Mindless Spending: Frequency Matters More Than Height

The following is a guest post from Marotta Wealth Management.

Dieting and budgeting face similar hurdles in the American lifestyle. Some of us live to eat; others eat to live. Attempting to reduce our spending is every bit as challenging as trying to slim our waistlines. Some shop to live; others live to shop.

We can better understand mindless spending by looking at some of the psychological studies that Dr. Brian Wansink describes in his book "Mindless Eating." He explains, "Everyone--every single one of us--eats how much we eat largely because of what is around us. We overeat not because of hunger but because of family and friends, packages and plates, names and numbers, labels and lights, colors and candles, shapes and smells, distractions and distances, cupboards and containers."

"We all think we are too smart to be tricked," warns Wansink. "That is what makes mindless eating so dangerous."

One study compared the amount people would drink using two differently shaped glasses. One glass was tall and skinny. The other was short and wide. Each glass had the same capacity, but people would drink 25% to 30% more from the short glasses than the tall ones.

Interestingly, our brains focus too much on the height of objects and underestimate the effect of their width. So people with short wide glasses had to fill them more before they believed they had consumed the same amount as those with the tall skinny glasses.

We all think we can't be fooled by something as obvious as the shape of a glass. But our brains are wired that way, without exception. If you want to drink less, you can measure every portion or simply buy tall skinny glasses. Better yet, buy glasses that are very narrow at the bottom or elevated on a stem.

Finances work the same way, and by extension, so does mindless spending. Many families are struggling to get a handle on their savings. They are trying, often in vain, to find ways to cut back. But when we are worried about our expenditures, we tend to look at the dollar amounts more than the frequency of our purchases.

For example, a young woman named Emily inherited a sizable sum of money. She could have used it to make a sizable down payment on her first house. But instead of protecting her windfall, Emily attached a debit card to the account for the convenience of paying for a few items she needed.

In less than two years she had spent most of her inheritance in increments of no more than $35. That doesn't seem like a lot of money because the $35 height is relatively small. Given a width of three times a week, the height isn't even noticeable. The same $105 Emily spent would have seemed like a much larger budget item if it had been in a single purchase. In that case she might have refrained from handing over her debit card so casually.

Other purchases were $50 monthly memberships or $100 a month services. Very few of these purchases were over $100, but when they were added up, Emily had drained her account.

The frequency of a purchase matters even more than its height. But our brains tell us to be more concerned about the height.

Marketing firms use this principle all the time to bypass our defenses when they break annual purchases down into low monthly payments.

An offer I received in the mail recently explained its cost as "Only $4.99 per month with an annual subscription (billed as one payment of $59.88)." The advertised rate only applied if you were willing to purchase the entire year. If you wanted to be billed monthly, the rate was $9.99.

Advertising a $59.88 annual subscription fee as $4.99 per month relies on the fact that consumers are more sensitive about height than breadth. Note that the primary way they advertised the subscription, $4.99 a month, was not one of the options! Even more deceptive would have been making the offer 16.4 cents a day for an annual subscription. Less than a penny an hour!

They even marketed as a feature the service of charging your credit card automatically each year: "All subscribers get the hassle-free advantage of the Unlimited Automatic Renewal Program. At the conclusion of your first term and each subsequent term (one year or one month) we will automatically renew your membership upon expiration for the same period so you get continuous service unless you tell us otherwise."

Madison Avenue takes advantage all the time of the way your brain works. So it's in your best interest to learn to use your brain to your own benefit.

We recommend that every household have a dollar limit that domestic partners agree not to exceed without consulting the other. This way they can avoid budget busters, single items that can wreak havoc on a spending plan. The same caution ought to be put in place for any reoccurring charge, no matter what the price.

Similarly, when people are seeking ways to reduce their spending, they tend to look at big-ticket items or daily needs. A much less painful and more productive alternative is to look at the purchases you don't have to decide about every day (e.g., automatic subscription services).

Consider that the average family spends hundreds of dollars on a host of monthly services such as iPhone, Skype, TiVo, Netflix, Palm Pre, GPS Pet Locator, World of Warcraft, The Sims Online, anime subscriptions, comic subscriptions, health clubs, season tickets, and online file sharing or backup. Average people who can't afford to pay for their own health-care costs pay twice that amount in monthly subscription fees.

