1 00:00:01,630 --> 00:00:06,087 In this section, we're going to talk about the psychology of money. 2 00:00:06,088 --> 00:00:09,882 There's a little joke that a group of people is waiting at the bank to do all 3 00:00:09,882 --> 00:00:14,227 kinds of transaction, get money and so on. All of a sudden, two robbers come in. 4 00:00:14,228 --> 00:00:17,290 They point their guns. They try to rob the bank. 5 00:00:17,290 --> 00:00:21,192 They do all kind of things. Unintentially, one of them, as they move, 6 00:00:21,192 --> 00:00:24,818 puts his masks out, and all of a sudden his face is visible. 7 00:00:24,818 --> 00:00:29,654 He puts his mask back on and he turn to the person next to him and says, did you 8 00:00:29,654 --> 00:00:31,766 see my face? The person says, yes. 9 00:00:31,766 --> 00:00:35,798 Boom, he shoots him dead. He turns to the next person and says, did 10 00:00:35,798 --> 00:00:38,105 you see my face? The person says, yes. 11 00:00:38,105 --> 00:00:42,764 Shoots him dead. He turns to a third person, a woman, and 12 00:00:42,764 --> 00:00:47,790 he says, did you see my face? And the woman says, I did not, but my 13 00:00:47,790 --> 00:00:51,957 husband did. What is the psychology of money? 14 00:00:51,958 --> 00:00:55,647 When we think about money, money's all about the opportunity cost. 15 00:00:55,648 --> 00:00:59,300 Every time we buy something, we buy a sandwich, it's about what we are not going 16 00:00:59,300 --> 00:01:03,096 to be able to do in the future. If you buy one thing, the money would come 17 00:01:03,096 --> 00:01:06,321 up from somewhere. But this opportunity cost is something 18 00:01:06,321 --> 00:01:10,810 that is very hard for us to envision, very hard to, hard for us to think about, very 19 00:01:10,810 --> 00:01:14,627 hard, for us to actually realize the trade-off that we're making. 20 00:01:14,628 --> 00:01:18,910 So instead, what do we do as human beings? We look at all kinds of shortcuts. 21 00:01:18,910 --> 00:01:22,355 All kinds of other things that we could do with money, to make us feel that we're 22 00:01:22,355 --> 00:01:26,250 making the right decision. This is why we do things, like we care 23 00:01:26,250 --> 00:01:29,016 about the method of payment that we're using. 24 00:01:29,016 --> 00:01:32,770 We look at relativity. We look at relative prices. 25 00:01:32,770 --> 00:01:37,326 We do all kinds of other things that are not perfectly rational, but at least makes 26 00:01:37,326 --> 00:01:40,279 us feel that we're making the right decision. 27 00:01:40,280 --> 00:01:44,854 And my hope is that, by the end of this section, you will not just better 28 00:01:44,854 --> 00:01:49,745 understand the psychology of money, you might actually be able to make slightly 29 00:01:49,745 --> 00:02:21,346 better decisions with your own money. Hi. 30 00:02:21,346 --> 00:02:26,080 Today, I want to talk a little bit about the psychology of money. 31 00:02:26,080 --> 00:02:29,847 Now, this might seem strange, because after all, we use money all the time. 32 00:02:29,848 --> 00:02:34,144 We use it day in and day out, over time, lots of kind of payments, cash, credit 33 00:02:34,144 --> 00:02:37,012 cards and so on. And because we use it so much, we might 34 00:02:37,012 --> 00:02:40,940 think we're experts in using money. But I want us to question this. 35 00:02:40,940 --> 00:02:45,000 I want us to go back a little bit, and I want us to ask, are we really, do we 36 00:02:45,000 --> 00:02:49,240 really understand how money works? Do we really kind of figure out how it 37 00:02:49,240 --> 00:02:53,720 works, what kinds of tricks it has, how we use it, how it influences what we're 38 00:02:53,720 --> 00:02:56,360 willing to do? But before we say some bad things about 39 00:02:56,360 --> 00:03:00,104 money, my mother always told me that it's always nice to say something good. 40 00:03:00,105 --> 00:03:03,210 To start with, so let's talk about some good things. 41 00:03:03,210 --> 00:03:08,765 So, money is an incredible invention. Just think to yourself how the world would 42 00:03:08,765 --> 00:03:12,147 look like without money. We would probably have to do barters all 43 00:03:12,147 --> 00:03:15,417 the time. We might grow broccoli and somebody else 44 00:03:15,417 --> 00:03:20,592 might raise chickens and we would have to take our broccoli and go to the chicken 45 00:03:20,592 --> 00:03:23,810 farmer and try to trade. How much broccoli for how much chicken? 