Not everyone is good at saving money. While there are people who have mastered the art of managing their accounts, a majority of us fall prey to the inherent human nature to be bad at saving money, despite a number of efforts. Additionally, we can be pretty irrational about expenditure.
Dollars and Sense (2017) by Dan Ariely and Jeff Kreisler point out the reasons why rationalism with our own money eludes us. They touch upon fundamental human characteristics, emotions versus common sense, and other flaws that are at the crux of bad spending habits.
No One Considers An Alternative to Expenditure
A few years ago, Dan Ariely, asked a few Toyota customers at a dealership, what purchases were they giving up in order to buy a new car? Most of the customers did not understand what his questions meant. Upon explaining further, many said that they were giving up on the opportunity to buy a different car. However, out of those few who did make the connection, answered that were giving up on a vacation, or eating out, etc.
What most people do not realize is that while money might be an abstract concept, its value enables our choices. However, humans do not naturally think of alternatives to what their money can get them. These alternatives, in economics, are known as Opportunity Costs. Most do not even consider these opportunity costs, making massive expenditure errors.
Enticing, Misleading Value Cues
As customers, we tend to place importance, and rely more on ‘value cues’. ‘Value Cues’ are external signs and hints that are suggestive of an item’s real value.
In a utopian situation, rationality would make people consider ‘opportunity costs’ while making purchase decisions, rather than focus on value cues such as, “limited offer” or “end-of-season-sale”. Salesmen often use such value cues to entice customers to make their purchases now, or miss the opportunity forever!
Yet, value cues can be helpful too. They can provide a true sense of the value of any commodity, and help in making practical purchases. However, they are used by companies to mislead customers into making buying decisions. Additionally, misleading value cues are used to skew a customers’ sense of value.
Value Cues, Comparison Shopping, and Decision Making
If we are susceptible to be misled by enticing value cues, how do we really make buying decisions? Do we understand the value of the things we buy? If we do understand, then why do we not consider opportunity costs?
Actually, it is difficult to ascertain the value of any product by simply looking at it. For example, if we want to buy a phone, we do not look at other factors such as the cost of labor, materials, shipping, manufacturing, etc. affecting its overall value. Instead, we use comparison with similar products, a mental shortcut, to determine the value of the phone we want to buy.
Such comparison-shopping can be misleading too. Nevertheless, humans, as customers, need value cues to guide their buying decisions. In 2012, Ron Johnson took over as the CEO of JCPenney, the department store. The routine practice there was to increase the prices of products and then introduce sales, discounts, and coupons, to bring the prices back to retail value. Johnson did not like the practice of misleading customers and decided to discontinue the practice, with good intentions. He discontinued all discounts and retained original retail prices. This made customers unhappy, and within a year, JCPenney lost $985 million.
Consumers needed the enticing, misleading value cues for the feel good factor of getting a bargain.
What If’s, Mental And Emotional Accounting
Everyone uses mental accounting to make financial decisions. Mental accounting is weighing out one’s options while making financial decisions. Therefore, mental accounting is a very subjective concept and differs based on one’s circumstances, understanding of the situation, and of course, financial understanding, and its implications. Mental accounting can be irrational by nature.
For example, lets look at two ‘what if’ scenarios –
- What if the $100 bill concert ticket you bought, flies out of the bus window on the way to the concert? Would you buy another one for the same price? And,
- What if you lost a $100 bill on the way to buying the $100 concert ticket? Would you still buy it?
Different people do mental accounting differently. For example, for someone, the money has already been spent on the ticket that got lost. The feeling will be different from when the $100 bill is lost, as the value for the $100 is not assigned a category (in one’s mind) yet.
Many who were asked these ‘what if’s’, chose to take out a new $100 bill and buy the ticket, however, not buy a new ticket if the one already purchased gets lost. Such is the irrationality of mental accounting.
However, there is a purpose to mental accounting too. Rationally, in both the scenarios, the value of the lost ticket and the lost $100 bill is the same, and therefore, the loss of value is the same. However, we all get countless opportunity cost options every time we think of any expenditure. How we choose is another thing altogether.
That is where emotional accounting comes into place. Emotional attachment to money and value greatly influences buying and spending decisions. Emotional accounting can be bad and one has to be wary of it. For example, when someone deals with money that comes to us from a source that we do not like, they try to add justifications to the expenditure of that money only to make themselves feel better. They might donate a small part of it to charity, feel better, and then frivolously spend the rest of it.
Perception Of Value
Our perception of the world around us and our experiences with our surroundings are hugely influenced by language. Let us try to understand the differences between the following two sentences –
- Living with 20% lesser salary
- Living off of only 80% salary
There is no difference between the two! Nevertheless, in 1988, a Journal Of Consumer Research study showed that people were more interested in spending their retirement with 80% of their income rather than 20% less of it. it was just a play of words.
Similarly, language is used as a key for advertising and influencing customer choices. For example, in restaurants, a wine with ‘earthy notes of oak and tobacco’ will easily sell for $80, whereas it wont even sell for $30 at a grocery store.
This phenomenon is known as ‘consumption vocabulary’. It links a word to the superiority of a product in consumers’ minds. For example, the word ‘artisan’ gives one the feeling of superiority, handmade, and thus more expensive.
Another way by which our perception of value increases is by adding a ritual around a product. This ritual can improve the experience. For example, the ritual of swirling wine in a goblet, taking in the heady fragrances, and finally tasting it, creates an experience that increases the value of a wine tasting.
Self-Control And Resisting Expenditure
Often people look for new ways to budgeting their money and reducing expenditure simply because we are irrational. Yet, despite efforts, they fail to save their money. This happens because they are unable to exercise their self-control while spending, making bad decisions.
It is essential that people start to consciously exercise their self-control by connecting emotionally to their own futures. This can be done by thinking of your future self. For example, one can see their future selves as fat couch potatoes binging on ice creams. While they know that their current habits are leading them towards that future, they choose to give in to the temptations because that future-self is remote, far, and un-relatable. Additionally, the fact that our future-self is a probability, we dismiss it.
One way to work around such temptations to spend, according to UCLA’s Hal Hershfield, is to write a letter to your future-self and forging an emotional connection. Additionally, one can also create visions or imagine your future-self appreciating past efforts of saving and enjoying the benefits.
Setting a tangible fixed date to retirement is another way to encourage yourself to save for it. for example, saving for use after ‘10 November 2050’ makes it more real than saving for ’30 years later’, which sounds like a generalization.
Concluding With The Ulysses Contract
According to the famed Greek legend, Ulysses had to be tied to the mast of his ship by his crew to avoid the Sirens’ alluring and deadly songs. Similarly, a Ulysses contract is setting up a structure or a process where a bad decision is not an option at all.
For example, if a person is habitually bad at managing credit cards that person should best avoid keeping credit cards and stick to debit cards. Or if a person cannot seem to save money, they should set up a standing instruction to directly put an amount in savings from their monthly paycheck.
Automated savings have shown to help people save about 81% more yearly.
In conclusion, even though we are wired to be bad at spending money, and make irrational expense decisions, we should stop making excuses and take efforts to save more and make better spending decisions. While changing spending habits doesn’t come naturally, nor happens instantly, one can definitely try and use methods such as Ulysses Contracts to help them save.
