Everything Is Relative — Why Your Brain Is Secretly Terrible at Handling Money (And What to Do About It)

Episode Summary: Your brain doesn't think in dollars. It thinks in comparisons — and that one quirk might be quietly sabotaging your finances in ways you've never noticed. In this episode, we dig into the fascinating, sometimes hilarious, and occasionally terrifying world of financial relativity. Why does a $10 discount feel different depending on what you're buying? Why do people take on $30,000 in car debt right after signing a mortgage? And what does Einstein (yes, that Einstein) have to do with the way you tip at restaurants? Buckle up — it's about to get weird, wonderful, and genuinely useful.

What You'll Learn:

• What "relativity" means in behavioral finance and why it controls more of your decisions than you think
• The Anchoring Effect: how the first number you see hijacks every financial decision that follows
• Contrast Effect: why your spending goes haywire right after a big purchase
• The Relativity Trap in income: why earning more can make you feel poorer
• Reference Point Theory and why your financial "zero" might be in the wrong place
• 5 practical, actionable strategies to rewire your relationship with money comparisons

Key Concepts Mentioned:

• Anchoring Bias (Tversky & Kahneman)
• Contrast Effect
• Social Comparison Theory (Leon Festinger)
• Reference Point / Prospect Theory (Kahneman & Tversky)
• Hedonic Adaptation
• The "Decoy Effect"

Resources & Further Reading:

• Predictably Irrational by Dan Ariely
• Thinking, Fast and Slow by Daniel Kahneman
• The Psychology of Money by Morgan Housel
• Misbehaving by Richard Thaler

Transcript

Relativity? Like Einstein? Kinda!

The Anchoring Effect - Your Brain's Embarrassing First Impression

The Contrast Effect - The $500 Floor Mat Problem

Income Relativity - Why More Money Can Make You Feel Broke

Reference Points - Where Is Your Financial Zero?

