3 Reasons You May Fall Into a 'Spending Trap'
Even financially savvy people can fall into spending traps, such as impulse buying a new pair of shoes marketed to you as a great deal on social media that aren't actually worth the cost.
That’s because money can elicit emotional responses that force us to neglect a cost-benefit analysis. Lotteries, alluring credit card welcome bonuses and "free" products and services that will tempt you to overspend are all examples of potential spending traps. In order to better prepare yourself to take a pause before you next pull out your wallet, consider these three reasons you may fall for a spending trap.
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1. Sunk cost fallacy
The sunk cost fallacy is the notion that you should keep investing your time and money into something just because you’ve already been doing so. Often, people want to make that time and money worth something — and they see continuing as the only way to do that. Studies show that we tend to hate losses more than we enjoy gains.
In personal finance, this behavior can manifest in many ways. Maybe a credit card bonus offers rewards if you spend a certain amount, but halfway through spending you realize you’re spending more than you have budgeted for just to snag the reward. Instead of halting your spending and giving up on receiving the reward, you may be tempted to keep spending so you can get it. Overspending on a credit card and racking up debt you won’t be able to pay back quickly could be much more detrimental than missing out on the welcome bonus reward.
Before you continue to spend, force yourself to pause and calculate your potential losses as well as your potential gains.
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2. Urgency bias
Urgency bias refers to our tendency to prioritize tasks that seem urgent over long-term ones — even if those ones we have more time for are more important. For example, some companies use time-limited offers to incentivize purchases within a certain window. They may have special offers that expire at midnight or a "buy one, get one free" sale that only lasts a few days. Shoppers may prioritize making this purchase over their long-term financial goals, like saving for a mortgage, because of the perceived urgency.
These types of promotions often work because people take the time they should to consider a purchase if they have a limited time to do it. Pause and reflect before making one of these purchases. Some people implement a "24-hour rule" in which they force themselves to wait a day before moving forward with a purchase, giving them time for their heightened emotions to cool before hitting "buy."
3. Illusion of control
The illusion of control is when people overestimate their abilities to know the outcome of something — and it can be costly.
Investors with this cognitive bias may invest in speculative stocks or buy risky options contracts and expect that they will be more successful than the average investor, for instance. It can also be as simple as thinking you know what direction the stock market will head next, when even professionals on Wall Street have trouble doing so.
To avoid falling victim to this bias, focus on making investing and spending decisions backed by data and find opinions on potential decisions you’re considering that contradict yours so you have the full picture.
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