Why we spend: Are you falling for these costly biases?

Until a few years ago, I used to frequent a store that gave $10 (technically a credit of $10 toward future purchases, but it wasn't cash) back for every $50 purchase. Whenever I got to $40 in purchases, I would add unplanned items to bring the total up to $50 as I couldn't leave the “free” $10 on the table. My rationale was that these items were technically free. But in reality, the rationalization is nonsensical because: (1) The $10 credit was only applicable for purchases made weeks after my original visit and, by the time it became eligible, I had invariably forgotten that I had the credit and so it naturally would expire; and (2) I only needed $40 worth of items, so even though I could get $60 worth of items for $50, I paid $10 more than I intended to and I ended up with $20 worth of stuff that I didn't need. It took me a while to stop this behavior.

We all make money mistakes, and some of us make more than others. But most of time the mistake isn't obvious to us because we also have a lot of biases that prevent us from making rational decisions. Here are some of the biases that cloud our judgment:

1. Status quo bias

In general, people don't like change, especially a change that might result in a loss. We love to do … nothing. So we stick to same old routine, same old insurance or phone company, same investment plan, etc. We continue to do this even when there are better options available because change takes effort.

2. Relativity trap

Also called anchoring, it is one of the popular techniques companies use to make people feel good about the price of an item. It is quite simple and very effective. All the stores have to do is to anchor you to a high price and offer a “discount” to get to the current price — originally $149, now only $79. By seeing the $149 price tag, you are anchored to that price and you feel relieved that you don't have to pay the full price; you feel happy that you are getting such a bargain at almost 50 percent off. At this point, we stop considering whether the item is worth $79, ignoring the original price tag. That is what the store wants us to do, and we fall for it easily.

3. Present bias

In general, we like to live in the present and postpone pain to the future. In a study by Read and van Leeuwen (http://www.ncbi.nlm.nih.gov/pubmed/9831521), when people were asked to choose what they wanted to eat the following week, 74 percent of the participants chose fruits. When asked to make choices for the present week, 70 percent chose chocolate! Why wait when you can get the stuff right away and can worry about paying for it later, right? That is why $0 down mobile contracts and $0 down long car loans are so very popular.

4. Familiarity bias

Advertising works. If we have seen a product many times on TV, billboards, online, etc., we somehow, without meaning to, start thinking it is a better product. We start associating familiarity with popularity and are willing to pay a premium to get the better product even if we know absolutely nothing about the quality of the product.

5. “It's free” bias

One of my favorite biases — and one of the worst to succumb to — is the word “free.” It has a very seductive power over us and makes us do a lot of irrational things. Most of time we end up paying for the free stuff in one way or the other, but we still can't let something that is “free” go. Free-after-rebate items are hugely popular because the rebate redemption rates are super low (ranging from 2 percent to 70 percent, and most commonly about 40 percent). We actually achieve a high from the euphoria of getting a free item and conveninetly forget or mess up the complicated mail-in rebate procedure.

6. Fear of loss

Just about everyone knows about this bias and, at one point or other, has probably experienced loss aversion. We would rather avoid losses than make a profit. Fear of loss is what made millions of people sell their retirement portfolio during the recession and lock in their losses instead of waiting it out. This is also why people overbid on Ebay.

As you might expect, the first step in fixing these mistakes is by acknowledging them. It is difficult, but it can be done. What other biases affect how you spend, and how do you counteract them?

More about...Psychology

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Beth
Beth
5 years ago

I’ve seen many articles on this topic and one of my favourites is the Sunk Cost Fallacy. In my case, it used to do with hobbies… “I spent $x on materials, I might as well spend a little more and finish what I’ve started.” I’ve since learned to just give away my UFOs (unfinished objects). Right now the Status Quo worries me. I’ve already saved money by checking my insurance, telecommunications services, and all that jazz — but my investments? The more I read about ETFs and dividend paying stocks, the more I’m convinced I need to think outside the… Read more »

Nina @ RichLife.io
Nina @ RichLife.io
5 years ago
Reply to  Beth

I know the sunk cost one in a somewhat similar way. I’ll no longer be enjoying something I am spending time on, but since I’ve been with it for a good while, I keep at it because of what I already put in it and also the fear that if I stop now I might regret it soon.

Carol
Carol
5 years ago

At a yard sale, years ago, I put all my unfinished “projects/hobbies” out for sale for low prices. What a weight was lifted off my shoulders/mind when they all went!! I was free! Didn’t realize til then how they weighed on my psyche!

Scooze
Scooze
5 years ago

This is a great article – thank you! It is one of the best I’ve read on why we overspend.

Incidentally, I’ve been paying too much for cellular, simply because of status quo bias. I need to do something about that!

