While I’m driving around the U.S, I’ve asked a few personal finance friends to share their wisdom. Today we have Maggie of NorthernExpenditure.com here. Maggie is dishing out great advice on how to avoid being tricked into spending more money by beating our own brains. Behavioral Economics for the frugal win!
Kara was so sweet to have me guest post here at Frugal to Free. Since my fellow Kara fans are all people looking to save money, I thought I’d chime in with some Behavioral Economics research to enlighten your path and help you make wiser spending choices. I’m not saying I do all these things right myself, but I’m a researcher, by profession, so I can at least tell you, based on research, how it is supposed to work!
Let’s start out by talking about the anchoring effect. You’ve probably heard of this concept. At the very basic level, anchoring means that when you think a shirt is going to cost $30, when it’s actually $20, you’re thrilled! (And much more likely to buy that $20 one than the $12 one next to it because, after all, you’re “saving” money since it’s not the $30 you thought it would be).
The power of the anchoring effect is very well studied and it runs much deeper than we think. If I randomly say the number 65 and then ask you what percent of computer science graduates nationwide are female, you’re bound to guess higher than if I said 15 or didn’t say a number at all. If you write down the first two numbers in your house number and then bid on something, you’re going to bid higher if you live at 97 than if you live at 11. Anchoring numbers can be completely unrelated to the purchase!
1) The 3 options anchor
Behavioral Economist Dan Ariely was reading The Economist online. He noticed that subscriptions had 3 different options. You could purchase an online-only subscription for $59. Print only was $125. Print and online was ALSO $125. That’s right, the middle option, for the paper-only version was the same as getting the paper and the digital version together. So why was it included as an option? Ariely ran a test. When people were presented with all three options, 84% picked the combined print and online option for $125. When Ariely removed that option and showed them just the online-only subscription for $59 and the print and online combined option for $125, only 32% picked the combined option and 68% picked the online-only!
2) The “percent off” anchor
We are so accustomed to shopping 50% off sales that we create our own for everything. Instead of focusing on actual dollars saved, we focus on percents. Researchers by Daniel Kahneman and Amos Tversky found that if you were offered headphones for $50, but told you could get them for $40 if you drove 30 minutes to the other store. In the speaker scenario, the speakers were $400 at the store you were at or $385 30 minutes away. 20% of people said they would drive across town for the headphones, but less than 4% would for the speakers.
Why? Even though you could save $15 instead of $10 by driving for the speakers, the percent saved is less. We subconsciously calculate this. Because we’re so caught up in percentage, we waste money on big purchases. We tack on hundreds of dollars of add-ons to our expensive computers and cars because $200 is just 1% of the total purchase price of $20,000. On the flip side, we over-focus our frugality on getting 60% off the little things like shampoo and office supplies when the amount saved is often less than a dollar.
3) The “actual price” anchor
Have you ever NOT purchased something that says: “reg price: $48” “Our price” or “Sale price: $39”? Nearly every tag comes with this. Now, based on anchor examples #1 and #2, let me give you the following scenario: There are 2 shirts you like equally well. One is $45 (reg. price $90) and one is $40 (reg. price $50). Which one will you end up buying? That’s right, the $45 one even though you like them both equally.
Now that we’ve identified 3 different types of anchors we all face every single day, it will be easier (though not at all easy) to avoid the draw of the high anchor number. But we need assistance if we are going to success. Let me propose a possible solution to all 3 anchor scenarios:
Solution: Create your own anchor
For this to work, you have to pick something in the $5-15/range that you LOVE. I discovered this trick when I was pregnant with my second child. My favorite food is French toast (no, not the cereal!!) If you’re ever in Anchorage, Alaska the Snow City Cafe has a stuffed French Toast that is ah-mazing. The French toast is $12. When I was pregnant, I wanted to eat that stuffed French Toast every single day. (I didn’t of course, because I am a rational human being with an ounce of self-control… but I sure did think about it a lot.)
Because I so desperately craved this French toast, everything in my brain was calculated in stuffed French toast increments. I could go see that movie, or I could get a stuffed French toast. I could buy that outfit, OR I could buy 4 stuffed French toasts! This exercise was immensely helpful in helping me focus on dollars instead of percentages and it gave me an anchor price that was low. (I know how much joy the $12 from stuffed French toast brings me, I couldn’t imagine an outfit bringing me 4x that joy!).
Adding your own low anchor also messes with the options anchor tactic. If you were to ask me if I wanted an online Economist subscription for $59, print and digital for $125, or stuffed French toast for $12, I would pick the French toast every time. And if I really wanted the subscription (I would have already calculated that the subscription was about 5 stuffed French toasts), I would choose the lower option because my anchor point is lower.
Now you are armed with RESEARCH. Pick your anchor point and think about it during every transaction. If you pick a powerful enough anchor, you will save money just by thinking about it! Go and beat the sales!