Mind Over Money. Claudia Hammond
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best offer, but half of them were told they would need to pay in cash – and would be allowed to visit an ATM if necessary – while the other half were told they could pay with a credit card. How much would they offer for the tickets?
The difference was striking. Those paying cash bid an average of $28, but the card payers were prepared to offer more than double that amount: $60.30
Now I say this result was striking, but even so I doubt it surprises you that much. I suspect the behaviour of the MIT students mirrors your own attitudes. It certainly does mine. Paying with cash always feels that much more real somehow; and parting with it, that much more painful. Paying with a card delays the pain and makes the transaction easier. Some would say too easy. With the increase in the availability of instant credit, personal debt in the UK, for example, more than tripled between 1990 and 2013.31 There is a lesson to learn from this. Whenever you are tempted to buy something on a credit card, imagine getting the same amount out of a cash machine and spending that instead.
Perhaps the card-paying MIT students could afford $60 for the basketball tickets – and thought that was a fair price. If so, okay. But I suspect they overbid, determined to win the tickets, whatever the cost, and not worrying about how they would pay for them.
One final thought on the cash or credit question. The MIT experiment took place in 1999, when students with credit cards were a relatively new phenomenon. Indeed for us all, cash-free payment is a fairly recent thing, certainly for the majority of purchases. Now, one of the reasons why personal debt has risen is that personal finance markets have mushroomed and there are many more ways of acquiring credit. But another is surely that we are still in something of a mental transition period from cash to cashless. And during that transition our grip on ‘virtual’ money is not as tight as it should be. Maybe it should come as no surprise that we tend to spend it more loosely than we do ‘real’ money.
Perhaps children growing up now, children who will almost never see their parents pay in cash, will not make the sometimes dangerous distinction between cash and cashless – respecting the first and being cavalier with the second. Indeed cash may soon disappear altogether. For people of the near future, ‘real’ money will only be numbers on a screen. And maybe they’ll soon find virtual transactions involving lots of digital noughts as daunting as we do handing over a stack of notes.
3
MENTAL ACCOUNTS
Why the more an item costs, the more careless with money we are, why we should all use psychological moneybags and how certain budget airlines could have saved themselves a lot of grief.
IMAGINE YOU ARE on a seaside holiday and you decide to hire a bike to cycle along the coast road. You walk along the promenade checking out the prices. The first hire shop you find is charging £25 a day, but then you see a sign for another shop that offers a bike for just £10 a day. The second shop is a 10-minute walk away, but with a price difference like that, maybe it’s worth checking out the cheaper bikes. As long as they look reasonably roadworthy, you can hire one of those instead and congratulate yourself on saving £15, enough to pay for a second day’s cycling or a nice lunch in a café on the cliffs.
Now imagine that you are back home and are buying a new car. In the first showroom you find one you like for £10,010. You want to check you are getting a good deal, so you go to a second showroom 10 minutes away. They have much the same car for £10,025 (this might sound unlikely, but for the purposes of these experiments you need to bear with it). Is it worth going back to the first shop to save £15? Almost certainly not. For a transaction that big, a difference so small feels inconsequential. Yet the sum you could save is exactly the same as with the bike hire. In the earlier example, you are delighted with that saving. Now you dismiss it.
Countless studies have demonstrated that we constantly make judgements like this, viewing a saving as a proportion of the total cost, rather than as an actual amount of money with a determined spending power. This is called relative thinking, and it is particularly common among people who are comparatively affluent.1
This struck me forcefully when my husband and I moved home recently. It involved the largest financial transaction of our lives. London prices, so hundreds of thousands of pounds: a huge commitment, and one we weighed up carefully. Yet we behaved exactly in line with the research which shows that the bigger the purchase, the greater the likelihood people will take little care over associated costs. Having made such a massive outlay on the house itself, we should have been keen to save every penny we could on other aspects of the move. Yet we didn’t check that the solicitor handling the exchange was offering a competitive rate; we simply used the one we’d been to last time we moved. Likewise we took a friend’s advice – ‘They’re not the cheapest of all, but they’re really good and it makes life a lot easier’ – when it came to hiring a firm of furniture movers. In the context of buying a house, a few hundred pounds – which usually we would be so careful about – felt neither here nor there.
Not everyone can be so cavalier of course. The Indian economist Sendhil Mullainathan asked people in poverty attending a soup kitchen whether they would be prepared to travel for 45 minutes to save $50 on a household appliance. 2 He knew all about the research famously done by Daniel Kahneman and Amos Tversky, which showed that people tend to make decisions of this type within the context of the original price.3 In these cases, if a household appliance cost $100 before the markdown, then a 50 per cent discount would make the journey worthwhile, but if the full cost of the item was $1,000 it wasn’t worth bothering with a saving of $50. What Mullainathan showed was that the people in the soup kitchen couldn’t afford to think this way. They weren’t swayed by the initial price because whatever that price was, a $50 saving for them was a sum of money they couldn’t afford to forgo.
On the face of it, theirs was the more rational behaviour. But does that mean that richer people are being wholly irrational? Not necessarily. We factor into our thinking not just the financial saving but the value of our time, which in some cases is more precious to us. Unlike the people at the soup kitchen, we often consider we are – to use the cliché – ‘money rich, but time poor’.
Yet we don’t behave entirely consistently in making these calculations. Many of us spend hours online, finding the very cheapest deal on a flight or a rail ticket and saving relatively small sums in the process. Now that might be sensible for people who can hunt for bargains in the office (without the boss seeing), in which case they’re making the saving and the firm is paying for the time. But I work freelance from home a lot of the time and do the same thing. I’ve never calculated it, but it would almost certainly make more financial sense for me to spend the time working. Yet in this instance, the lure of a cut-price deal is irresistible. Moreover, research has shown, we aren’t prepared to spend the same time to review much bigger, ongoing financial commitments.
To take one example: in the UK, people have the option to change energy suppliers to find the best deal, but research has shown only 1–10 per cent of people regularly monitor prices and save money by switching.4 And this, despite the fact that savings on utility bills can run into hundreds of pounds a year.
So why do we make an effort in some cases and not others? Sometimes it is to do with necessity. We have to choose a train ticket because we need to get somewhere, but we don’t have to bother changing electricity supplier. But there is another reason. We hate committing ourselves to future work. The first stage of switching energy supplier is easy enough to do, but it involves more of a commitment than making a one-off purchase. There will be the hassle of reading the meter at a future date, sending the information off to the new supplier, checking the direct debits are working correctly and so on. It’s all a bit of a chore. And of course the reward is a saving in the future, not the instant gratification of shopping in the sales, where you’ve paid less than you might have done and got something shiny and new straight away.
What should be clear from these examples is that the idea that every pound is worth the same to every one of us – a concept that underpins our system of monetary exchange and which we all take for granted – is not true at all, psychologically speaking. Indeed each of us individually puts a different