Elle
Elle
5 years ago
Reply to  Scooze

Ditto here! My prob is car/home insurance. It goes up EVERY SINGLE period—though naturally the car and home are both worth less every single period. I’ve questioned it and got no bites from the company as to anything they can do. I know I should try someone else—but I’ve been with these guys since 1990. And now another January is here so the home premium was paid out of my escrow already. In the back of my mind (over the summer) I thought I should do something before that kicked in, and I missed it again. (Six month car premium… Read more »

Hoping to Adopt
Hoping to Adopt
5 years ago
Reply to  Elle

You can change your insurance coverage at any time – you do not have to wait for the renewal date. I just updated my insurance coverage for my home, but my renewal date had been in June. I stayed with the same provider, but I changed the coverage amount and deductibles. Because of the specific changes that I was making, they had to “rewrite” the policy and essentially open a new policy and close the old one. The insurance company issued me a refund check for the remaining premium on my old policy. The escrow paid the new premium, and… Read more »

Sherry
Sherry
5 years ago
Reply to  Elle

While I would agree that the value of the car goes down, the value of the home should not, unless it is a mobile home and therefore considered by insurance companies as just that – mobile, and therefore a vehicle.

Dave Ramsey talks about people getting emotionally attached to their first credit card. Getting attached to an insurer is equally useless, especially if it’s costing you money. Keep in mind that “shopping” your insurance providers is not a commitment to switch – it’s just letting these companies compete for your business and it’s worth your time.

Beth
Beth
5 years ago
Reply to  Elle

That happened to me with my telecommunications provider. I kept asking and asking if there was any better deal they could give me and didn’t get an answer. Until I went out and found a better deal and called to cancel my account. Then they were happy to cut me a deal. It was a hassle to get to that point, but it paid off. Shopping around doesn’t mean you have to leave. You can always go back to your provider and say “I found this deal at company x. Will you match it?” Or talk to their customer retention… Read more »

Jeff
Jeff
5 years ago
Reply to  Elle

My last auto insurance company was doing that to me and claimed that it was “normal”. I told them to kiss off and switched to another provider, who has given me the same rate now for two years straight.

Beth
Beth
5 years ago
Reply to  Scooze

Your car may be worth less but a hefty portion of the cost of insurance is in liability. Replacing vehicles is cheap compared to lawsuits.

Also, older cars have fewer safety features that protect people when an accident occurs. The worst case scenario for an insurance company is someone becoming disabled as a result of an accident. That’s another reason why there isn’t a huge difference between insuring a beater and insuring a new car. (At least in Ontario)

I’m grateful to have a very knowledgeable broker 🙂

Mrs. Frugalwoods
Mrs. Frugalwoods
5 years ago

Another bias I see is the concept that new items are always better than used. I often find that the opposite is true, because I’m able to afford higher quality used items. Since just about everything (cars, furniture, clothes, etc) depreciates the minute they’re purchased new, the used market is an opportunity to gain value without the high mark-up of new. The flip side of this is the danger of always assuming that used items are a better value–I find that I still need to exercise caution at thrift stores and on Craigslist. Price-checking used items against their new contemporaries… Read more »

Margaret Mary Myers
Margaret Mary Myers
5 years ago

I agree with you. Years ago, I discovered I could buy clothing as cheaply, new, at Wally’s, as I could at the GW thrift shop (I think that has shifted a little bit since then).

However, I also realized that I could find “treasures” at thrift shops, which were of higher quality. I will even buy something of high quality, cheaply, & then switch out the buttons to suit myself, and I’ve still saved a bundle over buying new.

Beth2
Beth2
5 years ago

Then there’s the oftentimes false assumption that all our friends really want us to be like them, do what they do, etc. My friends understand I’m careful with my money (I’m single and working through my golden years) and respect it. In fact, they’re positively curious about my obviously rich cultural life, comfortable home, and zest for managing and getting the very best value for my money. We’re in different places, but respectful of each. I’ve become a resource for them — and vice versa. Keeping up with the Joneses doesn’t need to be part of the picture.

Sherry
Sherry
5 years ago

For HopingtoAdopt and others whose lending institutions do their escrow, I would suggest looking into doing your own. Underwriters don’t like it, but if you have a good track record, haven’t missed any payments and want to hang onto whatever interest your “targeted savings” glean instead of letting the mortgage holder collect it, it’s worth the discussion.

PawPrint
PawPrint
5 years ago
Reply to  Sherry

I, too, prefer not to have an escrow account. However, with the last two house purchases (rental and primary), I would have had to fork over some cash to opt out of the escrow account. So when I borrowed the money, I had the company set up the account, then after the transaction closed, I asked that the escrow account be closed.k That didn’t cost anything. It was two different mortgage companies, and I have no idea why they require payment to opt out of the escrow account.

Jeff
Jeff
5 years ago
Reply to  Sherry

I had the option to do it myself but I went with escrow simply because I want as few bills as possible to keep track of every month. Making just one payment that covers mortgage, taxes, and insurance is just simply convenient and helps de-clutter the budget.