46 00:03:23,810 --> 00:03:26,722 Do you they want some broccoli today or not? 47 00:03:26,722 --> 00:03:32,652 The world would be incredibly difficult if we had to do barters on a domain by domain 48 00:03:32,652 --> 00:03:37,236 in domain by domain abil, way. Now, what does money do? 49 00:03:37,236 --> 00:03:42,660 Money creates a central mechanism that everything could be traded of. 50 00:03:42,660 --> 00:03:47,220 We can trade broccoli for money, and then money for chicken, and so on and so forth. 51 00:03:47,220 --> 00:03:50,120 So now, we don't need to worry about all of those exchanges. 52 00:03:50,120 --> 00:03:54,877 We can just do one exchange with money. So, from that perspective, it's amazing to 53 00:03:54,877 --> 00:03:59,500 think about what an invention money has been, and how it helps the market operate 54 00:03:59,500 --> 00:04:02,110 in a much more efficient and wonderful way. 55 00:04:02,110 --> 00:04:07,044 I think it's a, at the level of the wheel. Like it's a, such an important invention 56 00:04:07,044 --> 00:04:09,882 for society. Okay, so now that we've said something 57 00:04:09,882 --> 00:04:14,284 good about money, let's start examining the bad side about mar, money and the, all 58 00:04:14,284 --> 00:04:19,208 kind of the challenges that we have. So psychologically, what is money about 59 00:04:19,208 --> 00:04:25,005 and how should we think about money? Well, money's all about opportunity cost. 60 00:04:25,005 --> 00:04:30,771 Every time you spend $2.50 on a cup of coffee, what should you be thinking to 61 00:04:30,771 --> 00:04:34,387 yourself? You should be thinking about what else 62 00:04:34,387 --> 00:04:39,190 could you have done instead. Where is this money coming from? 63 00:04:39,190 --> 00:04:44,773 Would it have been best spent on a cup of tea today and a cookie tomorrow? 64 00:04:44,773 --> 00:04:49,850 So when the tea and cookie sum the same amount, should you save it for a long time 65 00:04:49,850 --> 00:04:54,842 and go to the movies in 15 years or maybe buy a slightly different stereo in, 35 66 00:04:54,842 --> 00:04:58,155 years from now? Every time you're buying something, it's 67 00:04:58,155 --> 00:05:02,187 about what are you giving up, and what else could you do if you did not take this 68 00:05:02,187 --> 00:05:05,114 action. And of course, thinking about money this 69 00:05:05,114 --> 00:05:08,794 way is incredibly difficult. You can ask yourself, when was the last 70 00:05:08,794 --> 00:05:12,729 time that you thought about opportunity cost, that you made those trade-offs? 71 00:05:14,010 --> 00:05:17,537 In fact, we went to a Toyota dealership a few years ago. 72 00:05:17,538 --> 00:05:21,660 We went to a dealership and we got people who were just about to buy a new car. 73 00:05:21,660 --> 00:05:26,010 And we said, please tell us, what are you giving up? 74 00:05:26,010 --> 00:05:30,014 If you go ahead and buy this car, what would you not be able to do? 75 00:05:30,015 --> 00:05:32,175 And people gave us no answer. Why? 76 00:05:32,175 --> 00:05:35,437 Because nobody thought about it. They kind of, stumped them. 77 00:05:35,438 --> 00:05:38,140 You know, what, what do you mean something would, would give up? 78 00:05:38,140 --> 00:05:41,505 But then, we insisted. We said, hey, something we'll have to give 79 00:05:41,505 --> 00:05:43,677 up. What are you going to give up? 80 00:05:43,678 --> 00:05:47,915 And the most people would, would give us, the most they told us is that they buy a 81 00:05:47,915 --> 00:05:52,330 Toyota, they can't buy a Honda. Which means that they made a substitution 82 00:05:52,330 --> 00:05:55,469 in the same time frame in the same category. 83 00:05:55,470 --> 00:06:01,271 Now, what people should have said is that, this amount is equivalent to what I would 84 00:06:01,271 --> 00:06:06,406 have to give up by two weeks of vacation for the next four years, and 700 lattes, 85 00:06:06,406 --> 00:06:09,795 and 37 books. Something like that, which is across time 86 00:06:09,795 --> 00:06:13,906 and across many categories. But the fact is, it's incredibly hard to 87 00:06:13,906 --> 00:06:15,692 work this way. So, we don't. 88 00:06:15,692 --> 00:06:21,156 Now, there's another thing to think about money, which is the way that we have money 89 00:06:21,156 --> 00:06:24,990 functioning in our environment makes it more difficult. 