How we are wired to spend
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Illustration: Karl Hilzinger
Many financial publications, including this one, are happy to give you ideas on how to spend your money. But just as valuable, and more often neglected, are lessons on how not to spend money. Australians over the past five or so years – and especially since the crisis of 2008 – have started taking a measurably more careful approach to spending. In the 20 years leading up to the mid-2000s, the household saving ratio as revealed by the ABS dropped from above 20 per cent to 7 or 8 per cent. Since then it has rebounded by about 10 percentage points. Budgeting is definitely the new black.
The prime budget-buster, however, remains the credit card. The amount Aussies owed on their cards topped $50 billion for the first time last year, even if balances are growing at the slowest rate on record. And now experts have found we are hard-wired to indulge in what the plastic provides: the opportunity to buy in haste and repent at leisure.
“The nature of credit cards ensures that your brain is anaesthetised against the pain of payment,” says George Loewenstein, a neuro-economist of Carnegie Mellon University, in Jonah Lehrer’s The Decisive Moment, a book on “how the brain makes up its mind”. Lehrer describes how the two offers of an Amazon gift certificate now, or a slightly more valuable one in a few weeks, activate different neural systems, one associated with emotions and the other with rational planning.
“When self-control breaks down and we opt for the rewards we can’t afford, it’s because the rational brain has lost the neural tug-of-war,” Lehrer writes. And it loses it often. Two business professors at MIT showed this when they set up a real sealed-bid auction for four tickets to a basketball game. Half the bidders were told it was cash only, the other half were told they could pay only by credit card. The second group bid twice as much on average.
The subprime lending phenomenon in the US can also be understood in the way the brain is physically ill-equipped to weigh up rewards now with costs later. The most common of these home loans was the “2/28”, an adjustable rate product that came with a very low fixed interest rate for the first two years and then an often ruinous rate for the next 28. But it wasn’t just those who would otherwise have been unable to realise their dreams of home ownership who got suckered; at the peak of the housing boom, more than half of all 2/28 mortgages were sold to borrowers who were capable of getting a prime mortgage, Lehrer writes. So now if you’re accused of playing free and easy with your credit card, you can say: “My brain made me do it!” Patrick Commins
Patrick Commins Smart Investor