Strategies to Fight Financial Relativity

Outro and Your Challenge

SPEAKER_00 0:05

Hi everyone, welcome to Personal Finance with Molly, where we talk about all things personal finance. I am your host, Molly Ford Coates. Let's dig in. Hey everyone! Welcome back to Personal Finance with Molly, the podcast where we talk about money in a way that doesn't make you want to take a nap or question every life decision simultaneously. We are all about where your money, your mindset, and your behavior intersect. I am pumped about today's episode. Okay, quick question before we dive in. Have you ever noticed that a$5 price difference feels huge when you're buying a coffee? Like you'll walk three blocks out of your way for a cheaper latte. But that same$5 feels completely meaningless when you're buying a car or booking a vacation. Like, oh, it's just five bucks, throw it in. Same five dollars, completely different reaction. Or, and this one's wild, have you ever bought something absurdly overpriced right after a major purchase and it felt weirdly fine with you? Like you just signed papers on a$400,000 house and suddenly you're spending$3,000 on a couch without blinking when two weeks ago you would have called that couch outrageous. If any of this sounds familiar, congratulations! You are a human being with a brain, and your brain is doing something very specific and very sneaky. It's called financial relativity. And today that is exactly what we are talking about. Now, I know what you're thinking. Like relativity, like Einstein? And listen, I love the energy. We are absolutely going to talk about Einstein for about 30 seconds and then pivot hard into behavioral finance, and it is going to be so worth it. Here's the thing: Einstein's theory of relativity is basically about this. Nothing exists in a vacuum, right? Time, space, motion, they all only make sense relative to something else. There's no universal fast. There's only fast compared to something. Your brain does exactly the same thing with money. There is no universal expensive. There is no universal good deal. There is only expensive or cheap compared to something else. And the tricky part is you don't always get to choose what that something else is. Your brain chooses for you. Often badly. So this is the core idea of today's episode, and it comes straight out of the field of behavioral finance, the study of how real and messy and wonderfully irrational humans actually make financial decisions, as opposed to how economics textbooks assume we should. Let's dig in. Let's start with what is probably the most well-documented, most studied, most, I can't believe this is real, phenomenon in all of behavioral economics, and it's called the anchoring effect. Here's the study or the step up. Back in the 1970s, two psychologists, Daniel Kahneman and Amos Tversky, the absolute rock stars of behavioral science, ran a fascinating experiment. They spun a wheel of fortune in front of participants. The wheel was rigged to land on either 10 or 65. Then they asked participants, what percentage of African countries are in the United Nations? Here's the wild part, friends. People who saw the wheel land on 65 gave significantly higher estimates than people who saw it land on 10. The wheel had nothing to do with the question. Random number, and it still infected their answers. That's anchoring. Your brain latches onto the first number it sees and uses it as a reference point or an anchor for every judgment that follows, even when that number is completely demonstratively irrelevant. Now, imagine what this does in a financial context. So let me paint you a picture. You walk into a car dealership. You're thinking maybe$25,000 for a car. The salesperson walks you to a gorgeous, fully loaded model, and the sticker price? You actually kind of like it, but it's way out of your budget. Then they say, but let me show you this one. And they point to a$35,000 car. And here's where your brain breaks. That$35,000 car now feels cheap. You weren't even considering spending$35,000 before you walked in. But compared to$52,000, it feels like a bargain. The anchor has been set. The$52,000 car wasn't there to be sold to you. It was there to make the$35,000 car feel reasonable. You've just been anchored, my friend. Skillfully and professionally anchored. Now this is not an accident. Car dealerships and real estate agents and luxury retailers, they all understand anchoring at a deep intuitive level. They lead with the expensive thing, not because they expect you to buy it, but because it recalibrates your sense of what is normal to spend. And it's not just big purchases. Research by Daniel Arielli, the author of Predictably Irrational, which is essentially a greatest hits album of human beings being weird about money, found that when people were asked to write down the last two digits of their social security number before bidding on items at auction, those with higher digits consistently bid more for everything, for chocolates and wine and computer equipment. A random, personal, meaningless number, and it still anchored their willingness to pay. So, what does this mean for you in real life? It means that before you make any significant financial decision, you need to ask yourself, what is my anchor here and who set it? Did you decide that$800 was a reasonable monthly car payment? Or did the dealership's$52,000 sticker decide it for you? The antidote, friends, and we're gonna dig deeper into strategy here in a little bit. The antidote is to set your own anchor before you walk into any negotiation, any purchase or any financial decision. Do your research. Know what you're willing to pay before you see the first number. Write it down. Your brain will fight you on this, but it is absolutely worth the effort. Okay, so anchoring is about the first number you see hijacking your judgment. The contrast effect is its sneaky cousin, and it operates in a slightly different way. The contrast effect is this the way we evaluate something is dramatically influenced by what we compare it to in the moment. Not just the first number. Any number nearby changes how we feel about another number. Here's the classic example, and I call it the$500 floor mat problem. So you just negotiated a$45,000 car purchase. You're feeling great. You haggled, you did your research, you are practically a financial warrior. The salesperson says, fantastic! Now let me go through some accessories with you, and they slide across a