90 00:06:24,991 --> 00:06:29,623 So imagine, for example, that we I was in charge of your finances and every week I 91 00:06:29,623 --> 00:06:33,978 would give you an envelope with cash, and this was the cash that you had to spend 92 00:06:33,978 --> 00:06:39,704 during that week and you had nothing else. What will happen in the beginning of the 93 00:06:39,704 --> 00:06:43,204 week? You would feel that you could pay for a 94 00:06:43,204 --> 00:06:46,947 cab and buy a sandwich, and get beer, and get a new shirt. 95 00:06:46,948 --> 00:06:51,650 But as the money, as the amount went down and down and down, you would realize your 96 00:06:51,650 --> 00:06:55,344 trade-offs to a higher degree. You would say, if I buy this, I can't buy 97 00:06:55,344 --> 00:06:58,078 that. And the trade-off would become that much 98 00:06:58,078 --> 00:07:00,520 more clear. Now, that would work out if I gave you 99 00:07:00,520 --> 00:07:03,080 money for a week. And it would only probably really kick in, 100 00:07:03,080 --> 00:07:06,770 in the last few days. What if I gave you money for the whole 101 00:07:06,770 --> 00:07:09,065 year? Now, it would be really difficult to think 102 00:07:09,065 --> 00:07:11,590 about this. But, what if the world looks like the 103 00:07:11,590 --> 00:07:14,360 current economy in which I gave you credit cards? 104 00:07:14,360 --> 00:07:18,680 And I made, I gave you student loans and mortgages and car payments. 105 00:07:18,680 --> 00:07:23,510 And now, in that environment, what would have been the horizon of your pain? 106 00:07:23,510 --> 00:07:27,109 You see, if you get an envelope with a fixed amount of money, that's your 107 00:07:27,109 --> 00:07:29,990 horizon. It's easy to see the cost and benefit. 108 00:07:29,990 --> 00:07:31,670 It's easy to see the trade-off that you're making. 109 00:07:31,670 --> 00:07:36,695 But if you don't have a clear horizon, it's saving for a retirement not really 110 00:07:36,695 --> 00:07:41,345 clear how long I would live, I have all these student loans, and I have these 111 00:07:41,345 --> 00:07:45,100 mortgage. The horizon is so unclear, the trade-offs 112 00:07:45,100 --> 00:07:50,196 that we're making are less clear. So, the point is that we are supposed to 113 00:07:50,196 --> 00:07:54,620 be thinking about money in a, a, a trade-off analysis. 114 00:07:54,620 --> 00:07:58,520 We're supposed to think about the opportunity cost, or what sometimes called 115 00:07:58,520 --> 00:08:01,202 the shadow value of price, the shadow value of money. 116 00:08:01,202 --> 00:08:06,220 But, it's hard to do anyway. And the financial environment that we've 117 00:08:06,220 --> 00:08:08,974 created makes it even harder to think this way. 118 00:08:08,974 --> 00:08:13,468 So, what do we know in general when people face a problem that is too difficult to 119 00:08:13,468 --> 00:08:16,467 compute, too difficult to figure out the right way? 120 00:08:16,468 --> 00:08:20,840 We take some shortcuts. We figure out other ways to do it, not the 121 00:08:20,840 --> 00:08:26,836 right ways but at least some, some ways. And this is what I want to talk about. 122 00:08:26,836 --> 00:08:31,930 And this cartoon clearly indicates the idea of opportunity cost. 123 00:08:31,930 --> 00:08:34,370 Not in the domain of money, but in another domain. 124 00:08:34,370 --> 00:08:38,396 It says, we found, we really missed going to the theater and eating in nice 125 00:08:38,396 --> 00:08:43,020 restaurants, so we gave our kids away. Because kids are the ultimate opportunity 126 00:08:43,020 --> 00:08:45,035 cost. You get kids, there's lots and lots of 127 00:08:45,035 --> 00:08:48,108 things you can't do. But even with kids, many people don't 128 00:08:48,108 --> 00:08:51,487 think about it up front about what they're going to give up. 129 00:08:51,488 --> 00:08:56,468 Here is one experiment that very elegantly illustrates this problem that we have with 130 00:08:56,468 --> 00:09:00,080 thinking about opportunity cost. So, imagine that you gave it, you were 131 00:09:00,080 --> 00:09:03,737 given a choice. And you said would you prerfer to buy a 132 00:09:03,737 --> 00:09:08,470 Sony stereo system for $700 or a Pioneer system for $1000. 