£25 a day, but then you see a sign for another shop that offers a bike for just £10 a day. The second shop is a 10-minute walk away, but with a price difference like that, maybe it’s worth checking out the cheaper bikes. As long as they look reasonably roadworthy, you can hire one of those instead and congratulate yourself on saving £15, enough to pay for a second day’s cycling or a nice lunch in a café on the cliffs.
Now imagine that you are back home and are buying a new car. In the first showroom you find one you like for £10,010. You want to check you are getting a good deal, so you go to a second showroom 10 minutes away. They have much the same car for £10,025 (this might sound unlikely, but for the purposes of these experiments you need to bear with it). Is it worth going back to the first shop to save £15? Almost certainly not. For a transaction that big, a difference so small feels inconsequential. Yet the sum you could save is exactly the same as with the bike hire. In the earlier example, you are delighted with that saving. Now you dismiss it.
Countless studies have demonstrated that we constantly make judgements like this, viewing a saving as a proportion of the total cost, rather than as an actual amount of money with a determined spending power. This is called relative thinking, and it is particularly common among people who are comparatively affluent.1
This struck me forcefully when my husband and I moved home recently. It involved the largest financial transaction of our lives. London prices, so hundreds of thousands of pounds: a huge commitment, and one we weighed up carefully. Yet we behaved exactly in line with the research which shows that the bigger the purchase, the greater the likelihood people will take little care over associated costs. Having made such a massive outlay on the house itself, we should have been keen to save every penny we could on other aspects of the move. Yet we didn’t check that the solicitor handling the exchange was offering a competitive rate; we simply used the one we’d been to last time we moved. Likewise we took a friend’s advice – ‘They’re not the cheapest of all, but they’re really good and it makes life a lot easier’ – when it came to hiring a firm of furniture movers. In the context of buying a house, a few hundred pounds – which usually we would be so careful about – felt neither here nor there.
Not everyone can be so cavalier of course. The Indian economist Sendhil Mullainathan asked people in poverty attending a soup kitchen whether they would be prepared to travel for 45 minutes to save $50 on a household appliance. 2 He knew all about the research famously done by Daniel Kahneman and Amos Tversky, which showed that people tend to make decisions of this type within the context of the original price.3 In these cases, if a household appliance cost $100 before the markdown, then a 50 per cent discount would make the journey worthwhile, but if the full cost of the item was $1,000 it wasn’t worth bothering with a saving of $50. What Mullainathan showed was that the people in the soup kitchen couldn’t afford to think this way. They weren’t swayed by the initial price because whatever that price was, a $50 saving for them was a sum of money they couldn’t afford to forgo.
On the face of it, theirs was the more rational behaviour. But does that mean that richer people are being wholly irrational? Not necessarily. We factor into our thinking not just the financial saving but the value of our time, which in some cases is more precious to us. Unlike the people at the soup kitchen, we often consider we are – to use the cliché – ‘money rich, but time poor’.
Yet we don’t behave entirely consistently in making these calculations. Many of us spend hours online, finding the very cheapest deal on a flight or a rail ticket and saving relatively small sums in the process. Now that might be sensible for people who can hunt for bargains in the office (without the boss seeing), in which case they’re making the saving and the firm is paying for the time. But I work freelance from home a lot of the time and do the same thing. I’ve never calculated it, but it would almost certainly make more financial sense for me to spend the time working. Yet in this instance, the lure of a cut-price deal is irresistible. Moreover, research has shown, we aren’t prepared to spend the same time to review much bigger, ongoing financial commitments.
To take one example: in the UK, people have the option to change energy suppliers to find the best deal, but research has shown only 1–10 per cent of people regularly monitor prices and save money by switching.4 And this, despite the fact that savings on utility bills can run into hundreds of pounds a year.
So why do we make an effort in some cases and not others? Sometimes it is to do with necessity. We have to choose a train ticket because we need to get somewhere, but we don’t have to bother changing electricity supplier. But there is another reason. We hate committing ourselves to future work. The first stage of switching energy supplier is easy enough to do, but it involves more of a commitment than making a one-off purchase. There will be the hassle of reading the meter at a future date, sending the information off to the new supplier, checking the direct debits are working correctly and so on. It’s all a bit of a chore. And of course the reward is a saving in the future, not the instant gratification of shopping in the sales, where you’ve paid less than you might have done and got something shiny and new straight away.
What should be clear from these examples is that the idea that every pound is worth the same to every one of us – a concept that underpins our system of monetary exchange and which we all take for granted – is not true at all, psychologically speaking. Indeed each of us individually puts a different value on each pound we have, depending on the circumstances. From one moment to the next, we consider the money we have differently from the money we spend.
PSYCHOLOGICAL MONEYBAGS
Some years ago, I interviewed the Nobel prize-winning psychologist and best-selling author Daniel Kahneman.5 He told me one of his all-time favourite thought experiments, which is something of a classic in behavioural economics. It involves a woman who has spent $160 on two theatre tickets. She is looking forward to the show, but when she arrives at the theatre she can’t find the tickets. She empties out her bag. She goes through her pockets. No sign of them. She feels slightly sick as she thinks of the large sum of money she’s wasted. But what about the show? Will she spend another $160 on replacement tickets, or will she just give up and go home?
When Kahneman tested this scenario with a sample of people back in the 1980s, nearly nine out of ten assumed that having lost the tickets the woman would forgo seeing the play.6 But what if the scenario was slightly different?
This time, the woman hasn’t booked in advance. Instead she has brought $160 in cash with her, ready to buy tickets at the box office. But when she gets to the theatre she opens her purse and sees that the money is somehow missing. Does she use her credit card instead?
With this scenario more than half of the people Kahneman questioned changed their answer and said yes. So why is it okay to in effect pay twice for the tickets in the second scenario, but not in the first?
The theory advanced by the economist Richard Thaler, famous for the behavioural theory ‘nudge’, is that we have different ‘mental accounts’.7 We assign different characteristics and purposes to different portions of our money. ‘Spending money’ is different from savings. Money you win in a bet is different from money you earn. Even as an adult, the £10 note sent by a great-aunt in a Christmas card is more exciting than the £20 note I’ve just collected from a cash machine. These mental accounts aren’t generally organised like real bank accounts. We don’t make precise, conscious deposits into them or monitor the balances to avoid overdrafts. Indeed, most of the time, most of us are barely conscious of them. But they can nonetheless exert a powerful influence over the way we use our money.
For Thaler, the explanation for the different attitudes above would run as follows. The theatre tickets come from a mental account devoted to entertainment and making a double purchase out of that account after the tickets have been lost feels unduly extravagant. But lost cash is different: it sits in a ‘general’ mental account, and there’s still
