vouchers for free pizza, and a third group, who got a compliment from their boss via text message.

All conditions improved worker productivity relative to the control group. However, there was no “best” procedure; all three were identical. Interestingly, the reward of $25 was the worst option because it actually decreased productivity by 5 percent the second day before leveling out again, whereas the others had less severe productivity curves.

According to Ariely, what this means is that good will, without a strictly monetary reward, is very important for workers.

“We found money can be a motivator — and it can be a killer,” he said. “Paying people explicitly can reduce goodwill.”

The same problem was found with the No Child Left Behind education law, he said. It sought to monetarily incentivize teachers to improve students’ test scores. However, once a price was put on teachers’ effort, they paradoxically felt devalued because it intruded on the goodwill of their service.

Ariely related another study that was conducted in Kenyan slum. The study was about savings and how to create it for Kenyans who lived hand-to-mouth their entire lives, sometimes under the crushing burden of inescapable debt. He said in the U.S., 40 percent of citizens do not have $2,000 saved away.

“As a society, we prey on the poor because they’re desperate,” he said.

The study had seven groups. The first received a text message reminding them to save. The second received a text message but written from the perspective of their children. Two groups received 10 percent and 20 percent, respectively, if they saved successfully. Another two groups received the save reward, but were “pre-matched” before they saved. Finally, the last group received a coin they could use to track their progress.

Regardless of the control placed on the group, they all improved, Ariely said. However, one group exceeded the rest, doubling their savings. That group was the coin users.

“It’s tangible. It’s visible, and they got to see progress,” he explained. “It reminded them to save every day.”

To close the lecture, Ariely advised the audience to ponder what kind of electronic wallet they desired.

“Do we want to create ones that are effortless and seamless that we don’t pay attention to and there’s no pain of paying, and we don’t think about the future?” he said. “Or do we create different ones that make us think about trade-offs, our loved ones, our savings, our kids’ college, all of those things? It’s an interesting fork in the road, and I hope we are able to take the right way.”

Q&A

Sherra Babcock: Dan, what will Vlad and Connor and Katherine do with their graduate degrees in behavioral economics?

Dan Ariely: So the question is what would Vlad, Katherine, Connor do with their degrees. So the problem is that I don’t want to think about that. It’s really wonderful to have them around, so for now they’re not getting away from us anytime soon. And don’t even think about that.

Q: What’s the — we’ll ask them, later — what’s the difference between irrationality and rationality and intuition. We say “counterintuitive,” but don’t we really mean “counter-rational?”

A: Yeah, actually, before I do this I’ll answer slightly more seriously about what people can do with a degree in behavioral economics. You know, there’s basically two paths for this kind of research: one is the academic path, in which people become professors and teach others, and the other one — which is becoming much more common and popular — is to actually apply it. So behavioral economics, in many ways, is an applied version of social science. We do field experiments, right? Academics don’t always care about field experiments. We care about how to implement things, how to make things work. And it’s an interesting cycle because you do an experiment in the field, and you learn something new about it, and you do more experiments so it’s a very applied approach. There are more governments who are interested in applied stuff, there are more companies who are interested in applied stuff, health care is increasingly more interested. Actually, half of our research center doesn’t do research but actually does kind of free consulting for for-profit institutions. So we work on nutrition, mostly in Africa, we work on financial institution, mostly for the poor in the US. for example, for the last three years, we’re working with a company called “Intuit.” They have a product called TurboTax, and they have a version of TurboTax that is free for people that are below the poverty line, and what we’ve been doing is changing the software to try and convince those people to put some of their tax refund into savings. For poor people in the U.S., the tax refund is the biggest check they get in the year. It’s delayed — they submit it now, but they get it later. It’s a really wonderful opportunity to try and get them to save so we’ve been working on all kinds of applied projects like that.

In terms of intuition — look, intuition and irrationality and rationality don’t have to be different things. It’s an empirical question of whether our intuition is good or not good. And our intuition is kind of a mixed blessing. It’s sometimes good, but often not. The problem is, we have tremendous faith in our intuition. How many of you read Blink? Yeah, so if you remember Blink, Blink starts with all these wonderful things, which our intuition is surprisingly good at. You see somebody for 10 seconds, a thin slice, and you have an idea about who they are. And that idea has some truth to it. Now, the problem I have with Blink is that people read Blink and they get this extra confidence in their intuition and then they come to my class and I have to shake it out of them. Because the reality is that our intuition is correct in a very restrictive set of circumstances. And when I talk to Gladwell at some point, I really complained about that. I said, “You’re just — there’s a whole generation of people who think their intuitions are right. Why are you doing this to us?” And he said when he wrote the book, he wrote it like a detective novel — that when you start, you think the intuitions are the hero, and you hear all the good things. And only later you realize that they are the villain, and actually intuitions are not right, and so on. But you know, I asked you, “How many of you have read the book?” and how many of you have read the last part of the book? That’s a problem. People don’t get to the last part of the book, and by the time they get to the last part, they’re so convinced by the first part that even if they do get there, they don’t get the point. So think about what would you need in the world to develop good intuitions? Think about something like basketball. You stand there, and you shoot hoops and you get immediate feedback. That’s a good place to develop good intuition. That the moment the ball leaves your hands, you kind of feel if it’s going in the right way or the wrong way. But life is often not like that. In life, often it’s as if you’re throwing to the basket, and then it becomes dark and then the basket moves somehow. There’s some randomness in the world, or there’s a big wind that moves your ball without you knowing. And not only that — you don’t get immediate feedback. Maybe you shoot and you hear about what happened to your shot from yesterday or from last week. So if you think about the conditions for developing good intuitions, are the conditions in which we get lots of high quality feedback, what are those cases in life? They’re incredibly rare. Most things in life, we get stochastic, delayed feedback. Can we develop good intuition about that? Incredibly, incredibly difficult. So the tragic thing about intuition is people have this belief about intuition. But it’s often not the right belief.

