This behavioural economics series is turning into an epic.
This week’s hot topics are the pain of paying and mental accounting – those who know me realise that my accounting skills are a bit off the wall but I don’t think that’s what we mean here.
The pain of paying
The pain we feel when paying for something is magnified when our feelings about spending money are coupled with consumption:
- paying per bite for a meal makes economic sense but you wouldn’t enjoy the meal with the waiter hovering over you counting every mouthful
- paying for a holiday on the day you come home makes more financial sense than paying the balance three months before you leave as you’d accrue more interest with the money in your own account. But you probably wouldn’t enjoy the holiday as much, especially the last day.
The pain of paying adds a moral tax to consumption and the timing and method of payment changes our enjoyment.
If you want to increase the pain of paying:
- pay with cash
- receive notification whenever money is spent
- increase salience i.e. watch the petrol pump meter spin round as you fill your car, use an electricity coin meter or add consumption meters to all your household appliances
To decrease the pain of paying:
- pay with credit cards
- keep payments hidden
- prepay before you consume
Prepayment can focus our attention on the enjoyment of an experience – think of all-inclusive holidays.
All the men out there if you’re looking for the perfect gift you need to know two things:
- it should remove the pain of paying
- it should be something that she wants but the pain of paying is preventing her from buying it
So, the pain of paying involves the opportunity cost, the hassle component, the moral tax with its associated guilt, the method of payment and the timing of the payment.
We experience less pain of paying when the form of payment is distanced from the pure representation of money, e.g. credit cards, casino chips as prepaid money is easier to spend.
That’s all from the perspective of a customer but organisations, especially local authorities should consider the pain of paying because let’s face it, who actually wants to pay their council tax or a parking fine.
Once money is assigned to a certain category it is non-transferable. In our heads we assign money to certain categories and spend it accordingly. Assigning money to categories controls how we feel about that money and we treat unassigned money differently. Just the other day I lent HimIndoors £40 at the cashline. In my head that became lost money so when he gave me it back I spent it on rubbish instead of holding onto it and paying for food shopping or something useful. It is mental accounting that allows us to have a low interest savings account yet at the same time have a high interest loan because we see them as two different domains – spending and saving.
If we were all perfectly rational, mental accounting wouldn’t make sense. However, it can be an adoptive strategy. It allows us to partition our spending and make financial decisions more manageable.
So, there are two approaches for helping people think about their money:
- assume they are rational and can effectively manage money between categories
- optimise existing mental accounting techniques, even if they are irrational
If you want people to pay their bills instead of spending it on chocolate and wine get them to compartmentalise their money into funds. Make it as easy and as painless to pay – this is tricky for councils though. Credit cards may be the pain-free method but removing people completely from money and the pain of paying makes it too easy to buy unnecessary items on the never-never and so the debt spiral begins.
The council I work for is closing its cash halls and removing the ability to pay council bills in cash in council offices. Our preferred way to receive money is by direct debit or online payment but for a lot of people cash is simply the safest method to keep it all real and prevent money becoming some airy fairy notion and credit considered there to be spent, whether the monthly balance can be paid or not. Cash at a PayPoint or a Post Office may be the best option in the long-run for these people. otherwise we run the risk of future rent and council tax arrears because financially vulnerable people think we’re encouraging them to get debit cards and the overdrafts that go with them or worse, credit cards to pay council bills.
You can sign up to a watch list for Dan Ariely’s Beginners Guide to Irrationality course on Coursera but next time I’ll be sharing his thoughts on fairness and reciprocity, loss aversion and the endowment effect.
Tune of the week
Gentleman June Gardner – It’s Gonna Rain