Save More and Spend Less by Increasing Your "Mental Transaction Costs"

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You like to start each morning with a fresh latte from your local coffee shop. It's your daily indulgence, and you're more than happy to spend $4 a day for this little ritual.

But then each autumn, everyone and her Aunt Marge suddenly goes crazy for that seasonal Gourd Spice Latte. Instead of zooming in and out with your morning cuppa like you do the rest of the year, you are stuck waiting in a long line of GSL enthusiasts. So, every fall when GSL fever takes over your neighborhood, you skip your morning latte and make do with the stale coffee in the breakroom at work.

Your annual avoidance of your favorite coffee shop is the effect of mental transaction costs on consumer behavior.

What Are "Transaction Costs?"

According to economic theory, transaction costs are the various costs associated with making a purchase. We tend to only think of cost in terms of money, like the $4 you shell out for that latte each morning. But there are additional mental transaction costs that we often forget to account for, such as:

• Time Costs: The coffee lover who is unwilling to stand and wait in a long line.
   
• Search and Information Costs: The work you do shopping around for the best price, or determining the best product to suit your needs.
   
• Bargaining Costs: The effort to come to an agreement, as home and car buyers often have to do.
   
• Policing and Enforcement Costs: Making certain the other party adheres to the terms of your contract. (Anyone who has ever bought a lemon has experienced these costs.)

Retailers and marketers are well aware of these mental transaction costs and they work hard to remove them from your shopping experience. Within the industry, removing these inconveniences is referred to as "reducing friction."

However, mental transaction costs are a good thing for frugal consumers. The more friction you experience, the less likely you are to buy. Since retailers are always looking for new and inventive ways of reducing friction, it is up to you to increase mental transaction costs for yourself so that you do not find yourself making impulse purchases. Here's how.

1. Carry Cash

There is an excellent reason why so many personal finance experts (including yours truly) recommend that you carry cash rather than rely on plastic for purchases. Credit card purchases have very little "friction," since you do not have to feel the pain of actual money leaving your wallet. Even the act of having to double-check that you have enough cash on hand to pay can be a sufficient transaction cost. It's a bit of a hassle to count out the bills and empty your pockets for change. It can seem easier to just go without whatever you were thinking of buying. (See also: 12 Habits of Highly Responsible Credit Card Users)

2. Make It a Pain to Get Out Your Credit Card

You have probably heard the old-fashioned advice to freeze your credit card in a block of ice in order to make it impossible to make an impulse purchase. This is actually an astute (if extreme) method of increasing your transaction costs. If you realize you have get out a hair dryer to access your credit card, you will probably decide to forgo the purchase.

A less radical way of achieving the same results would be to keep your cards in your wallet, but use a rubber band to wrap a folded piece of paper around them on which you write the following questions:

• Do I need to buy this?
• Do I need to buy it now?
• Will purchasing this item help me reach my goals?
• What else could I do with the money I spend?

Not only will these questions help you think through each purchase, but the simple transaction cost of unfolding the paper from around your cards can be enough of a pain in the neck to keep your buying in check.

3. Turn Off One-Click Purchasing

One of the biggest recent innovations in reducing friction was the creation of "one-click" purchasing. You are bound to overspend when you can go from coveting an item to purchasing it with a single click. Having to get up to get your wallet and enter in your credit card information can provide you with enough of a mental transaction cost to keep you on the straight and narrow.

Additionally, you might consider deleting your account information on any shopping sites. Typing in your mailing address every single time you are on your favorite Internet retail site sounds like no fun (for good reason) — but shouldn't spending money you can't afford be something less than fun?

4. Say No to e-Tailer Memberships

Retailers know that the word "free" breaks our brains. That's because we tend to ignore all other transaction costs when something costs us nothing. This explains the free shipping trap, which causes normally rational human beings to spend more on items they don't want in order to avoid paying for a shipping fee on the only items they do want.

The "easy" way to avoid that trap is to upgrade your membership (for a fee), and avoid all shipping costs. Except that spending $99 per year for Amazon Prime (for instance) means the retailer not only gets your membership fee (which costs them nothing to receive, since there is no merchandise or shipping involved), but you also lose the shipping deterrent that often keeps you from making unnecessary purchases. You also lose the motivation to comparison shop, since you have already sunk money into the Amazon membership.

It's a better idea to skip memberships altogether to increase your mental transaction costs. That will force you to consider each purchase on its own merits. And considering the fact that Amazon has just raised its free shipping minimum purchase to $49 for non-Prime members, it's that much more likely that you will either plan purchases more carefully, or skip things that are non-essential.

5. Enlist an Accountability Buddy

Another classic piece of personal finance advice is to discuss any purchase over a certain dollar amount with your spouse. This allows for both transparency and compromise in a marriage — but it also seriously increases mental transaction costs.

For instance, when the Girl Scouts come knocking and I am the only one home, I would be sorely tempted to hand over $100 in exchange for all the Samoas and Thin Mints. But if my husband and I had previously agreed to discuss all purchases ahead of time, then I would be facing mental transaction costs — either call him at work, which he would probably not appreciate, or own up to the illicit purchase after the fact, which he would also probably not appreciate. That would put a serious damper on my cookie enthusiasm.

Making an agreement with your spouse or a friend that you will each discuss purchases ahead of time will provide you with a layer of hassle that will make impulse purchases seem much less alluring.

Do you use any of these or other mental transaction costs to help you live frugally?