Money 2.0: Why We Bust Our Budgets

This is Hidden Brain. I'm Shankar Vedantam. There's something about the prospect of getting a good deal that does curious things to our minds. Imagine, for example, that you need to buy a new bedspread. You're in luck because there's a sale happening right now at a store near your house. Usually, the bedspreads are priced according to size. A double costs $200, a queen costs $250, And a king-size bedspread costs $300. But on this day, all the bedspreads are on sale for the low, low price of $150. You have a double bed. The question is, what size bedspread do you buy? The behavioral economist Richard Thaler once told me about a friend who faced just this situation. She had a double bed. Again, the usual price was $200. The sale price was $150. She was ecstatic about the idea of saving $50. But then she got to thinking about how she could save even more. If she bought the queen, she'd save $100. And if she bought a king-size bedspread, she would save a whopping $150. You can guess where this is headed. She snapped up the best deal, Went home with the king, which meant, of course, that the enormous bedspread now draped onto the floor. Now maybe you're thinking, I'd never do that. I'd buy the bedspread that fit my bed. But chances are good that at some point your decision-making around money has been hijacked. Maybe you bought a pair of uncomfortable shoes because the price was simply too good to pass up. Or you splurged on a vacation you really couldn't afford after receiving a very small tax refund. Today we continue our new series, Money 2.0, by looking at the puzzling choices we make when it comes to spending money. We also consider how we can avoid some of the psychological pitfalls in making and sticking to our budgets. Deals, Decisions and Debt. This week on Hidden Brain. Support for Hidden Brain comes from Southern New Hampshire University. The brain isn't fixed. It's flexible. That means we're always capable of transformation. A master's degree from SNHU can help you build the skills to become whoever you want: a leader, career changer, dream chaser. With no set class times and low online tuition, SNHU makes grad school possible because it's never too late to learn something new. Get started at snhu.edu/brain. Support for Hidden Brain comes from Planet Visionaries. Professional climber and environmental advocate Alex Honnold hosts Planet Visionaries, a podcast spotlighting the people tackling climate challenges with real hopeful solutions. Throughout season 6, Alex brings together extraordinary changemakers for powerful Conversations about grit, determination, and the power of hope to fuel our fight for a better future. In partnership with the Rolex Perpetual Planet Initiative, this is Planet Visionaries. Listen or watch wherever you get your podcasts. Support for Hidden Brain comes from Progressive. Whoever says saving money is hard doesn't know that new customers who bundle and save with Progressive save hundreds. Because switching your home and auto insurance is better than cutting down on those iced lattes you love. Switch to Progressive and and see if you could save. Get your quote today at progressive.com. Progressive Casualty Insurance Company affiliates and other insurers. Not available in all states. Many people around the world worry about money. They worry that they don't have enough, and they worry they won't have enough in the future. Month after month, Many of us feel we spend too much and save too little. Sometimes when we look back at our own behavior, we see that we were penny-wise and pound-foolish. Last week, in the first episode of our Money 2.0 series, we explored how emotional scripts around money shape our financial well-being. Today, we explore a curious cognitive trap that affects how we make and blow through Our budgets. At the University of Chicago, psychologist Abby Sussman studies this trap. She also explores ways to turn this trap into a kind of superpower that can improve our financial lives. Abby Sussman, welcome to Hidden Brain.

Thank you so much for having me.

Abby, I want to take you back to your first job out of college. You were a research analyst at the investment banking firm Goldman Sachs. And your task was to analyze the economics of the airline industry. You had to make predictions about the long-term financial health airline companies. Now, you were given instructions on what kind of expenses to include and what kind of expenses to exclude. What were you told to do?

In this first job that I had working as a financial analyst, one of the main tasks was understanding what the future income and expenses of each airline would be. And so as part of this, you had to understand, first off, what were the expenses that they had last year that you think would continue coming in the future, and what were the expenses that maybe were one-time in nature that were surprising and unexpected and that you would not predict would continue in the future? And so I was working with the airline industry between 2004 and 2007, which was a period when there was a lot of turbulence in the airline industry. And so one of the things that I noticed was that these types of expenses that were listed as non-recurring ended up actually occurring with quite a bit of frequency.

So I understand there was like Hurricane Katrina in 2005, and there was a mechanics strike in, you know, 2005, 2006. Now, each of them might have been a one-off, but you were noticing that these one-off events happened with some regularity.

