Do you prefer to carry around cash as opposed to using your bank card? With the popularity of Dave Ramsey’s Debt Relief program, this is becoming a measure that many people are turning to. However, have you heard of the denomination effect and how it effects your spending habits? Read on to find out more about this theory as well as learn a money saving tip that you can apply right away.
What is the Denomination Effect?
It is basically a theory that when you carry around large denominations of money (like a $100 bill), you are less likely to break it. However, if you have $100 worth of money in smaller bills, you are more likely to spend them because it just doesn’t seem like a big deal to spend a few bucks here and there.
Before you know it, your $100 is gone and you probably have nothing to show for it.
Researchers have conducted studies that have shown this to be true. For example, one study gave a group of students $1. They told them that they could either save the money or buy candy. They gave half of the students four quarters. The other half received a single dollar bill. At the end of the experiment they found that nearly 75% of the students who received a dollar bill held on to it, whereas only 37% of the students who received coins saved their money.
Similar findings held true for a group of Chinese housewives. Researchers gave the participants 100 yuan each and told them they could either save the money or spend it on household products. Half of the women received a single 100 yuan bill. The other half receive 100 yuan broken down into fifties, twenties, and tens. At the end of the experiment only 10% of the housewives who received the smaller bills saved their money. Conversely, 80% the housewives who were given a single bill held on to it.
Why is this?
It is believed that the denomination effect exists because we tend to overvalue large bills. We also tend to mentally separate bills. The result of these two ways of viewing money usually results in it being easier to spend five $20 bills but hesitating before spending a $100 bill – even though they are worth the same amount of money.
So how do you combat this? Instead of going to the ATM to withdraw cash, go to a teller and ask for large bills rather than small ones. That way when you go to break a bill, you will be more likely to pause and think “Do I really need this?”
Do you find that you spend more money when you have small bills in your wallet?