Learnings from the lab: Present bias encourages spending

Background

Aside from partnering with credit unions, fin-tech companies, and nonprofits, we also strive to be a thought leader in the space by conducting studies in the lab. Below, we detail a theoretical study we conducted which helps explain why we tend to spend in the present, without regard for the future.

Study on present bias and spending behavior

In general, people have difficulty spending money in a balanced way. We spend too much money at the beginning of the month, after we get our paychecks, and end up with too little at the end of the month. We also spend too much money while we are young, so that we have too little left for our old days. What drives us to spend our money too soon, and what can we do about it? We ran an experiment that examines these questions.

Experiment

We ran an experiment at the North Carolina State Fair. The Fair is a good place to look for irrational spending. Participants played a very simple bowling game. This game had the essential ingredients to look at spending behavior: a budget, diminishing marginal utility of spending, and a temptation to spend too early.

Each participant received 15 balls for 10 rounds of bowling, and they were free to choose how many balls they wanted to throw in which round. The 15 balls were the participant’s “budget”, throwing the balls was like “spending” the budget, and the 10 rounds provided a temptation to spend too early. In each of the 10 rounds, 10 new pins were lined up.

At each moment in the game, the participant could choose to either throw a ball at the (remaining) pins, or to move to the next round and get 10 new pins. For each pin knocked over, the participant had a chance to earn 25 cents. In throwing a ball, there was no skill involved: One ball just knocked over a random number of the remaining pins.

The tempting, but bad, strategy is to keep on throwing balls in one round until the very last pin is hit. An ideal strategy is to throw only one or two balls of your total each round, and then move on to the next round and start with a new set of 10 pins to knock down. It is much better to “save” those balls for later, when there are more pins you can hit per ball.

The worst situation to encounter is to have no balls left to throw at a playing field full of pins. So rational players will spread their throwing over the different rounds. This feature of the game is also true of reality: Because every extra dollar spent early on brings increasingly less happiness, we should space out our spending more over time, to have more to spend later in the month when we need those same dollars more.

The problem is that people tend to look at the world through a present bias, where we think a lot more about the present, rather than the future. In our game, present bias means that participants are tempted to keep throwing balls in the round they are in, rather than wait for a more opportune moment in the future.

Our goal was to quantify the intensity of this bias, so we scored participants on this tendency, with a score that ranged from 1 if they used all their balls in the first round (1 = fully present biased) to 0 if they spread throwing perfectly evenly (0 = no present bias), and to –1 if they threw all their balls in the last round (–1 = fully future biased).

Results

Most participants exhibited present bias, and this present bias made people lose money.

Participants who had little present bias did well and hit 65 pins on average. But if you look at all participants, they hit on average only 59 pins, almost 10% less. In dollars, this meant that people forwent $1.50 in just a few minutes.

In line with our casual day-to-day observations, we are bad at spending in a balanced way, and this present bias makes us spend too early. People fail to balance spending even in a simple game that lasts only a few minutes.

The results of this study help us to understand why we have such a strong propensity to spend now, rather than in the future. Moreover, the game provides a platform in which to test hypotheses about how to overcome present bias.