Have you ever made a New Year’s resolution to start saving for your pension, only to find that by the next year you haven’t managed to save a penny? Are you frustrated and bewildered by your own erratic shopping habits? 

 We all like to think that we’re rational creatures who make cool, informed decisions about everything in our lives. But when it comes to money, that simply isn’t true. As a small kid, we’re already becoming “financially socialized” by our parents, soaking up information about what money means and how to behave with it. By the time we grow up, money has become layered with our own complex associations and emotions. We link it to comfort, freedom, and security. It can make us feel exuberant, or filled with shame. No wonder we can’t make rational decisions – money pushes all our buttons!  

 In this post, you’ll have a chance to explore your own irrational thinking about money and become empowered to make better decisions about how you spend it, and what you spend it on. 

Money evokes strong feelings in all of us. 

 Imagine seeing a million dollars going up in flames in a bonfire, the enormous pile of crisp 50-dollar notes emitting belches of foul smoke as it burns away. How would you feel? Probably nothing short of unbridled horror and fury, right? 

 Well, that’s precisely what British art duo the K Foundation did in 1994: they lit one million pounds on fire. The motivation behind their action? To perform a conceptual art piece. 

 You’re probably asking why on earth two men would burn such a vast sum of money – money that could have been used to buy food for the hungry or houses for the homeless. How could they have been so selfish?  

 According to one of the art duo’s members, Bill Drummond, they hadn’t actually destroyed anything real. They’d burned a big pile of paper rather than, say, apples and bread.  

And therein lies the inherent contradiction of money. In a way, Drummond is right. Paper money in itself is valueless – or at least it would be if you lived on a desert island where there was nothing to buy.  

 But we don’t live on such an island. In reality, a million pounds can be exchanged for an enormous range of things. You could buy truckloads of apples or even create a huge apple orchard that could feed schoolchildren for generations to come.  

 If the K Foundation had destroyed a yacht, or a diamond ring valued at a million pounds, they may have received less of a backlash. But instead they destroyed something that was essentially a blank check for everybody’s dreams and aspirations. Understandably, this led to them facing a huge amount of controversy. 

 The backlash the art duo received derives from a simple truth: we all imbue money with meaning. We imagine what we could do with it, or how it could make our lives easier, happier, and more powerful. We resent others who have more of it. And we mourn the times we’ve lost it.  

 Money affects our lives so much that many yearn to enter a currency-free utopia. Imagine a world where we would never have to worry about mortgages – or how to buy a loaf of bread!  

 But maybe money itself is not the problem. Instead, maybe it’s how we allow it to unconsciously affect our choices and psychological states. We’ll examine our relationship to money and how it influences our life choices.  

We undergo financial socialization at a very young age. 

 We start learning about money at a very young age as we study the behaviors and responses of our parents. But just how young? 

 Well, in one experiment at a Finnish kindergarten, a group of six-year-olds were asked to create a theater play of their own design. All the decisions – from the story to the set to the casting – were theirs to make. Researcher Marleena Stolp observed them for six weeks, and she found that money dominated the kindergarteners’ conversations. They talked at length about what to charge for tickets and which merchandise they could sell to bring in extra income. This was despite the fact that financial considerations weren’t an explicit part of the task. Already, at the age of six, they held sophisticated insights about the need to generate money – and how to do so effectively.  

Even more strikingly, studies have shown that children already have fixed ideas about how money affects social status. In one study, children as young as five were shown two photographs and asked to imagine the inhabitants. One photo was of a run-down, shabby house with peeling paint; the other depicted a well-maintained, gleaming home. Middle-class children were quick to judge the inhabitants of the run-down house, positing that they were “lazy” and “mean.” They had already absorbed the social messages about what it means to have – or not have – money. 

Studies such as these show that young children absorb knowledge about money and its importance by observing us adults. So how can we provide them with a good basis for dealing with money?  

 We can start by being more open and honest with them. Researchers have found that many children reach adulthood with no idea what their parents earn or have saved. This can give them a warped idea of the household finances, and of how money works. Psychologist Neale Godfrey suggests remedying that by being explicit about household finances while your children are still young, and even taxing their pocket money to help them grasp how money works in the real world. 

 But even more important than what we say is what we do. Children are exquisitely attuned to the behavior of their parents. If we go on wild spending sprees, or are anxious around money, they will soak it up. At the end of the day, the best way we can give our children financial competence is to get our own affairs in order.  

We never grow out of our fascination with banknotes and coins. 

Do you remember when you first became aware of money? Perhaps a grandparent slipped you a crisp bill for your birthday. Or you started accumulating all the change you could find in a piggy bank. 

