‘Dollars and Sense’ co-author offers tips to minimize irrational money moves
Personal Finance Writer
Exploring the cultural impact of credit cards
Do you ever (or worse, frequently) make purchases you later regret? Does anticipation of your monthly credit card bill fill you with dread? Is your savings plan on life support? Are you totally bummed by your routine money mistakes?
It might be time to rethink your approach to money and start flaunting that 401(k) instead of that luxury credit card, suggests Duke University behavioral economist Dan Ariely.
In a wacky new book entitled “Dollars and Sense: How We Misthink Money and How to Spend Smarter” co-written with financial comedian Jeff Kreisler, Ariely insists that, while technology advances and new payment forms are making it hard to feel the pain of payment, correcting our money blind spots can and should be a laughing matter.
In fact, the very name that Ariely, a popular TED Talk speaker, chose for his laboratory – the Center for Advanced Hindsight – shows he’s dead serious about making money makeovers fun.
In this interview with CreditCards.com, Ariely talks about how it was easier to save money back in the day when we dealt in chickens and cows instead of rewards and cash back points, and offers a few simple course corrections we can all access to help take the pain out of paying.
Money’s opportunity cost is becoming harder to see
Q: Though clearly tongue-in-cheek, your center’s goal – advanced hindsight – seems to nail our irrational approach to money, in that we anticipate the satisfaction of purchasing something without looking back to consider the ‘opportunity cost,’ which is what we’re really giving up to do so.
A: That’s right. The thing to recognize with money is how difficult money is and how technology is making it more difficult.
Money is supposed to be about opportunity cost: What are we getting, what are we giving up? But technology, things like Apple Pay and Android Pay, are making this much harder to think about.
If you go to a restaurant, it’s very hard to think about what exactly you’re giving up. If you have student loans and a mortgage and so on, and tomorrow you’re going to buy a new bike, it’s very hard to figure out what you’re giving up for the pleasure of having a new bike.
When you compare that to a world where you only had cash and only enough for the next month, opportunity cost would be more clear.
“A thousand years ago, when we dealt in goats and chickens and cows, the nice thing about that was we could compete with our neighbors on who had more cows or goats. But then, when we invented money, we made spending very visible, but we made saving completely invisible.”
Q: In fact, long before gold and currency made our wealth mobile, it was much easier to make that call, right?
A: A thousand years ago, when we dealt in goats and chickens and cows, the nice thing about that was we could compete with our neighbors on who had more cows or goats. But then, when we invented money, we made spending very visible, but we made saving completely invisible.
There was a study last year that shows that when people win the lottery, their neighbors start spending more money, because it’s so natural to compete on whatever we can compete on, and with money, we’ve just made it so that we can’t compete on savings.
Moving from animals to gold to cash had lots of benefits, but it comes with some baggage. The interesting thing about our [digital] times now is, we can actually decide how to design a new balance, but it’s kind of up to us to decide how we want to create those things. Do we want people to have zero payment pain and not to see what they’re saving, or do we want people to be a little more thoughtful about money?
Want to feel some payment pains? Put that card away
Q: How did the introduction of credit cards in the 1950s affect our collective money muddle?
A: Even when you just had cash, opportunity costs were not very clear. What credit cards did was to change the pain of paying by basically disassociating the time of consumption from the time of payment. That turns out to change dramatically the pain we feel about paying.
So, imagine that tonight, you’re going to dinner, your bill is going to be $200 for a fancy dinner, and you’re going to pay with cash or a credit card. Paying by cash feels much worse and it will definitely slow you down from spending more, whereas the credit card would feel much freer; you would not feel the pain of paying and you would more easily spend more.
The credit card is a little bit like the chips in a casino; it disassociates consumption from expense, and in that way, they allow us to spend more without thinking about it.
Q: Ironically, credit cards were marketed as a convenient way to better manage our finances. What happened?
A: The reality is, you could have had the benefits of plastic differently. Think about prepaid debit cards, which from a planning perspective are even better than a credit card because you have a spending limit. Of course, credit cards were not sold as being a way to spend money without thinking about it and being surprised at the end of the month. Maybe it wasn’t the declared marketing plan, but that’s what they did.
Now, if you and I were trying to create a new type of plastic, we could make it in a way that people would feel the pain of paying.
“Technology is not necessarily bad, but the way we’ve designed technology so far has been at the service of the payment industry, not the savings industry.”
For example, in the morning, we could give people a notification and tell them how much money they should be thinking about spending for the week. And if they spend, we could tell them how much they have left. And if they go into a place where they usually spend too much money, we could say, ‘Be careful.’ There are all kinds of things we could do.
So, technology is not necessarily going to make it harder for us. We need to recognize that thinking about opportunity cost is very hard. Technology is not necessarily bad, but the way we’ve designed technology so far has been at the service of the payment industry, not the savings industry.
If all the organizations that do savings had been in charge of creating our payment methods, it wouldn’t have been designed to get us to overspend, but instead to be very mindful of saving.
Want to cut overspending? Pay now, spend later
Q: So, if debit cards had preceded credit cards, would we be making better money choices today?
A: Yes. The choice [with credit cards] was to disassociate payment from consumption – spend now, pay later – whereas with prepaid debit, it’s pay now, spend later. It’s kind of guaranteed that you can’t spend more than you have. All the things about ease of use and tracking and so on could have all been with prepaid cards.
Q: Has the increasingly complex legalese of financial terms and conditions simply caused some consumers to shut down to minimize payment pain?
A: The financial world is becoming more and more complex. Whether it’s understanding what’s happening in the stock market or how much money you will need now that we live longer, things are very, very complex.
That’s true, by the way, in many areas of life, including health and education and all kinds of things. So, as life is moving forward, we need to spend more and more time doing things self-service. And as things become more complex, we often just give up. And when people don’t know what to do, they basically succumb to all kinds of mistakes.
Dan Ariely’s 3 steps to minimize irrational money moves
- Try to make saving a bit more visible. “It could be talking to your spouse about how much you have in your 401(k), it could be driving a little nail in the door every time you save another $10,000 in your long-term account,” he says. “Do something that serves as a reminder of saving and not spending.”
- Think about relativity. “If you’re buying something big, like a car, and for $1,000 more you can add a stereo, the odds are that you will spend way too much once you’ve paid a lot already. One way to do this is to think about something you really love,” Ariely says. “For example, our family loves going to a particular movie place, have dinner there and go and see a movie. I know how much it costs, so then, when I look at something else like shoes, I can say, ‘Instead of these shoes, I can have X movie nights.’ Compare what you’re thinking of buying to something you know and love.”
- Think about the pain of paying. “How do we budget in advance? In the book, we suggest you budget on a weekly basis starting on Monday,” he says, “because if your budget starts on Friday, you tend to spend too much on the weekend and run out of money. Get a grasp of your credit and debit cards and create a system that allows you to control your budget instead of letting other people control it.”
See related: $10 incentive encourages long-term saving, 5 mental money traps to avoid
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