Handling Finances

On Wednesday, I wrote about recognizing expensive habits that can bust any budget. While recognizing habitual spending can help set priorities, recognizing how we make decisions can help us to develop good habits to begin with. Unfortunately, this isn’t as easy as it might sound.

To put it bluntly, our days fighting tigers in Africa have left us with some quirks that lead to poor decisions.  Advertisers are fully aware of these behaviors and use them extensively to affect our behaviors.

Be aware of anchors.

The first is something I find particularly fascinating — anchoring.  We don’t simply memorize every single price we’ve ever seen, instead we tend to compare similar items to determine value.  A good example of this is in restaurants where there’s a long list of similar foods for various prices.  If sales of the more expensive (and profitable) dishes are slow, lowering prices can actually hurt sales further.  Instead, increasing the price of a couple of dishes will make the rest of the food seem more reasonably priced!  Similarly, even discount stores will often prominently display expensive items along with slightly lower “sale” prices to make the sales seem even better than they are.

Similarly, when people develop anchors, they’re hard to change.  When people move from areas with low house prices (say, Iowa) to places with high prices, they tend to buy much smaller houses.  If they move from areas with high prices to low prices, they tend to pay the same amount and get much larger houses.  In moving, it’s generally a good idea to rent for a year or so to allow time to reset the anchors.  With other  items, it’s important to evaluate the actual value (i.e. will you use the item?  How often?) and consider what else that money could purchase.

Consider cost with each purchase.

Say you normally make coffee at home, but one morning you didn’t have enough time.  You purchase a small cup at the coffee shop near work, and go on with your day.  It’s just a one-time thing, right?  Probably not if you’re an average human.  You see, we’re wired to take shortcuts in our thinking and one shortcut is that we avoid making the same decision more than once.  Once you’ve bought coffee at that coffee shop, you’re much more likely to go back in a couple days — maybe even if you didn’t forget to make coffee in the morning!  To avoid this kind of habit, you have to develop the habit of considering the cost every time you make a discretionary purchase.  Don’t just assume (as we’re all prone to do) that because you have been spending at a particular coffee shop, the spending is worth the cost because it’s entirely possible (even likely) that that spending started as a “one-time thing” that you just never reconsidered.

Think before buying.

Again, it’s important to think before each purchase — even everyday purchases.  Experiments have shown that simply thinking about what else you could purchase with the same money minimizes the effect of anchors and habitual spending.  Spending some time to consider the purchase can result in odd behavior — I sometimes stand in line for a few minutes for a drink or snack before turning around and leaving when I decide the purchase isn’t worth the cost.  Still, I think that a little weirdness is well worth the saving you get from carefully thinking before buying.

This entry was posted on Sunday, April 20th, 2008 at 7:48 pm and is filed under Saving, Spending. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.