Lusardi, Tufano and TNS Global asked 1000 U.S. residents the following question:
You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options:
a) Pay 12 monthly installments of $100 each;
b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now.
Which is the more advantageous offer?
Result:
Here are all the results from the survey. Unbelievable. The questioning was done over the phone which could distort the results a bit but it's nevertheless a disaster.
You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options:
a) Pay 12 monthly installments of $100 each;
b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now.
Which is the more advantageous offer?
Result:
Here are all the results from the survey. Unbelievable. The questioning was done over the phone which could distort the results a bit but it's nevertheless a disaster.
Mahalanobis - am 2009-06-30 19:20 - Rubrik: Finance
Marcin (guest) meinte am 30. Jun, 20:28:
Thing is, the way it's worded in your post, it sounds a lot like option b is 20% interest on principal of $1,200. I had to read it several times, and it's only because $1,200 is 120% of $1,000 that it makes any sense to read it as a total payment of $1,200.Also, for a lot of people, even if they understood that the total payment is the same under both, if they actually don't have any good investments (e.g. they only have a non-interest-bearing current account) then the appropriate discount rate for them is extremely low.
Mahalanobis antwortete am 30. Jun, 20:45:
Good point,
I thought it's obvious that you borrow $1,000 from the bank to pay $1,000 to the appliance store immediately and owe the bank $1,200 at the end of the year. My pet theory was that people thought: 20% interest? Nothing can be worse! After all, look where Libor is! ;-D
Donald A. Coffin (guest) meinte am 1. Jul, 00:10:
It may be rational
Note that Option B requires you to save an amount on a regular basis to have $1200 available in 12 months to pay the loan off (more than $83.33, less than $100, per month). Suppose you think you will not have the willpower to save regularly enough to make the payoff, but that you will make the monthly payment. Then you might rationally bind yourself to the monthly payment.Another example of this. I teach at a university at which we get paid in 10 monthly installments (1 September through 1 June). A substantial fraction of my colleagues regularly ask that the University switch to paying on a 12-month basis--take the current annual salary and divide it by 12 (rather than 10)--the annual income is the same. When I suggest that simply having $X deducted and deposited each month in a savings account would accomplish the same thing, they tell me that they're afraid they would lack the required self-discipline.
Mahalanobis antwortete am 1. Jul, 09:57:
Interesting
Would be interesting to know how people react when told how much money they leave on the table. With 10% p.a. return (half of what the bank charges) it's almost 5 bucks per month. Paying $100 vs $95 just because of lack of self-discipline... *(1200/(((1.008)^12-1)/0.008) = 95.7)
Donald A. Coffin (guest) antwortete am 3. Jul, 00:46:
Of course, with interest rates on savings accounts at our credit union currently at 0.55% per year, the difference between the required savings and the monthly payments is very closw to zero.
Bill (guest) meinte am 1. Jul, 19:44:
I read it as pay 20% annual interest and then pay a lump sum 1,200 at the end of the year. If it had read pay 12/100 or pay the entire amount plus 20% at the end of the year I would have got it right.Though answer C) save up 1000 and then buy it for 1000 would be my preference.
