EarningInvestingPsychology

The psychology of the denomination effect

The denomination effect is one of the major psychological factors not letting people to save money. It is working in practice in several ways and unfortunately, it is making managing finances rather tricky even if you really know how to keep your budget intact. You should be aware of this factor as it is engraved in people and know how to deal it.

The denomination effect and small banknotes

One of the most popular issue connected to the denomination effect is the ease with which most of the people are spending small banknotes while they are more careful about spending large ones.

Indeed if you take a banknote of one hundred dollars you will not be thus willing to spend it. At the same time, having one hundred of dollars in several small banknotes does not seem an equally large sum of money and the majority of people are feeling ready to spend it. This fact has already been proved experimentally by several independent research groups. As you can imagine, this tendency is particularly intense in the countries where the majority of money transactions is made with cash.

The denomination effect and the value of goods

The way we are perceiving the value of banknotes is not the only example of the denomination effect in action. Another popular result of this effect is the willingness with which people are purchasing a bunch of items with small prices even if they really do not need them while feeling rather uncomfortable of spending the same sum of money on one item which is necessary for them.

It is obvious that people are again getting into the trap of a psychological delusion which makes a large number of small expenses seem smaller than spending a large sum of money at a time.

Unfortunately, for some people this can be come a real problem not allowing them to save money for something important and wasting money on a large number of goods of a poor quality.

Instalment plans and the denomination effect

Finally, one more popular outcome of the denomination effect messing with your financial decisions is getting into instalment plans. Even though in the majority of cases purchasing goods using a hire purchase plan usually results in paying a larger amount of money, it looks more appealing to people as every month they will have to pay a relatively small amount of money. Certainly, sometimes people just do not have any choice so they are using such shopping options, however, everything depends on whether a person really needs the good he or she is going to purchase in such a way.

For example, if a family cannot afford a new fridge while the old one is simply not working anymore, it is sensible to use an instalment plan. Yet, in the case a person just needs to buy a new model of a smartphone even though the previous one is working perfectly, it is better to learn saving money for such purchases made for sheer pleasure rather than get into an instalment plan.

What can you do to address these issues?

Certainly, it will be a good idea to take large banknotes when you are going out. This will make you feel several times before you decide to spend money on a purchase.

In case you want to stop a torrent of small purchases, it will be sensible for you to keep a track of all the details of the money you are spending every day. Use a special money-tracking app or do it in a conventional way writing down the expenses on paper. Anyway, pay your attention to the final sum of money spent on your small purchases and imagine more expensive useful good or the goods of a higher quality which could have been purchase for this sum of money.

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