Spending and Saving Money Is All About Trade Offs

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Author and professor Dan Ariely has gained fame from being able to make his behavioral economics research accessible to the general public. We all want to understand better why we do what we do. His newest book is The Upside of Irrationality. You can read sample chapters from his books for free via the eBook Taste of Irrationality.

One of the problems he’s trying to address is saving for retirement. Why do so many people save less than they need to? Here’s what Ariely says, via a recent interview on the Betterment blog:

The world around us (wants) us to spend money now. The incentives (to spend) are always very high. It’s hard to resist that, and sadly, after being tempted towards spending, spending, spending, what we have left for savings is not enough.

Investing is between now and later. It’s about the trade off, and because people are not making these trade offs correctly, we’re basically in the (bad economic) situation that we’re in.

Money is fungible. Any time you spend money on anything, it could be spent on something else. The $10 lunch, the $1,000 TV, the $20,000 car. We all know this is true, but in practice we tend to weigh things differently. Here is a thought experiment taken from a recent talking engagement (paraphrased):

Imagine being presented with the decision to either by a $700 Sony speaker set or a $1000 Pioneer speaker set. Most people go for the better and more expensive Pioneer speakers.

Now, what if the same people were instead presented with the decision between the $700 Sony set + $300 in CDs and DVDs or a $1000 Pioneer speaker set? Ariely found that now most people go for the Sony set and music package.

Why? It’s easier to imagine the value of $300 of CDs as opposed to the diluted value of $300 spread across all the possible things in the world to buy.

Perhaps it would help us to remember a list of things at different price points that are really important to us, so that we can better judge our daily spending. For example, if I really enjoy my daily $3 coffee, then I could think of other small purchases in terms of giving up that coffee. Now, getting everyone to agree to delayed gratification is something for which I don’t think there is a simple solution.

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  1. That’s a really good idea. I may have to come up with a list like that. I’m not a big spender, but deciding not to pack a lunch and buying one on campus is a big issue I have. I’ll have to pull the prices of different things I buy for lunch and come up with equivalents.

  2. I guess I’m not a thinker, because the thought experiment makes no sense to me. If that is how “most people” decide things then why don’t any of my neighbors drive Ferrari’s — ie, if getting the better more expensive thing is the deciding factor. I’m not even sure why the Pioneer system is better other than it’s more expensive than the Sony one. In the alternative proposition, you’re spending $1k so it’s a wash, it does not matter which one you choose. I actually don’t think “most people” would choose that if they perceive the Pioneer as better. I’m shocked at how much my sister spends on her iPhone because she sees $200 as the price.. not how much the monthly service fee costs, not how much she spends on apps, not how much see spends on a case, extra charger, etc. I’d love to have a gaming system, but when I look at the cost of the unit, add games, add extra controllers, etc it’s 5x the base “getting started cost”. If you’re going to get either of the speaker systems, you’re going to need something to play on it, so why not the Sony with CDs & DVDs? It seems like this is being presented as a bad option, but it’s really the same $1k cost except you’ve factored in the add-ons. In all scenarios, the Pioneer is a poorer choice unless you can quantify why it is “better”.

  3. Isnt the whole point of the zero interest rate policy and other FED policies to induce us to spend now? Here’s a though experiment: I can use my money to buy something now for $100 or I can save it at 0.01% or invest it at -5% to be able to buy the same thing for $250 in 10 years. Of course this assumes my bank doesn’t collapse in the meantime and wipe out my savings. Or my investment doesn’t become frozen in a failed exchange. I think that the FED, the Feds and Big Finance have done all they can to prevent us from saving. It’s not just a choice between Sony and Pioneer.

  4. I don’t think it’s a matter of thinking the $1000 speakers are better just because they cost $300 more. I think that people tend to look at the options and decide whether the additional quality or added features is worth the higher price. They don’t think about whether the higher price is worth it for them. Are they going to notice the difference in sound quality? Will it last longer and delay the need to buy a new one? Am I going to use the extra features it comes with? Most people look at which one has the best features and whether the price is reasonable for the features it has rather than asking themselves if they would be happier buying something that isn’t quite as elaborate and be able to spend the difference in cost on something else, or save the money for later.

  5. I already do this, but in a bad way…. For example, we need to repave the driveway, but the cost is equal to taking two big family vacations, so I just can’t stand the thought of spending it on something so boring!

  6. Matt Hartrich, NY says

    So few people are willing to accept delayed gratification.

  7. Good post and excellent point. Some people are happier however, on balance, not deferring gratification. Interesting recent Newsweek article” The Money Brain” makes the point that you can change this if you really want to.

  8. Main argument against delayed gratification is upcoming rampant inflation.

  9. In my opinion, it is all about self control and discipline. Most people know what they should be doing with their money, they are just not able to control basic impulses and desires.

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