133 00:09:08,470 --> 00:09:13,716 And basically, what you are being asked in this question is, how do you value of the 134 00:09:13,716 --> 00:09:18,922 quality of the two stereos compared to the saving the financial savings of $300? 135 00:09:18,922 --> 00:09:25,460 How much is the Pioneer better than the Sony, and how useful is the $300 for you? 136 00:09:25,460 --> 00:09:29,217 That's one setup. And in that particular setup, lots and 137 00:09:29,217 --> 00:09:34,730 lots of people choose the Pioneer system. In the second set up, it was given in a 138 00:09:34,730 --> 00:09:39,316 slightly different way. It says, would you like to pay a $1,000 139 00:09:39,316 --> 00:09:43,397 for this Sony stereo or a $1,000 for the Pioneer stereo? 140 00:09:43,397 --> 00:09:49,572 But if you pay a $1,000 dollars for the Sony stereo, you also get $300 to spend on 141 00:09:49,572 --> 00:09:51,810 CDs and DVDs. Now, think about it. 142 00:09:51,810 --> 00:09:56,006 This second phrasing. You take the same $300 you had before when 143 00:09:56,006 --> 00:10:00,943 you only spent $700 on this Sony station, on this Sony, stereo. 144 00:10:00,944 --> 00:10:05,315 But now, this $300 goes only for CDs and DVDs. 145 00:10:05,316 --> 00:10:10,607 From the rational perspective, the second case is less appealing. 146 00:10:10,608 --> 00:10:15,636 Because the Sony includes $300 you can only spend on CDs and DVDs, when the first 147 00:10:15,636 --> 00:10:20,417 case, you could have taken this $300 and spend it on anything else you want. 148 00:10:20,418 --> 00:10:23,866 But what happens? Now the Sony Studio looks even more 149 00:10:23,866 --> 00:10:27,154 appealing than the previous case. Why is it? 150 00:10:27,155 --> 00:10:32,504 It's because when you think about the representation of $300, right? 151 00:10:32,504 --> 00:10:37,910 Sony for $700 plus $300. This representation doesn't include a lot. 152 00:10:37,910 --> 00:10:42,455 It's a general fuzzy topic. What exactly am I getting with $300? 153 00:10:42,455 --> 00:10:45,466 But, in fact, what you could do is you could take this $300. 154 00:10:45,466 --> 00:10:48,418 And you could make them concrete in one domain. 155 00:10:48,418 --> 00:10:53,524 And while, generally, they'll be worthless than more now that you have one domain, 156 00:10:53,524 --> 00:10:58,630 you can think about them in more concrete way, and you can actually get more excited 157 00:10:58,630 --> 00:11:01,310 about it. I'll give you one more example of this. 158 00:11:01,310 --> 00:11:06,660 Can you imagine that you like coffee? I assume most of you like coffee. 159 00:11:06,660 --> 00:11:10,453 And let's say that they, the price for a cappuccino is $3. 160 00:11:10,453 --> 00:11:16,356 Can you imagine that I could get you to do something for me, for a cappuccino, that 161 00:11:16,356 --> 00:11:21,364 you would not be willing to do for $3? And if that's the case, and many people 162 00:11:21,364 --> 00:11:26,332 report that this is the case, that means that the representation of the cappuccino 163 00:11:26,332 --> 00:11:30,232 is somehow worth more in your mind than the preservation of $3. 164 00:11:30,232 --> 00:11:34,796 Even though you could take the $3 and buy a cappuccino or you could buy all kinds of 165 00:11:34,796 --> 00:11:39,420 other things, the representation, the hedonic value, the emotional appeal that 166 00:11:39,420 --> 00:11:43,462 we have from a cappuccino is higher than the emotional appeal for $3. 167 00:11:43,462 --> 00:11:48,570 So what this, going back to the Sony and the Pioneer example, what this suggests is 168 00:11:48,570 --> 00:11:53,486 that we just have money in the equation. It's not as valuable because it's about 169 00:11:53,486 --> 00:11:55,440 opportunity cost. It's general. 170 00:11:55,440 --> 00:11:59,296 We don't know how to think about it. And because of that, we could take that 171 00:11:59,296 --> 00:12:04,444 amount of money, make it specific, make it concrete, make it less valuable from 172 00:12:04,444 --> 00:12:08,810 economic perspective. But nevertheless, have a higher perceived 173 00:12:08,810 --> 00:12:12,811 value for it. And with that, change how people make 174 00:12:12,811 --> 00:12:13,854 decisions.