Three Common Money Mistakes

Sean Makasi Flynn PhD is the author of, amongst other books, the excellent Economics for Dummies. From it I've noted some common mistakes that we make with money, even those of us who are normally financially savvy.

1. We let things that happened in the past affect our future behaviour

I'm not (necessarily) talking about investing, this applies to shopping and probably lots of other things as well. Let's say you go to Pizza Hut at lunch time and take advantage of their all-you-can-eat buffet. I think it costs about £6. How much should you eat? Should you stuff your face till you feel sick?

The answer is that you should eat exactly the amount that makes you feel happy. It doesn't matter if you paid £6 or £60, as how much it cost you is now irrelevant. As an economist would say, the price paid is in the past, so you should now maximise your future happiness. After you've paid, you weigh up the potential costs and benefits of your future options. Do I eat too much and feel awful, or do I eat till I'm comfortably sated? Besides, how grim is it to see someone finish their plate "because they feel they have to"?

2. We mistake a small percentage for a small pound amount

Let's say that, rather than buying a DVD player for £100 from a local shop, you decide to make a 10% saving and buy it for £90 by driving for ½ an hour to an out-of-town department store.

You then decide to buy a 50-inch HDTV and think about whether to buy it locally for £3,000, or to drive out to that same department store to buy it for £2,990. You get out your calculator and find that you're saving less than 1%. You decide to buy the TV from the local shop.

As Professor Flynn says, this is "colossally inconsistent and irrational". You were willing to drive for half an hour to save £10 for one thing, but not for another. The cost - a longer drive - and the benefit - saving yourself £10 - is identical for each. The percentage saving isn't relevant. So do you or don't you want to save that £10?

3. We mistake average gains & costs for future gains & costs

Let's say a council builds three bridges at an average cost of £10m each. A study shows that the economic benefits total £36m per year, or £12m per bridge. On this basis, the council decides to build another.

However, by relying on average figures for other bridges, they've missed the point. If they'd hired an engineer to estimate the cost, they'd have found a fourth bridge will cost £15m, because the river is much wider at the fourth site. Meanwhile, an economist does a survey to show that a fourth bridge won't add more than £8m per year to the local economy.

The professor's advice is sound: "So watch out anytime somebody tries to sell you a bridge."

> Be financially savvy! Compare prices of credit cards and savings accounts.