Finance Your Budget You’re probably saving money wrong

You’re probably saving money wrong

'Relative thinking', an example of fuzzy math, could be holding you back. Photo: Getty
Twitter Facebook Reddit Pinterest Email

A psychological flaw causes us to pinch pennies while letting thousands of dollars slip through our fingers, a finance expert has warned.

Gregory Mowle, who is researching a PhD at The University of Canberra on financial literacy, revealed to The New Daily that this frugality blindspot has been a “standout theme” of his early findings.

Participants in his study will go out of their way to save money on small purchases, but fail to comparison shop on much bigger purchases.

“People do stuff like drive three suburbs away to save 2 cents a litre on petrol, but they won’t do anything about their mortgage or credit card rates,” Mr Mowle said.

Academics are working to unravel the mystery.

Prof Ofer Azar.
Israeli researcher Prof Ofer Azar says we need to be more wary of “relative thinking”.

Israeli researcher Professor Ofer Azar, at Ben-Gurion University of the Negev, is one of the leading authorities. He explained the phenomenon to The New Daily as a “tendency to consider relative differences [even] when it is no longer appropriate and beneficial”.

Prof Azar’s research has proven that we save big on little things, but neglect the ‘little’ savings on big things that would actually save us more money overall.

The problem can be combatted by “educating people to be more informed consumers in general and to notice this tendency of relative thinking in particular,” the Israeli professor said.

In his landmark 2011 study, Prof Azar asked participants how much of a discount would justify 20 minutes of effort. On average, they would strive to save $3.75 on a $10 pen, but wouldn’t do anything to save money on a $30,000 car purchase until the potential saving reached $277.83.

There are several possible explanations. One is the Weber-Fechner law, a general rule of psychology, which says a noticeable difference in a stimulus is proportional to the intensity of the initial stimulus. So, if a light is very bright, you won’t notice a slight dimming. But if a light is very dim, you’ll notice a slight brightening.

The law is sometimes used to explain our reaction to prices. A big difference in a small price (a 20 per cent discount on $10) is more noticeable to us than a small difference in a big price (2 per cent discount on $1000), even though the absolute saving in that scenario — $2 versus $20 — should make us care more about the bigger price.

Economics also has an explanation. Professor Richard Thaler’s ‘mental accounting theory‘ says we categorise money differently depending on how we intend to use it.

For example, we give ourselves a smaller mental budget for small purchases like food and coffee, and thus feel more psychological pain when we overspend here. But we give ourselves a bigger budget for things like financial products, and thus don’t feel as much ‘pain’ when we overspend.

Sale discount. Photo: Getty
Marketing gurus use the flaw to their advantage. Photo: Getty

This was illustrated by a 2007 study, which found that shoppers buying lunch at a local market spent 36 per cent more when thinking about their bank accounts (a larger mental account) than when thinking about cash in their wallets (a smaller mental account).

Marketers take advantage of this blindspot, too. As explained in the book Contagious by marketing expert Jonah Berger, they have devised something called the ‘rule of 100′. They use it to decide whether to market a discount as ’20 per cent off’ or ‘$200 off’ depending on which sounds bigger.

The rule says to use a dollar figure for anything over $100, and a percentage discount for anything under.

View Comments