How To Save (Or Waste) Money

And some of the ways we make suboptimal decisions

We may think we make good decisions but research over the years and decades has shown there are many ways in which our brains trick us into making suboptimal decisions - particularly in financial scenarios.

Recently on a trip to the UK we were sitting at a car hire centre very late at night after a long day’s travel behind us (myself and my family). I was waiting for my turn and was thirsty and wandered over to the vending machine to see that a small bottle of water cost £4. What! I exclaimed; I’m not paying that for a bottle of water!

You may think that was a reasonable reaction but there were a number of factors that influenced that decision many of which could be considered irrational – and ironically knowing a thing or two about decision making I should know better. Indeed, I do know better but that gut feeling is still hard to go against.

So, what was happening with this decision?

Is £4 reasonable for a bottle of water for tired and thirsty traveller? Would I have paid £2? Yes, I certainly would have. Would I have paid £3. Probably. So, it seems like the extra £1 was what blocked me. But is £1 really that much to ask for a tired and thirsty traveller?

In this particular example there are two decision-making factors at play. First is anchor points. Second is proportionality. Both of these are very important in all decision-making scenarios and particularly in corporate contexts.

Anchoring

Anchoring is a term used commonly in behavioural finance. It describes the effect of creating an “anchor”, a starting point, against which everything that follows is compared.

Anchoring is used often in negotiations particularly when starting points are not known. Anchors can also be indirect. For example, in one common experiment participants are asked to estimate the population of a country like Mongolia (to which most people are pretty clueless). Without giving an indirect anchor, answers vary wildly from a few million to dozens of millions.