Which would you choose - a new car or 8 trips to Hawaii?

You've likely never asked yourself this question before.  But if you want to optimize your use of money - and your happiness - this is exactly what you should ask yourself before you buy a new car, according to Dan Ariely, professor of behavioral economics at Duke University.  In this video clip he outlines a few interesting ideas.

Compare the price to something else you want.

Before you buy that new car, think about the price in terms of something else you want in the future.  Let's say your car is 4 years old - we all love the look, feel and especially the smell of a new car.  But instead of just comparing the price of a new Lexus to a BMW, compare the new car price to something else you might enjoy even more - let's say a Hawaiian vacation.

The average new car costs $31,169 (including 9.75% sales tax).  One website I found estimates the cost of a Hawaiian vacation to be $3,770 per week, including airfare for two people, hotels, food, activities and entertainment.  So the new car actually costs you 8 trips to Hawaii.

By comparing the new car to Hawaiian vacations, you're placing a value on the car in terms of something you can identify with - not just its price.  You're also comparing spending the money today vs. what you could spend the money on in the future.  I suspect that in four years the new car smell will be long gone and you'll have racked up 60,000 miles (the average American drives 15,000 miles annually).  But if you kept your current car, you'll have been to the Big Island four times and you'd still have four more years of Hawaiian vacations to enjoy! 

Note that you're not sacrificing driving - you still have your 4-year old car.  The only thing you're sacrificing is the luxury (and burden) of having a new car.  A decent car today can easily last 200,000 miles so the maintenance costs on your existing car won't become a major problem for a long time.

Feel the "pain of paying"

I have often said that if we actually saw and felt how much we spent on different things we would spend more on things we value and less on everything else.  Writing checks and tallying your account balance after each check is written forces you to see how you're spending money and you can see your bank balance decline with each purchase.  When my in-laws were newly married they put cash in envelopes for each budget item (food, clothing, gas, donations, etc) to make sure they had money for the important things.

Dan makes the case of feeling the "pain of paying."  For example, if we eat at a restaurant and the owner sits at your table and removes money from your wallet with each bite, you'd spend less at the restaurant - and you'd enjoy the meal less too!  The pain of paying robs you of the enjoyment of the meal. 

His point is not to go through life feeling miserable, but to become more aware of our spending and to make conscious decisions about which categories we want to spend more on, and which categories to spend less on.

How can we feel more pain?  Paying with cash raises our awareness more than debit cards because we actually see the money leaving our hands.  Dan doesn't mention paying with checks, but I think paying by check, having to show three forms of identification, recording the amount and subtracting it from a running balance in the check register would be even more effective.

Paying with debit card raises our awareness because we know the money is being deducted from our checking account immediately, and if we don't have the money in our checking account, the purchase won't be approved.  Credit cards are the least effective because psychologically we're getting something now but paying for it in the future, so we feel no pain - it actually feels great!  Of course, this is one reason why people get themselves into credit card debt so easily.

What does all this mean?

Be more conscious about your spending.  When considering of a large purchase, think of the price in terms of something more valuable to you.  Carry a small notepad with you and write down everything you buy throughout the day for at least a month.  You can also scrutinize your expenses on your bank and credit card statements every month or in Quicken software.

The goal isn't to become a miser - the goal is to see where your money is going today and to consciously spend more on the things that are most meaningful to you today and in the future - and less on silly stuff.