Research shows that when making spending decisions we try to avoid difficult comparisons – but it’s the easy comparisons that can get us into trouble.
Rationally everyone knows that, roughly speaking, money has an absolute value. $10 is $10 is $10. Yes, the prices of goods vary, but generally speaking we know $10 will buy us a book just as easily as a CD.
This may be self-evident economic reasoning, but it’s actually a poor basis for understanding how we make decisions about money. In reality, we often don’t view $10 spent on a book in the same way as the $10 for a CD, because comparing a book with a CD is not an easy job.
Here’s one reader’s response to my call for questions about money:
“I would love to understand why I find some things expensive and won’t buy them, and other things not so expensive and will buy them, when they are the same price/cost. For example, I’ll spend $50 going out for dinner with my kids when we don’t have to (a treat) but I won’t buy a $50 appliance for my kitchen (new toaster). And, I’ll spend $250 on an outfit for a special party, but would never spend that on jeans I’d wear twice a week. I imagine that if I understood why I do this, I’d be able to spend my $ more wisely.”
This (excellent) question goes right to the heart of why money is such a strange beast and why our decisions about money often appear irrational. The question comes down to this: is it possible to compare treating your kids to dinner with buying a toaster? Or: can you compare buying a dress you’d wear to a party to regular, everyday jeans?
When we’re trying to make decisions about money, our brains prefer to work in a relative way.Psychologists have found that these kind of cross-category comparisons are exactly the kind we have a problem with. When we’re trying to make decisions about money, our brains prefer to work in a relative way. We will tend to compare the cost (and benefit) of treating the kids to dinner at a cheap restaurant compared with, say, a more pricey restaurant, or, at a stretch, with some other comparable activity, like going to the cinema – but comparing treating the kids with buying a toaster? Too tricky. At best we might be able to compare buying the toaster with a different kitchen appliance, like a kettle.
Usually, of course, the marketplace for goods and services is so crowded that there’s no need for us to make a decision without a comparison. It’s when either there is no comparison – or we try to make a difficult one, like restaurants and toasters – that we end up doing all we can to avoid the problem.
Unfortunately trying to avoid the problem is what gets us into trouble.
Monetary relativity explained
How we can be tripped up by easy comparisons is neatly demonstrated in a study reported by behavioural economist Professor Dan Ariely in his new book ‘Predictably Irrational‘. Ariely showed 100 MBA students three different options for subscribing to The Economist – options that actually appeared in a real advert – like this:
- Website-only subscription: $59.00 per year.
- Print-only subscription: $125.00 per year.
- Print & web: $125.00 per year.
There’s something strange going on here – why include two options, one for print-only and one for print & web at the same price? You’ll see in a minute. First let’s look at how many chose each of these options:
- Website-only subscription: 16
- Print-only subscription: 0
- Print & web: 84
Unsurprisingly the students preferred the print & web over the print-only. It’s a no-brainer. Most also went for the higher priced option over the cheaper website-only option. But look what happened when Professor Ariely took out the middle print-only subscription. So now they are choosing between website-only and print & web:
- Website-only subscription: 68
- Print & web: 32
What a difference that option makes to the Economist’s subscriptions! Suddenly most people are plumping for the cheap option rather than shelling out for the pricey print & web option. What’s going on?
One of these things is not like the others
Ariely explains that this shift is down to our preference for avoiding comparing things that are too dissimilar. In this experiment the easy option is comparing print with print & web. It’s obvious how much better print & web is than just print. Who would choose print-only for the same price? The website-only option gets ignored because it’s difficult to compare it with the other two options.
But, once the print-only option gets removed we’re stuck comparing dissimilar items, so then students go for the cheap option as suddenly this seems a safer choice.
The solution? Think globally not locally
So how can we avoid the relatively trap? Ariely argues that one solution is forcing ourselves to make these cross-categorical comparisons. Don’t focus on seeing the money you spend in the context of similar purchases, but instead think what the money means to you globally.
Focus on what the money means to you globally.For example, imagine you’re about to buy a new flat-screen TV, and you can’t decide how much to spend. The key is not to think about the price differences between the different TVs. Chances are you’ll end up thinking that if you just spend a little more, you’ll get a much better TV.
Instead it’s better to think about the particular TV you want in terms of other areas of your life. Think about the total price of that TV in terms of what other things you could buy with that money. Then you’ll have a better idea of how much you want to spend.
So, to return to the reader’s query, the answer is actually there in the question. Trying to compare restaurant meals with toasters, difficult though it is, will probably help you, and the rest of us, spend money more wisely!
[Image credit: cypherone]
