By Chris Taylor
NEW YORK(Reuters) - No offense, but you are probably dumb with money.
You are human, and we are simply wired to make dumb financial decisions, like spending too much or saving too little.
Famed behavioral economist Dan Ariely set out to discover where we go wrong in his new book, "Dollars and Sense: How We Misthink Money, and How to Spend Smarter." Reuters spoke with the Duke University professor to talk about our financial foibles, and how to fix them.
Q: You start the book by saying we do not really understand money at all. Why is that?
A: Money is all about opportunity cost. Every time you buy a $4 cup of coffee, you are giving up $4 that could be going to something else. What we should be asking ourselves all the time is, 'Is this the best possible way to spend $4?' But it is hard to think about life this way, especially if you have payments that aren't made immediately, like credit cards or mortgages or car loans or taxes.
Q: You also say that we often value things incorrectly. How so?
A: We evaluate things not based on the product itself, but on a whole range of other attributes, like the effort that has gone into it, or the language used to describe it. Companies like Apple (NASDAQ:AAPL) are very good at this: They go on stage and tell us about little things like the type of metal they use for laptop hinges. Then we say, 'Look at this amazing design, and how much effort they put into this!' And we pay all this money.
Q: You likened our financial decision-making to Enron. Are we really that bad?
A: We use funny mental accounting all the time, to trick ourselves into spending more. Companies like Enron had shady accounting practices, shifting money around between different departments, and we do the same thing. For instance if we decide something comes from our 'entertainment fund,' then we are usually OK with spending it.
Q: Even when we know the right financial thing to do, we often still don't do it. Why is that?
A: It's about short-term versus long-term, and humans are just not good at thinking long-term. It is also about abstract versus concrete: Give up something concrete now, for something abstract later.
It is also because digital money has changed the act of saving. A thousand years ago, you used to look in your yard and see how many goats you had, and compete with your neighbors. Now your saving is invisible, and that is a terrible thing. No wonder we give it less attention.
Q: How do we overcome all these failings, and save more for the future?
A: Envisioning yourself as an older person really helps, because it makes the prospect seem more real. Another trick is to discuss your 401(k) savings with your significant other or your family. That way the act of saving will be appreciated, and it goes from being invisible to being visible. You should also set up barriers to temptation, like automatic deductions, which can help us stay closer to where we want to be.
In terms of valuing things correctly, try to ignore sales and discounts, which basically mean nothing. If a $200 shirt is marked down to $100, don't think about it being 50 percent off; think about whether or not you want to pay $100 for a shirt.
Another tool for thinking about value is having a yardstick. For instance, if you're buying a new bicycle - is that bicycle worth 20 hours of your labor? Or if you are having a nice dinner, is that dinner worth three hours of work? That way you can compare it to other things you love. That is opportunity cost - and that is the essence of money.