Q: There are three questions here that are related. I want to read all three because they’re slightly different from each other, but they introduce a topic we haven’t discussed. It’s about government and money: one asks, “How can we get federal governments to feel the pain of paying using grease in Puerto Rico as examples?” Another says, “Could money, taxes, be used to increase the percentage of voting in America?” And the third says, “Are their other incentives to get Americans to vote?”

A: Yeah. So, let’s start with the other incentives to get Americans to vote. So, first of all, there was a very nice program in Arizona. People who went to vote got a lottery ticket and more people showed up. And the reason, of course, the question — actually somebody in the audience here is part of the issue of voting is in the middle of the week, right? It’s very hard to vote in the middle of the week for many people. But I’ll tell you about one experiment I did. Two elections ago, I took all the people in my address book, I divided them into two, emailed half of them, six weeks before the election with a calendar invitation to put a time in their calendar to go and vote. The other half I did not send this invitation to. And when I asked them for their voting rates, there was an 11 percent increase in the people who made up time in their calendar. Lots of things — if you put time in your calendar — you will go and do it. If you don’t put time in your calendar and you think about it the day before, it will just not happen. So I think there’s lots of simple things on how to change the procedures, how do we make it easy, and then the question is, “Do we do other incentives?” By the way, in Australia, they force people to vote. You have to vote and you can argue whether this is a good idea or not a good idea. And the other thing about taxes — so here’s something funny we did. We went to a public library in Chapel Hill and we asked people, “When was the last time they got a benefit from taxpayers’ money?” They couldn’t remember. They couldn’t remember the last time they got a benefit. And this goes back to our discussions about showing effort. I think actually, the government is really doing a pitiful job in terms of telling us — the shareholders — about what they’re doing with our money. We have this kind of sense, in which they take our money but we don’t really understand where it goes. From time to time, we hear some statistics — this is what the cost of a missile is, or something like that. But if you thought about the entire activity — roads, schools and so on — we tried something quite interesting. Imagine that we told people that they would have the discretion to decide where 5 percent of their income would go to. And what if we connected it with voting. So what happens if when you went to vote, you basically got this list, and the list showed you all the things that the government is doing in healthcare, in education, in research, in science, in foreign aid, and you got to see all of those things and you got to confront your own priorities as well. And you got to vote. At least, the early data that we get — because we can’t do it for real — at least, what people report is that they would feel more connected, they would feel more responsibility, they would feel more accountable and they would feel happier paying taxes. So I think this issue is about how do we get the receipt from the government about our taxes, how do we know where our money is going and do we have some discretion against connecting, and if we give people a chance to sign their amount and also seeing everything the government is doing, all of those would change how people view taxes. By the way, it’s really strange — Americans — It’s the nation that gives the most amount to charity, and seems to hate paying taxes the most. Those things just don’t seem to fit. They should be kind of similar, rather than the opposite.

Q: This is the question of the hour: For those of us who handle money badly, what one piece of advice would you give us to improve our relationship with money?

A: Is this relation between people or individuals with money? When it says “relationship,” do we mean romantic relationship or?

Q: It sounds like it’s romantic relationships with money. No, it’s specifically the relationship with a person handling money badly. Their relationship with money.

A: So I think the wisdom about budgeting is actually very important. So if you have a hard time, what I would do is I would say, “Let me think about how much money I have in discretionary spending. And let me take that amount of money every month and put it on a prepaid debit card. And that’s my discretionary spending and I can’t get over it. This is it. This is the amount, and if I want to go ahead and buy new jackets, I have to wait a little bit until I have the money.” But you can separate your bills and savings and so on into one bucket, you take the discretionary bucket, and you treat it very, very separately. And by doing that, you basically are reducing your world to a world as if you get paid $40 every day. Now, you could do it monthly, you could do it weekly, however you do it. I would separate discretionary money from not. By the way, there’s some really strange things. What happened is the inflow of money is not at the same frequency as the outflow of money. Money comes in from salary once a month, goes to rent once a month, but grocery bills every few days and some things once a year, tax bills once a year. All those things make things very, very difficult. So that’s one thing I would do as a very easy solution. The other thing I would say about something about romantic relationship and money — so money, of course, is a big source for fights in families. And we looked at all kinds of pipings. So imagine you’re two people, and each of you have a salary, and both of your salaries go into your separate checking account, and then you have a joint account and you put money in there, in the joint account, for things that have to do with the household and so on. I’ll re-imagine the situation in which you have a joint account, money comes into your joint account from your salary and then you each take a little bit of pocket money to do things that you don’t want the other person to know, or say, “Okay, I have a few hundred dollars, I can have whatever I like.” The second one seems to be a much healthier approach. What happened, is that if you have two separate accounts, and let’s say one person makes twice as much as the other person, the rule of what seems to be fair is that that person puts twice as much in the joint account. But of course, it’s not clear that this is fair. Because it means that if you bring more money in, then you kind of have more money for yourself. But what about the other contribution of the household? In contrast, if all the money goes to a joint account, and then every person draws a little bit as pocket money, they draw a little bit of the same amount, not the same percentage. And I think equality in the relationship — you see, what happens is that relationships are about lots of things. Money is one of them, but money is incredibly measurable. So what we do, is we pay a little bit too much attention to who brings the money into the family. But the fact is, that if one person brings more money, the other person does more other things, it can’t be that we would equate all the different dimensions in life. We really need to think about relationships as being equal. And this idea that money first goes into a joint account, “This is our money,” in many ways, and then each of us can take a little bit of money — one person likes coffee, the other person likes shoes — that’s perfectly fine.