Four mind tricks financial predators use against you
It's an old real estate trick – host an ‘open house' so that dozens of potential buyers come at once. Why? It all comes down to “Social Proof”. We look around, see lots of admiring eyes, and think that this house must be worth buying if so many people are interested – which encourages us to pay more than we otherwise would.
The next time a salesperson is telling you about all the other people who have bought and loved a product, they're probably trying to play on the concept of social proof. This is just one mind trick used to fleece you of a few extra dollars, but there are dozens more.
A common one, easily spotted on TV shopping channels, is the “Scarcity Principle”. ‘Time is running out!', ‘While stocks last!' and other catch-cries like these are not helpful reminders; they're manipulations that tap into a primitive part of our brain that encourages us to take advantage of scarce resources before it's too late. The problem is that feeling that you have a limited time to act or that something is rare will spur you into action whether or not that feeling is grounded in fact. The truth is there are probably a billion Sham-Wows in the warehouse.
Commitment and consistency
The next time you buy a car or are comparing loans, watch out for the “Low-Ball”. The strategy works like this: the trickster will offer a low ‘core price' (or teaser interest rate in the case of loans) to get a customer's commitment. Once committed, however, and it's time to pay, extra costs are then added at the last minute. We don't want to go back on our word to save a few pennies, so we agree to the higher price.
One trick used by the financial services industry is the percentage-based fee, “…it’s only 1%”. Sounds small right, but you don’t have to have a huge investment before this 1% becomes the largest bill you’ll pay out of all the services you use. This is why InvestSMART created the capped fee portfolios. Yes, there are some additional costs (brokerage and fees charged by the exchange traded funds the portfolios invest in) but even when you add those costs in, the overall costs when compared to a percentage-based fee is chalk and cheese.
The low-ball strategy plays on the “Commitment and Consistency Principle”: we feel the need to keep promises and remain consistent with prior decisions. After we commit to something we tend to think up justifications for that commitment so that we feel we made the right choice.
A broader scheme using the commitment and consistency principle is the “Foot-in-the-door technique”: start with a small request and build to a much larger one. In the book Influence, psychologist Robert Cialdni discusses an experiment where people were asked if they would put a large and ugly ‘Drive carefully' sign in their front yards. One group were asked cold, the other group were first asked if they would place a discrete ‘Be a safe driver' sticker in their window prior the larger request. Just 17% of people agreed in the first group, but the second group had a compliance rate of 76%.
There's no free lunch
Curiously, the opposite of the foot-in-the-door strategy also works: it's called the “Door-in-the-face” technique – and charities caught on to this one long ago. They know that one way to boost collections is to ask for a large sum, say $100, then – after you refuse – back down to something smaller: ‘No worries, but can you at least spare $20'.
Starting with a very large request – that will probably be turned down – and then making a concession back to what they were really after plays on the “Reciprocity Principle”: we feel compelled to give back to someone who has given us something (and often give more back than we received).
Free gifts play on the reciprocity principle too. That pen or Christmas card you received from your insurer isn't them being nice – it's about reinforcing your patronage of the company by making you feel like you owe them something in return. The next time you pull out your wallet after receiving a free sample at the grocery store, ask yourself whether it's because the product really tastes good or if you just want to return a favour.
With such simple principles proven to boost compliance, it's crazy for salesmen and marketers not to use them. They're everywhere you look so avoidance isn't a solution. It's also worth pointing out that just because a marketing department uses these nudges doesn't mean that the product is unworthy of your attention. You can probably spot a few principles at work on our site.
How a message is delivered can influence your decision but what matters is the product behind it. An awareness of these principles will hopefully arm you to make better financial decisions. The best defence, however, is to take your time and do your homework.
This article was originally published 27 July 2017.
Frequently Asked Questions about this Article…
The 'Social Proof' principle is a psychological tactic where people are influenced by the actions of others. In investment, seeing many people interested in a product or service can make you believe it's a good choice, potentially leading you to invest more than you intended.
The 'Scarcity Principle' creates a sense of urgency by suggesting that a product or opportunity is limited. This can pressure investors into making hasty decisions without fully evaluating the investment's true value.
The 'Low-Ball' strategy involves offering a low initial price or interest rate to secure a commitment. Once committed, additional costs are introduced, making the final price higher than initially expected.
Percentage-based fees might seem small, like 1%, but they can accumulate to become a significant expense, especially with larger investments. It's important to compare these with capped fee structures to understand the true cost.
The 'Foot-in-the-door' technique starts with a small request to gain initial compliance, followed by a larger request. This method leverages the commitment and consistency principle, making people more likely to agree to the larger request.
The 'Door-in-the-face' technique involves making a large request that is likely to be refused, followed by a smaller request. This plays on the reciprocity principle, where people feel obliged to agree to the smaller request after declining the larger one.
Free gifts exploit the reciprocity principle, making recipients feel obligated to reciprocate. This can lead to financial decisions influenced more by a sense of obligation than by the actual value of the product or service.
The best defense against financial manipulation is awareness and education. Understanding these tactics allows you to make informed decisions. Always take your time and do thorough research before committing to any financial decision.