And each of these monthly fees is laden with extra features for an additional charge. Before the era of cell phones, I would save my quarters. If I needed to call home, I would stop at a pay phone. In addition to driving safely without the distraction of talking at the same time, which of course is still advisable, my phone expenses for the month were minimal. The latest base cost for an iPhone over two years is about $4,000, which could go a long way toward covering a family's annual health-care costs.

If you can afford a full-featured cell phone, by all means indulge. I assume you've done your retirement planning and are saving more than enough each month. If not, and you only need a cell phone for emergencies, however, buy a single-use cell phone and keep it in your car. You will only pay for the minutes you use, and the money you save will be significant.

If you saved and invested $2,000 a year at market rates of 10% a year, you would have about a million dollars in 40 years. Every young person with an iPhone is missing a million dollars at retirement to fund that trendy subscription.

Cutting back on reoccurring spending is easier because you don't have to decide every day to refrain from spending. Sometimes it is as simple as deciding to eliminate features. Extra charges accrue for voice mail, another for call waiting and still another for unlimited text messaging. If after you have dropped all these subscriptions and features you decide you really miss them, you can always add them back later.

If you are trying to cut back on your spending and save money, review every reoccurring charge on your credit card. Try living without the service or at least eliminating features. Many companies will release you from your contract and cancel your service for reasons of financial hardship. If you need to stop paying immediately, cancel the credit card being charged and get a new one.

Take your savings and set up an automatic transfer to your investment account. You can achieve big goals by making small changes consistently over time, which is the cornerstone of successful financial planning.

And although our brains aren't wired to realize it, frequency matters even more than height.

Comments

[bill]

This is definitely food for thought. I always cringe when I think how little I contribute to retirement versus the cable bill, the cell phone bill, etc. Thanks for posting this.

[D]

I was faced with the same problem; So I solved it. I cut my cable down to the basic service and havent looked back since. I really dont miss "cable" that much. Anything I want to watch I can always rent or watch on the net. It took a while to get used to having a reduced number of channels, but right now, I dont even notice. What I do see though is a $60/month difference. I may drop vonage and try skype... trying to sock away! Anyone on here try MagicJack or anything like it? Does it work?

[cmadler]

While this post makes a good point, I do take issue with the blanket criticism of full-featured cell phones. For less than half the quoted cost for an iPhone, I have a similar phone. The $80/month I pay, in addition to giving me the convenience of a cell phone, PDA, email, etc., allows me to go without a home phone (about $30/month without long distance) and go without a separate internet provider (about $10/month for dialup, $20 to $50 for broadband). Compared to my next best alternative, I'm paying less than $30/month for all that convenience. I don't know about you, but to me that's a bargain!

[BenG]

10% market returns my butt. We are presently living in a world where the SP500 10 year return was negative and the 15 year is a hair over 7%. Past performance is no guarantee of future returns. But is sure does look sexy to post a million dollar return over 40 years, doesn't it?

[Jeff]

We don't spend a lot of money on telecom or other monthly expenses. We don't have cable, but we do have a basic mobile plan, basic broadband and a(n) (underused) gym membership. It's amazing to me what many people spend on monthly subscriptions for mobile phones, cable, etc.

@D
Yes, several months ago we dropped our landline for MagicJack. I think that the sound quality is fine, though some people I talk to claim that the volume is too low.

Some disadvantages I'd list are:
- your phone service is only as reliable as your ISP
- no easily visible "new message" indicator (i.e., you have to look at your local computer, dial into voicemail or check email for messages)
- loss of phone service during power outages
- have to keep your computer on and logged in all the time

Overall I'd say that these are minor inconveniences compared to the increased features we get for $400+ of savings per year!

[Eugene Krabs]

10% per year of market return is, in my opinion, way too optimistic. I recommend to plan more like towards 5% to 6%. Even if I am wrong, it's still better to end up with too much money then it is to end up with too little.

