Why it's hard making good spending decisions - pt 2
This is part 2 of my 2-part summary of my recent talk at the launch of IxDA Brisbane. Illustrations by the supremely talented Annie Lee @thesidewalks.co.
Previously in part 1 I wrote about how plans can go wrong and introduced the concept of the 2 Systems from the book ‘Thinking, Fast and Slow’.
Here, we’ll look at some of our limits and biases as humans and conclude with some tips on how we can overcome our reliance on System 1.
Limits and biases
As humans, we have limits in our cognitive abilities. Our autonomous System 1 readily accepts these shortcomings with little resistance and therefore undermine our ability to make good spending choices at all times. Here are a few that are applicable in the context of spending.
It’s hard to determine the intrinsic value of things
When the iPhone first came out in 2007, it cost US$499 for a 4 gig model and US$599 for an 8 gig model. Competitors mocked the proposition from Apple; Microsoft CEO Steve Ballmer famously said there was ‘no chance’ the iPhone would get ‘any significant market share.’ Blackberry didn’t believe in touch screens. Nokia had the N95, a technically superior phone with a better camera.
Back then, I couldn’t justify purchasing an iPhone - my modest salary as a new designer didn’t help either.
My inability to justify the purchase was directly correlated to my failure to understand the intrinsic value of the device. Why should I pay extra for this new phone compared to other devices on the market?
I couldn’t know the cost of the components that went into the iPhone, nor the labour, design, research and development that went into the visionary product. I had reservations about the touch screen keyboard, and I was already using an iPod. And who needed apps anyway?
This is the case with almost everything we can buy. You only need to compare the sale price of homes between capital cities to know the cost to buy a house has very little to do with the intrinsic sum of the material, labour the land which it sits on.
This seemingly impossible task to objectively value things makes us susceptible to relativity and anchoring. We can only value things by comparing them to other similar objects - our anchors. Not only this, emotion, social pressure and the media all play a role to nudge System 1 further away from ‘true’ value.
Cryptocurrency and fine art are other great examples where their value is almost never determined by the inherent value behind how their creationist .
It’s hard to calculate opportunity cost
Opportunity cost is the forgone benefit from an option you didn’t choose, basically everything else you give up when you make a choice.
If I spend $2,500 in 2021 to replace my 2020 iPhone, my opportunity costs could be a family holiday, a small renovation project, Christmas presents or investments with compounding interest for my future self.
Unfortunately, the pleasure I get from the instant gratification of buying that shiny new thing in the present easily trumps the mental effort required to calculate the opportunity costs.
Of course, it’s not feasible to calculate opportunity costs for every spending decision, but it can be a problem when we make important decisions without intervention from System 2.
Some of us ‘hack’ our decision-making process through mental accounting. Allocating money using buckets (in my case, physical accounts). However, mental accounting violates the fungibility of money and can lead to incorrect spending decisions.
A great example of this is when we receive bonuses in a lump sum. Often we justify making large purchases using our bonus because it feels separate from our regular income. Since our usual expenses are already accounted for by our regular income, we spend our bonus more frivolously.
It’s hard to overcome biases
Behavioural scientists have proven that we have natural biases. These System 1 traits are the result of our brain attempting to simplify the information we process.
We value things more which are scarce (scarcity bias).
We don’t like changing the status quo once set (status quo bias).
We find it hard to start a (good) habit (inertia).
We value things we own more than those we don’t (endowment effect).
We can be primed subtly (priming).
We value losses more than an equivalent gain (loss aversion)
We can be overly optimistic (optimism bias and planning fallacy).
What we see is all there is (availability bias).
In the context of spending, loss aversion can actually protect us. The pain of paying is highest when the act of payment and consumption is close and the attention to what you’re giving up is high.
Of course, marketing teams know this.
It’s why prepaid gift cards, BNPL products, credit cards and digital wallets do so well. They reduce the pain of paying by reducing the attention of what you’re giving up and increase the time between payment and consumption.
Our choices as designers
Designers are choice architects - whether we like it or not. The decisions we make can subtly, or obviously impact choices by our users. Therefore we have some power to help users make better decisions.
How?
Be aware of what users are up against. Even financially literate people can easily make the wrong decisions. Empathise with your fellow humans and learn more about our nature.
Find ways to minimise System 1's influence when an important decision needs to be made. Make it easy for users to achieve good outcomes, and hard to reach bad ones. Slow them down by increasing friction during important decision points in their journey.
Leverage our limits and biases. If you can’t beat them join them. Use good defaults to leverage our status quo bias and inertia. Use automation to reduce temptation - all we see is all there is. Use contrast, hierarchy or the element of surprise where attention is required.
Train your System 1. By improving your instincts, you’ll be better equipped to trigger System 2 when necessary.
Lastly, give users an out. It’s easy to think we know what’s best for our users, but every individual circumstance is different. Nudge, rather than compel or take away.
Parting thoughts
It's hard making right spending decisions all the time because we're human and the consumer world is against us.
But if we, as choice architects, don't help our fellow humans, who will fight the good fight for us?
Thanks for reading!