Mary Grace
Mary Grace
5 years ago

Hi Linda, this is an awesome post. Thank you for reminding us about “anchoring”. A business enterprises “best techniques” to make a fast profit. We, the consumers, should be aware of anchoring.

The word “sale”, or “50% OFF” are attractive. I have no idea how to control my mind when I saw that banner stating those words.

I think if an item is not listed in a budget plan, whether it is on sale or not should be avoided.

Linda Vergon
5 years ago

(This comment came from Ann, a reader of our daily newsletter.)

This is a wonderful article. I do the same thing. Thank you. Now that I see it in print, I thought this is what I do too! NO more.

Ben Luthi
Ben Luthi
5 years ago

It’s interesting to see what advertisers will do to get us to spend money. Anchoring is usually pretty easy to see through. As far as status quo, I usually shop around for car insurance once a year to make sure I’m getting the best deal.

Steve | Live Smart Not Hard
Steve | Live Smart Not Hard
5 years ago

So true, especially “anchoring.”

It reminds me of an old cartoon I once saw. The owner of a mega chain grocery store laughs as he asks his new stock boy how much pears are. “89 cents” the boy replies.

The owner then grabs the intercom: “Attention shoppers, for the next hour, pears will be on sale for 99 cents.”

The shoppers rush to buy up all the pears, thinking they’re getting a deal.

Kalie
Kalie
5 years ago

Great article. I think we tend to underestimate how effective advertising and marketing is on us. Spending more to get “free” shipping is one that sometimes gets me, especially to save the hassle of going to the store. But it’s not free if you are spending extra, as you pointed out. I’m also tempted to buy inexpensive used items at second-hand stores, like children’s toys and clothes. If the price tag is small but you don’t need it, it’s not a good deal.

Kayla @ Cash Smarter
Kayla @ Cash Smarter
5 years ago

Great article. I have totally fallen for some of these before, particularly ones like your example of ‘Spend X to get $X off your next purchase!” and “Spend X to get free shipping!” so I add a few more things to my order so it qualifies.

BD
BD
5 years ago

Haha, I could totally tell the opening paragraph was about Kohl’s Cash. They’re so sneaky that way. But, if you time things really well, you could make good money off deals like that. For example, if your vacuum dies and is beyond repair, and Kohl’s happens to have one on sale for a better deal than you could find elsewhere, then spending the $50 on the vacuum and getting the $10 cash might be worth it. Stick the coupon up on the fridge with a magnet so you don’t forget about it, and plan accordingly. Make a list of things… Read more »

PawPrint
PawPrint
5 years ago

I was out-of-town at a Target store getting stuff for my daughter. I don’t shop at Target and know nothing about their pricing. The item I was buying was on sale and, wanting to know what the regular price was, I looked underneath the sale tag. The nonsale price was less than the sale price. I was miffed and pointed that out to a salesperson, who gave me the cheaper price.

LeRainDrop
LeRainDrop
5 years ago

Thanks for the motivation. I just overcame the “status quo bias” by calling Comcast and renegotiating my cable and internet costs. Major savings and took just 15 minutes!

Nick | Millionaires Giving Money
Nick | Millionaires Giving Money
5 years ago

I fell prey to this marketing ploy many times. I now only spend what I need according to my budget. If I get an offer for spending this fixed amount then that’s OK, however, if I’m expected to spend more for the promo I forget about it. Clever marketers are always looking for ways to take our money! Thanks for sharing this insightful post.

Marie
Marie
5 years ago

“Mom and pop guilt” is my excuse for not shopping for a better price for insurance. We do business with small, locally-owned companies whenever possible, so finding a better price from a faceless conglomerate makes me feel like I’m stealing food from my neighbor’s children.

SavenoSpend
SavenoSpend
5 years ago

You forgot the 7th bias: limited time to buy something. In a nutshell LE or Limited Edition. In the makeup industry it’s a hot way to get people to pull the trigger on soon to be rarefied products. Even though they may re-release them (MAC does this a lot). But the same goes with any company trying to get the impulse purchase. It’s everywhere. It’s a bias that people forget about. The solution? Try checking out the other brand (one company’s LE, is another’s standard feature), try buying used, and try just waiting and realizing it’s a trap. There was… Read more »

Beard Better
Beard Better
5 years ago

I think that biases for, and against, convenience can be pretty powerful. I know that I have been swayed at the grocery store to go for unhealthier, more expensive, frozen meals than what I actually wrote on my list. On the other hand, I also threw out most of a container of risotto because I was not the culinary genius that I had imagined myself to be when I saw it on the shelf. Going through the process of making it was not as rewarding as I had thought. Those both had minimal impacts on my finances, but only because… Read more »

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