Welcome to episode 202 of Profit Boss® Radio! Today, I’m sharing another timeless episode from the Profit Boss® Radio archives with one of my most popular and commented-on episodes ever.
I had the privilege of speaking with world-renowned economist and author Dan Ariely. Dan is a Professor of Psychology and Behavioral Economics at Duke University. He’s a three-time New York Times bestselling author, the co-creator of the Center for Advanced Hindsight, a two-time TEDx speaker, and the creator of a documentary called (Dis)Honesty – The Truth About Lies.
Among the many great insights that Dan shared in this episode, you’ll learn about the psychology behind why good people with good intentions–and how women in particular–make the same financial mistakes over and over again.
We’ll also discuss the surprising reasons why money problems might not be your fault, how social norms and new technology encourage us to spend more and think less, and what you can do to build more wealth and make better financial decisions. Are you ready, Profit Boss®?
Here’s what you’ll find out in this week’s episode of Profit Boss® Radio:
- What stops people from thinking rationally about money and what they can do to maximize GOOD decisions.
- Dan’s theories about what makes women financially challenged.
- Social norms for women that may impact their lack of involvement in the stock market.
- The role behavior modification can play in powerfully addressing the looming retirement crisis.
- How something as arbitrary as our Social Security number convinces us to pay a premium for something, whether it’s a book or a share of a stock.
- The things in the world designed to make it hard to think about money, including mortgages, interest rates, savings, and pleasure.
- Why no one is immune to making irrational financial decisions.
- Why investing and wealth-building isn’t normalized for women.
- Why so many professional athletes go broke within four years while failing to improve their quality of life–and what this can tell us about our own spending.
- The key questions to ask yourself as you make big (and small) financial
- Why Dan’s newest book, Payoff: The Hidden Logic That Shapes our Motivations is a valuable resource for parents, employers and everyone looking to motivate themselves or other people.
The Money Blueprint℠ for Business Owners
The Money Blueprint℠ is profit coaching that puts you in control of your business finances for good. No more Head-in-the-Sand Syndrome. No more fear, stress, or shame. Simply total confidence. Learn more here!
Resources and Related Profit Boss® Content
- Follow Dan Ariely on Facebook and Twitter
- Payoff: The Hidden Logic That Shapes Our Motivations
- Center for Advanced Hindsight
- (Dis)Honesty – The Truth About Lies (documentary)
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Hilary Hendershott: Today, I’m excited to share with you a timeless episode from the Profit Boss Radio archives. It’s a conversation with world-famous economist and author, Dan Ariely. This is actually one of my most popular and commented-on episodes ever, so I hope you love it. Dan Ariely is a world-renowned economist, three-time New York Times bestselling author, co-creator of the Center for Advanced Hindsight, a two-time TEDx speaker, and creator of the documentary, (Dis)Honesty – The Truth About Lies. He’s a James B. Duke Professor of Psychology and Behavioral Economics at Duke University, and he’s dedicated his life’s work to understanding why good people with good intentions are consistently doing the wrong things. So, do you find yourself making the same financial mistakes over and over again? Today’s conversation is just for you. Dan and I speak specifically about why women struggle with money. You’ll learn about money problems and how, surprisingly, they may not be entirely your fault. Social norms, the pain we experience when paying cash, and new technology that encourages us to think less, all of these things impact our ability to make our best choices. So, tune in to find out what you can do to start building more wealth. Let’s do this.
Hilary Hendershott: Dan Ariely, welcome to Profit Boss Radio.
Dan Ariely: Wonderful to be here.
Hilary Hendershott: Dan, you’re an economist. And economics is often called the dismal science. You also don’t write about how to get rich quick or conspiracies in the government, and you don’t write fiction, yet you’re practically a household name. How do you get people so interested in economics and irrationality?
Dan Ariely: Well, I think that’s exactly it, that it’s more the irrationality side in economics, and I think economics for a long time has tried to kind of take math a little bit too seriously and made lots of simplifying assumptions about how people behave in order to fit the math. And the people in my part of the discipline in behavioral economics are saying, “Let’s not jump ahead and assume that people are rational and can perfectly think about everything and compute everything. Let’s instead put people in different situations.” And when you put people in different situations, people actually look a bit more like candid camera than rational beings because when you put the camera to us, you basically find that we are fascinating, interesting, or that we don’t understand ourselves as we have all kinds of quirks and that we make all kinds of mistakes. And just in terms of science, I think that people used to think that the big mysteries of the world are kind of what’s out there in the stars or what’s in molecular biology or inside the Earth. But we’re realizing that this stuff between our ears and our brain and our own behavior, even though they’re with us all the time, is still something that is kind of bizarre and mysterious, and we don’t understand it. And if we pay a bit more attention, A, we learn a lot about ourselves but also it’s incredibly practical because we can defend ourselves against all kinds of mistakes and do better.
Hilary Hendershott: So, in terms of studying people, you lean more towards observed psychology than math.
