The psychology of spending

Rational economic theory would say that a quid is a quid – it can just about cover you for a chocolate bar and a bag of crisps. But how we perceive the value of that pound changes depending on how we got it in the first place. A pound found down the back of the sofa is a windfall, whereas the coin in our savings account is more likely to go towards a holiday abroad or a car.

Having a basic handle on behavioural science not only helps explain why we make certain decisions when it comes to money, it can encourage us to change our mindset and habits for the better. Behavioural science is also being used increasingly by regulators and companies alike to understand everything from how consumers handle debt to why they give to charity.

You may be richer than you think

David Bach, American author of The Latte Factor, espouses behavioural science as a way for ordinary people to realise they are richer than they think. He says that saving $2,000 a year from 19 to 26 ($5.41 a day) means they will have $1 million by 65. Most of us are not millionaires, but according to people like Bach, most of us have a serious spending problem.

How to counter that? Author of You’re Not Broke You’re Pre-Rich, Emilie Bellet, encourages readers try to adopt a “growth” money mindset, where you encourage yourself to keep up with those small, positive changes, instead of convincing yourself you might as well give up at the first hurdle. Yes, you can get out of debt. Yes, you can stick to a budget. You can save for your retirement. It also means being kind to yourself, just as you would if your best friend came to you with a money problem.

“It’s not our net worth, but our self-worth, that is the number one goal,” she writes.

Thinking about money

Kim Stephenson, author of Taming the Pound, a former financial adviser turned occupational psychologist, insists that money is simple – it’s people’s emotions that are complicated.

Kim works with clients to change the way they think about money. He stresses that saving for the long term, and buying “experiences” – like a holiday, which you not only enjoy at the time but happily anticipate during the run up – are more likely to make clients feel positive and fulfilled than buying material goods.

Doing the ‘mental accounting’

Ariel Cecchi, head of research at Be-IQ, a behavioural profiling firm, says that the way we value money often comes down to our “mental accounting” – in other words, the way we put money into different buckets in our minds.

“Income is related to effort, so we understand that as something very valuable,” he says. “We don’t relate a tax refund to the effort of earning; we see it more as a bonus. This behaviour is not irrational, it’s because we can’t keep track of anything that falls outside of our income – we can estimate what the tax rebate might be, but we don’t know exactly when it’s coming and how much it will be for.”

Giving away rather than spending

But spending money isn’t just about us – people in the UK gave £10.3 billion to charity in 2017. It gives us a “warm glow” of altruism. But have you ever wondered why you signed up for that monthly charitable donation and forgot about it for years?

In fact, a lot of our daily lives are governed by habit, from our morning routine to our direct debits. Living on autopilot has the evolutionary advantage of not wasting too much energy on every daily decision, but it also means it can be difficult to do something outside of our daily norm.

Dealing with debt

The way we spend and give money away to charity also tells us something about how we view and repay debt.

Ariel at Be-IQ explains that people tend to view their available overdraft as part of the total sum in their bank account, even though dipping into their overdraft means they would have to pay it back.

Credit card debt is another hot topic related to the way our minds work. In 2018, the FCA published a study that sought to uncover why so many people were making minimum repayments, even those who could afford to and wanted to pay off their debt quicker. The FCA concluded that consumers “commonly, mistakenly expect[ed] that paying the minimum will lead their credit card debt to amortize [go down] dramatically faster than it actually will.”

It also stated that more financial education could help shift people’s mindsets and help enable more positive changes.

Take control of your finances

“Guilt is not the answer, and neither is excessive discipline,” says Ariel. So how do we change our behaviour?

A budget is key. Even if we work for ourselves and can’t predict our income, we all should have a handle on our basic needs. Ariel recommends creating at least three buckets – one for daily necessities like bills and rent, another for items such as clothes and entertainment, and a third for luxuries like holidays.

Another way to change our habits is to simply talk openly about money with friends and colleagues. Alex Holder, author of Open Up: The power of talking about money, wrote "The six things that had happened since being honest about her finances" and that she has slept better, improved her mental health and solidified friendships - she has even earned more.

Embrace technology

We often know what we have to do, but could use a little help to get there.

“Nudge theory” suggests that subtle shifts in our environment can help us to make beneficial decisions that improve our situation. This is where technology can sometimes come in.

Starling Bank’s integration with Moneybox allows customers to contribute spare change from, say, buying a coffee into their investments and Starling’s Goals feature helps customers to separate savings into buckets, for example one for a holiday and another for a wedding. Many small changes together can add up to make a big positive result.

Is it time to change your behaviour?