How to be frugal - the smart way

What role do perception and relativity play in our purchasing decisions? What causes us to be smart shoppers in some areas, and neglect to pay the same attention in others?

An article in the New York Times stated that, in general, consumers are more likely to make greater efforts to save a small amount of money, if it represent a relatively larger part of the total purchase.

For example, if you found out a $50 top you bought was on sale for $40 at a mall across town, you might make the trek. However, if a $400 jacket is on sale for $385 across town, you would be less likely to inconvenience yourself. The absolute total dollar savings are higher in the second scenario, but the perception of savings is higher in the first.

This is the price relativity concept that behavioural economists Dan Kahneman and Amos Tversky have proven through their research on consumers. It makes intuitive sense because you are saving a higher percentage in the first scenario, but in reality, you are choosing to travel across town for less savings every single time.

Why does this happen? Partly because of the way we are marketed to as consumers, and often because the savings are easier for us to conceive in areas we understand. Here's another example: A young family might spend countless hours clipping coupons and planning out their grocery budget to save $500/ year. This same family will spend more than $500 on an accountant because they do not have the time to complete their own taxes every year.

What are some ways you can learn to reverse this way of thinking in your own life? Learn to consider absolute dollars instead of relative percentages. After all, it is dollars that you keep in your ban account, not percentages.

Below are two strategies we recommend:

1) Your Absolute Budget - The first step is to learn to consider your entire budget when spending. As an experiment, try cutting that overall budget by 10% to 20%. Assume you earn this new lower amount and see how you decide to reallocate your funds throughout your test period of 1 to 3 months. You will be mimicking a low-income situation which will force you to make decisions based on new trade-offs. For example, when you look at making a big purchase, the dollars you save will mean more to you than they did before - because you will be forced to pull them out of another area of your budget.

2) Re-evaluate Marketing - We often think in relative terms because we are marketed to that way. Start to assign an hourly rate to your own time. If it is $20, then you know you will only shop around or switch stores for something which will save you more than that. Just remember that this only works if you stay within a budget. Effectively, you will become smarter at evaluating which sources of discounts represent true savings in your particular case.

What is important to adopt is the new way of looking at your spending overall. Saving money in general, no matter which area the savings come from, will allow you to grow your savings by investing it, or applying it to self-improvement and growth. This will allow you to reach your financial and life goals more effectively.

To learn more about frugality and adopt a new wise way of spending money, check out our Overhaul Your Financial Behaviour Checklist.