Dan Ariely: Yes. So, what I do is I put people in different situations. So, I like to do experiments, which means that I put some people in one situation, some people in a different situation, and I see how people behave differently. So, I don’t usually like to ask people what they would do and they often don’t like to ask people why they’re doing what they’re doing. Instead, what I do is to put people in different situations, see how they behave, and infer from that the mechanism. So, if you think about people’s risk attitudes, if you can ask people about the risk attitude, they’ll tell you one thing but if you observe what they actually do, it’s something very, very different. So, we like to observe real behavior, and then what we do is we put people in different situations and say, “Let’s see how that changes.” So, just as an example, in one experiment, we asked people to write down the last two digits of the Social Security number. So, mine are 79, yours might be 12, whatever it is. And we say, “Here’s a list of six products. Tell me whether you would pay that price, $79 or $12 for each of those products,” and people say yes, no, yes, no, yes, no.
And then we say, “Okay. Now, that you’ve said whether hypothetically you would pay this price, tell us how much you would really pay for it. We’ll do an auction and we’ll figure out who is the winner and so on.” And people for each product look at the product. These are physical products, books, chocolates, and so on, and they set up how much they’re willing to pay for them. And then we asked people, “Do you think that your Social Security number, 79 or 12 or whatever it was, influence your willingness to pay your bid price?” And people say, “Of course not.” But then we calculate whether people with high ending Social Security number actually set up higher prices than people with low ending Social Security number, and we find out that’s actually the answer. It’s sometimes even twice as much. And what happens is that our first decision has the capacity to taint our later decisions without us seeing that.
So, if I looked at the book and I thought to myself, “Is this worth $79?” And you looked at the same book, and because your Social Security number ends with 12, you thought of it as $12. And maybe I said I would not pay $79 but you said you would pay $12. Nevertheless, that number 79 for me and 12 for you stayed in your mind for a little too long and has the capacity to influence our later decision, how much would you pay for it, and therefore you’re likely to pay less than I would.
Hilary Hendershott: Then it makes no sense that my Social Security number would impact how much I would pay for a book and yet it’s true.
Dan Ariely: Yeah. That’s right. It makes no sense. It nevertheless works. And this is a case when we take an arbitrary number but, of course, there are many cases in which the numbers are not arbitrary. So, think about something like buying a stock. To what extent is your willingness to pay for a stock or to sell a stock influenced by the price you originally paid for it or buy something else? How much is it what’s called true valuation, your true understanding of what it is versus something that just happened to be historically something that you remember or something that you did but over time you get overly attached to that number?
Hilary Hendershott: How did you become so interested in studying human irrationality?
Dan Ariely: So, my personal story, my biggest, I think we all encounter irrationality all the time but for me, the biggest time where I encountered it in a big way was in the hospital. So, when I was 18, I was badly burned in about 70% of my body and I spent a long time in hospitals and hospitals give people a lot of opportunities to observe irrational behaviors, and there were lots of things in hospital. There were things that have to do with painkillers and there were things with timing and so on. Among them was the question of how to remove bandages from burn patients. And the nurses thought that the right approach is to reap the bandages off quickly to take a short duration even at the cost of every second being very painful so short very, very painful duration whereas I wanted them to take their time, make the duration longer but have every second be less painful. And they were sure that what they were doing was right and I was sure that what they were doing was wrong. But of course, they had the power so they did what they thought was the right thing to do.
And when I started studying at the university, one of the first things I tested was exactly that. I put people in the lab and I hurt people in different profiles and different durations and different timings. And I found out that indeed, the nurses were wrong. That if you take an experience of pain and you make it twice as long, you don’t multiply the pain. But if you take a painful experience and you make the intensity higher, now you’ve really changed it. So, the nurses had kind of the wrong mental model. And of course, I talked to the nurses and I give lots of talks in the hospital since then. But the real question was how can it be that good people with good intentions trying to do the best for their patients, their clients nevertheless are doing things that are wrong? And you basically have to realize that we have intuitions about the world and we have lots of intuitions about the world, and most of our intuitions have not been tested. You know, if you just look at all of your decisions and you say, “How many of those decisions do I really know the answer and how many of them do I trust my gut intuition?” And if you trust your gut intuition, you say, “Is this accurate?”
And the interesting thing about studies with doubt your gut intuition is all of a sudden you get to lots of cases in which you say, “Oh, I’m just not sure. I’m just not sure what’s right.” And being unsure, I think, is the first step into getting things to get better because now you can start testing yourself, trying things in a different way, and maybe improve what we’re doing.
Hilary Hendershott: We have this whole unknown frontier, right? Could I get my workout done in 30 minutes instead of 60? And that would dramatically improve my life. Your website says, “I became engrossed with the idea that we repeatedly unpredictably make the wrong decisions in many aspects of our lives and that research could help change some of those patterns.” And you did talk about stock price anchoring, and I think that is one of the strangest things I hear people say is, “Well, I bought it at 100. It’s at 90 now. I’m going to wait for it to come back to 100 before I sell it.” What are some other wrong decisions you see people make with money?
