Did you know that the payment methods you use influence your spending habits?

We’re spoilt for choice nowadays when it comes to payment methods. Contactless, one-click and fingerprint purchases are all routine, and someday soon, buying goods could be as simple as blinking. All of these advances make it easier than ever to pay for your chosen product or service in a flash. A word of warning, though: the steady stream of innovations aimed at improving your access to and experience of the purchasing process may seem endless, but that doesn’t mean that your budget is! In this article, myLIFE explains why digital payments should be approached with caution.

According to Merchant Machine, mobile payment methods will account for transactions worth a total of $14 trillion between now and 2022. Around the world, digital payment methods are in high demand among consumers of all ages, who are drawn by how easy they are to use (sometimes disconcertingly so). Luxembourg has embraced the trend and now ranks ninth in the world for annual growth in non-cash transactions per inhabitant according to the World Payments Report 2018.

While these new digital payment methods undoubtedly represent a major step forward for consumers, it’s also important to recognise how they are reshaping our spending habits. And the evidence is clear: digital payment methods make it harder for us to spend money in a rational and reasonable way.

E-commerce sites know this all too well. They’ve cottoned on to the fact that the more they streamline the payment experience, the more painless the checkout process is for consumers, and the more willing we are to part with our money without really counting the cost. Your favourite brands are all intent on minimising the pain associated with making a purchase because they know that this will make you spend more.

How the pain of paying shapes the purchasing process

You may not be aware of it, but most of your purchases are not purely the result of rational decisions. In fact, deep-seated psychological mechanisms and forms of cognitive bias play a key role in the decision-making process. The most powerful of these is what we might call “the pain of paying”.

Described in 1996 by Ofer Zellermayer as direct and immediate displeasure or psychological pain derived from the act of making a purchase, this psychological mechanism is the modern manifestation of a form of cognitive bias left over from our biological history: aversion to loss. Our caveman ancestors were fearful of losing any possession that could help them to survive. Despite not being relevant to most of the situations we find ourselves in today, this survival instinct is still alive and well, and one of the ways it manifests itself in our modern brains is our aversion to debt.

Researchers George Loewenstein and Drazen Prelec explain that the pain of paying, which heightens the discomfort we experience when we are in debt, is one of the main reasons why consumers regulate their own spending. Thinking about the cost of a purchase before we make it can diminish the pleasure we derive from it. Conversely, focusing primarily on the benefits and enjoyment associated with the purchase substantially reduces the pain of paying, i.e. the psychological pain we experience when we make a payment.

However – and this is the key point – the intensity of this pain depends on the characteristics of the payment method used. It’s a question of transparency and distance.

Three criteria determine the transparency of a payment method: its form, the prominence of the amount paid, and the time it takes for the money to leave our account.

People who regularly use digital payment methods tend to spend larger sums and reach spending decisions more quickly and less thoughtfully.

How digitisation drives spending

The more transparent and tangible the payment method (a prime example is taking bank notes out of your wallet), the more the pain of paying wins out over the pleasure of making a purchase. When you pay in cash, you can clearly see coins and notes changing hands.

Although it’s not the most secure form of payment, cash is therefore the best way to curb your spending because the pain of paying will be at the forefront of your mind.

Consumers who use cash most of the time are likely to withdraw smaller sums from cashpoints. They use their bank card sparingly and, on average, tend to have more cash available in their bank account. Paying in cash is therefore an excellent way to make yourself more aware of your spending.

Conversely, digital payment methods tend to create a physical, as well as a temporal, distance between the act of paying and the painful sensation of parting with your money. This reduced transparency means that the enjoyment of consumption outweighs the psychological pain of spending.

In other words, credit cards, one-click payments, tokens and other forms of payment by substitution, such as mobile wallets, make payment a faster process and reduce the initial discomfort we feel at the checkout. People who habitually spend money in this way are more likely to become compulsive shoppers, lose control of their spending and deviate from their budget.

People who regularly use digital payment methods also tend to spend larger sums and reach spending decisions more quickly and less thoughtfully.

National and supranational public authorities have done everything in their power in recent decades to boost the emergence and adoption of digital payment methods because of their safety and efficiency. Won over by the peace of mind they offer, citizens have been quick to follow suit and adopt each new innovation that chips away at the physical and psychological barriers standing between us and our purchases.

We’ve now reached the point where the status of cash itself is being challenged by the emergence of cryptocurrencies. To date, no studies have investigated their effect on consumer spending, but it stands to reason that the inherently virtual nature of cryptocurrencies will increase psychological distance and reduce transparency significantly. Certain consumers are likely to “play around” with cryptocurrencies without fully appreciating the real impact this will have on their bank account.

The key challenge is to ensure that over-indebtedness isn’t the price we pay for easier payments.

Why a little pain is a good thing

From a purely hedonistic perspective, it’s natural for consumers to try to avoid thinking about what they’re spending when they make a purchase. On the other hand, they can’t make a rational decision without being fully aware of the cost of the item they’re about to buy. It can be difficult for consumers to strike the right balance between these competing impulses. In light of this, authorities, banks and FinTech companies are growing increasingly conscious of the need to provide consumers with better tools to manage their spending so they can protect themselves against financial risk.

The key challenge is to ensure that over-indebtedness isn’t the price we pay for easier payments. In that regard, the pain of paying shouldn’t be seen as merely a handicap. Just as physical pain plays a role in alerting us to danger, the pain we feel when we make payments can act as a safeguard against compulsive spending.

It’s not necessarily easy to stay in control of your spending by going without the “painkillers” that are digital payment methods, but luckily there are tips and apps that can help you get on the right track.

Many banks offer their clients proprietary apps with budget overrun alert systems to help clients stay in control of their spending.

Combining smart wallets and cash

Now that you understand how the payment methods you use influence your spending habits, one of the first steps we recommend is taking the time to look through all of your payment methods and trying to categorise them, or at least making a list so that you can see the total impact of each method on your budget.

You probably have one or more credit cards, use an online payment service and have your bank details saved or linked to several e-commerce or other mobile payment sites.

That’s not a bad thing in and of itself. But the fact that the payments and transactions you make don’t always show up in your account straight away is cause for concern, as this time lag may encourage you to spend more than you budgeted for without realising.

Keeping a regular spending diary can be a good way to create a tangible, transparent record of these digital spending methods. By doing so, you’ll revive some of the pain of paying that is lost when you prioritise the instant gratification of making a purchase over a future shortfall in your budget.

It may also be wise to discuss your spending with your family or bank adviser to improve your understanding of your profile and weaknesses as a consumer. Consumers who are spenders rather than savers are often in denial and falsely believe that they’re in control. You may find that it’s easier to review your habits if you download one of the many budget management apps available online.

Many banks also offer their clients proprietary apps with budget overrun alert systems to help clients stay in control of their spending. The most important thing is to be honest with yourself and set stricter limits than might seem necessary initially.

A good system must also be able to flag any unusually large purchases, categorise your spending by type and provide data on a regular basis (ideally at least once a week). Online smart wallet services are amazing tools when it comes to managing your spending.

That said, no smart wallet can ever fully make up for a lack of self-control. At the end of the day, it’s up to you to spend your money responsibly. If you’re struggling to stay in control, you may want to try strategies such as leaving your credit card at home, turning off your mobile phone, going shopping with a lump sum in cash, or only allowing yourself to withdraw a set amount from the ATM per week.

Be it physical or psychological, pain is our alert system. To stay on track with your budget, a therapeutic dose of the pain of paying is just what the doctor ordered.