A Counterintuitive Way to save More Money: Make Spending as Painful as Possible
Modern life has made it far too easy to spend money
Opportunity cost is one of the most important concepts in economics—and many people ignore it.
Put simply; opportunity cost is the potential gain we give up by choosing one option over another. Most people think of opportunity cost in the context of investing; How much money is given up by sticking $1,000 into a savings account instead of investing it in something with higher expected returns.
Having extra money you can invest is more important than what you invest it in. You can’t invest anything unless you spend less than you make. Opportunity cost can play a huge role in keeping your spending in check—but most people ignore the opportunity cost of spending money.
In this article, I review the research that suggests a simple way to reduce impulse spending is to make spending money more painful by considering the opportunity cost.
Most of us don’t consider opportunity cost when buying things
Traditional economic models assume that we all consider the opportunity cost of each purchase we make.
Of course, we know intuitively that this isn’t the case.
When you spend $10 at McDonald’s, are you thinking about how many pieces of chicken that $10 could have bought you?
No.
A study by Frederick et al. (2006) found that most people do not consider opportunity cost when making purchases—unless they are prompted to do so.
The researchers asked people if they were willing to buy a movie they wanted to see for $14.99—for my younger readers, 2006 predated the streaming era when people bought these things called DVDs.
The researchers framed this decision in one of two ways for each participant in the study.
“Do not buy.”
“Keep the $14.99 for other purchases.”
The people given the framing “keep the $14.99 for other purchases” were less likely to buy the movie. This tells us that people don’t naturally consider opportunity cost in purchasing decisions—but they can easily be nudged into doing just that.
Not thinking about opportunity cost makes it easy to overspend
Whether to spend more or save more is a question of opportunity cost. Spending more today means saving less and having less money to spend in the future.
If you don’t consider the opportunity cost of spending, you get the immediate gratification of buying something—but you are ignorant to the future pain you will feel later in life if you are a chronic undersave.
The result?
You’re more likely to overspend.
The solution?
Reframe opportunity cost in your mind and emphasize the pain.
Another study by Prelec and Loewenstein (1998) found that the more we are aware of the price tag of the things we buy, the more immediate pain we feel when we spend money. One of the problems of modern society is that we have never been less connected to the price of everything.
Most people don’t write a check to the government—their income taxes come right from their paycheck.
We don’t go down to the bank to pay the electricity bill—an automatic payment takes the money from your bank account each month. The same is true for our Netflix, internet, cell phone bills, car payments, etc…
Want to buy a new rug for the living room? You can literally one-click purchase it on Amazon.
Even when where we go to a physical store to buy something, odds are you are scanning it through a self-checkout machine and paying with your credit card instead of physical cash—which research has shown causes more pain.
For better or worse, none of these modern conveniences that make it easier to spend are going away. Few people reading this will cancel their automatic payments, cut up their credit cards and start paying for everything with cash.
But it’s essential you don’t spend your money mindlessly. You need to remind yourself how hard you worked for every dollar you spend.
One way to do that is to make the price the last thing you think about before making a purchase and take note of how you feel.
A study by Knutson et al. (2007) used brain scans to determine if the pain of a high price tag would make someone less likely to buy something. Participants in the study were first shown a product, then they were shown the price, and then decided whether or not to buy.
When people were shown a price that they felt was too high, the area of the brain associated with experiencing pain was activated, and they did not buy. If you focus on the price of what you are buying, you’ll feel the pain and be less likely to spend. That is unless the anticipated joy of buying is greater than the pain of paying for it.
Remember, the goal isn’t to avoid spending money altogether. The goal is to avoid mindless spending and spend on what matters most while leaving some to save for your future.
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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.