Spend less money with commitment devices
Mitchell Barr, Client Associate
I have a love/hate relationship with Costco. On the one hand, I love it because I can buy 500 garbage bags at a discounted price and not have to worry about garbage bags for two years. If consumer staples were all I bought at Costco, the relationship would be all love, but unfortunately, whenever I go in there I always come home with something I don’t need (150 Rice Krispies Treats.) No one person needs to purchase 150 Rice Krispies Treats at once. Yet for some reason I eat three per day to please the dopamine dictator that is my brain, instead of a sensible one per day for five months. Usually, my fiancé has to step in and slap my hand when she sees me going to the pantry for my fourth Krispie of the day. The other issue with having so many treats around is that I eat so many, it’s hard to realize that a few extras make a difference. If I simply purchase a seven pack of treats I can see when my stash is dwindling and try to have enough self-control (or lazy inertia, another behavioral tendency) to resist going to the store to get more.
So let’s play a game now. Would you rather have $1 million in the bank, or receive a monthly payment of $5,000 per month for life? A recent Wall Street Journal article posed this very question1. As my college economics professor used to say, “It depends.” Based on current annuity prices the two options are actually proposed to be approximately equal financially for a 65-year-old (you can buy an annuity that pays $5,000/month for $1 million), but from a behavioral standpoint, they are not.
For instance, let’s assume you are a spendthrift and can’t stop yourself from buying five things a day on Amazon Prime (oh, the wonders of free shipping). Well, the annuity strategy looks pretty good because you receive a certain amount every month and you can’t dip into the rest. This is the equivalent of buying the seven pack of Rice Krispies instead of keeping 150 in the pantry. Should you buy an annuity? The downside to the annuity strategy is that you no longer have your $1 million, which opens the door for regret. Buying the annuity forces you commit to that stream of payments and forgo any other potential use for that money. It’s certainly possible that you could purchase a higher paying annuity in the future or make more money by investing the $1 million in the stock market.
The other option you have is to hire someone to help you spend less money, which is similar to my fiancé slapping my hand when I go to the pantry. This can be very helpful because now there is a gatekeeper to keep you from blowing your $1 million. You can keep your $1 million and invest it with their help. You can even create different strategies that allow you to take more money when the investments are kicking butt, and less when they aren’t, so the well doesn’t run dry. The problem with the advisor solution is like sneaking into the pantry for one more treat – there is really nothing stopping you from spending more out of your own accounts or firing the person you hired to help you.
Despite the fact that there’s not one correct answer to this annuity question, it is clear that relying on self-control is a recipe for disaster. Self-control and willpower appear to be finite resources, and the more effort you put into culling your spendthrift ways, the worse they may get. If you are asking “how do I spend less and live more,” having some sort of commitment strategy or structure can help save you from yourself when the money monkey takes over. The key is to strike a balance between commitment and maintaining your freedom and well-being. That way you can keep chomping down Rice Krispies without packing on the weight.
Mitch writes the popular blog, The Money Monkey, where he focuses on common mental mistakes made by investors, how to avoid being your own worst financial enemy, and thinking about investing in new ways.
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