3 misunderstandings about money that cost a lot in the long run

Analysis: we can learn a lot from the psychology of financial decisions to help avoid losing money

By Deirdre Robertson , ESRI

Money. We all use it. Many of us misunderstand it. At the Behavioural Research Unit in the ESRI, we study the psychology of financial decisions to understand how to help people avoid losing money.

Here are 3 misunderstandings that cost a lot in the long run:

"It's only a few pennies-a-day"

We all learned to add and subtract in primary school but we’re not very good at adding up lots of small numbers. When behavioural scientists ask people to quickly tot up a grocery bill or energy bills for the year, people think they are about 5 to 10% less than they really are. This might not sound much but most of us have many subscriptions and monthly bills such as streaming services, phone, insurance and the gym. Some providers even charge more overall if you pay by month than a once-off payment. If we underestimate all of them by 5 to 10%, we won’t realise just how much we are paying.

One US survey found that many people who used the gym infrequently could pay $85 per month at a cost of $1,020 per year instead of a one-off payment of $850 per year. We sometimes pay monthly bills if we don’t have the full amount but the same study found that those infrequent gym goers still paid monthly but could have saved $600 by buying 10-visit passes for $100 each instead. Using a calculator to add up your monthly bills and maybe saving up to pay one bill upfront could save you a lot of dosh.

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From RTÉ Radio 1's Drivetime, ESRI's Dr Deirdre Robertson on the psychology of money and long-term spending and savings

One of these fivers is not like the others

Two plus two equals four, €5 is always worth €5. Only it isn’t in our minds. We don’t tend to value money consistently. One of the most famous experiments that tested this asked people to imagine they were lying on a beach on a hot day and that their friend had offered to go and buy them beers. The friend wanted to know how much they were willing to pay. Some people were told that the nearest place to buy a beer was a local corner shop. Others were told that the nearest place was a fancy hotel.

The people who thought they were buying from a local corner shop were willing to pay, at today’s prices, around €4. The people who thought they were buying from a fancy hotel were willing to pay over €7. Now of course we might not expect to get a beer from a fancy hotel for less than €7. But in that case, we should be willing to pay €7 for the beer from the local corner shop as well.

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From RTÉ Radio 1's The Nine O'Clock Show, Sarah Adekola's discusses money management, common pitfalls and the importance of savings

The reason we aren’t, is that we don’t just think about price when buying something: we are also influenced, sometimes unknowingly, by how fair we think the price is and by anything that signals quality. This makes it very easy to influence us into paying more by indicating that something is high quality, even when it’s not. Be wary of sales pitches that suggest a difference in quality where there isn’t one.

The unintuitive nature of exponential growth

Imagine you share a post online and 10 of your friends reshare it. The next day 10 each of their friends share it, the next day 10 each of their friends share it and so on. How many days will it take for the video to reach 10 million shares? Within one week, a video that started with ten shares can end up being shared by 10 million people because (10)7 = 10 million. If the speed surprises you, you’re not alone. One thing we know about human psychology is that most people find that kind of exponential growth very hard to comprehend. But what does this have to do with money?

Read more: 3 common traps to avoid with loans and credit cards

Let’s take a pension. Imagine you are 30 and deciding whether to start a pension now or wait. There might be lots of reasons to delay, but one should not be that you’ve underestimated the cost. Let’s forget tax relief, fees and all other features of a pension. Let’s just imagine you have an account that gives you 5% interest every year. If you start at 30 and save €100 per month, you would end up with around €110,000 by age 65. If you wait 5 years, you would have an extra €6,000 to spend in those five years, but nearly €30,000 less by age 65. That €6,000 may be important to you now so that may be a reason to delay, but if the only reason is that you don’t think five years will make much difference, think again.

We are trying to understand more about how people in Ireland make financial decisions so that we can help people get better deals. We are looking for volunteers to do two short, online, anonymous surveys. The surveys are for anyone with a mortgage, loan, credit card or current account and for anyone who may get one of these in future. Everyone who takes part will get access to a new webpage that takes a user-friendly and fun way to show you how to get a better deal.

Dr. Deirdre Robertson is a senior research officer in the Behavioural Research Unit of the Economic and Social Research Institute. She is an Adjunct Associate Professor in the School of Psychology at TCD and a former Irish Research Council awardee.

The views expressed here are those of the author and do not represent or reflect the views of RTÉ