menu. Premium floor mats,$500. A cargo net,$150. Extended warranty,$2,000. Paint protection package,$800. And here's the thing: you, the person who last week Googled, is$14 too much for a sandwich? You're nodding along. Sure, yeah, floor more floor mats, why not? You know, it's only$500. Only$500? Compared to$45,000,$500 feels like a rounding error. Your brain has completely lost the plot. This is the contrast effect in action. The$45,000 purchase creates a context in which smaller amounts feel trivially small. Even though$500 is$500, regardless of what you just bought, money doesn't care what you compared it to. It spends the same. And dealerships, and basically every major retailer, knows this. This is why furniture stores try to upsell you on the warranty right after you've agreed to the couch. This is why hotels push spa packages at check-in after you've already paid for the room. This is why wedding vendors come in right after you've booked the venue that costs more than your first car. The contrast sets the stage, and suddenly things that should make your eyes water feel like a completely reasonable add-on. This, friends, this gets even more interesting at the macro level. There's research showing that people who receive a large financial windfall, like a bonus or an inheritance or even a tax refund, are significantly more likely to make large impulsive purchases in the weeks that follow. The windfall creates a new reference point, and everything below it feels manageable. A$3,000 impulse purchase feels different when you just receive$30,000 than it would in a normal month. Now, friends, I want to tell you, this is not weakness and it's not stupidity or anything like that. This is just how human brains work. We are comparison machines. We can't help it, but we can learn to work with it. One practical trick that I love: always evaluate a purchase in isolation. Before you add the floor mats, before you say yes to the warranty, mentally remove the context of the big purchase and ask, would I buy this on a normal Tuesday if it were the only thing I was considering today? If the answer is no, put it back, friends. All right, let's zoom out from the individual purchase and let's talk about something that affects your entire financial life. This one fascinates me. Here's a scenario: someone earns$50,000 a year. Their neighbors, friends, and coworkers mostly earn around the same. So, you know, life feels pretty okay. That same person gets a promotion. Now they're earning$90,000, let's say. Amazing, right? They should feel fantastic. And for a while, they do. But then something creepy happens. As their income grows, so does their social circle, so does their neighborhood, so does their lifestyle. Now their new frame of reference is people earning$120,000 or$150,000. And slowly and gradually,$90,000 starts to feel like$50,000 used to feel. Not objectively, but relatively. They're earning almost double what they used to, and they feel kind of the same, and maybe they even feel a little bit worse. This is what psychologists call the social comparison theory, first described by Leon Festinger in 1954. And we evaluate our own situation not on an absolute scale, but by comparing ourselves to the people around us. And financially, friends, this is absolutely devastating. There's research that asked people to choose between two scenarios. In scenario A, you earn$100,000 a year and everyone around you earns$85,000. Scenario B, you earn$115,000 a year, but everyone around you earns$200,000 a year. A meaningful percentage of people chose scenario A. Objectively less money because relative status matters to our brains in a deep and almost primal way. Now, this isn't just about ego. There are real financial consequences. When your reference group shifts upward, when you move to a wealthier neighborhood, or when you take a job at a high-earning company, or when your friend starts making significantly more money, your spending tends to follow. Bigger house, nicer car, fancier vacations, more expensive dinners. Not because you need these things, but because they start to feel normal relative to the people around you. So this is the Joneses problem, right? The classic keeping up with the Joneses. Now, that isn't really about the Joneses. It's about your brain using the Joneses as a reference point for what normal looks like. And here's the kicker: the Joneses are doing the same thing. They're keeping up with their Joneses. It's comparison all the way down. And the cruel twist to this, friends? Research on hedonic adaptation, which is our tendency to return to a baseline level of happiness after positive changes. This adaptation shows that lifestyle upgrades stop feeling pretty good quickly. You get the big house, and for a few months, it is thrilling. Then it's just your house, and now you need a bigger house. The income treadmill is real, and relativity is the motor. The move, the actual effective move, is to consciously choose your reference group for financial comparisons. Not your wealthiest friends, not Instagram, not the colleague who just bought a boat. Instead, compare yourself to your past self. Am I better off than I was three years ago? Am I making progress on my actual goals? That's the only comparison that generates forward momentum without the endless hedonic treadmill. Okay, so we're in the home stretch of our concept tour, and this one ties everything together. It's called the reference point theory, and it's the backbone of one of the most important frameworks in behavioral economics, prospect theory. And that was developed by our by our old friends Kahneman and Traversky. Here's the core insight: people don't evaluate financial outcomes in absolute terms, they evaluate them relative to a reference point, essentially a psychological zero. And gains and losses are assessed from that zero, not from an objective baseline. And here's where it gets interesting: losses loom larger than equivalent gains. Like measurably and significantly larger. Losing$100 feels about twice as bad as gaining$100 feels good. So remember, this is called loss aversion, and I've talked about this in several episodes, and it is one of the most replicated findings in psychology. But the really fun part for our purposes today is that the reference point itself is flexible, and our brains are surprisingly bad at setting it correctly. So let me give you an example. Imagine you bought a stock at$100 and it shoots up to$160. You're