Lesson type: Think like an investor

How being human makes it hard to manage money

Conceptually, spending less than you earn isn’t hard to understand - but many Australians have trouble doing it. Financial issues are reported as the leading cause of stress for one in two Australian households[1], so let’s look beyond the numbers and analyse our underlying spending behaviour.

Marketers’ have been using behavioural concepts to influence our spending via product placement and pricing for some time, making spending less than you earn challenging not only from a ‘numbers’ perspective but a psychological one too.

Do you know how much you spend?

The average Australian spends $130.08 on utilities a month[2]. Does that figure sound about right?

 Of course, your answer will vary depending on your household usage and your state, however it’s more about recognising what reference points you used to determine if the figure above was right for you or not.

How did you calculate your own monthly spend?

Most energy and water bills are charged quarterly, whereas other utilities, like phone and internet, are often monthly. Then there is working out if $130.08 is close to your monthly amount, or did you multiply it to get a quarterly or annual amount to make the comparison?

Beyond this, there are many ways to pay your bills. Direct debit, BPAY, credit card. If you employ multiple methods to take care of your living expenses then it becomes even harder to track and reference quickly.

Most of us don’t require a budgeting spreadsheet to determine how much we’re earning – it’s generally a consistent amount, and received on a regular frequency. Our expenses aren’t quite as straightforward, and as the above example shows, they come in at irregular timeframes, vary amount and are often handled by different payment methods.

 Do you know how you spend?

Imagine you needed to buy a laptop today. You’re going to use it mostly for word processing, emails, some spreadsheets and web browsing.

You enter the electronics store, and there are three products on offer to you:

  • #1 has a 12” screen, has the ticket ‘best buy’ attached to it and priced at $350
  • #2 has a 13” screen, a list of ambiguous features and priced at $580
  • #3 has a 13” screen, an even longer list of ambiguous features and is priced at $2,675.

Which one would you buy?

Studies into the Comparison Effect[3] suggest most of us would purchase #2. Not for any other compelling reason than it isn’t that much more expensive than #1, and at such a low price, there is probably something ‘wrong’ or ‘less desirable’ about the one with the ‘best buy’ tag. Based on the brief, #1 can probably perform adequately however many of us would part with an extra $230 simply to avoid the cheapest one.

Research into the confirmation bias[4] shows us that if we pay more for a bottle of wine, we’ll report that it is more pleasing than the one we know that was less expensive[5]. Further to this, other studies have shown that when we’re given a more ‘reassuringly expensive’ brand of painkillers, we’ll report that our headaches have subsided quicker than a generic brand of painkiller, despite both brands containing the same chemical composition[6].

Our minds seem to be conditioned to spend more money than we need to.

 Ways to balance the equation

Get started on reviewing your spending behaviour by doing the following:       

  • Take the time to determine the ways your cash flows out of your bank account and if you can streamline how you pay your bills to get an accurate monthly tally of your expenses. Most of our expenses can be handled by a credit card, so applying all your bills to this method will help you track your spend (and of course, ensure you maintain good credit habits by paying it off, in full, every month, in order to avoid interest charges!).
  • If you find that you’re running a deficit this isn’t necessarily a bad thing. Review your savings and see how long you can sustain this deficit. Importantly, determine what you can change to keep your spending below your income.
  • Keep yourself accountable. By reviewing your spend monthly you will know how you’re tracking and how much more action is required to balance out the income and expenditure figures.
  • Each time you’re about to part with your hard-earned cash, consider if any behavioural biases are at play before you make the purchase, review your underlying need for the item, and make an informed choice.

Equipped with ways to track your cash flow and tips to avoid the marketers’ mind games, spending less than you earn can go beyond being simply a concept, and become our habitual money behaviour.

Shayne Sommer is a Financial Adviser with Shadforth Financial Group. This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or seek advice from a financial adviser and seek tax advice from a registered tax agent.  

[1] Stress and Wellbeing in Australia Survey, 2014, Australian Psychological Society

[2] Australian Bureau of Statistics Household Expenditure Survey 2011

[3] Simonson, I. (1989) Choice Based on Reasons: the Case of Attraction and Compromise Effects. Journal of consumer Research, 16, 158-174

[4] https://en.wikipedia.org/wiki/Confirmation_bias

[5] Plassman, H. et al (2008) Marketing Actions Can Modulate Neural Representations of Experienced Pleasantness. PNAS, 105(3), 1050-1054

[6] Branthwaite, A. & Cooper, P. (1981) Analgesic Effects of Branding in Treatment of Headaches. British Medical Journal, 282, 1576-1578

The opinions expressed in this content are those of the author shown, and do not necessarily represent those of No More Practice Education Pty Ltd or its related entities. All content is intended for a professional financial adviser audience only and does not constitute financial advice. To view our full terms and conditions, click here.

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