Exactly. And so to the extent that you're trying to predict, is there going to be another extreme hurricane event happening next year, or is there going to be another union strike of a particular sort happening again next year? The answer to that probably was going to be no. But if the question instead was reframed as, is there going to be some type of non-recurring expense of approximately the same magnitude? That question was then going to be much harder to answer. And that wasn't the frame that, that most people were taking in terms of trying to make these forecasts.

So this accounting blind spot doesn't just affect big organizations like airline companies. It affects people like you and me as well, right?

Absolutely. So when I got to graduate school, actually, one of the very first questions that I was interested in understanding is, is this type of financial accounting practice, is that something that also influences individuals when they're making their own spending decisions? So I thought about a lot of different times when there was just one expense, and I thought, I can spend as much as I want on this particular expense. It's only happening once. It's not going to happen again. And then, of course, that particular expense didn't happen again. But there was some other expense that happened a couple of weeks later, and I had a very similar type of reasoning of, well, this particular expense is not going to happen again, and so I can essentially neglect it for the sake of thinking about my budget.

And in a way, what you're describing is so human. When I'm making a budget, it makes sense that I say, here's what I need for rent, here's what I need for groceries, here's what I'm setting aside for entertainment. But what's common to all these expenses is that they're predictable. Unpredictable expenses by definition are unpredictable, so many of us simply exclude them from our budgets, right?

That's absolutely right. And so I think that the idea is that even though it's gonna be hard to predict what the specific unpredictable expense is gonna be, you might still be able to predict that there will be an unpredictable expense. And even more than that, I think often these one type of expenses actually are predictable, they're just infrequent. And so, It might not be that you couldn't have predicted that you'd have to buy a wedding present for your friend's wedding that's coming up, but it's not something that you are constantly thinking about. And so it's not your groceries. It's not as frequent as something that you need to buy every week. And so even though it's predictable, you might not be incorporating it into your budget because it's infrequent.

Now, you've also found that these unexpected events also produce certain kinds of features in the way we think about them. It's not just that we're likely to spend money on unexpected things, but we're likely to overspend on these things when they come around. Why would that be?

Yeah, so there are 2 main reasons why this is. So one is just from a purely motivational perspective, you might be looking for reasons to spend more, and so you can justify spending more because you think that this is an unusual sort of event and it's okay. The part of it that I think is actually even more interesting than this motivational piece is that we actually believe that this is a one-time event, and so it's not going to matter a lot for our budget. It's almost the opposite. You realize it's a large expense, but because it's going to occur so infrequently, you don't have a good way of understanding the impact and of grouping that with other expenses that similarly are infrequent.

And I'm also thinking that these unexpected events lend themselves to storytelling of a certain form. When I think about exceptional expenses, a wedding, a graduation, or even my car is broken down and needs a new transmission, These don't just feel unusual. I feel like I should treat these expenses as something special. So I might pay $500 more for the car repair because I tell myself, I don't want to have the hassle of another breakdown. Or I might pay for really expensive wine at a party because I tell myself, how often am I going to celebrate a big event like this? You once wrote a paper with New York University psychologist Adam Alter where you laid out a hypothetical scenario of unexpected expenses that many listeners will find Relatable. Could you sketch out that series of imagined events for me?

For one, you could think about, for example, you have one of your favorite bands that's performing nearby. And so that's something that you think is really important, and you're going to spend a lot of money getting the best seats. And so even though the performance costs more than you ordinarily spend, you decide it's well worth it. The following week, your TV breaks. That's something that you couldn't have predicted. And so although you could potentially buy a replacement pretty cheaply, you're only buying one once every couple of years. And so you wanna spend more on just the very best TV you can get. And then the week after that, you're celebrating your wedding anniversary. Let's say it's a round number. It's your 10th wedding anniversary. This is something that only occurs once in a lifetime. And so surely you should splurge on celebration for this special occasion. And so I think only by actually listing them out side by side Do you understand that there's even any connection? And the connection is not in the type of expense. It's in the fact that you are spending money on something that is unusual.

We've all experienced these sorts of unusual expenses. They can wreak havoc on our finances. And when we experience them over and over again, they can have terrible consequences over the long term.