feeling great. Then it drops back down to$120. Are you still happy? Well, you should be, right? You're still up 20%. But research shows that most people feel like they've lost money because their reference point shifted from$100 to$160. The high water mark became the new zero. That$120 feels like a$40 loss, even though it's a$20 gain. This is why investors hold stocks too long, hold losing stocks too long. They're waiting to get back to zero relative to their purchase price, even when the smart move is to cut and reinvest. The reference point creates an emotional anchor that overrides rational calculation. And it also explains a phenomenon in savings and budgeting. When people get a raise, they often feel like they've already spent, quote unquote, the extra money before they receive it. The anticipated new income becomes the reference point. And staying at your current savings rate feels like falling behind, even if your absolute savings are unchanged. Friends, one of the most powerful things you can do for your financial life is to consciously set your reference points before your emotions do. Define what winning looks like for you in your own terms, on your own timeline, before external anchors, before social comparisons, or before market fluctuations get to define it for you. Define what winning looks like for you. Write it down. What does financial success look like for you in five years? That becomes your reference point. Not your coworkers 401k, not whatever the SP 500 did last quarter, yours. All right, friends, we've diagnosed the illness. Now let's talk about the cure, or at least the daily vitamins. Here are five strategies to start pushing back against the relatively trapped relativity traps your brain sets for you. Strategy number one, set your own anchor first. Before any significant purchase or negotiation, decide on your number before you see theirs. Research fair market value. Write down your walkaway price. Put it on your phone. Then when you see the$52,000 car, your brain already has a competing anchor, the$25,000 you decided on this morning. And it's much harder for the dealership's number to take over. So set your own anchor first. Strategy number two, the normal Tuesday test. Before approving any upsell or add-on or impulse purchase in the context of a larger purchase, ask yourself, would I buy this on a normal Tuesday standing alone, knowing this is the only thing I'm spending money on today? If the answer is no, friends, or even if the answer is probably not, then walk away. Strip the context. The floor mats are$500 on a normal Tuesday and they're$500 today. Strategy number three: compare yourself to yourself. This one takes practice, but it's transformative. Once a quarter or even once a year, do a personal financial review where the only comparison is to your past self, not your peers, not your national averages, not whatever your algorithm is serving you this week. Are you better positioned than you were 12 months ago? Are you moving toward your actual goals? That's the only scoreboard that matters. Strategy number four, delay lifestyle upgrades after income increases. When you get a raise or a bonus or a windfall, and this is counterintuitive, try to delay any lifestyle changes for at least 90 days. Let your reference point stay where it is. Bank the difference. This is where the actual wealth building happens. Most people immediately upgrade to match the new income, which is how you can earn significantly more and somehow save exactly the same amount. The 90-day pause gives you time to be intentional before relativity takes the wheel. And strategy number five: name your reference points out loud. This is simple, but friends, it works. When you notice yourself thinking, that's a good deal, or that feels expensive. Stop and ask compared to what? Name it. I think this$300 dinner is reasonable because I just got a$500 bonus. Or I'm inclined to buy this because everything else in the store costs. What's more naming the reference point doesn't make the feeling go away, but it does take away its invisibility. And invisible biases, these are the dangerous ones, friends. All right, so those are the five strategies. Set your own anchor first. Do the normal Tuesday test. Compare yourself to yourself. Number four, delay lifestyle upgrades after income increases. And finally, name your reference points out loud. Okay, so let's bring this home. Your brain is not broken. I say that a lot. I really want to be clear about that. The fact that you're a comparison machine, that you think in relative terms, or that you anchor to numbers and contrast things and compare yourself to your peers, that's not a bug. For most of human history, that was a feature. Quick relative judgments kept you alive. Is this Barry safer than that, Barry? Is this situation more dangerous than usual? Fast comparative thinking is deeply efficient. The problem is that we're applying Stone Age software to a world of 30-year mortgages and stock portfolios and salespeople who have studied the psychology of anchoring. The context changed. Our brains are still running on version 1.0. The goal is not to stop thinking in relative terms. You can't, friends. The goal is to notice when relativity is driving your financial decisions from the back seat and then gently move it to the passenger seat where you can keep an eye on it. Einstein was right, friends, everything is relative, but you, you get to decide what it's relative to. So here's your challenge for this week. Pick one financial decision that you're currently considering, whether it be a purchase or a savings goal or an investment, and consciously audit the reference point you're using. Where did that number come from? Who said it? Is it actually meaningful for your life? Or did some clever retailer or algorithm or social comparison set it for you without your permission? That awareness is the beginning of everything, friends. You got this. Hey, thanks for listening to Personal Finance with Molly. Thanks for hanging out with me today. If this episode made you think or made you laugh or made you pause before buying something, that's the whole goal. Share it with a friend who needs to hear it. Leave a review if you're feeling generous. It genuinely helps more people find the show. If you are enjoying this podcast all about where your money, your mindset, and your behavior intersect, I would really appreciate leaving a review or sending a message. Until next time,