The Art of Thinking Clearly: Better Thinking, Better Decisions

See also The Halo Effect (ch. 38); Primacy and Recency Effects (ch. 73); Confirmation
Bias (ch. 7–8); Induction (ch. 31); Fundamental Attribution Error (ch. 36); Affect
Heuristic (ch. 66)

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84
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 realise 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 to 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 neighbourhood. 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 realised how irrational my behaviour 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 mouldy kitchen or replacing old tyres. 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 $1,000. I won all that earlier.’ ‘But it’s the same amount!’ ‘Not for

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me,’ he laughs.
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 per cent 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% were prepared to gamble – even though the expected
value for both options was the same: $30.
Marketing strategists recognise 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 flyer 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.