Hey, Big Spender!

“I don’t want to stress out when I think about money”.  That is a common comment I hear people make. Given what we go through to earn a dollar why then stress out over that buck?   We want to enjoy it - feel confident that we are on the path to a stronger more secure financial future. 

Now, unless you’re the person who wins the lottery or receives the $2 million dollar inheritance from a long lost great aunt - I haven’t seen anyone get into a financial secure position by spending more than they earn.  Living beneath your income is one habit people who find themselves with financial freedom share.

I am a Financial Planner and a big believer in having a household budget, but I’m well aware we’d all much rather stick needles in our eyes than spend time looking over line item by line item where we are spending our money.

So as a first step (before you go rushing for the needles) I want to introduce you to a concept that can help us adjust our mindset when it comes to spending money.  

It is really important to recognise that we often view our spending in relative terms not absolute terms. To explain what this means – Dan Ariely the author of a great book “Predictably Irrational” and a Professor of Psychology and Behavioral Economics at Duke University developed a series of comparisons about how we view our spending in relative terms not absolute terms (and I’ve tried to add some local context!).

Imagine going down to the local Chemist to buy some sunscreen.  You go up to the counter with your chosen sunscreen – and the shop assistant sees you’re wearing a Collingwood hat – they explain they don’t want to take advantage of a fellow Magpies fan and say, “I want to let you know that another Chemist has the exact same sunscreen that we sell for $15 – they are selling it for only $7. It’s $8 cheaper – less than half our price.  It’s 3 blocks down the road – so it’s up to you if you want to buy from here or down the street at the other Chemist.” 

Now you ask yourself – will you walk 3 blocks down the street to save $8?  Most people would think about that and say, “yes, I would do that”.

Now consider a slightly different scenario.  You are going to buy an IPad – an expensive IPad from the Apple Store.  It costs $1,050 and as the store assistant extolls the virtues of the device with all the requisite enthusiasm of an Apple employee – they notice you’re wearing a Collingwood hat and turn and say, “as a fellow Pies fan I’ll let you in on something that I shouldn’t be doing – 3 blocks down the road JB Hi-Fi is selling this exact IPad for $8 less – instead of $1,050 they’ve got it for $1,042.” 

Would you take the trip down 3 blocks? Most people would say absolutely not.

The reality of the situation is our bank account doesn’t care where $8 comes from.  It doesn’t care whether it’s from sunscreen or an Ipad – whether it’s from a small purchase or a big purchase.  But the funny thing is - we care! 

An $8 saving from $15 feels like a big amount – it is more than half!  However $8 from $1,050 looks like a really small amount. 

Another example that illustrates this similar point is consider you are buying a car that costs $45,000.  The sales person says for $2,000 more you can get leather seats.  Apparently leather seats are all the rage!  Now imagine a second case where you are going to buy a chair for your office.   The sales person tells you for $2,000 more than the price of the chair – the chair costs $500 – you can get a leather seat on the chair. 

Would you do it? 

Now most people say the first one is an easy decision the second one is outrageous – paying $2,000 extra on a chair worth $500 for a leather seat!  Now presumably you sit more in your office chair at work than in the car – and for whatever the benefits are from leather they would be higher in the office than in the car but that is not how we think about it.  When we spend $45,000 - $2,000 seems very small.  When we spend $500 – an extra $2,000 looks incredibly large.

So when it comes to spending money – we need to try and overcome our natural tendencies of looking at things in absolute terms not relative terms and think about how we can go about fighting this.  What this really involves is not making a decision on something relative to what we are spending – we need to think about them as independent – and the trick is to train ourselves to do that.