How You Think Decides How You Spend

I just read Steven Pinker’s latest book, When Everyone Knows That Everyone Knows. In a simplistic way, it is a book about how we think. He tackles many of life’s enigmas—harmony, hypocrisy, outrage, cancelling culture—and weaves them into game theory and common knowledge.

I have picked out five aspects or narrations from which we can take a money application.

Lesson I: Actions Speak Louder Than Our Words

A defendant was on trial for murder. There was strong evidence indicating his guilt, but there was no corpse. In his closing statement, the defence attorney stated to the jury: “I have a surprise for you all. Within one minute, the person presumed dead will walk into this courtroom.”

After making that bold declaration, he turned and looked towards the courtroom door. So did the judge. So did people in courtroom. There was silence in the court as all eyes were on the door.

The defence attorney eventually broke the silence with, “Apologies. I made it up. But you all looked at the door in anticipation, not disbelief. So, clearly there is reasonable doubt as to whether anyone was killed. That itself should lead to a verdict of ‘not guilty’.” When the jury pronounced a verdict of ‘guilty’, the jury foreman explained: “We all looked, but your client did not.”

Learning: Actions speak louder than words. You may proclaim that you live a fairly frugal life, but money just slips through your fingers. The truth is, if you add up all your expenditure, you may realise where your blind spot is.

Lesson II: The Need For Communication

James and Charlotte enjoy each other’s company and decide to meet for coffee. Being a workday, they decide to meet at 6 pm. However, James’s cell phone’s battery dies before they could fix the venue. So where will they meet?

Both are aware that James frequents ‘Java Joint’ and Charlotte frequents ‘Connection’.

James heads to ‘Connection’ because he assumes Charlotte will go to her favourite place. But realises that she will predict that James will go to his favourite place, and she will land up at ‘Java Joint’. Anticipating her move, he decides to go to ‘Java Joint’. Charlotte is whipsawed by the same futile empathy.

Learning: Communication is key to managing finances in the family. Always communicate. If you see the above situation, there is no conflict of interest.

They both want the same thing. But they were confused as to what the other person is thinking. It is the lack of communication that leads to discord or second guessing.

Lesson III: There Is A Cost To Decisions Made

A and B are arrested for a crime. The prosecutor detains each in separate cells. He knows they are partners in crime, but lacks the evidence to convict them. So, he offers a deal. If one defects on his partner by testifying against him, he will go free, and his partner will get 10 years in prison. If each rats out the other, they each get six years. If they keep mum, they will each serve six months.

Learning: When you live in a family, your financial decisions impact the rest of the family. If you decide to support your sibling’s education, you may not be able to take your wife and child on a global holiday due to shortage of funds. Or, if you decide to dabble in derivatives trading and lose money, your family will bear the price. It is not just about you. Always ask the question: Who is paying the cost for decisions made?

Lesson IV: Tone Down Expectations

We recently witnessed the cryptocurrency mania. Like all currencies, the supply rate of crypto is also limited in order to prevent hyperinflation. This is accomplished by allowing people to “mine” it by solving math problems that require substantial time and power.

If speculators anticipate that the demand will outrun this supply, fuelled by the perception that crypto is the wave of the future, they might buy crypto now in hopes that they can sell it at a profit later. And that can work only if there are buyers out there who plausibly expect that they can sell it as a profit to other buyers.

Learning: What fuels a bubble is expectation. Everyone expects that the asset price will rise. Which does make it rise, at least for a while. But expectations cannot fuel a rally forever. You need to ground your expectations in some fundamentals.

In a speculative trade, the two sides disagree on what they think an asset will be worth in the future. One expects the price to go up and wants to buy, the other expects it to fall and wants to sell. One of them is going to be wrong. Common sense should tell them that they can’t both be right, so they should give no more weight to their own convictions than to the other guy’s. But each are convinced that they are the more rational, informed, and competent of the two.

This is why you should never speculate with huge amounts of money. And never throw caution to the wind. Remember that you could be very wrong.

Lesson V: Never Talk Down To Someone

Writer Bruce Feiler of the Gourmet magazine was given a weird assignment. He had to go to popular restaurants in Manhattan on a Saturday night, with no reservation, and attempt to grease the palm of the maître d’ to jump the queue and be seated with priority.

He kept imaging the worst possible retorts: “What kind of establishment do you think this is? You think you can get away with that?”

Each time, he looked the maître d’ in the eye and slipped a $50 bill with various requests: “I hope you can fit us in. I was wondering if you might have a cancellation. Is there any way you could speed up my wait? We were wondering if you had a table for two. This is a really important night for me.”

To his astonishment, it worked every single time.

Learning: Situations are governed by relational models. They stipulate who is entitled to what and under which terms. The maître d’ is in an authority relationship with patrons. He has the right to seat them when and where he pleases. Treating him with respect, even if with a bribe, was key to getting what Feiler wanted.

Money is a very sensitive and prickly issue. Be polite and respectful. I know a gentleman who views his wife’s salon trips as ‘wasteful’ but his weekend drinking, however expensive, is ‘necessary spending’ to de-stress and bond with friends. Using a condescending and accusatory tone does not help in monetary discussions with family. It leads to tension and hard feelings. Be respectful of the needs of the other. Listen, don’t just point fingers. Always view money in context of your relationship.

By Larissa Fernand, Behavioural Finance Expert