Definition: When irrelevant information impacts our decision making process.
Example: Real estate.
Example: Market prices as an anchor for how much we value something.
Example: Salary negotiations (the first offer).
Reference: Tversky and Kahneman experiment (1974) - Wheel of Fortune as an anchor for questions about UN African Nations.
Reference: Drazen Prelec, George Loewenstein, and Dan Ariely experiment - Social Security Number as an anchor for prices people were willing to pay.
Insight: We find it difficult to challenge our previously held beliefs (anchors).
Insight:Herding (going with the crowd) and self-herding (basing personal decisions on previous decisions we have made) are dangerous consequences of anchoring.
Insight: Confirmation bias (when we interpret new information through the lens of our preconceptions) can result from anchoring to our previous decisions.
Insight: "The less we know about something, the more we depend on anchors."
Insight: More experience, knowledge, or research makes us less prone to anchors.
Insight: Anchoring is powerful with products that are first to market, where there is no reference price.
Insight: "Past decisions are no guarantee of future results. Or, to put the lesson another way: Don't believe everything you think."
Insight: Pricing anchors have a long term impact through arbitrary coherence: although an initial pricing anchor may be arbitrary, future prices are anchored to that initial arbitrary amount.
Insight: We have two rules when we consider our demand price for goods. We firstly determine the baseline price arbitrarily, but then later decisions are based on the initial (irrelevant) anchor, which makes those decisions irrational.
Definition: When we interpret new information in line with our preconceptions and expectations.
Example: We pick news outlets and information sources that confirm existing beliefs.
Insight: Choosing information sources, or being subjected to algorithms that confirm our existing beliefs is harmful for citizens and nations, as it polarises opinion.
Insight: We have a tendency to make new decisions that confirm our previous decisions.
Insight: Financial decisions are particularly prone to confirmation bias - we tend to assume that we made the best decision possible. As a result we tend to follow suit in the future.
Definition: The idea that we value what we have just because we own it.
Reference: Ellen Langer Harvard psychologist; Richard Thaler demonstrated the Endowment Effect in studies.
Example: Most people respond with opposite answers to the following two questions with exactly the same meaning but are framed differently: 1. Could you live on 80% of your current income? 2. Could you give up 20% of your current income.
Insight: Owners overvalue items and tend to want to sell at a higher price than market or that others are willing to pay.
Insight: The Endowment Effect is linked to Loss Aversion (Kahneman and Tversky), or the idea that we feel the pain of losing something more strongly than the pleasure of gaining the same thing. We don't want to lose what we own because we overvalue it, and we overvalue things because we don't want to lose them.
Insight: Tangible items are regularly subject to the endowment effect because they are easily visible.
Insight: We feel a strong sense of attachment and pride when we make something ourselves.
Reference: Richard Thaler introduced mental accounting and that we think about money in the same way organisations do to budget.
Insight: Mental accounting is irrational, but it can be useful if used well - it can help us plan finances and control spending.
Insight: When mental accounting rules are vague, they are malleable, and this can weaken our self-control - we create loopholes and often make poor financial decisions.
Insight: We have cognitive limitations with financial information and opportunity costs - mental accounting can be a useful heuristic to simplify decision making.
Insight: Mental accounting is not rational, but it is sensible.
Insight: Mental accounting occurs because we do not assign the same value to each one of our dollars (fungibility), we place them in categories - which leads to biased decision making.
Insight: If there is money left over in one of our mental accounts it is easy to spend it.
Insight: Mental accounting is a flaw in how we think about money - in a rational world we should treat money as fungible.
Definition: What we give away in order to do something. Alternatives. Opportunities we sacrifice.
Insight: We should consider opportunity costs every time we use money and make financial decisions.
Insight: When we spend money now, we should think about what we are giving up.
Insight: Our biggest money mistake is that we don't consider opportunity costs enough.
Insight: Considering opportunity costs is challenging because money is abstract.
Insight: We only compare the value of something with relatively few alternatives (competing products, similar items), which causes us to make irrational decisions.
Definition: The desire not to change anything.
Insight: Savings can be increased when we overcome the status quo bias, and take actions to automate increases in savings when we experience salary increases.
Definition: Any arrangement where we create barriers against future temptation. Where we give ourselves no choice.
Example: Preset limit on credit card.
Example: Superannuation or 401(k).
Insight: Ulysses contracts for savings are extremely effective.
