The Psychology of Money – Spending & Saving

The Psychology of Money – Spending & Saving

 


It seems to be much easier to spend money than it is to save money.
 
Have you ever wondered why this is? Why do you spend money the way you do? Just like anything that we do in life, there are underlying psychological factors that dictate how we choose to spend, save, and invest our money. These unconscious mechanisms in our brains have the ability to control both our conscious behaviours and attitudes towards our finances.
 
Given the expensive price tag that tends to accompany the holiday season, it is not uncommon for Canadians to enter the New Year with higher-than-normal levels of debt. Re-evaluating your spending habits and quickly getting on top of managing your debt is critical to starting the New Year off right. The first step to overcoming poor financial habits is to recognize and understand them.
 
First, ask yourself the big question: “why?”
 
 
Your Brain: Why You Spend
 
 “Why do I keep buying things I don’t need?” “Why can’t I pay down my credit card bill?” By understanding the reasons why you over-spend, fail to make your debt payments, exceed your monthly budget, and struggle to save money, you are able to enact strategies that help you overcome these damaging financial behaviours.
 
Dopamine release. Scientific studies have shown that the human brain releases dopamine – a pleasure-inducing neurotransmitter when purchasing something new. The positive emotions that we feel as a result of this chemical response, leads us to repeat the behaviour in the effort to feel good, once again. Another scientific study showed that typically, an individual’s dopamine level spikes even higher when the shopper believes they are receiving a good bargain on something.
 
This can have a greatly damaging impact on your finances if you are in constant pursuit of the positive feelings you experience when purchasing something. Understanding that the high you feel when spending money is impermanent can help you to consciously negotiate if the purchase is necessary, or if you are buying something simply for the sake of buying it.
 
 
Immediate gratification. The human brain is wired in a way that makes us crave and seek out immediate gratification. Immediate gratification, also known as instant gratification, is the desire to experience pleasure or fulfillment without delay or deferment. Essentially, we want to feel good; and we want to feel good now. For example, it is much more satisfying to buy yourself a new expensive outfit today, than it is to save for when you retire thirty years from now.  
 
This concept goes against the basic principles of financial goal-setting. In order to achieve your larger financial goals, sacrifices must be made now. Recognizing that the positive feelings associated with immediate gratification are temporary and will likely be replaced with feelings of guilt, sadness, or emptiness, is crucial to not succumbing to impulse spending. Conversely, saving your money and working towards a greater financial goal tends to result in greater and longer-lasting levels of satisfaction.
 
 
Spending triggers. People will also have different spending triggers. Identifying your triggers can help you determine what the reason is behind your spending. Some common reasons that people spend too much money include boredom, the desire to fit in, the desire to increase their self-esteem, and convenience.
 
Studies show that people with lower levels of self-esteem typically display more impulsive purchase behaviour and spend more money on things they don’t need. So, if you notice that you are using your purchases to relieve personal feelings of inadequacy, there is a bigger, underlying problem that needs to be addressed. In this case, taking steps to tackle your self-confidence issues will provide you with a more sustainable source of happiness (and change your spending habits along the way).
 
 
Mental accounting. Mental accounting is a behavioural economics concept that explains how individuals classify funds differently and therefore are prone to irrational decision-making that affects their spending and investment behaviour. Basically, the concept explains that humans will make financial decisions (sometimes illogically) based on factors such as the source and intended use of the money.
 
For example, you are much more likely to carelessly spend $100 that you find on the sidewalk, versus $100 of your hard-earned money. While the value of the $100 is the exact same, the source of the $100 will result in you making a vastly different financial decision.
 
To overcome the mental accounting bias, you should try to treat money as objectively as possible. Let’s say you negotiate your monthly bills and are now saving $100 a month. Your brain may trick you into thinking that this is money that you can now spend frivolously elsewhere. Redirect this money into retirement savings or investment account that will serve you in the future. 
 
 
Mode of payment.  Researchers at MIT studied how your chosen mode of payment (cash, debit, or credit) can influence how much money you spend. They conducted a study where participants had to purchase tickets to a sporting event using either cash or credit. The results of the experiment revealed that the participants that were using credit cards were prepared to pay almost twice the amount that those paying with cash were willing to pay. The participants’ willingness to spend more money when purchasing with credit is due to the fact that the positive feelings associated with the purchase situation are disconnected from the negative ones they experience when it comes time to pay their bill.
 
Making the switch from credit to cash or debit can help you control your spending. Purchases made with cash or debit won’t give you the same delayed emotional response associated with credit purchases, that may be letting you spend so much.
 
 
Additional Strategies to Control Your Spending
 
Understanding the psychology behind why you spend money is the first step in spending less. Here are some additional strategies that can help you get your spending under control so you can begin tackling that post-holiday pile of debt.
 
 Automate your finances. The great success of this strategy functions on the principle of “out of sight, out of mind.” By allocating your money to your various savings, investment and retirement accounts, you are removing the option to spend it needlessly. When you don’t have money in the first place, any temptation to spend is reduced.
 
Replace credit with cash. As stated previously, replacing your credit cards with cash can greatly help you control your spending. Consider taking out cash at the beginning of every week to fund your activities for that week. When you run out of cash, you’ve run out of your allotted spending for the week.
 
Go on a spending detox.  It is easier to commit to something when you have a specific goal in mind. Creating a short-term challenge for yourself can help to motivate you to kick-start a behavioural change.  Similar to a health detox where you commit to cutting out all sugar, go on a financial detox and cut out all unnecessary expenses for an allotted period of time. This can show you how good it feels to save money and help to establish healthier financial routines in the New Year. 
 
Educate yourself. Educating yourself on a variety of useful financial concepts will allow you to understand money better, and in turn, teach you how to be more intentional with how you spend and where you put your money. For example, taking the time to understand how compound growth works and how much your investments can grow over time because of the power of compound growth, can incentivize you to allocate more of your money to various investment and savings accounts. 
 
 
Understanding the psychology of money is the first step in tackling debt and enhancing your financial wellbeing.  With the New Year upon us, now is the time to take a look at your finances and re-establish healthy financial behaviours.