A Nobel Laureate’s advice on how to spend your money

Are you good at managing your money? Do you make your purchasing decisions on rational grounds? With your long-term benefits in mind? If your answers are yes here, you might have to think again, at least if you are to believe this year’s winner of the Nobel Memorial Prize in Economic Sciences, Richard H Thaler…

Humans are complicated beings, not least in the way we spend our hard-earned money. Often we make impulse buys (even when we know we ought to save our money), buy more items than we need (because we think we are getting a good deal) and we do not always understand what is best for us when it comes to how we should invest our money (if we have that opportunity).

This is due to limited rational thinking abilities and a lack of self-control. Our only hope is that an exceptionally clever person in our vicinity will nudge us in the right direction and make us think more wisely about this.

This is, very generally, the core thinking in Richard H Thaler’s research, this year’s Nobel Prize winner in Economic Sciences. Thaler, and his research in behavioural economics, has proven that we are far from the rational, long-term thinking, controlled decision-makers we would like to think we are. His research has been ground-breaking when it comes to how you use psychological insight in economic decision-making, both on a personal level but also in society in general.

Below are a few examples from our everyday life where our rational thinking might be disputed:

• You have most likely, on numerous occasions, fallen for the tempting offer of “three for the price of two”, even though you were actually only planning to buy one (or perhaps none!) of these items. You pat yourself on the shoulder thinking you have landed yourself a really good deal, when in fact you have just spent twice as much money as you were planning to do. A question you might like to ask yourself is: why are they not selling this item at a discount instead and let you decide whether you then would like to buy one, two or three…?

• Imagine you have decided to buy a new watch costing £ 100 and while you are standing there in the shop, about to reach for your wallet and pay for it, you find out that just a few blocks away, another shop is selling this very same watch for £ 90. It is quite likely that you will then put the watch down and go to the other, cheaper shop to make your purchase. If on the other hand you were out to buy a 50 inch TV, costing £ 1,000 in the store of your choice, and you found out that the same TV cost £ 990 in a another shop nearby, you would probably not think it is worth going to the other shop, you might as well just buy it here and now. The financial gain would be the same, yet your decisions are different. The explanation is that in the first case with the watch, you would save 10 percent and in the case of the TV, you would only be saving a measly one percent. The fact that the actual money saved is the same is something that you neglect to see…

• You have decided to save up for a holiday next summer, a new car, your dream house or for your retirement… Then all of a sudden you stumble across this stunning (and very expensive) coat in a shop window and you simply cannot resist your impulse to buy it. A short-term temptation makes you forget your long-term intentions and in a flash a few months’ savings go out the window. 

These are examples regarding our private economy, but Thaler’s research has also had a big impact on a socio-economic, national level, where it has become apparent that a “friendly nudge” in the right direction can mean more than rational arguments and suggestions:

• In the UK, house owners were encouraged to insulate their attics, as an energy-preserving measure. This was not a very successful appeal, despite information campaigns and offers of large subsidies. With Thaler’s help, they discovered that the reason people were hesitant to accept these offers was that their attics were full of large amounts of stored junk which needed to be cleared out. When the local authorities offered to help remove the junk, they received five (!) times as many applications.

• The tax morale was also dramatically improved with the help of a small “nudge”. When the authorities sent out a polite and friendly letter (instead of threats of visits from the bailiff, for example), where they reminded people that “most people in your area have already submitted their tax returns and paid their taxes”, the ambition to pay increased considerably.

• In the US, Thaler’s research has been used to successfully convince millions of people to start pension savings. People who did not feel they could afford to put anything away in savings at the time still agreed to save some of their future pay rises in pension funds. It is easier to give up something you might have in the future than to give up something you have today.

So what has all of this got to do with leadership, you might wonder? Well, we humans do not always make rational decisions for the simple reason that we are just that, humans who sometimes let our emotions govern us. Always evaluating all the alternatives we might have, and their potential long-term consequences, is simply a nearly impossible task. To be able to make any decisions at all, we must narrow our focus and simplify our rules around decision-making. And then things sometimes go wrong.

However, as a leader, you are always able to offer a ”friendly nudge” in the right direction…

PS 1. To “buy three, pay for two” is of course not always a bad idea. Tinned tomatoes, for example, will last more or less forever and will always come to use.

PS 2. What you have just read is of course a much, much, much simplified description of Richard H Thaler’s research. For those of you wanting a more extensive account, you may find this here (which is also where I have found my references and inspiration):

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