Dan Ariely: Well, so first of all, before we go into money, if we think about just misery around the world, in general, it’s very easy to say that most of the misery in the world is manmade. From time to time, we have a tsunami. From time to time, we have some kind of disaster but most of the stuff we do to ourselves. I mean, we text and drive and we smoke and we hate.
Hilary Hendershott: Have insecurities.
Dan Ariely: Yes. I mean, just a lot of things like this and many of them are accelerating our mortality and making us very, very miserable. So, you look at it, it is just incredible how many bad decisions we make. And of course, texting and driving is another one that is very salient and common. Nevertheless, most people admit that they are doing it despite knowing that it’s really stupid. In terms of financial decision-making, there’s really a lot of them. And part of the problem, well, there’s a couple of problems. So, first of all, if you think about money and you ask, “What is money all about?” money is all about opportunity cost. Right? Every time we spend $3 on a cup of coffee, we don’t have these $3 to spend on something else. So, that’s the essence of money. We don’t have money for its own sake. It’s only for the use that we have in other things. But the problem is that because we can use money on lots and lots of different things, it is unclear what we’re giving up. So, imagine I ask you, would you prefer a cup of coffee or a cup of tea? You know which one it is. And you know if you take coffee, you give up tea. If you take tea, you give up coffee. It’s very clear.
If I said, “Would you like to pay $3 for this cup of coffee?” what exactly are you giving up if you’re getting it? Like there’s no good, visceral way for you to represent yourself there, the opportunity cost. So, what do we do? We behave as if there’s no opportunity cost. In English, there’s this expression when people talk about difficult decision. They say it’s like comparing apples to oranges. The reality is that comparing apples to oranges is very easy. You know, nobody is baffled by the fruit plate saying, “I have no idea which one I want to pick.” But figure out whether an apple is worth $0.75 or $1.50 or $2, that’s very, very hard. So, the first thing to realize is just thinking in terms of money is really tough because money is all about opportunity cost and it’s hard to think about it.
The second thing is that the world around us is trying to make thinking about money harder for us. So, think about something like mortgages. It used to be that mortgages had one dimension. What is the percent of interest that you’re paying? And when that was it, it was quite easy to figure out that 4% is more than 375 and 350 is more than 325. But then some people added the second dimension to mortgages. We had interest rate plus we had how many points do you want to buy? And just adding a second dimension got people confused and got people to start making mistakes. And lots of financial decisions are like that. They’re not as simple. The world is trying to make those more difficult for us, for all kinds of reasons. And as they become more difficult, even moving from one dimension, which is just percentage to percentage plus points, starts confusing us. And then another big problem is, of course, the savings. Saving I think is one of the most difficult human challenge of them all. And it’s because saving involves two things. It involves now versus later, and we don’t do well on every now versus later decision, right? It’s why we overeat and don’t exercise and all kinds of other things, right?
So, we see something now we want it now and later is not as appealing. So, that’s why I call hyperbolic discounting. But the second thing is it’s also concrete versus abstract. So, if I see a new bicycle now or a bottle of wine or a book or whatever it is, it is now versus if I save it, it’s abstract. Something concrete now and something abstract later, which also makes it hard. So, if you think about all of those things, money is about opportunity cost. It’s becoming more and more complex because of multi-dimensions. It’s now versus later and it’s concrete versus abstract. All of that is making it much, much tougher. And then, of course, there are other little things with money that also makes it more complex, for example, credit cards or Apple Pay and Android Pay. There are lots of new technologies, even credit cards that there are at least some of the benefit used to decrease friction, to decrease the costs of transacting. But by doing so, they also decrease the amount of thinking that we have about money. And with that, we actually think less about opportunity costs.
So, as an example, imagine that you go out tonight to dinner. It’s an expensive dinner. Let’s say it’s $125 and you can either pay with cash or with credit card. Which one of those would feel worse to you?
Hilary Hendershott: I always pay with a credit card.
Dan Ariely: Yeah?
Hilary Hendershott: I hate cash.
Dan Ariely: Yeah, that’s right. That’s what everybody says. You know, cash is very, very painful. It’s painful to spend the cash. Why? What’s happening with the cash? Well, what happened is that the cash is creating what we think of as the pain of paying. And let’s take a more extreme example for this. Imagine that I owned a restaurant and I figured out that people eat 50 bites and pay $50. And I came to you and I say that, “Because you’re such a wonderful person, I’ll give you a discount. Instead of a dollar per bite, $50, 50 bites, I’ll charge you only $0.50 per bite. And not only that, I’ll only charge you for the bites you eat. The bites you don’t eat, you don’t need to pay.” So, you’ll sit back in your chair. I’ll serve you a dish and I’ll sit back. I’ll take my pencil and my notepad. And every time you take a bite, I’ll mark a little V on my notes pad. And at the end of the meal, I’ll charge you only $0.50 and only for the bites you eat. So, it’s half price and you only pay for the bite you eat. It’s a really good financial deal but you’ll suffer throughout the whole meal.
