Ever arrive home from your regular commute without a clear picture of how you got there? You’re safe, thankfully, but you can’t remember making every turn or even walking the last 500 feet to reach your door.
The same thing can happen when you’re spending money throughout the week.
“The overwhelming majority of our decisions are automatic,” says Mariel Beasley, co-founder of Common Cents Labs, which is part of the Center for Advanced Hindsight at Duke University. That’s not always a bad thing, as taking mental shortcuts can save you time and keep you from getting overwhelmed. But when it comes to money, automatic decision making isn’t necessarily best for your wallet.
“Generally, what these shortcuts mean is we tend to prioritize what’s easy, follow what other people are doing (we take other people’s behavior as cues as to what we should be doing), and we have natural ways that we think about money,” says Beasley.
Here are a few examples of how those shortcuts could work against you – and some ideas for how to break free.
We get stuck comparing apples to apples
“The rational way that we should approach spending decisions is by thinking about opportunity costs,” says Beasley. In other words, if you spend $500 today, you’re missing the opportunity to spend it later.
Calculating opportunity costs can be simple when there’s a clear trade-off – it’s easy to understand what you’re giving up when you have to choose between a cookie and cupcake. However, you can spend money in an almost infinite number of ways. “It basically means that it’s very difficult for us to think about the optimal way to spend money,” explains Beasley.
Failing to consider the opportunity cost of a purchases is the first mistake. But there’s still another trap. Even when they think about opportunity costs, people often only consider direct comparisons. Buying car X means I won’t get car Y, or buying drinks tonight means I can’t go out tomorrow night.
“When we think about these trade-offs, people should be thinking about different domains,” says Beasley. “It’s not one car or another, it’s a few vacations or a car.”
We only see what others’ buy
Our surroundings can have a strong impact on how we dress, what we watch, how we talk, and how we spend money. That’s not particularly surprising as many people have observed or experienced how spending increases in an attempt to keep up with the Joneses. But we often don’t know the Joneses’ entire situation.
“We see what people buy, but we don’t see what people choose not to buy,” says Beasley.
In 2016, the Center for Advanced Hindsight partnered with the Arizona Federal Credit Union to study how social proof impacts spending. The online experiment asked credit union members to estimate their eating-out spending relative to other similar households.
“Across the board, people assume that everyone else is spending more than them,” says Beasley. “We assume that we’re better than others on things we do regularly. Partially this is because overconfidence in ourselves, but it’s also because all we see is people eating out. We don’t see people eating at home.”
When members who spent more than the average were confronted with real statistics some dropped out of the process, but those who continued and finished the experiment decreased their spending on dining out over the next few weeks. But gradually, their spending reverted to the post-study levels.
We separate the pleasure of consuming from the pain of purchasing
Spending money can be hard when you have to hand someone cash. But it’s easier with a debit card, even easier with a credit card, and could be painless when you only have to click a button or tap your mobile device.
“There’s research that shows if you do all your spending on a credit card, your spending goes up versus using a debit card or cash,” says Beasley.
Making it easier to spend money is convenient, but sometimes inconvenience is what keeps us from making purchases that we’ll regret later.
We think of money in relative terms
Another way that our brain can trick us into spending more is that we can value the same amount of money differently depending on the context. Marketers know this, which is why salespeople may try to sell you lots of add-ons when you’re making a large purchase.
The relativity trap comes into play for day-to-day purchases as well.
“If you’re thinking about making a purchase and you have $100 in your pocket and you’re going to spend $50 of it, it feels like a lot,” says Beasley. But if you use a credit card that has a high credit limit, or it was payday and your direct deposit just cleared, the $50 might not seem like so much.
Sales and discounts take advantage of this mindset when they show an initial high price crossed out and replaced by a lower price. The initial price acts as an anchor, and you start to think of the sales price relative to that anchor.
Thinking of money in relative terms is also why adding a little more credit card debt onto an already large balance doesn’t feel like a big deal.
What can you do?
Breaking habits is hard. Fighting ingrained instincts that have evolved over thousands of years is even harder. And yet, both are possible. Here are a few ideas to help you get started:
- Join or create saving-focused communities. While saving may be invisible in many places, some groups enjoy and celebrate savings as an achievement. Connecting with these groups online or offline could lead to a change in your mindset and behavior. (Hint: Join Varo’s Facebook Group MoneyTalks as a starting point.)
- Find an accountability partner. Sitting down on a weekly or monthly basis and reviewing your purchases with someone else can be a powerful exercise. Partially, this is because when you’re about to buy something, you’ll be confronted with the knowledge that you’ll have to explain the purchase at a later point.
- Focus on short time frames. If you want to limit a certain type of spending (such as on eating out), try to set a short time frame. “If you commit to spending X amount in a month, it’s too easy to spend a lot early in the month,” says Beasley. “It’s easier to control if you commit to weekly spending limits.”
- Limit the frequency rather than the amount. Another trick if you’re setting a budget for a specific category is to limit the number of times you’ll do a certain activity rather than how much you’ll spend. For example, try to eat out twice a week rather than setting a total dollar limit and having to figure out how many (or few) times you can eat out.
- Reconsider your anchor prices. Knowing that relative amounts and anchors can influence spending, come up with your own anchor based on your values and desires. You can then frame your purchases relative to those costs and principles.
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Louis DeNicola is a freelance personal finance writer and credit enthusiast. You can find him on Twitter @is_lou.
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