Dan Ariely’s latest book, “Dollars and Sense: How We Misthink Money and How To Spend Smarter,” focuses on the ways we think about money that cause us to make poor financial decisions. But the bigger theme of his research circles back to one thing: irrational behavior. (Three of his earlier books are titled “Predictably Irrational,” “The Upside of Rationality,” and “Irrationally Yours.”)
In his discussion with Experian Editor-in-Chief Aaron Task, Ariely says he is most interested in the kind of irrationality that drives our decision-making—and developing tools to help us overcome our human tendency to made bad money choices.
Watch the video below for the full discussion.
Does having separate ‘buckets’ of money make sense?
For example, when people make budgets for different categories of spending — like vacation, dining out and retirement—that’s a way of circumventing our money irrationality, says Ariely.
“Sometimes we recognize our irrationality and bucketing our money helps us budget. It’s not ideal, but given our limitations, it actually helps us,” says Ariely. “Imagine that you try to think about opportunity cost, and every time you go to buy lunch, you think what else you’re going to give up. That’s just too exhausting, too complex, too difficult—so we’re not going to do it. So instead, you say, ‘Let me now think about the whole set of opportunity cost, let me create the bucket for eating out.’ And now I see how eating out is taking from that bucket.”
That’s why Ariely recommends an easy hack for not getting overwhelmed by the idea of opportunity cost.
“Take your discretionary spending, [like] Lyft and eating out and buying gifts and entertainment. Decide on a budget per week. Put that [amount] on a pre-paid card that alerts you every morning how much money you have left, and spend everything on that card…If it’s for a week, you can actually think about..the opportunity cost,” explains Ariely.
“You can say, ‘If I go and eat a big dinner tonight, I will have to save for the next few days.’ So, sometimes a good solution [is to] realize we’re not perfectly rational and create a system that we can act within that in a semi-optimal way. Not perfect, but at least closer.”
Just remember to load the card on a Monday rather than a Friday—so you’re not tempted to blow it all weekend, he adds.
To err is human, but you don’t have to be irrational
In the accompanying video, Ariely explains the differences between traditional economic theory and behavioral economics. In addition to being a bestselling author, he is the James B. Duke Professor of Psychology and Behavioral Economics at Duke University and a founding member of the Center for Advanced Hindsight.
“There are two ways to think of irrationality. One is the standard economic thinking: here is the perfect rational human being who can think about everything, make decisions the right way, take everything into consideration, has no emotions,” says Ariely. “I want to disprove this point, because the rational human being is kind of the center for policy decisions.”
When companies or governments implement policies based on the idea that consumers always behave perfectly rationally, they often make the wrong decisions, he explains. This is the policymaking version of ‘garbage in, garbage out’.
“The second version of irrationality for me, and maybe the more important one, is when we don’t understand what’s causing our decisions,” says Ariely. “[When] we ourselves don’t understand why we act in a certain way, there’s a potential for a pitfall. That’s a potential for us to make mistakes… so how do we get ourselves to a better understanding of where we make the right decisions, where we make the wrong decisions, and how do we improve things to prevent that terrible human waste?”
Understanding why people make the decisions they do—which are often not best for them—is the goal of behavioral economics. “Let’s understand why exactly we work in all kind of ways of working where we deviate from rationality, and then let’s think about how we design the world to get us to optimal outcome,” he says.
For example, when people make poor decisions, like choosing to overeat or to text and drive, conventional wisdom suggests just telling them not to do those things.
“From the rational perspective, if people are doing the wrong thing, it can only be because they don’t know. In behavioral economics we say that’s just not true. People know that texting and driving is an incredibly stupid thing to do, [but] we get addicted to these little devices,” says Ariely. “We know that eating too much is not good for us but it’s about the long term and we care about the short term. So at the end, it means the solutions are not just about telling people what to do, it’s about arming people with better tools.”