You’re So Irrational!

We like to think of ourselves as sensible, but when it comes to money (among other things), we’re frequently not. Many books on behavioral economics or behavioral finance offer examples, experiments and explanations — and are fun to read.

For instance, we may drive across town to save a few dollars on a small item we want to buy, but then spend several thousand dollars on something else without shopping around for the best price first.

In an experiment, people were asked whether they’d rather earn $50,000, when everyone around them earned $25,000 — or $100,000, when everyone around them earned $200,000. Half chose the lower income, even though the higher one would have permitted them a nicer home and/or more nice things.

Also consider two stores trying to sell a $10 item. One advertises it at 50% off, and the other announces that it has been discounted by $5. Both stores are selling it for $5 now, but consumers, irrationally, are more likely to be drawn to the 50%-off sale, as it seems like a deeper discount.

“Anchoring” means to fixate on a certain price or number. In investing, we may anchor on our purchase price for a stock and refuse to sell shares at a lower price, even if the company is struggling. This effect also leads us to view a $4 cup of coffee as reasonably priced if there’s also a $6 coffee available.

The “bandwagon effect” has us following the crowd too closely, jumping into stocks that have soared to unreasonable levels because we don’t want to be left out of any gains, or selling out of stocks in a market correction only because others are doing so.

Learn more about how your financial brain works so that you can thwart it when it’s behaving irrationally. Good books on the topic include “Misbehaving,” by Richard H. Thaler (W.W. Norton & Co., $17); “Why Smart People Make Big Money Mistakes and How to Correct Them,” by Gary Belsky and Thomas Gilovich (Simon & Schuster, $17); and “Predictably Irrational,” by Dan Ariely (Harper Perennial, $16).