Why are we always losing money and there’s nothing we can do about it?

A long time ago our capability of realizing a danger meant knowing the difference between life and death. At that time we had to choose whether we are going to eat a squirrel right now or to wait for a deer one week or even more. Our brain learned that it is wiser to pick the squirrel than to wait for the deer. And this was the right decision.

However, times have changed a little. Basically we will not die of starvation and probably we will receive a pension regardless how incompetent and lazy we are. This phenomenon is called hyperbolic discounting. Actually, we are not able to think about the future in a rational way because our brain is not made to work like that. It has been proved that even if we think about our near future we assume that we are more patient, disciplined and we will stick to our plans, in contrary to our present self. But when this future finally arrives we succumb back to the behaving of our actual self (see Frederick et al. 2002).

Banks, credit cards, deferred payments and that sort of thing is working just because of this deprivation. Thus, it seems to be better to buy something unimportant, than to wait and acquire an essential.

Obviously, the worst are tobacco corporations or drug traffickers, which will kill you with your money, and you will not even notice it. But this is just the beginning.

Let’s assume your personal computer crashed and it is time to buy a new one. But quite recently you bought a new mouse and keyboard. And that’s why your brain will not allow you to buy a new computer, including both things, even if it is much cheaper.

We will not always choose the best offer for us since we do not rational weigh the options for action, rather we take the investments from the past as a justification for our irrational behaviour. This natural instinct including already accrued costs is also known as sunk cost fallacy (see Sutton 2007).  Instead of considering things from a rational view and, consequently, to make a decision, our automatic system will do the opposite. Furthermore it is convinced to save money.

But why are we not taking a better computer and resell the surplus keyboard and mouse on eBay or other Consumer-to- Consumer-platforms?

Such an idea would be great, but only in theory. In practice we think that everything is worth exactly the money we used to pay for it. That’s why our brain will preserve everything, even if some of those things lose their value over time. The same might count for the opposite. We are willing to sell something valuable if the price is just a little higher as we paid for it. Although, we could achieve a greater profit.

Maybe from your point of view you are very good at dealing with money, but mostly this is not the case. Some experts ascertained the so called denomination effect. This means in practice people are less likely to spend larger bills than the same amount in smaller bills. In an experiment some university students were given a dollar, either as a single dollar bill or in coins. Those who had the loose change were more likely to spend it, than those who had the dollar bill (see Raghubir and Srivastava 2009).

The thing is that our brain does not analyse the value you can obtain, but only numbers. And this is why we are not able to understand money at all. We will always make monetary loss and somehow have to get along with that. But “money alone can’t buy happiness”!

 

Reference:

Frederick, S. and Loewenstein, G. and O’Donoghue, T. (2002). Time Discounting and Time Preference: A critical Review. In: Journal of Economic Literature, Vol. XL, p. 351-401

Raghubir, P. and Srivastava, J. (2009). The Denomination Effect. In: Journal of Consumer Research, Vol. 36, p. 701-713

Sutton, J. (2007) Sunk Costs and Market Structure: Price Competition, Advertising, and the Evolution of Concentration. In: Mit Press Ltd; Auflage: 1st MIT Press Pbk. Ed

 

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