smart spending

7 psychological money traps and how to avoid them

How to outsmart your brain: "Whenever you see the term 'free,' consider it a warning to slow down and consider your choice very carefully," advises Ariely. Do the math and always consider what you are giving up when you choose the item attached to something "free." Usually -- but not always -- there is a real cost to something touted as "free."

2. The 'anchor-price' persuasion 

Have you ever lusted after an expensive piece of jewelry, only to discover later a comparable item that was much cheaper? You were probably thrilled by your "bargain" find -- even if the cheaper jewelry still cost several thousand bucks, and possibly out of your price range.

Or how about when a real estate agent shows you two expensive homes first, then introduces you to two cheaper ones? Again, the less expensive ones now seem like bargains, comparatively.

Thank a mental trick called "anchoring" for this habit, says Ariely. In short, he explains, our brains naturally latch on to the first price we see in a new-to-us purchase category -- thus creating an "anchor" against which we compare all other prices. "This natural process helps us bypass the difficult decision of deciding what something new to us is worth," he says.

When you shop for a new TV, the price of the first one you seriously consider will be the price by which you compare all new TVs. Similarly, Ariely explains in his book, when people move to new cities, they tend to compare home prices to what they paid for a house in their previous city -- and spend the same amount.

Example: If a family previously spent $500,000 in an expensive housing market, they'll tend to pay that same price for a house (a much nicer one, most likely) if they move to a cheaper rural area. They don't pay less for a home, even though they could.

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How to outsmart your brain: In the case of a house, rent in a new city for a year, until your brain adjusts to home prices in your new city. In the case of jewelry or other new-to-you items, don't buy in the heat of the moment, just after you find "bargain" items. Wait and consider your purchase for a while. Give your brain time to decide whether the "cheaper" bracelet is really something you want to afford.

3. The instant-gratification attraction 

We all know we should save for future goals like vacations, college and retirement, but many of us still don't. Why? Because, "You feel that you need a cup of coffee and, by the way, that pair of shoes is to die for. So you spend the four bucks at Starbucks or you buy the new shoes, because both kinds of spending give you the intense pleasure of an immediate reward -- especially if you pay with a credit card," says Jason Zweig, personal finance columnist for the Wall Street Journal and author of "Your Money & Your Brain."

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