Small children value money as an object in itself. It’s shiny, decorated with heads and animals, and has a satisfying weight in the palm. Paper notes crinkle satisfyingly, sport exotic colors, and can be nestled in a wallet.  

As we grow up, that early fascination with money as an object remains. While we might like to think we have sophisticated ideas about saving and credit, we’re still irrationally attached to actual bills and coins.  

Money objects are imbued with great symbolic importance. That’s partly why people got so upset when the K Foundation burned that stack of bills. In countries like Australia and the United States, it’s even illegal to destroy or deface money.  

What money looks like is also a regular source of contention. Indeed, there are no debates more heated than those about whose head should be placed on banknotes. For example, when the Bank of England decided to replace abolitionist and prison reformer Elizabeth Fry with Winston Churchill on their five-pound notes, a furious exchange resulted. Feminist activists even received death threats for protesting the measure. This just goes to show how potent money is as a symbol of both nationalism and economic clout.  

And it helps explain why many European countries were affronted by the introduction of the Euro in 2002. Suddenly, the notes and coins that were so familiar to them were replaced with a completely unfamiliar currency. Part of the backlash was probably fueled by nostalgia, too. People wanted to keep using the money their parents and grandparents had used for generations.  

Currency changes introduce practical problems as well. When we are forced to switch to using money we don’t know, it can feel less real, like Monopoly money. And this means that we can underestimate what things really cost. Take Italy, for example. After the introduction of the euro, the general population assumed things had become cheaper. This was because euro prices were in single digits – in stark contrast to the Italian lira, which was measured in thousands. 

Banknotes and coins are sensually captivating and politically symbolic. But what happens when we start moving to credit and virtual money systems? How do we think about money then?  

Our savings are drying up as we become increasingly irrational with money. 

Since the day we were given piggy banks as kids, all of us have been aware of the importance of saving money. As we grow older, those messages are amplified into dire warnings about what will happen to us if we don’t start saving for retirement today! If that’s the case, how is it that so many of us find it difficult to save money – despite our best intentions? 

The rise of credit cards has been catastrophic to our abilities to save. In fact, personal debt in the United Kingdom tripled between 1990, when credit cards were widely introduced, and 2013. Why is this? Well, studies have shown that people value credit and cash differently. Although theoretically the money we’re spending is exactly the same, when we buy on credit it feels less real.  

This was confirmed in an experiment with MIT students, who were given the chance to bid on coveted tickets to a basketball match. Half were told they could only pay using cash, which they could withdraw from an ATM afterward. The other half could only use credit cards. Perhaps unsurprisingly, the cash group bid, on average, half of what the credit card group did.  

Not only are our conceptions of cash and credit irrational, we also have ideas about future spending that don’t measure up to reality. For example, we often imagine that we’ll start earning more in the future. This, of course, means we’ll be able to save more money. Such irrational optimism means that we’re consistently putting off saving till a hypothetical tomorrow – one where we’ll be earning big and have steely financial discipline.  

However, the truth is that behavior is very hard to change. The best indicator we have for how we’ll handle money in the future is how we’re dealing with it right now.  

But this doesn’t mean that we should throw up our hands and stop trying to save altogether! Being realistic about our behaviors gives us the opportunity to develop practical strategies that can actually work. For example, we can save money in accounts that penalize us for withdrawing it too early. Or participate in schemes like the Save More Tomorrow program, where you commit to saving an extra percentage of your income each time you get a pay rise. In the long term, you’ll end up greatly increasing your savings. 

We’re all prone to mental accounting when it comes to money. 

You’re in the supermarket stocking up on supplies. A good bottle of gin catches your eye, but you flinch at the price tag: it costs 20 dollars, which feels way too expensive! A week later you’re on holiday, about to order a gin and tonic on a sunny terrace. It costs 10 dollars, but you barely notice the price. In fact, it’s about time for a refill! 

Most of us make similarly inconsistent decisions about how we spend our money. The concept of monetary exchange is based on the idea that a dollar is worth the same amount in all circumstances, but that doesn’t take into account the inner workings of human psychology.  

All of us have what Richard Thaler calls “mental accounts” in our heads, where we divide up our money into different categories. For example, it’s common for people to have an “everyday expenses” account, a “groceries” account, a “travel” account, and so on. Mental accounting explains why the same person who pinches pennies in the supermarket is prepared to spend a small fortune on a drink: one purchase comes out of the “groceries” account, while another is taken from the “travel” account. The latter, according to our inner mental accountant, has much looser purse strings!  

In addition to mental accounting, we’re also prone to relative thinking. This involves us ascribing a different value to money in relation to the total amount we’re about to spend. For example, imagine you’re on holiday, and you want to rent a bike. You can either rent one for 25 dollars from a conveniently located rental place, or go 15 minutes out of your way to find one for 10 dollars. Most of us would almost certainly opt for the latter – after all, that’s the price of a good lunch en route!  

