We all know the saying, “Money doesn’t buy happiness.” But why is that? Surely if we had more money, we could buy the things we want and need, and be happier as a result, right?
It turns out that there is a lot of psychology behind our spending, saving, and investing habits. And it explains why, even when we have more money, we don’t always end up happier.
Here’s a look at some of the key psychological factors that influence the way we handle money.
The sunk cost fallacy
One of the most important psychological factors that influences the way we spend money is what’s known as the sunk cost fallacy.
Basically, the sunk cost fallacy is the tendency to continue investing in something as long as we have already invested a lot of time or money, even if it’s clear that it’s not a good investment.
For example, let’s say you buy a new car for $30,000. After a few years, the car starts having a lot of problems and it’s clear that it’s not going to last much longer. You start looking at new cars and see that you could get a much better car for the same price.
But even though it would make financial sense to trade in your old car for a new one, you might not do it because you feel like you’ve “sunk” $30,000 into the car and you don’t want to lose that money.
Of course, the $30,000 is already gone and you can’t get it back, no matter what you do. But the sunk cost fallacy makes us think that we need to keep investing in something, even when it’s not a good investment, because we don’t want to “waste” the money we’ve already spent.
The endowment effect
Another important psychological factor that influences the way we spend money is the endowment effect.
The endowment effect is the tendency to value something more highly just because we own it.
For example, let’s say you’re considering buying a new coffee maker. You see one that you like for $100. But then you find another one that’s exactly the same, but it’s on sale for $50.
Which one are you more likely to buy?
If you’re like most people, you’ll probably buy the more expensive one. Even though it’s the same product, we tend to value it more highly just because it costs more.
The endowment effect also explains why people are often reluctant to sell things they own, even when they’re not using them.
For example, let’s say you have an old bike that you never ride anymore. Someone offers to buy it from you for $50. Even though you don’t need or want the bike, you might be reluctant to sell it because you feel like it’s worth more than $50 to you.
The anchoring effect
The anchoring effect is another important psychological factor that influences the way we spend money.
The anchoring effect is the tendency to base our decisions on a reference point, even if that reference point is not relevant.
For example, let’s say you’re buying a new car. The salesperson tells you that the car is $30,000. You start to negotiate, and eventually you agree on a price of $27,000.
You might think that you did a good job of negotiating, but you probably didn’t. The reason is that the salesperson used an anchor price of $30,000, which influenced your decision-making.
Even though $27,000 is a lower price, it’s still higher than you would have paid if the salesperson hadn’t used $30,000 as an anchor.
The bottom line
These are just a few of the key psychological factors that influence the way we spend, save, and invest our money. Understanding these factors can help you make better financial decisions and avoid making common mistakes.