As for Magicjack, I've heard several anecdotes that they do work as advertised.... However, they're just a VOIP device, but just happen to be one being marketed for non-techies. Truth is, there are a lot of VOIP options out there, both hardware and software, and marketing aside, they can be just as easy to use. In fact, I use mine for free via Skype (computer-to-computer only). The cost usually comes in when you want to reserve a land-line number and access along to your VOIP.

The main take-away message to this enty is good though. Make certain savings a habit, and it can have a profound impact later on in life, and without much pain if you're used to it.

[D]

I have my extra computers hooked up to my network and use them at content repositories and back up mechanisms right now, so leaving a computer on 24/7 doesn't bother mean and I can always SSL into it to see if I have any messages (albeit a pain in the @ss to do so) Might not be a bad idea though... thanks for the advise Jeff.

I hardly use our Vonage phone service right now anyways, I only hope I can get the wife to accept it since she is the one that uses it to call her family 22/7.

[Eugene Krabs]

Curse my lack of proof-reading. :D I post these during spare lulls at work....

Anyways, I also wanted to add that if you are like me and don't use phone too often, you can use a combination of free VOIP and a cheap discount cellphone.

For example, I use a Tracfone right now. Even though they're considered as cheap 3rd party phones, the signal and coverage is in fact, technically better than many premium service providers.

On top of that, because I rarely use the cellphone, my total phone bill is also cheap. At roughly $0.09 per minute, it usually comes out to be about $5 a month for me (my lowest was $3, and my highest so far was $15). That and I still have a cellphone.

For longer conversations, I usually fall back to Skype. There, it helps to have friends who are also on computers.

Food for thought....

[Old Limey]

Entertainment is an important component of a happy lifestyle and provides necessary relaxation, entertainment and education.

I don't believe that live entertainment is good value for money at all, especially when you add in all of the other costs involved in a night out, such as travel, parking, food & beverages etc.
This is especially true for older couples like us that don't care to be out on the freeways late at night, sharing the road with intoxicated drivers. In our younger days we had season tickets to the San Francisco 49'ers. but after two disasterous seasons we gave them up, something we have never regretted. We find cable to be very good value since it brings first class entertainment, education, sports and news, in high quality HDTV, right into the comfort of our family room where we can watch it on cold winter evenings in front of a cheery fire while relaxing in comfortable recliners. Another excellent and inexpensive entertainment is Netflix that enables us to choose our movies from tens of thousands of titles, and very importantly to read customer reviews before making our choices. Compare this with driving to a movie theater and paying at least $10/seat to watch a new release that you know little about, surrounded by lots of people, some of whom may even have the H1N1 virus.

I would have to be really hard up before I would drop or cut back on Cable or Netflix.

Another area where you obtain excellent value for money is eating at home. It's amazing sometimes to work out the actual cost of preparing a fine meal from some of the best ingredients available, ex. Alaskan King Crab, and then compare it with what a nice restaurant would charge, plus tip, and the exorbitant price they charge for a bottle of wine. We eat out twice/week to give my wife a break, but use inexpensive neighborhood restaurants.

[Old Limey]

BenG:
Here are the actual percentage returns:
-------- S&P500 -------- WIL-5000
05yr ... 6.07 ............ 6.29
10yr .. -2.47 ........... -1.38
15yr ... 6.03 ............ 6.21
20yr .. -1.28 ........... -0.51

The only way that most people can better these pathetic returns is by learning how to practice fund selection and market timing. I say "fund" because it is not practical to keep track of sufficient stocks yourself in order to maintain the necessary diversity in your portfolio. My 17 year return is 19.14%, it was over 21% before I became very income only oriented in 2007.

[Jclimber]

$4000/yr for an iPhone? I think not. Current ATT charges for the base plan is about $80 with taxes (includes unlimited Internet). That's $1920 for 2 yrs, then add in $200 for the phone. Still not even close to $2000.

And 10% market rate? That's pretty optimistic.

[Crystal]

Cell phones, cable, and internet would be the last luxury expenses my husband and I would cut. As cmadler and Old Limey already covered, those items allow us to save tons elsewhere.

