How might the COVID-19 pandemic influence on our financial decisions? There’s evidence it has led to a rural real estate boom. For others, it could open the door to a major purchase, a renovation or even cosmetic surgery. Kim Parlee speaks with Nico Lacetera, a professor at University of Toronto’s Behavioural Economics in Action at Rotman (BEAR), about why we may be inclined to make more impulsive (and more expensive) decisions during lockdown.
- The COVID-19 pandemic has a lot of people taking a step back, and reevaluating their life, and making some changes. And for some, that might mean moving out of the city. Others, it might be making a big purchase, big renovations. And for some, it might even mean cosmetic surgery.
But is now the right time to making those big decisions? Nico Lacetera is a Professor of Management at the University of Toronto and Behavioral Economics in Action at Rottman. He joins us now with today's Ask MoneyTalk question.
Nico, here's the question. "I just made a really expensive, impulsive, purchase. Why did I do that?"
- Well, in these particular times, there may be a number of reasons why not only did you make that purchase but you also considered it exposed, impulsive. Well, we are all a little exhausted by the situation. We are overwhelmed with information. We are concerned, of course, about our health, our jobs, perhaps.
And our mind can only contain and process a certain number of-- a certain level of information. And so sometimes we are also sort of overwhelmed with information, and we might not think fully straight about what we really need in a given moment. And perhaps, we might tend to overspend.
Also, the opposite might be happening in these times. We might feel too bored by being secluded at home, unable to see our friends and families as often as we would like. And so a major purchase might be a way out, just a way to make life a little more fun. But maybe it's short-lived fun, and then we realize that perhaps we didn't need to spend that much.
Another possibility here is what behavioral scientists call mental accounting. So what could happen here? Let me give you an example.
Let's assume I've been saving for a major trip, for a vacation, over the past 18 months. Almost ready to go. COVID comes. I cannot travel anymore. Now, I have in my mind these sort of account of-- I don't know-- $10,000 or whatever you want. And all of a sudden, I cannot use it for what I wanted to use it.
Because all of a sudden, that doesn't-- it's not worth $10,000 anymore. Maybe it's worth a little less to me. And so I feel like I can spend it for other things, but in a sense, by discounting how much it's worth to me. And as such, I might then end up spending too much as compared to what I would have done in another moment. So all these sort of tendencies might lead to overspend in this phase.
- I think a lot of people had trips that were canceled and are all thinking that way, including me. Let me ask you, why do you-- what is it about that? I mean, is that our brains are just really wired to think in the short term? We don't think about the longer term implications? And why is that?
- Yeah, that could be. We might not consider, maybe because of the uncertainty also, what the future holds for us. And so, for example, that's another tendency that scholars look at, what we call projection bias. We might over weight today situation. We might think that the world will be like this for a very long time. And as such, we might make decision as if this was the new normal forever.
So, for example, all of a sudden-- I work from home, and so I'm not commuting. So why not move in to the countryside, for example? Or why not making some changes in the house since I'm spending more time in the house? I don't know-- renovating the basement, buying some expensive physical exercise equipment, which is not only expensive but very bulky. So it's not just a matter of money. It's also a matter of space, which is cost, just like money.
And so all of a sudden-- at some point, COVID, hopefully, will be over, and I am 50 kilometers away. I need to commute again, and I have the house full of stuff that I don't have time to use anymore. And so we realize that maybe we sort of overcompensated in the short term and over weighted the likelihood that things will stay this way. So this could definitely happen.
- I think I'm going to respond to people who are asking me why I'm not cooking more at home, and why I haven't learned more to cook. I'm going to say, stop with your projection bias. I don't need to. Things will get back to normal.
Let me ask you, how do you avoid, though, in all seriousness, making big bad decisions? I mean, spending a lot of money. How do you make sure you don't fall into that?
- Well, actually, one way is to exploit something that, I guess, most of us, we just sort of go by introspection. I've been doing also in these days. Maybe because we have more time.
I guess this is a time also to think about what's really important in our life, being with family, being healthy, and perhaps, stepping down a little, and try to think what we really need in this moment or in any other moment, and take a little moment, take a little breath before making some major purchases or some major commitments.
It could be useful not only to rethink what your life is about, the meaning of your life, but also, the meaning of an expensive physical exercise equipment or an extension of your house. Why not?
- Nico, great insights. Thanks so much for joining us.
- My pleasure.
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