Your money brain

Klara feels ill, and a storm is coming, but she drives to a concert anyway. “The €80 ticket can’t be refunded,” she says. Most of us have made a choice like this. Our brains use shortcuts that work well in daily life, but some of them cost money.

Your brain takes shortcuts

Researchers such as Daniel Kahneman and Richard Thaler showed that people make the same kinds of money mistakes again and again. Both later won the Nobel memorial prize in economics. These patterns are not a sign of stupidity: experts show them too. Here are seven of the most common.

Wanting it now. Present bias means giving too much weight to today compared with later. Many people choose €100 today over €110 in a week. Yet they choose €110 in 53 weeks over €100 in 52 weeks, although the wait is the same one week.

Hating losses. Loss aversion means a loss feels about twice as strong as a gain of the same size. So many people refuse a coin flip that loses €100 or wins €150, although on average it pays.

Labels on money. Mental accounting means treating money differently depending on where it came from or what we call it. A “tax refund” feels like fun money, while salary is for bills. But every euro buys the same.

The first number sticks. Anchoring means the first number you see shapes your judgement. “Was €199, now €119” makes €119 look cheap, whatever the item is worth to you.

Following the crowd. Herd behaviour means copying what others do, especially when unsure. “Everyone is buying” can push prices far above any sensible value, until they fall.

Feeling too sure. Overconfidence means overrating your own knowledge or skill. A study of more than 35,000 US households (1991–1997) found that men traded shares 45% more than women. Trading cut men’s yearly returns by 2.65 percentage points, against 1.72 for women. The lesson is about trading too often, not about gender.

Throwing good money after bad. The sunk-cost fallacy means continuing something because of money already spent that you cannot get back. Klara’s €80 is gone whether she goes or not. The only question is which evening is better now.

Knowing is not enough: change the setup

Learning about biases helps only a little. Changing how choices are set up helps much more. A nudge changes the way a choice is presented without removing any option, an idea made famous by Richard Thaler and Cass Sunstein in 2008.

The strongest nudge is often the default: what happens if you do nothing. At one US company, 37% of newer workers joined the workplace pension plan when they had to sign up. When they were enrolled automatically and could leave, 86% stayed in. But many also stayed at the default contribution of 3%, which was low. Defaults are powerful in both directions, so it is worth checking yours.

Save More Tomorrow, designed by Richard Thaler and Shlomo Benartzi, uses two biases at once. Workers agree now to save more at their future pay rises. The sacrifice is in the future, which suits present bias, and take-home pay never falls, which avoids the feeling of loss. In the first company to try it, average saving rates rose from 3.5% to 13.6% over 40 months.