People save more money if they make it automatic. That's why it's so painless to save in a 401(k) retirement plan or a Christmas club account. You don't have to do anything. Automatic savings make people's lack of self-discipline work for them. This seemingly simple concept was the basis of a best-selling book, The Automatic Millionaire, by David Bach.
But the automatic approach has an evil flip side. It works against consumers when they're automatically spending instead of automatically saving. It's the health club membership you don't use anymore, the music club that sends CDs you don't want, the premium cable channels you don't watch, and the wireless phone minutes that go unused. The list of recurring monthly and annual charges goes on and on and amounts to a lot of wasted money. Check your bank statement or credit card bill for more examples.
Sometimes bad choices stem from good intentions. In the health club membership example, getting in shape is a good idea. If you use the gym several times a week, an annual membership ends up being cheaper than paying each time. But good intentions stray far from reality. Researchers found 85 percent of users who chose a monthly contract would have been better off paying by the visit. In fact, they were overpaying by an average of $700 during their membership term, compared with a per-use contract, according to research by Ulrike Malmendier of Stanford University and Stefano DellaVigna of the University of California at Berkeley.
Consumers generally don't work out at a gym as often as they anticipated when they signed up. The typical gym member used the facilities a paltry four times a month in the study.
So, automatic payments are most dangerous when we're making unsound judgments about ourselves, being too optimistic that we'll use the service that's incurring the regular monthly charges.
You can end the financial damage of automatic spending simply by canceling the products and services you don't need or use. Some commitments are more difficult to unwind, such as a vacation timeshare, which can be notoriously difficult and expensive to unload. In that case the recurring payment is the financing of the timeshare, the maintenance fees of several hundred dollars a year, and the cost of traveling to the timeshare to use it.
To prevent automatic spending gaffes, here are some tips:
- Buy a la carte. Always prefer the pay-as-you-go option, at least at first, until you know how much you'll really use the service. In other words, be as afraid of spending commitments as a dedicated bachelor is of engagement rings. Avoid yearly contracts, even if they include a discount over the monthly rate. Most times, you can switch from month-to-month to a discounted annual rate after you determine whether the service is truly worthwhile.
- Don't forecast high use. Realize that the moment you make a purchase or sign a contract is the most motivated you may ever be to use that service. You can't count on that same level of interest in the future. In fact, choose the initial contract based on your worst future behavior. Then adjust the contract later, if you find you use the service more.
- Check the cancellation process. Many services with automatic payments make it difficult to cancel. A health club might only allow you to cancel in person. A credit card might require you to cancel by writing a letter. Those procedures are designed so you procrastinate the cancellation. If it's a cumbersome cancellation process, it might be a sign that you'll underuse the service.
- Tally the numbers. Most automatic payments are expressed as a monthly fee, because the dollars don't sound as expensive. A $25 monthly contract seems harmless enough. But multiply it by 12 and determine whether the service still seems worthwhile expressed as $300 a year.
If you could cancel or downgrade just four automatic contracts you don't use: a health club membership, $70 per month; a premium channel on the cable TV package, $15 per month; Internet access on your cell phone, $10 per month; and a movies-by-mail subscription, $18 per month. That alone would save you $1,356 a year.
That's how wasteful automatic spending adds up.