Now imagine you had the option of buying a car with the same 15 dollar reduction, but the total price is much higher – thousands of dollars. Unsurprisingly, most of us wouldn’t care enough to get the discount. After all, what’s 15 dollars when you’re already spending so much? In relative terms, not much at all.  

Mental accounting can be seen at work here, too. Chances are, the purchase of a car comes out of a much larger account than a recreational bike trip. 15 dollars could still buy a delicious lunch, but relative thinking means that it suddenly doesn’t seem worth the effort.  

We need to be aware of how confirmation bias shapes our perceptions. 

Rudy Kurniawan was making a fortune selling rare vintage wines, with sales topping 36 million dollars a year. Wearing his trademark white leather coat and forever carrying a fluffy French poodle, he cut an eccentric and striking figure. Influential people and millionaires relied on him to guide them toward the rarest and most delectable wines.  

But it turned out Kurniawan’s operation was a sham; in fact, he was selling cheap red wine with fancy-looking labels. What’s surprising is how long he was able to get away with it. Wine connoisseurs were completely fooled by his bluff despite having supposedly refined taste buds.  

The reason they were taken in is simple: humans have a powerful confirmation bias. This means that we will see, hear, or taste what we expect to encounter. Kurniawan’s sommeliers had been told they were about to taste an exquisite 50-year-old pinot noir worth thousands of dollars, so their taste buds were primed to taste something delicious – and, sure enough, they did.  

 A team of researchers at the California Institute of Technology did a scientific study of exactly this phenomenon. They fed participants droplets of red wine while measuring their brain activity. When participants sampled the wine that the researchers pretended was expensive, the participants’ medial orbitofrontal cortex lit up. This is the part of the brain that registers pleasurable experiences. So, even though they were actually drinking cheap supermarket wine, just the idea that it was pricey made their actual experience of drinking it more pleasurable. That’s how powerful confirmation bias is!  

 It even affects something as fundamental as pain relief. Studies have found that expensive, brand-name painkillers are rated as much as a third more effective than their generic counterparts – even when the composition of the pills is exactly the same! The expense combined with the brand's reputation make people believe that the drug is more effective. And, thanks to this belief, it is more effective.  

So, what can we take from all of this – apart from the obvious lesson that you should be wary of poodle-clutching wine peddlers? Well, knowing about confirmation bias doesn’t necessarily mean we need to go out and always buy the cheapest brand. After all, if a painkiller works, then it works, whether its effectiveness is caused by its ingredients or by your beliefs. But a healthy awareness of confirmation bias may help you make better decisions. And if not, it’ll certainly help you steer clear of wine fraudsters!  

Money can actually get in the way of motivation on the job. 

Common wisdom dictates that money can motivate people to do just about anything. After all, would we get up and go to work every day if there were no pay involved? Probably not. Researchers have spent decades analyzing how money can incentivize different behaviors, and the results have been anything but straightforward. 

For example, more money doesn’t always get people to work harder. In fact, with repetitive, manual jobs like berry picking, it can be beneficial to pay people by the basket rather than by the hour. Workers are motivated to work harder and faster when their productivity is directly correlated to their paycheck. 

Higher salaries can also be counterproductive for highly trained professionals such as doctors or bankers. Often, people who choose to work in these fields have an intrinsic motivation to do what they do. Many find the work rewarding, meaningful, and intellectually stimulating. Others simply love the thrill of working in a high-stakes environment.  

Of course, these people want to get a good paycheck at the end of the month, but money is only one aspect of what motivates their efforts. In fact, trying to incentivize them to work harder by giving them a raise can backfire because you replace their natural inner motivation with an external one. They become accustomed to being validated and rewarded with money, and may actually stop working at activities they may have voluntarily done before.  

An experiment conducted by Edward Deci all but proved this. Deci took a group of journalism students and told half of them that they’d receive a cash bonus for every good headline they came up with; the other half didn’t expect to receive anything. By the end of the experiment, the unpaid group was creating good headlines at twice the speed of the paid group, and attendance at the unpaid group’s brainstorming sessions remained high throughout the experiment. In the paid group, attendance dropped drastically after the cash bonuses were slashed. The experiment had actually robbed them of motivation to do something that they had loved doing.  

However, there is one exception to the rule when it comes to bonuses – when they arrive as a surprise. Receiving money we aren’t expecting in appreciation of a task well done can increase our motivation. But if such bonuses become the norm, they won’t incentivize us to work harder in the future. We’ll just see them as part of our regular compensation – and become upset if we stop receiving them. 

