Why Money Is Not Naked

The Art of Thinking Clearly - Rolf Dobelli 2014

Why Money Is Not Naked

House-Money Effect

A windy fall day in the early 1980s. The wet leaves swirled about the sidewalk. Pushing my bike up the hill to school, I noticed a strange leaf at my feet. It was big and rust-brown, and only when I bent down did I realize it was a 500—Swiss franc bill! That was the equivalent of about $250 back then, an absolute fortune for a high school student. The money spent little time in my pocket: I soon bought myself a top-of-the-range bike with disc brakes and Shimano gears, one of the best models around. The funny thing was my old bike worked fine.

Admittedly, I wasn’t completely broke back then: I had managed to save up a few hundred francs through mowing grass in the neighborhood. However, it never crossed my mind to spend this hard-earned money on something so unnecessary. The most I treated myself to was a trip to the movies every now and then. It was only upon reflection that I realized how irrational my behavior had been. Money is money, after all. But we don’t see it that way. Depending on how we get it, we treat it differently. Money is not naked; it is wrapped in an emotional shroud.

Two questions. You’ve worked hard for a year. At the end of the twelve months, you have $20,000 more in your account than you had at the beginning. What do you do? (a) Leave it sitting in the bank. (b) Invest it. (c) Use it to make necessary improvements, such as renovating your moldy kitchen or replacing old tires. (d) Treat yourself to a luxury cruise. If you think like most people, you’ll opt for A, B, or C.

Second question: You win $20,000 in the lottery. What do you do with it? Choose from A, B, C, or D above. Most people now take C or D. And of course, by doing so, they exhibit flawed thinking. You can count it any way you like; $20,000 is still $20,000.

We witness similar delusions in casinos. A friend places $1,000 on the roulette table—and loses everything. When asked about this, he says: “I didn’t really gamble away a thousand dollars. I won all that earlier.” “But it’s the same amount!” “Not for me,” he says, laughing.

We treat money that we win, discover, or inherit much more frivolously than hard-earned cash. The economist Richard Thaler calls this the house-money effect. It leads us to take bigger risks and, for this reason, many lottery winners end up worse off after they’ve cashed in their winnings. That old platitude—win some, lose some—is a feeble attempt to downplay real losses.

Thaler divided his students into two groups. The first group learned they had won $30 and could choose to take part in the following coin toss: If it was tails, they would win $9. If heads, they would lose $9. Seventy percent of students opted to risk it. The second group learned they had won nothing but that they could choose between receiving $30 or taking part in a coin toss in which heads won them $21 and tails secured $39. The second group behaved more conservatively. Only 43 percent were prepared to gamble—even though the expected value for both options was the same: $30.

Marketing strategists recognize the usefulness of the house-money effect. Online gambling sites “reward” you with $100 credit when you sign up. Credit card companies offer the same when you fill in the application form. Airlines present you with a few thousand miles when you join their frequent-flier clubs. Phone companies give you free call credit to get you accustomed to making lots of calls. A large part of the coupon craze stems from the house-money effect.

In conclusion: Be careful if you win money or if a business gives you something for free. Chances are you will pay it back with interest out of sheer exuberance. It’s better to tear the provocative clothes from this seemingly free money. Put it in workmen’s gear. Put it in your bank account or back into your own company.