Why We Make Money Mistakes and How to Fix Them

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Imagine a person who always makes the right financial decisions. She never overspends, never falls for marketing tricks, and never lets emotions dictate her purchases. Let’s call her Penny. Penny is purely logical and rational, always optimizing her choices to maximize financial well-being.

Sounds unrealistic? That’s because it is. Yet for over a century, traditional economists assumed that people behaved exactly like Penny—rational actors who always made the best choices for themselves. It wasn’t until a few pioneering thinkers, like Nobel Prize winner Richard Thaler, began to challenge this assumption that the field of behavioral economics was born. Their research revealed that humans make financial mistakes—not just randomly, but in predictable ways. Understanding these mistakes can help you make smarter money decisions. Let’s explore some of the most common financial biases and how to overcome them.

1. The Endowment Effect: Overvaluing What You Own

Have you ever refused to sell something for a price higher than you’d be willing to pay for it? That’s the endowment effect in action.

For example, imagine finding an old pack of Pokémon cards in your childhood bedroom and discovering a rare, mint-condition Charizard. Even though you could sell it for $3,000, you decide to keep it because it feels special. But if you walked into a store and saw the same card priced at $3,000, you wouldn’t dream of buying it.

The endowment effect tricks us into assigning more value to things we already own than things we don’t. To counter this bias, ask yourself: "If I didn’t already own this, would I be willing to buy it at its current market price?" If the answer is no, consider selling.

2. The Sunk Cost Fallacy: Throwing Good Money After Bad

Have you ever forced yourself to finish a terrible movie just because you already paid for the rental? Or kept eating a meal you didn’t enjoy just to “get your money’s worth”?

This is the sunk cost fallacy—the tendency to continue investing in something just because you’ve already spent money on it. The reality is that those costs are “sunk” and can’t be recovered, so your decisions should be based on future benefits, not past expenses.

The best way to avoid this trap? Make decisions based on what will bring you the most value moving forward, not what you’ve already spent.

3. Transaction Utility: The Thrill of a “Good Deal”

Have you ever walked ten minutes to save $5 on a $15 item, but ignored the same $5 savings on a $675 laptop? If so, you’ve fallen for transaction utility—the tendency to feel better about a purchase if we think we’re getting a great deal, even if the savings are objectively minor.

Retailers exploit this by using inflated “suggested retail prices” to make sales seem more significant than they are. Instead of focusing on how much you’re saving, ask yourself: "Would I still buy this if there were no discount?"

4. Mental Accounting: Treating Money Differently Based on Its Source

Imagine you won $100 in a lottery scratcher. Would you be more likely to spend it on an indulgent treat rather than saving it? Many people would, because they mentally separate “found money” from hard-earned income.

This is mental accounting—the habit of categorizing money based on where it came from rather than treating all money as interchangeable. This bias can lead to irrational spending, like blowing unexpected savings on unnecessary upgrades rather than using them wisely.

The fix? Remind yourself that a dollar is a dollar, no matter where it came from. Before spending “extra” money, consider applying it to your actual financial goals.

How to Be Smarter With Money

You may never be as perfectly rational as Penny, but you can become more aware of the biases affecting your financial decisions. Before making a purchase, ask yourself:

• Am I valuing this item just because I own it? (Endowment Effect)

• Am I making this decision based on past costs that I can’t recover? (Sunk Cost Fallacy)

• Am I being lured in by a deal that isn’t actually saving me much? (Transaction Utility)

• Am I treating this money differently just because of where it came from? (Mental Accounting)

By recognizing these tendencies and questioning your instincts, you can avoid common money mistakes and make smarter financial decisions. You may never be Penny, but you can certainly become pennywise!