One More Behavior Finance Trap That Fools Me Every Time

by RJ

in Psychology

Two months’ salary.

When I was shopping for an engagement ring that was my starting point. If I spent less, I would have felt I was cheating my future wife out of the ring she deserved.

I bought that ring three years ago. At the time, I was living with “roommates” (alright my parents) rent free. Thus, saving two months of salary was fairly easy.

It’s funny to think back about my thought process, or the lack there of, at the time I was making the biggest purchase of my life. I never contemplated looking at a ring that was under two months’ salary. I’m very happy with the ring I bought, but I laugh at how I was stuck on two months’ salary.

Logically, the two month benchmark is the worst answer to the question, “How much should I spend on an engagement ring.”(Side note: The worst person to ask that too is your future mother-in-law.)  Not surprisingly, that benchmark was created by the diamond industry.

The two questions you should use to determine the price you pay is:

  1. What can I afford?
  2. What do I want to spend?

Why does nobody buy an engagement ring using logic? Because of the behavior trap known as anchoring. Anchoring occurs when you attach a price to a reference point that should have no bearing on how much you pay.

This is why most people buy an engagement ring they can’t afford. That two month figure has been crammed into your head over and over again. If you don’t spend at least two months’ salary, even if you have to go into debt to do so, you’re friends are going to think your cheap.

Other Examples of Anchoring

There are many other examples of price anchoring that cause us to make irrational financial decisions.

For example, when you go to purchase a car, negotiations usually start based on the sticker price. Knowing this, car dealers often jack up the sticker price to create the illusion that the car is more expensive than it is.

Another example is that if you were to go buy a house right now, your Realtor will tell you how much the house WAS going for. For example, your Realtor might say, “In 2008 this house was on the market for $500,000 and now it’s down to $300,000.” The Realtor does this so you think the house is undervalued. Logically, the house is worth what a willing buyer and willing seller agree to today, not what it used to be worth.

How to Avoid Price Anchoring

To prevent price anchoring, you must first look at why you use anchors in the first place. Price anchoring is like a shortcut for your brain. With little thought, your brain can attach, or anchor, itself to a past reference point. Therefore, the cure for price anchoring is actual critical thought.

Instead of using past reference points for financial decisions, ask yourself these questions:

  • Can I afford this today?
  • What do I really want to spend?
  • What are some contrarian alternatives?
  • Would a CERTIFIED FIANCIAL PLANNER® do what I’m about to do?

In the comments, list any financial mistakes you’ve made in the past due to anchoring.

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Photo by: Some Random Nerd

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{ 22 comments… read them below or add one }

RandyNo Gravatar March 23, 2011 at 7:46 am

I married right out of college. My salary more than doubled. Should I have bought a ring based on the old salary of the new? It was a long time ago, I think I spent a little over 1 month’s salary. We were married 17+1/2 years before I was widowed.

2 years later, I remarried. I was successful, my bride-to-be had returned to school and recently graduated and hoped to teach school. Two VERY different income levels. I spent a little under 1 month’s salary. We’ve been married for 10 years this fall.

I guess what I’m saying is that you buy what you can afford, what you & she like. Don’t go into hock and think about what you will have to give up to buy it. If this is real, she’ll think it’s the most beautiful ring she’s ever seen. That’s all that matters.

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RJNo Gravatar March 23, 2011 at 11:14 pm

Randy. Couldn’t agree with you more…”If this is real, she’ll think it’s the most beautiful ring she’s ever seen. That’s all that matters.”

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JeffreyNo Gravatar March 23, 2011 at 11:10 am

I’m not sure I have any specific examples, but I feel like I’ve encountered this an it aggravates me. This is especially true to the engagement ring example, which I’ve also found to be completely arbitrary (and potentially damaging to personal finances).

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RJNo Gravatar March 23, 2011 at 11:17 pm

Yep…I’ve known far too many who have gotten themselves into a nice hole by purchasing an engagement ring they couldn’t afford.

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EmilyNo Gravatar March 23, 2011 at 11:17 am

This is such a great point! My boyfriend and I had this discussion very recently. I think that two months salary is a ridiculous anchor. Think of all the money that could go to the wedding bands, the wedding, the honeymoon. You know your honey is just as interested in all of that being as nice as it can be, too.

My vote is talk about it with her, first. I think there is such a social expectation that “popping the question” is a surprise (just think about the language we use – “popping”), that this leads to a lack of communication on what is an extremely important subject. So broach the subject and talk about it together.

Randy, I love what you said: “If this is real, she’ll think it’s the most beautiful ring she’s ever seen. That’s all that matters.” So true! If you have the money and want to spend it, enjoy. But don’t get stuck on an artificial price-point!

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RJNo Gravatar March 23, 2011 at 11:18 pm

I’m kind of the opposite. I enjoyed surprising my now wife with an engagement ring. Just goes to show that everyone is different.

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MelissaNo Gravatar March 23, 2011 at 11:41 am

Diamond engagment rings are only the first step in what can be a long, stressful, and extremely expensive process of wedding planning. So, like with any smart shopping, you have to be aware of the tactics that wedding vendors and salespeople use when trying to play on such an emotional time in people’s lives. A sales pitch typically goes something like this, “Oh, but you want your day to be PERFECT. So really, what is an extra $500 on chivari chairs so that you can remember your perfect day forever?” As a bride-to-be, it disgusts me. I also find it interesting how much the jewelry and wedding industry tries to convince people that diamonds are the only appropriate engagement ring stone. When my fiance and I went shopping for engagement rings last year, the salespeople tried to do everything they could to discourage us from purchasing a sapphire engagement ring. (Although I wonder if that has changed now with the royal engagement ring that has been in the news!). Diamond prices in general are artifically inflated because of the monopoly on the market. Just because diamonds are expensive, does not mean that they’re worth that much in value.

