(Ir)rationality of our spendings

ksolymosi (67)in #met • 5 years ago

Bookworm Series #12 by Kriszta (@ksolymosi)

I have probably mentioned earlier that I love the style and thoughts of Dan Ariely, so I was very happy when I saw his new book, Dollars and Sense. It is about the irrationality of our spendings and I guess we all have a lot to learn on this field. Let me share a few parts I really liked…

Irrational spending stems from not considering the alternatives and an overreliance on external signs of value

Money is an abstract concept. What a piece of paper with some writing on it can buy you today could very well change tomorrow. We need money to almost everything in our daily life and while we know that money is important, still, we make bad spending decisions. Why?

One reason is that when we get an urge to buy something, we rarely stop to think about what else could we spend that money on. In economics, all the other things we could buy are known as opportunity costs, and our failure to consider these alternatives is one of our biggest mistakes. When for example Ariely asked people in a car dealership about what purchases they were giving up to buy a new car, he just got confused looks. So considering alternatives does not come naturally for most of us.

Another reason behind irrational spending is an overreliance on value clues. These are external hints and signs suggesting an item’s real value. Here, rational behaviour would be to determine an item’s value via the opportunity cost (so comparing it to alternative purchases). Instead, we go the less rational route, relying on value clues and paying attention to signs like ‘sale’ or ‘limited time offer’. However these value clues are often misleading!

Mental and emotional accounting play a big role in our decision-making – but they both have their irrational tendencies

What if you paid $100 for a concert ticket, but the ticket would fly out on your car window on the way there? If you could then buy a new ticket for the same price would you do it?

Or what if you lost a hundred-dollar bill that was in your hand to buy the ticket? Would you take out another $100 and still buy a ticket?

We weigh up these options using mental accounting. It’s a little different for each of us, as we all have our own subjective categories with their subjective values. You may value a concert ticket worth $100 differently to a hundred-dollar bill that you’ve yet to spend. The money toward the concert ticket might be in the “already spent” category, while the bill was lost before it got assigned a category, so it can feel like it’s still waiting to be spent. This is why most people say they wouldn’t buy a new ticket but would take out more money if they hadn’t bought one yet.

A rational mind wouldn’t treat these two scenarios differently, since they are both costing you the same amount of money. But the world is filled with countless options on how to spend money, and so mental accounting would be a valuable time-saving tool, even if it isn’t perfect.

Another type of accounting is emotional accounting. When you attach emotions to money, it can easily influence your spending decisions. Eg. if you got some money from a relative you don’t like, you might try to wash away the negative associations by donating some of it to charity – and then spend the rest frivolously once you felt better about it.

Language and rituals can change our perception of value

If you’ve ever tried feeding a toddler, you’ll know that language can make things a whole lot easier. Similarly, language shapes how we perceive and experience the world around us. The restaurant industry is very aware of how language can make their food and drinks seem more precious. When a waiter uses words like ‘complex and earthy notes of oak and tobacco’, they know that the customers will be willing to pay $80 for a bottle of wine that they wouldn’t buy at their local grocery store for $30. This is our consumption vocabulary, which is often linked in our mind to a product’s superior value.

Another way we can add value is through the rituals we create around a product, which tend to enhance our experiences. This is another reason why a glass of wine can seem so precious; as we ritualize the pouring, the swirling, the smelling and finally, the tasting. Each step gives the experience an extra significance. Studies show that when we create rituals around consumption, we perceive the objects related to that consumption to have greater value.

Ways to boost your self-control and resist the temptation to spend

One of the best ways to increase your self-control is to start emotionally connecting yourself to the future. Imagine a conversation or write a letter to your future self, imagine that you are enjoying the benefits of your good decision.

It also helps to think in terms of fixed dates. According to a recent study, we are more likely to be diligent about putting aside money if we set an exact retirement date.

Another way to increase your self-control is removing the temptation by setting up a process or structure whereby a bad decision isn’t even an option. If you are lousy with credit cards, then use only prepaid debit cards for example.

Replace your complex budget with a simple one. Figure out how much you can comfortably spend on non-essential items and create a broad category for this called “discretionary spending”. Every week put that amount on a prepaid debit card and you can stop worrying about overspending.