Money can help solve social problems – sometimes. 

Work performance isn’t the only arena where money has been proposed as a potential motivator. It’s also been thrown at some of our thorniest social problems, such as addictive behavior – and even test scores in schools! 

But can money really solve problems like a flailing public education system? In 2007, a controversial experiment distributed 9.4 million dollars among 36,000 school children across the United States. The condition? Passing a test or completing homework. While there were small improvements in test results, the money didn’t have a huge effect overall. The experiment worked best when rewarding effort rather than specific achievements. 

In other contexts, money can make all the difference in student performance. In Bogota, Colombia, for example, high-school students were offered a cash bonus equivalent to 300 US dollars if they graduated high school. The results were striking: graduation levels climbed from 22 to 72 percent in a matter of years. 

Why would that be? Well, 300 dollars in Colombia is no small sum. In fact, it’s enough to pay for a full college degree. With such a substantial reward, the money became a powerful motivator. It also may have made it financially possible for low-income students to complete high school instead of having to drop out and find work.  

But people aren’t only motivated by large sums of money. There are situations where a small monetary bonus can be a helpful incentive. For example, experiments that have used regular payments as small as 2 dollars to reward cigarette or cocaine users for staying clean have proved to be effective. The small rewards provide more than a cash influx – they also provide symbolic encouragement by adding external validation that the person who’s quitting is doing well.  

So, if money can help us quit cigarettes, can it also be used to promote positive civic behaviors? Policy makers have experimented with cash incentives to stimulate blood donation, for example. But this has proved complicated, as it risks changing the whole concept of blood donation. Doing so voluntarily allows people to nurture an image of themselves as altruistic. When you pay them, you take away this self image. This means monetizing blood donation actually repels people, rather than the other way around. And the ones who do donate in exchange for cash wouldn’t be inclined to do so if the money were to dry up. 

Money can make us happier – but only up to a point. 

When William “Bud” Post III won 16 million dollars through the lottery in 1998, he seemed to be living everybody’s wildest dreams. Who hasn’t fantasized about the life-transforming effects of such a huge win? 

Unfortunately for Post, the win turned out to be a curse. Within five years, he’d declared bankruptcy, had served a jail sentence, and had been married – and divorced – six times! Clearly, the money didn’t make his life better.  

Post’s example is extreme, but studies of other lottery winners have shown that winning a fortune doesn’t automatically translate into a joyous life.  

Lottery winners get used to their new affluence very quickly, in a process called hedonic adaptation. Imagine if you were to stay in a luxury hotel for the first time. Chances are high that the experience would be thrilling, as you’d be experiencing everything for the very first time. But if you start staying in luxury hotels every weekend, you’d probably begin to view the experience as normal rather quickly. 

This ties into the fact that to enjoy our lives to the fullest, we need more than nice things and experiences. Even more important is that we notice and appreciate them. This is called the “psychology of savoring.” While money might buy us access to the hotel, it might also get in the way of our being able to savor the experience.  

Of course, this isn’t to say that money is irrelevant to our happiness. Anyone who has been anxious about how to pay the rent can attest to that. Being continually worried about money causes our brains to emit high quantities of the stress hormone cortisol. This affects our decision-making abilities, our happiness, and even our physical health.  

Unfortunately, social stigma only makes things worse. For example, unhoused people have been demonized so thoroughly that many people view them with distaste or even disgust. What’s more, people who are struggling financially often get blamed for their own misfortune, accused of making stupid decisions like taking out payday loans with spiraling interest rates.  

For people in similar situations, a direct infusion of cash really can help. An experiment in Kenya showed that giving 1,500 dollars cash to people living in extreme poverty immediately lowered their stress levels – and improved their quality of life.  

The conclusion we can draw from this? Yes, a sudden change of financial fortune can make us happier. But after our basic needs are met, that happiness plateaus quite quickly. 

Money is so fraught and laden with meaning that it’s almost impossible to act rationally around it. We overestimate how much we have and are too optimistic about how much we’ll save. We’re susceptible to marketing that plays on our confirmation bias and relaxed attitude to credit. In order to change our behavior and make powerful decisions about how we spend our money, we first need to become familiar with our own irrational thinking.  

 

Action plan: Never pay your friends for favors. 

 If a friend is doing you a big favor, like helping you cater a party, you may be tempted to offer them some payment as a token of thanks. But that will turn a friendly favor into a monetary transaction, potentially stirring up resentment as your friend compares what you’re paying her to what a professional caterer would earn – or what she could earn at another job. If you want to thank her, perhaps go for a big bunch of flowers and some chocolate instead. That way, you acknowledge her contribution without trying to quantify it in financial terms.