amount in certain funds at set intervals, so you’ll buy
more when prices are low—and you won’t be tempted to
yank your money in and out as prices go up and down.)
Ariely has a tip for fighting loss aversion: If you go out
regularly for meals with someone, alternate paying the bill.
The person who pays will feel a little more pain, but not
twice as much. When you split the check, you both suffer.
In taking turns, the person who doesn’t pay is freed from
the pain of loss. Assuming the bills are about the same, you’ll
spend the same amount of money, but you’ll cut the number
of spending transactions in half. “These are the tricks we can
play with ourselves to make ourselves feel better,” he says.
From a financial
perspective, playing the
lottery is a bad bet. But
millions of us do it anyway, even though we usually lose money. This is
the flip side of the loss-aversion principle: The
lure of a huge payoff
overcomes our resistance
to drop a few bucks on a
(probably) worthless ticket. As economists put it, we
“overweight low probabilities.” That’s also why we buy
insurance for things like flight accidents, even though the
average American’s annual risk of dying in a commercial-airline crash is about one in 11 million.
The Effect
OUR BRAINS AREN’T REALLY WIRED to intuitively grasp the insignificance of very small
odds. But there are ways to turn the urge to
gamble on long shots to our advantage.
Harvard Business School economist Peter Tufano recently studied a savings plan called Prize-Linked Savings (PLS),
which uses a lottery to encourage people to save money.
Here’s how it works: Credit-union members open savings
accounts that pay less interest than normal accounts, but
each time members make a deposit, they are enrolled in a
lottery where they stand a small chance of winning a much
larger sum. And, unlike in a conventional lottery, they never
lose money. A group of Michigan credit unions started a
PLS program called Save to Win in 2009, but other states
currently don’t allow PLS-type plans, which are seen as
competitors to existing state-run lotteries.
Quick! Would you rather have $50 today or $52
in a week? Studies show
that most people take the
money now. But getting
$52 a week later is the
equivalent of earning 200
percent interest annually.
If your bank offered that
rate, you’d surely take it.
Researchers have conducted this now-or-later experiment with real money and
with pieces of chocolate (the latter study was published
last year in the journal Economics Letters) with the same
results: Our guts tend to be impatient. Economists call that
hyperbolic discounting, and it explains everything from drug
addiction to the slow response to global warming. “One of
the classic examples of this is people not saving enough for
retirement,” says Eric Johnson. Shortsightedness might have
made sense to our ancestors, who lived in a world of immediate threats. But it complicates our long-term planning today.
The Effect
JUST REVERSE THE QUESTION: “Imagine you
could have $52 in a week. Would you rather have $50 now?” Johnson asks. Phrasing
it that way harnesses loss aversion: Now it
feels like we’re losing $2. (CONTINUED ON PAGE 82)
COUR TESY OF ED WARD ADELSON; OPENING-PHO TO PROP S T YLIS T: ANNA MILNER
DON’T BELIEVE
YOUR EYES
Can you tell that square A on this checkerboard is the same exact
shade of gray as square B? To prove it, block off all the surrounding
squares. This perceptual illusion by MIT cognitive scientist
Edward Adelson demonstrates how bad our brains are at
judging absolute values. For William Poundstone, who
reproduces Adelson’s illusion in his book Priceless, it’s
also the perfect analogy for our imperfect sense of
financial value. “The way we relate to money is
very similar to the way we relate to light or sound,”
he says. “We see only contrasts, not absolutes.”
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