Shop smart for all things wedding related. It takes a lot of extra time, but it will save you a boatload of money.

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RJNo Gravatar March 23, 2011 at 11:22 pm

My favorite “sales tactic” was the explanation from the jeweler that an engagement ring was an “investment”. There’s so many different emotions going on when you’re engaged, that it’s easy to get taken advantage of. Like you said, it pays off to take your time.

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20 and EngagedNo Gravatar March 23, 2011 at 1:18 pm

I’m engaged and my fiance didn’t spend even half of 1 month’s salary because we have bigger priorities. To me, the ring is just a symbol (as well as an accessory) but I rather us not go into debt around it. When we’re in a better financial situation, we could possibly revisit ring shopping :)

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RJNo Gravatar March 23, 2011 at 11:24 pm

I know a lot of people who have done the same thing. It’s a great idea, especially if you have bigger priorities right now.

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NYGUYNo Gravatar March 23, 2011 at 1:33 pm

I wanted my girlfriend to come with me to the jeweler and help design what she wanted because I wanted to be 100& sure it was something more than sentimental and a style she wanted. I didn’t follow any rules and used money I had saved without draining my life savings. I spent three months my salary.

Strange how in every other circumstance I calculate purchases, savings but the engagement ring I felt the need to throw out my frugal rules and go with what we liked the best, within reasonableness.

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RJNo Gravatar March 23, 2011 at 11:26 pm

There’s nothing wrong with spending more than 3 months salary. If that was your priority at the time, that’s great.

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Jonathan HarmsNo Gravatar March 23, 2011 at 1:37 pm

Saving money when buying a diamond is a good idea, but buying a fantastic diamond is also a good idea, no matter the anchor attached.

Consider the investment. As a retail good, a diamond will keep pace with inflation vs. a canoe or culinary knife set for example. But also, if you buy a great diamond vs. scrimping on features like the four Cs, it will hold it’s value better in a declining value term (in my opinion). The value/investment doesn’t necessarily mean anything though if you believe that Marriage is an institution that is FOREVER (in sickness and health, til death).

In summary, a diamond is one of those big things in life that I think it is ok to splurge on and make your future wife’s eyes pop. That is an experience the two of you will never forget:)

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RJNo Gravatar March 23, 2011 at 11:29 pm

It is a experience you’ll never forget. I don’t regret spending two months salary. As long as you’re paying for it in cash, spend however much as you want to.

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MeganNo Gravatar March 23, 2011 at 4:44 pm

Interesting tidbit (100% sure it’s factual) that someone told me when I got engaged. The “engagement ring should be worth two or three months salary” thing started during the American Civl War (that’s what they said). Young men who were going off to war wanted to be able to leave their brides-to-be with something that they could sell to support themselves if their fiance never came back (or came back in a box). At the time, of course, women could do very little to support themselves in polite society, so the value of the ring was very important.

Anymore the original reason behind the amount you’re “supposed” to spend on an engagement ring has been hidden or distorted and taken over by the companies that sell the rings. Most women can and do work to support themselves (and their families), so the 2-3 month salary thing is no longer a meaningful standard.

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RJNo Gravatar March 23, 2011 at 11:30 pm

Thanks for sharing that. Very interesting Megan. Makes sense.

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Pat S.No Gravatar March 23, 2011 at 6:26 pm

I spent much more than 2 months salary on an engagement ring… and paid for it for over a year. Though I was able to finance the ring at the time at 0%, it was still really stressful to have that big of a payment for that long. Oh well… Just one of the few things that youthful exuberance and being in love will make you do without a second thought.

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RJNo Gravatar March 23, 2011 at 11:32 pm

The problem most have with financing their ring, is that the ring is just the first of many wedding expenses. It adds a lot of stress to the whole wedding process. The key, as always, is to learn from your mistakes.

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John HunterNo Gravatar March 23, 2011 at 10:59 pm

Just being aware of anchoring is helpful. Another strategy is to try and re-anchor on something else – is this worth more or less than having disability insurance the next 4 years, is this worth more more than taking the night school class, is this worth cancelling my cell phone and cable TV for the next 3 years…

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RJNo Gravatar March 23, 2011 at 11:34 pm

Good tip John. I always try to compare everything to airfare. So, is this $500 on X worth more than flying round trip to Y. This seems to help me put purchases in prospective.

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Levon MkrtychevNo Gravatar March 23, 2011 at 11:19 pm

Anchoring is an interesting concept and we should always use logic when making financial decisions, but use both logic and passion when making “life” decisions. It’s not easy to explain what I mean, but you should spend a “good amount of money” on your ring. If you love your fiance and you have the ability to purchase something nice, you must do it. Don’t go overboard and purchase something too expensive. If you do that, you will end up with less money to live your new married life and that isn’t good for anyone (and it isn’t smart). If you don’t have much, buy what you can, but it should push you a little to buy a ring. It should be a significant sum of money to you. You’ll know what feels right.

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engin33rNo Gravatar April 4, 2011 at 11:30 am

I spent about 4% of my gross annual income. She loves it though and gets more compliments than others who spend 10-20% of theirs. I still see her staring at it when we’re driving around.

I was lucky in my fiance has always wanted a yellow sapphire (and i didn’t even have to show her blood diamond). And you can always barter (we got the stone down 30% and the setting down 50% before all was said and done) even if there is a price tag on the ring. Also buying the stone and setting separately allows you to barter more effectively. Always walk out and think it over for a day or two then come back.

I actually had to argue with her that she was not allowed to get a cubic zirconia. If you have this problem tell them they will only last 2-3 years ;)

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