Hilary Hendershott: Because I look like a squirrel preparing for winter.
Dan Ariely: That’s right. You’re right. Sometimes when I teach my class on the psychology of money, I bring pizza and I charge them $0.25 per bite. And what do they do?
Hilary Hendershott: You get sick.
Dan Ariely: You guessed exactly. They eat such big bites. They suffer from the whole thing because they sit there with the pizza and if they just eat a regular bite, they will enjoy it. But the temptation to stuff themselves a bit extra and push the pizza a bit more inside is so high because it’s financially efficient. But then, of course, they are stuck with too much pizza. It’s not pleasurable. So, what happened is that the pain of paying is kind of a two-edged sword, right? The pain of paying is all about the fact that if we consume and pay at the same time, we enjoy consumption less and we suffer more. And you can say, is this a good thing or a bad thing? Well, it’s a bad thing for the joy of the moment. It’s a good thing for thinking about money. So, you could say if we took something like electricity and we wanted people to be more cognizant and thoughtful about electricity use, then what we should do is we should put a big meter of electricity consumption in the middle of the kitchen.
Hilary Hendershott: Yes.
Dan Ariely: Or maybe we should even get people to pay. It would be like a cash machine, like one of those things that you stuff bills in, like a vending machine,
Hilary Hendershott: So, you pay upfront before you turn the air conditioning on?
Dan Ariely: That’s right. There used to be these things in England when you would put coins in the heating system and it will run until the heating money ran out. Now, if we had this system, certainly we would be too cold in the winter and too hot in the summer. But we will save energy. So, the pain of paying sometimes you might want more of it and sometimes you might want less of it. But what’s interesting is that the people who are designing payments think about credit card companies, Apple Pay, Android Pay, Square, and so on. They all want us to think less about money. They want the pain of paying to be less because they want us to spend more now even if it means we’ll have less money later because they’re trying to optimize something different in our overall wellbeing. They’re trying to optimize their short-term wellbeing so they want to eliminate the pain of paying. And sometimes it’s good for us to eliminate the pain of paying but in many cases, those mechanisms are actually working against us.
So, we have a hard time thinking about opportunity cost anyway but then the people who are designing payment mechanisms want us to think about payment even less so they design systems that are basically like casinos. I mean, actually, casino is a genius. If you think about money, they really know what they’re doing. What happens in a casino? You show up with a thousand dollars and they make you turn it into chips. And at that moment, you said to yourself, “I’ve lost that money already. I don’t know exactly when and how but this money is allocated to a category of losing in a casino.” And it doesn’t look like money, doesn’t smell like money. I’m not going to feel bad about it like money. So, the chips basically get people to allocate money into this category. And then we have an easy time losing that money because they already have assigned it to this losing category. There’s actually lots of sad lessons to learn from casino but the rest of the world is becoming much more like that. Gift certificates are a little bit like casino, right? When you say, “Okay. I’ve given the money to this category and I know it will go into that category already.”
So, if you think about money from an evolutionary perspective, money is a very recent phenomenon. And not only is it recent but it keeps on changing all the time. We have money, we have gift certificates, we have checks, we have cash, we have credit cards, we have points on credit cards, we have stock, we have stock option, we have bonuses that we feel differently about than regular salary and we don’t have tools to kind of deal with those. So, we use all kinds of heuristics to figure out how to deal with this, which are sometimes helpful but sometimes work against us.
Hilary Hendershott: And what’s a heuristic?
Dan Ariely: Heuristic is a shortcut. It’s basically a generalized rule that doesn’t apply in all cases. And nevertheless, we use it in all kinds of cases, even when it doesn’t apply.
Hilary Hendershott: Like a decision framework.
Dan Ariely: Decision framework is one example. For this decision framework is often a bit more explicit than a heuristic. So, if you think about simple heuristic, it’s to say something like, “What appears more frequently, the letter R in the first place of a letter or in the third place?” When you have this decision, you say to yourself, “Hmm, rabbit,” and you come up with a few words. It’s harder to come up with words that have R in the third place, just harder because you don’t have the capacity to start with the letter R and basically make up a few words. So, you say, “Oh, the frequency in which those two things come to mind must be the same frequency that they are in the real world.” You don’t say, “Oh, it’s because this one is easy and this one is hard.” So, you go ahead and you assume that more words start with R than have R in the third place. If you think about what we started with, this idea of anchoring, you say to yourself, “Ooh, I’ve made this decision before. I remember buying this stock for 100. I remember saying that this thing is worth $79. So, if I made this decision in the past, it must be a fantastic decision. Let me do it again.” And then again and again and again.
So, all of those are ways in which we don’t think extensively about our decisions. Instead, we just assume that’s what we’ve done in the past is a reasonable decision. We just make it again.
Hilary Hendershott: So, there’s a blog article by the CFA Institute that quotes you as saying, “Humans are incapable of thinking rationally about money.” I mean, I think everyone always thinks that other people are rational but that they themselves are rational. Is anyone an exception from this phenomenon?