We've also started cooking more at home. Most recently, we've been recreating some of his family's recipes. Homemade cornbread stuffing from scratch (like make-your-own-cornbread and wait for it to cool kinda scratch) and OJ Sweet potatoes take HOURS, but is the most delicious stuff EVER!!! I'm living happy with those 2 dishes for the rest of the week. :)

[Rod Ferguson]

Marotta is right about spousal discretionary spending limits; my wife and I have an agreement of no more than $100 per week total in expenditures without consulting the other. In practice, we usually tell each other if we're going to spend more than $50 in one sitting regardless of whether we breach the $100 total for the week. It's really helped keep the budget on track.

[Eugene Krabs]

To augment what BenG and Old Limey said, that is also why it's so important to have proper diversification and asset allocation. If all of our money went into an S&P500-like mutual fund, we would have been in a wild roller coaster for the past 10 years.

There's just one thing I'd like to tweak regarding the S&P500 performance. I prefer to look at something an actual index fund such as VTSMX instead. Because, if you think about it, that's realistically what you will be buying if you wanted a one-fund total stock market exposure.

Most funds like that also offer a dividend, which floats somewhere between 1% to 2%. It's doesn't change the bottom line, but it's worth noting, because even over the course of 10 years, it could add up.

Finally, I'm have a feeling Old Limey said it tongue-in-cheek, but the truth is, market timing may be a fool's errand. And I say this fully confessing that I have also participated in market timing in my stock trades. But I only do it as a learning experience, and not so much because I think I am somehow smarter than the market, and therefore, will profit from it.

The bottom line is, it's hard to time the market. Anybody know without a doubt what will happen to the stock market one week from now? A month?

Oh, almost forgot about the iPhone. I once saw a total cost of ownership calculation for a brand new iPhone, via AT&T, and the cost for a 2 year contract did come out to be about $3500. However, I understand that you can lower the cost significantly now, especially if you buy an older, unlocked 3G only phone.

Still, at something like $1000 per year (data plan included), it's entirely too expensive for me to justify. That's why I have a cheap cell but that's it. No landline either, because believe or not, it costed more than my cellphone!

[VT]

I've been trying to get this point across to one of my young relatives ... that maybe she'd have more $$ and could work less if she hadn't saddled herself with satellite radio, top-tier cable with premium channels, Netflix and so forth.
I'm not suggesting folks give up everything, but there are less-expensive ways to have these goodies.

[Old Limey]

Gene:
It's very easy to time low volatility sectors, the prime example being junk bond mutual funds. They can be timed with around 3 to 4 switches/year.
Examples are BJBHX, SHYAX, MWHYX and NTHEX with ANN= 59.47%, 57.04%, 57.30%, 59.19% for the current year.
The best indicator is a filtered moving average with the best values obtained by backtesting. I used these very successfully over many years until I made the decision to go as conservative as you can get by holding only Muni bonds and CDs held to maturity.

The very highest returns are obtained by timing very volatile sectors, currently some international sectors, and back in the 1998-2000 period it was the Hi-Tech sector. The trouble with very volatile sectors is that they turn on a dime and you have to make superfast decisions. Sometimes the decisions are right but sometimes they are wrong and just after you get out they start up again. When you're right it's easy to think that you were brilliant whereas in fact you may have been just lucky.

Below is an extract from the daily log file I keep of my portfolio. During this period I was 100% in 4 or 5 very volatile Hi-Tech funds and had ridden the market up through 1998 and 1999 into March 2000.

"03/09/2000",3369058 (My Maximum Value - Fully invested - NASDAQ = 5046.86)
"03/10/2000",3359936
"03/13/2000",3229379
"03/14/2000",3144898
"03/15/2000",3021835 (Completely in Money Market funds - NASDAQ = 4582.62)

This is how I ended up losing $347,223 in the four market days it took me to get out when the DOT.COM bubble burst. As it transpired the NASDAQ didn't hit bottom until 2 1/2 years later on 10/9/2002 when it hit bottom at NASDAQ = 1114.11.
This is the point I am trying to make about market timing and why it saved my @ss.

Losses like these in 4 days, -$9,122, -$130,557, -$84,481, -$123,063 should get anyone's attention, especially after an unsustainable rise, but the facts are that the vast majority of investors didn't get out because they had bought into the fallacy of Buy and Hold.

