The Psychology of Spending Money

Perhaps the title of this blog should be 'The Psychology of Spending or NOT Spending Money'. What fascinates me and has encouraged this short article is people's views on the rights and wrongs or parting with their hard-earned cash. But first let's get back to basics - what is money? Money is purely and simply a means of trading. In my opinion it is one of the best of inventions in the history of mankind. Imagine living in a cash-less society, where trading is by bartering - my horse for your cow, my eggs for your beetroot, my iPad for your ??!!**! However, we mustn't lose sight of the fact that money per se, the coins, notes, bank and credit card statements, have little material value. It is the trading ability that is valuable. So my iPad might be bought by you for £200, which I could use to buy a pair of spectacles. The second-hand iPad has been traded for new spectacles using a third party. This demonstrates the flexibility and power of money.

The psychology of transactions really interests me and in particular how people tend to focus on the financial values of expenditure and income rather than how to use money to satisfy their needs and wants. Let's look at typical behavioural patterns for three examples of monetary transactions - buying and selling property, paying for medical treatment and buying insurance cover.

If you've decided to down-size your property in order to realise some cash and perhaps travel to places where you've always wanted to go but could never afford it, well that should be a fairly simple monetary transaction. You might think your house is worth £250k, you only need property for say £150k and so after an estimated £10k expenses you might net £90k for your travels. The property market is declining and after having your house for sale for 6 months you decide to suspend looking for your next property until your sale has been confirmed. You have also suffered the disappointment of several prospective buyers' views of the value of your house being lower than your expectation. It looks as though you're not going to get more than £225k and after about a year on the market, a cash buyer offers £220k. The £30k drop becomes a major issue to you. Why should I drop my price? I don't need to move. The buyer's offer is insulting. Three years ago my neighbour's house went for £260k (the fact that the housing market has dropped around 15% in that timeframe doesn't enter into your thinking!). The psychology of the monetary transaction comes into play because the £30k reduction is the new issue rather than what you want to do with your life, i.e. reduce your living space and travel. The £30k could probably be easily recovered by a combination of getting a good deal for your next property because you are a cash buyer and searching for bargains in the travel market for your worldwide excursions.

The next example is paying for medical treatment. Some countries such as the UK have 'free' medical treatment through, in the case of the UK, a National Health Service (NHS). It's not really free because it is funded by taxation so everyone pays whether or not they 'enjoy' any benefits. Now you would think any citizen who loves life would regard their own well-being as a number one priority. But when that priority is put to the test, it's not always demonstrated to be number one! In the UK, for example, the 'free' NHS treatment is seen as a basic right and the idea of paying to get a faster service for a non-urgent but nevertheless uncomfortable condition, is, for many people, not an option to be considered. The NHS does not have an unlimited budget and has to prioritise its treatments. So, for example, heart surgery would be a high priority, the removal of a benign external cyst might be a medium priority and an in-growing toe nail could be at the tail end (or even the foot end!) of the priority list. If your cyst operation has an 18-week waiting list but you can get private surgery next week for, say, £3k, you might think to yourself, why should I pay? In fact it could be a very small price to pay compared with the cost over the year of the substances you might buy to abuse your body, like too much salt, fat, carbohydrate, alcohol, cigarettes, junk food....do I need to name more?! Also the essential food items are very often consumed in excess or even thrown out.

My final example is insurance cover - the 'peace of mind' expenditure. Let me start with an indisputable fact - insurance companies make money. This means that their income from people paying insurance premiums, less the amount they pay out in claims, less their operating expenses, leave them with a very large operating profit. Do some simple calculations for yourself. How much have you paid out, during your driving career, for car insurance and is that more than the total cost of your claims? How much have you paid out for house insurance and is that more than the total cost of your claims? How much have you paid for medical insurance and is that more than the total cost of your claims? For most people the answers will be YES, YES and YES. There will be some variations but the reason I am confident with my 'most people' prediction is because that's why the insurance industry is so profitable. In other words, life is not as risky as we are led to believe but our fear of the unknown causes us to view insurance as a worthwhile expenditure. Perhaps it would be better to accumulate your own funds for unforeseen circumstances.

So there you have it folks, our spending habits are very often irrational and maybe that's because money distorts our perception of what we are trying to achieve, which, in the previous examples, were a rewarding lifestyle, a healthy body and a balanced view towards what reserves we require for unknown circumstances.

Cause and Effect fooled me again!

I believe that over the years I have developed many of the skills of a systems thinker. What does that mean? Well basically I try to take a helicopter view of life, issues, problems, whatever. Looking at the relationships between issues as well as the detail of life's 'building blocks'. One of the attributes of a systems thinker is the ability to think beyond seemingly obvious cause and effect relationships and particularly not to jump to simplistic conclusions like, for example, A caused B, which caused C, which caused D. Therefore, A caused D - maybe! Life's relationships are rarely as simple as A, B, C and D. Cause and Effect are not always obvious. Here's a statement, which might not register immediately, but is very profound:

Correlation does not imply causation.

Correlation, the apparent dependency of two events, does not mean that one event caused the other to happen. Every morning at sunrise I hear a cockerel crowing and I also hear the Imam chanting a call to prayer from a nearby mosque. Does the cockerel crowing cause the Imam to chant? Unlikely. Does the Imam chanting cause the cockerel to crow? Also unlikely. Do either the Imam or the cockerel cause the sun to rise? IMPOSSIBLE? What is most likely is that the Imam's chant is timed to take place at sunrise and the transition from dark to light also stimulates the cockerel to crow.

Does the cockerel only crow at sunrise? I don't claim to be an expert on cockerels' habits but I'm sure I have heard cockerels crow at other times of day. Could the cockerel crow at midnight? Possibly. Would that cause the sun to rise? DEFINITELY NOT! So now I hope you have grasped the fact that correlation definitely doesn't imply causation BUT causation requires correlation.

Now let's move on to a recent example of correlation and therefore cause and effect, playing games with me. Every morning I charge my two phones, a BlackBerry and a Nokia. They don't always need it but rather than get caught with a flat battery I developed this daily routine, which I rarely forget to do, rather like cleaning my teeth. Earlier this week I went through my charging routine, first plugging the BlackBerry in to charge and automatically looking at the face of the phone to note the little icon signifying the phone was accepting a charge. Then I followed the same procedure for the Nokia. I first plugged it in to charge, looked at the face of the phone and there was no icon, it apparently wasn't charging! Without pausing for a period of rational thinking to explore the possible cause and effect scenarios, my mind went into auto! The charger must be defective so I will go into the town and buy a replacement. Should I buy a branded Nokia device or a cheaper alternative? If, say, the Nokia product cost 20% more than the alternative brand but would have twice the life, then the Nokia route would be preferable. In the meantime, my wife, Sandie, also has a Nokia phone, a different model to mine but the charger might be compatible, in which case I would borrow it as an interim solution. I left my chargers and went to see my wife, but before I could explain the problem she informed me we had just had a power cut! In the period of time between plugging in the BlackBerry and noting it was charging and plugging in the Nokia and noting it wasn't charging, the mains electricity supply had been cut - ELEKTRİK YOK as we say in Turkish!

Now you might be sympathetic towards me thinking it's a fair assumption that the charger wasn't working but I can assure you I do not deserve your sympathy. In the area where we live, the probability of a power cut is far greater than the probability of a Nokia charger failing. So the fact that the phone didn't indicate it was charging correlated with the charger being plugged into the mains should not, on that occasion, imply the charger was defective. I can wax eloquently on the virtues of systems thinking, the danger of using linear models for a non-linear world and the nuances of correlation and causation but........life's a bitch!