Dan Ariely: I don’t think so. So, listen, here’s the thing. Opportunity cost, this idea that every dollar we spend, we could be spending on a million things now and later. How do you even compute this in an extensive way, right? What would you do? So, if I said, “Now, here’s another $1,000. What is the most rational way to spend it?” What are you going to think about? Do you even have a way to think about all the different ways in which you buy what you buy, how you’ll spend it now and later, and which one will give it the most amount of happiness? Now, you can have some shortcuts. You could say, “In the past, I really enjoyed shoes or in the past, I enjoyed this sweater. Well, I enjoy XYZ.” But you’re not thinking about everything. We just can’t. And the thing is that money is this beautiful thing that requires that we think about everything but we can’t. So, the fact is we can exchange money with everything is a wonderful idea. Like if you think about money, it’s an amazing invention, right? It’s kind of like the scale of the wheel in terms of how useful and wonderful it is. But a barter society would be one in which we could think about what we’re getting and what we’re giving up. Do you want this apple? Do you want this orange? Do you want three oranges? You want this book, right? We can make those things.
Hilary Hendershott: Because you’re actually physically trading it.
Dan Ariely: That’s right. And you have a sense of what is the hedonic value of this. But when you say something like, “Is this backpack worth $75 or $350?” I don’t know. I don’t know how even to compute it because I need to compare it to all the other things I could be buying and figure out whether this has the highest marginal utility compared to everything else. So, when you think about it like this, you realize that the true computation of how to translate money into pleasure would just take us forever to figure out. I’m not sure we can even do it, so we don’t. So, what do we do? When we can’t do things the right way, we do things the wrong way. And when it comes to money, there are all kinds of wrong ways to use, and we use all kinds of wrong ways.
Hilary Hendershott: So, a lot of my professional energies right now are directed at trying to motivate women to not only save their money but to invest it for the purpose of building wealth. And one of the things the research tells us is that women do save money but we often leave it in cash. So, is there a cognitive bias that would explain someone leaving their life savings in a vehicle where we know full well it’s losing money over time?
Dan Ariely: So, here’s a speculation and tell me what you think about this. So, we know that people like to invest in things that they understand. In stocks, they understand their business model. So, if there’s stock A and stock B and I understand the business model of stock A, I’m more willing to invest in that than in stock B. Now, of course, companies don’t have returns that is proportional to how much I understand their business model. It’s completely irrelevant. They don’t call me up and say, “Hey, how much do you understand our business model?” And then they say, “Oh, if you understand that, let’s make more money.” But people’s willingness to invest, stocks are kind of a unique animal that you say, “I want to understand what I’m investing in.” Now, could it be? So, this we know. We know that people like to invest in things that they understand the business model. Could it be that women are more modest about their understanding of the stock market and of companies? So, we know that men in many cases are overconfident. So, could it be that women are either under-confident or more accurately confident? And because they don’t think they really understand how the stock market works, how Apple functions, how whoever it is that this recognition of their lack of understanding true versus fictitious is basically saying, “We’re not interested in doing this.” So, this is just a speculation.
Hilary Hendershott: Maybe but then I think most women would never take a prescription drug or get in an elevator and take it to the 60th floor because we don’t understand those things either. Right?
Dan Ariely: Well, but I think that in an elevator that is so functional, there’s also no other way to do it. In a prescription, somebody is telling you exactly what to do and it’s a figure of authority. Whereas in the stock market, people are saying, “Look, you have choices and it’s up to you to make the choice.” So, you have a choice of do you put the money in cash or do you go into the stock market? If you go to the stock market, what do you do? So, that will be one speculation that it’s really about confidence and overconfidence that is underlying this. The second possibility, and we’re just speculating here, a second possibility is that it’s about social acceptance. There’s this very interesting phenomenon called social proof, and social proof is the idea that we don’t know what is the right way to behave and we look around us and we behave like the people who are around us. And in particular, we behave like the people who we think are similar to us. So, could it be that for men, all men kind of investor, there’s something in the stock market so it becomes a part of their discourse. It becomes part of the social norm. Everybody expects people to do this. Whereas for women, if it’s not part of what they know about each other or think that they do and so on, it becomes less likely that they will keep on doing it. So, this is just another speculation but I don’t really know.
Hilary Hendershott: I think with the second one, you pretty much hit the nail on the head because investing for women really isn’t normalized. And in fact, building wealth isn’t normalized. In fact, I talked to some of my wealthy female clients and they don’t want their friends to know that they have a financial advisor or can afford a financial advisor. So, I do think you hit the nail on the head and there’s a lot of talk about the retirement crisis now. I mean, it doesn’t really matter which research report you read. Most Americans are underprepared for retirement, and I do think it’s predictable that people would start calling on the government to solve that problem. But you know, I listened to your TED talks and read your books, and I know that you are a fan of behavior modification solutions. You talk a lot about this. Check the box if you want an opt-out solution. So, do you think that’s a big enough lever to solve this cultural problem that we in the U.S. don’t save enough?