[Andy]

I haven't had cable for years now. I thought it was pretty smart and that I was saving a ton of money. However, we still leak money all over the place. After reading some of the comments, maybe I'll try the couch-potato way again and see if it can keep us at home instead of compulsive spending elsewhere.

As for VOIP, I used Vonage for about 8 years, but recently switched to [email protected] when I got a TMo cell plan. It's only $10/month for unlimited VOIP. Not as cheap as magicjack or skype, but cheaper than and just as convenient as Vonage. Requires 2 yr contract.

[Eugene Krabs]

Old Limey, this is going to be kind of funny, because I sort of agree with you, but with a different spin.

Take a look at the housing bubble we just had and how that came about. One of the key contributors was faulty risk assessment of MBS based on backtesting. The resulting trend or moving average in those, prior to the bubble burst, showed a resilient and even well-diversified instrument that was deemed worthy of AA or above in rating.

Even with debt instruments, I think there is a limit on how far we can and should go with back tested technicals.

Typically, it's true that low-volatility sectors can be more predictable, but I believe that's only true in a "normal" trending market. We are in an abnormal market. There are several ways to cope with this, but the one thing I must politely disagree with is that normal rule sets for normal markets would not apply in abnormal markets. Moving averages are only good so long as the market continues to trend along those averages.

In the end, the answer has always been to be able to somehow out-time and out-maneuver the market. But the problem is, can we really do that in practice? Or are all these quants with their fancy math degrees who worked in name-brand risk assessment think tanks such as Standard and Poor's, using elaborate computer models and 20 years of back-testing are really just not all that bright, and they've collectively missed something that we haven't?

Maybe that's possible... but as you have said in so many words, we must be careful of the patterns we think we see in the noise.

[Old Limey]

Gene:
Back in the early 90's when I was developing an investment code that I eventually marketed I was fortunate in making contact with over 200 users of the database that it used and we all communicated daily on a website bulletin board. There were some very experienced investors among them that gave me all kinds of good ideas and some became my beta testers. There were 2 or 3 that were self proclaimed experts in market timing and one day we decided to collectively create a timing system that would rotate between 2 funds, it would hold either the best Fidelity Select fund out of technology and healthcare or hold home finance as the money market fund, using an automatic trading system produced by another developer that used this same database. After very extensive backtesting and tweaking of the system by numerous investors we reached a point where we finished with backtested results that we just could not improve upon no matter what we did. At that time in 1995, we had 7 years of data starting in 1988, and the backtested results had 26 winning quarters out of 28 and a 7 year annual compound rate of return of 59.4%. The system was christened "The Winner" and I wrote an article about it in a newsletter that the database proprietor published.

Guess what! When some of the guys started using "Winner" going forward in real time it was a big disappointment. Years later another developer created a very sophisticated trading system that used artificial intelligence, I was very impressed when he demonstrated it at a conference. Later I asked him how it had fared recently during a very tricky period in the market - he replied, "It didn't work and we had to override it."

That's basically what you were saying and it can be summarized as "History never repeats itself".
This is why the only sector I used very successfully for many years were low volatility junk bonds and they give you lots of time to get in and out using exponential moving averages.

When I got out of the DOT.COM bubble just after the top the primary force that prompted my action was that I have a tremendous aversion to losing a lot of money quickly and my pain threshold was penetrated pretty swiftly. I didn't wait for a signal - the losses were signal enough.

[Eugenen Krabs]

Thank you for that thought, Old Limey.

It truly is fascinating, and I will take a closer look into your methodology, regarding trends with low volatility sectors.

Aside from filtered moving averages, were there any other major technicals that you used in the analysis?

[Mike Ryan]

I like this article alot. I do think that we, as Americans, spend a lot of money in small increments. I am sure, including myself, that if we took a look at what we spent in a week, that we would be outraged, well, most of us who give two shakes of a stick about our finances. I have a similar post about this on
my bad credit information website

[Doug Ramsey]

Everything has done better than the S&P500 recently:

Ten Year Average (Total Index Average)
9.78% MSCI Emerging Markets Index (23.10%)
11.67% MSCI Australia Index (10.09%)
8.87% MSCI Canada Index Fund (11.76)