Dan Ariely: So, no. So, the current retirement savings in 401(k)s, the amount there is just not high enough. So, let’s say you start working at age 30, you work until 65, that’s 35 years, and then you live until 90. That’s another 25 years. That means that you have 35 years of work and 25 years of retirement. That’s really hard to afford. It’s really hard to afford, right? It’s almost a ratio of 1:1 that for every year that you work, you need to save, you need to live that year plus you need to save for almost another year at retirement. So, it’s a very, very hard thing to do. So, if we save 10% yearly, it’s not going to make up for this. So, I think that we need to increase the amounts that people are saving. And of course, what it means is we need to decrease the amount that people are spending. And one of the things that really bother me about financial advisors and you tell me, “What do you do?” is that financial advisors come to clients and they say, “Tell me how much you want to save, and I’ll help you optimize that amount to help you figure out your risk attitude and your allocation and so on.”
But I want to ask some financial advisors that if you spend more time with each of your clients and you learn more about their preferences and you spend more time on their portfolio, how much more could you get them to save? What would be the increase in their portfolio? And some people said a quarter of a percent, some people said it wouldn’t matter but it was a very, very small amount. And then I asked the same group. I said, “If you actually talk to your client about what they’re spending and you try to get them to spend less, how much do you think you could help them save more?” And the numbers were often around 10% a year because you could choose one saving approach versus another and you could optimize a portfolio but the real issue is how trading off spending now versus saving in the future. And I think that financial advisors need to be the kind of the money experts, right, not just the optimization of portfolio allocation but they need to help us figure out what to spend, what not to spend.
I work a few days a month at Google and I meet lots of young people who gets paid a little bit too much. And my friends who work at Google and other tech companies, it’s not just Google, basically get this large infusion of cash every month, and they spend a lot of it, they spend a lot of it. And I think if they had advisors that would help them against themselves, that would be incredibly helpful. Do you know this baseball player, something Griffin Junior?
Hilary Hendershott: I don’t.
Dan Ariely: Okay. So, anyway, you’ll excuse my ignorance. I didn’t grow up in this country. I don’t remember much about baseball but there was a baseball player that I met at some conference, something Griffin Junior, very famous baseball player. And he told me that when he was a young player, he got his first professional job and got the first training and they were kind of on the field and the coach gave them each an envelope with their paycheck and he opened the paycheck and it was $2,000. He said, “What? I just became a professional player. This is $2,000. How can it be?” He called his manager and his manager said, “Don’t worry, I have your money. This is how much you have to spend on discretionary spending. If you need more money, call me and we’ll talk.”
Hilary Hendershott: I wish everyone would do that. I wish all employers would do that for their employees.
Dan Ariely: Yeah. Because you know, the data on professional athletes is really depressing. Most of them are bankrupt within four years. And these are people who make a ton of money. But what happened is that often as people make more money, their quality, the quality they’re spending on their lives is increasing disproportionate to that amount and they don’t save more. They actually just spend more. And this idea of helping people against themselves, I think, is very important. And for me, the realization in behavioral economics, there’s this notion that we make decisions as a function of the environment that we’re in, right? Everything in our environment is a player. You open the refrigerator and the design of the refrigerator, it changes what you eat. Right? The fact that we put fresh vegetables in an opaque drawer in the bottom of the refrigerator and we put soda on the side of the refrigerator. And you know, whatever it is that we put on the front shelf basically means you open the refrigerator and you don’t think fruits and vegetables. You think whatever you see ahead of you.
And the way that Apple Pay and Android and credit card, all of those are designed for the environment and the fact that every coffee shop is trying to pump the smell of fresh baked goods and coffee out to get you to be tempted to buy this. So, the world is really not thinking about our long-term well-being. Most of the players in the world are thinking about their short-term well-being rather than our long-term well-being. And we fail. We fail all the time and the question is who is on our corner? Who is in our corner to help us think better and really make tradeoffs between now and later in a more thoughtful way? And retirement saving is one of those things that we don’t have a second chance. It’s not as if you get to retirement at age 70 or 65 and you say, “Oh, I made some mistakes. Let me go back.” It’s over. It’s done. So, it’s not something that we should leave to people to learn by themselves. You can say, “Let people learn by themselves about dating because you can do it multiple.” But you know, even dating, we don’t have that much experience.
Hilary Hendershott: You can do more trial and error there.
Dan Ariely: That’s right. You can do more trial and error. Not a lot but you could do some. But with savings, we really don’t have much opportunity. I mean, we can save a bit more. You can save a bit less. But some of the mistakes we make is certainly at the young age when compound interest would have been in our favor. There’s just no going back.
Hilary Hendershott: Right. I will say to answer your question about digging into someone’s spending, you really have to have someone’s permission before you give them that kind of advice or coaching because they feel a little defensive or violated if you start questioning what they spend their money on. So, not only do they have to hire you as their financial advisor but then you need to get specific articulated permission to say let’s dig into your spending.
Dan Ariely: And it is. It is painful. And we did the project once we started. We call it spending buddies. You ask people. Actually, it was all women but we asked women to meet once a month, show each other their credit card bill, and explain every item. And the fault was that after doing it a few times, the voice of your friend will start echoing in your mind before you decide to buy something, not after. Because if the experience was only about explaining things after the fact and it wouldn’t change behavior, then it has no value. But we were hoping that it would kind of start. You would look at something in the store and you would say, “Oh, do I really want this? Can I really explain it later to my friend?” And it was only a small study but it was very effective. And by the way, I don’t think it’s good just for women. I think it’s good for everybody to have some kind of more accountability into what we’re doing. And I think you’re right that it’s a very tough role to take because often we feel embarrassed and defensive and so on but it’s incredibly helpful to be able to justify our behavior to somebody else, especially somebody we appreciate.
Hilary Hendershott: So, that experiment did work?
Dan Ariely: Yeah. The experiment did work. But you’re right, it’s a painful process, right? It’s not fun but it’s also not fun to get to retirement with not enough money.
Hilary Hendershott: Right. So, your new book is called Payoff: The Hidden Logic That Shapes Our Motivations. Who is this book for and what inspired you to write it?
Dan Ariely: Who is it for? Everybody. So, the book is really about all the ways in which our motivation and not just about money. And I start the book with a very personal experience of a kid that was very badly burned, and his mother asked me for some help and I helped him out. And throughout helping him out, it was nothing but misery for me. I cried. It was difficult. It was painful, it was emotionally draining, and so on. But nevertheless, I was motivated to try and help him out and I spend a lot of time. I actually just wrote him the day before yesterday, even though we started talking a few years ago, it’s still not easy. And through that initial point, they said, “What are we trying to maximize?” And we think sometimes if we try to maximize pleasure and that’s kind of the pleasure principle but saying, is this really the case? If you look at all the things that we do from climbing mountains to helping people to succeeding at work to raising kids and so on, how much of it is really about pure pleasure maximization? Pure pleasure maximization can be sitting on some beach drinking mojitos. This is not what we’re striving for. This is not what we try to do. You know, maybe we’ll do a couple of days of those things but it’s not what we would call a fulfilling life.
And therefore, I try to explore what are all the ways that motivate us. What are all the things that give us a true sense of meaning and purpose and deep joy, not just to the superficial joy? And from this perspective, it’s very important for people who run a business and try to motivate other people but it’s also important for us to understand our own motivation. We need to motivate ourselves to do all kinds of things. We need to motivate ourselves to save and to have relationships and to keep friendship and to do exercise and to do all kinds of things. And understanding our own motivation and the motivation of others, I think is part of the human condition. We need to understand it better. So, I think there is something in this for everybody who’s trying to motivate themselves or others.
Hilary Hendershott: The one thing I was able to get about the book on it because it’s not even released yet, and as of the airing of this episode, it will have been released and we’ll share with you how to get it. But as of the day of our conversation, the book isn’t out yet. But I read that one of the things that you – or studies that you did was about how people make tradeoffs between compliments, pizza, and money.
Dan Ariely: Yes.
Hilary Hendershott: And what you learned is that people are more motivated by pizza than anything else.
Dan Ariely: Yes. So, this was a study at Intel, the chip manufacturer. And we basically measure whether motivating employees was better off with money, pizza, or compliments, and we found that they were very, very different, the three of them. And on the day that we offered the bonus, they all worked the same way. But the day after the bonus, the money basically backfired. What happened on the money is that the day you offered me money, I worked hard but the next day I said, “Oh yes, they offered me money. I worked hard. Today, they’re not offering me money. I’m not interested anymore.” And the other two, the compliments and the pizza did not backfire in the same way. So, the idea is that a lot of work has a huge component of goodwill. When we lived in a world in which people did something very basic and specific like layering bricks or pumping water or something like this that you could measure exactly, you could pay people based on their productivity. But as we move forward in the knowledge economy, we depend a lot on goodwill. We depend on the fact that people would want to perform, that people would think about work on the way home and in the shower and focus and work hard, and so on.
We can measure how much time people sit on their chair by the computer but we can’t measure focus and concentration and so on. And what’s happened is that, of course, we have to pay people. There’s no question about it but payment doesn’t necessarily get you goodwill, and sometimes it can actually undermine goodwill. Whereas compliments are much more of a relationship between employer and employee. They kind of represent kind of a different system of evaluation, one that has more long-term approach rather than short-term money for performance and therefore, you actually get more goodwill from things like gifts and compliments than with paying exactly for performance.
Hilary Hendershott: And this is compliments with an I, right, the boss telling you, you did a great job?
Dan Ariely: Yeah. In this case, it was exactly like this compliment, which was actually a text message. They didn’t even say explicitly.
Hilary Hendershott: And so, people chose the pizza over the money but the money was just $30. Was the pizza worth more than $30?
Dan Ariely: No. It was actually worth less but it wasn’t that people chose it. So, a quarter of the people were told nothing. A quarter of the people were told, “If you perform at this level, you’ll get money.” A quarter of the people were told, “If you perform at this level, you get pizza.” A quarter of the people were told, “If you perform at this level, you get the compliment in a text message from the boss.” So, it wasn’t what people choose. Actually, people often choose the things that don’t motivate them the most. It was that when the different type of rewards were offered, people’s motivation changed.
Hilary Hendershott: I see.
Dan Ariely: So, imagine this podcast and imagine if you said, “Oh, then would you mind doing a podcast with me? I will give you $25.” What do you think will happen to my motivation? Do I say, “Gee, I get to chat with Hilary plus I get $25. That’s great?” No. What would I say? I would say, “Oh, $25, this is work. I’m not interested. Give me a couple of thousand dollars, we can have a chat again.” So, what happened is that money is a motivator but it also changes the relationship of the exchange, and we don’t always see that. So, imagine you worked for me and I said, “Hilary, we have two options. I can either send you to the mountains for a weekend or I can give you a thousand dollars in cash.” Now, you would probably prefer the cash because you would say, “Give me the cash. I’ll go somewhere cheaper and I’ll buy the new Apple, whatever.” But the question, of course, is not just what’s more efficient for me to transfer wealth to you. The question is what would get you to care more about the work?
So, imagine that I offer you now this choice and you choose the money or imagine I just send you to the weekend to the mountains. And imagine if in three weeks I ask you to stay late one night. I say, “We have this project. We really have to finish it. Would you mind pulling an all-nighter?” Under which of those conditions would you be willing to pull an all-nighter? And it’s not the one that they gave you the cash. It’s the one when I showed my appreciation in a more social way where it’s a part of a system that basically said I did a favor to you and we have now a more social kind of favor-for-favor system rather than paying cash for performance. And that’s something that people don’t always see. For example, think about something like the No Child Left Behind Policy that we had in the US for a while now where we basically took teachers who are very motivated and interested in the profession. And all of a sudden we say, “Hey, if you work very hard then your kids do very well on this specific test and then you’ll get $400 more and you have to teach the tests throughout the year for this to work out.” And basically, what we did was to eliminate the motivation from most teachers. So, sometimes what we do is that by paying, we change the nature of the relationship and often not for the best.
Hilary Hendershott: Great. So, I see this book as being especially applicable for employers and parents and anyone who wants to motivate, people who are dating, who want to motivate people, and we will put a link to buy the book in the show notes. Dan, my last question for you, where can someone start if they’ve discovered today that their life is negatively impacted by irrationality? What would be the first step to a more consciously controlled life?
Dan Ariely: So, I think the first step is probably to kind of be able to recognize some of the big mistakes. I think that living a life where you think all the time about small mistakes, it’s just not doable. I think what we need to do is we need to maybe once a year or a new year is not the bad time is to revisit the big decisions, and some big decisions are clear, like buying a house, switching job, getting married, having kids. Some big decisions are just a combination of lots of small decisions like buying coffee, groceries, going out, and so on. And revisit those decisions and then basically ask yourself, “Are those decisions the right approach?” and do it. Do it once. You can’t do it all, all along. And then ask yourself this question and then figure out this strategy for the next year. So, you can tell, “You know what?” By the way, one of the things we find in terms of the regret in lots of categories so far, it seems that people really regret going out compared to all other categories. They say that people spend a lot of money on this and don’t get as much joy as they think they do it but they somehow don’t seem to remember.
Hilary Hendershott: Going out for dinner and drinks like that?
Dan Ariely: Yeah, exactly. Relatively to the amount of costs, people don’t seem to derive the joy that they expect from this. This is the finding we have. So, you sit there and you say, “Here’s a category I think I’m spending too much on, and here’s a category I’m not spending enough on, and here’s something I do. And let me try to figure out how in the next year, I could align myself more closely to something that is going to do better. So, I don’t think that living rationally on a day-to-day is possible but I think that once in a while we can kind of examine our life, find out what the big points of mistakes are, and then try to do something about that specifically.
Hilary Hendershott: Fantastic. Sounds perfect timed for this episode airs that people could spend some time thinking about broad strokes. What are the things that you’re doing right, what are the things that you’re doing wrong, and where do you want to improve instead of trying to be, as Dan said, as rational on a daily basis? Thank you so much for being here. It’s an honor to have you on the podcast. I’m excited for your book. I’ve read all of your books and recommend that my listeners do the same and we really appreciate your presence.
Hendershott Wealth Management, LLC and Profit Boss® Radio do not make specific investment recommendations on Profit Boss® Radio or in any public media. Any specific mentions of funds or investments are strictly for illustrative purposes only and should not be taken as investment advice or acted upon by individual investors. The opinions expressed in this episode are those of Hilary Hendershott, CFP®, MBA.