So there are a bunch of interesting statistics that look at what leads people to draw money from their retirement accounts and to undersave. And so the most common reason that consumers withdraw money early from their 401 accounts is to cover unpredicted expenses. And so these withdrawals end up costing consumers about $7 billion a year in terms of penalties. And it's actually even, even more than that. So in a recent survey, done by Pew, about 60% of households report having had an unplanned financial shock. And a financial shock is essentially just an unpredicted expense. 26% said that they face difficulty saving because of expenses they didn't plan for in most months. So the idea of, you know, these unplanned-for expenses happen a lot and have pretty big consequences.

It's important to note that Abby is not pointing a finger at people and accusing them of having poor self-control. What she's describing is nearly universal. Among the many people who've been hit with unexpected expenses is Abby herself. She remembers the time she was renovating her apartment in New York.

This was the first home renovation that I've done. It's actually the only one that I've done After it, I think I was sufficiently scarred from the experience. But so in this renovation, for each additional room, let's say, that we were renovating, there were approximately 20 different opportunities to spend additional money on things. And so in the case of the bathroom, picking out bathroom tiles, you could pick out sort of cheaper tiles or more expensive tiles. And in that case, it's like, well, we're doing this whole renovation. It seems surely it's worthwhile to spend extra money to get— You know, a higher-grade bathroom tile. It's only an extra, you know, $200 in the context of this much more expensive renovation. Surely that's not a big deal. But of course, that was not the last opportunity to upgrade. And so you go through and it's, you're choosing the sink and you're choosing the bathtub and you're choosing each one of these different things and you realize they definitely add up. Yeah.

And if you treat each of them as a one-time expense that is non-recurring, eventually you're gonna have a renovation project that costs twice as much as you had initially budgeted.

Exactly. And I would argue that this is actually in some sense an easier situation than the one of having your TV break and wedding celebration come up because at least it's all in the confines of one project. And so you realize, right? So the difference is that when these opportunities are disconnected, I think you go through spending on all of them and you actually don't realize even after doing all of the spending that you've overspent. Whereas in the context of the renovation, it's perhaps more painful within a single project because you do realize how much you've overspent.

So we'll talk later in the conversation about why our minds tend to ignore these one-time expenses. But it's worth underlining that this kind of thinking is more than just about money. We also apply the same kind of reasoning to food, the choices we make as we decide what to eat. Can you explain how that works?

One of the things that my research with Adam Alter and Anna Paley has picked up on is that we often tend to think about certain types of eating experiences as unusual or infrequent. And when we do so, we actually discount the impact of those calories on our diet.

You know, I have to confess, I'm feeling very called out here. I just got back from a trip, and generally, I, you know, I dislike airline travel with the hassles that come with going through airports and flights. But I have to confess, there was a part of me that actually looked forward to this trip because I knew I could allow myself to eat whatever junk food I could find because I could tell myself, you know, it's hard to find healthy food at an airport.

Absolutely. And of course, since you're only gonna be eating that unhealthy food at the airport once in a while, and so it's probably not gonna have such a big impact on your overall diet or overall health, right? And so one of the things that we find in the paper is that when people eat foods that they don't frequently eat, or that they perceive that they don't eat frequently, which could also be based on context, that actually they consume larger portions of of those foods. And not only that, but later in the day, they don't adjust their diet as much. And so most people, if you eat a bigger lunch, you'll eat a smaller dinner. But if the bigger lunch is made up of exceptional foods, if your bigger lunch was at the airport, then your dinner might be actually just your normal-sized dinner anyway, even though you overate at lunch.

When we come back, it turns out that thinking about one-off events as aberrations and ignorable is actually only one part of a much larger phenomenon. When it comes to money, that larger idea is called mental accounting. You're listening to Hidden Brain. I'm Shankar Vedantam. Support for Hidden Brain comes from Progressive. Whoever says saving money is hard doesn't know that new customers who bundle and save with Progressive Save hundreds. Because switching your home and auto insurance is better than cutting down on those iced lattes you love. Switch to Progressive and see if you could save. Get your quote today at progressive.com. Progressive Casualty Insurance Company, affiliates, and other insurers. Not available in all states. Support for Hidden Brain comes from Quince. We all have those pieces in our closet that we can count on. The versatile jacket, the perfect t-shirt— these are the pieces that make getting dressed easy, and that's what Quince does best. Quince makes elevated everyday essentials using premium materials in designs that are timeless, thoughtfully crafted, and made to be worn again and again. And when the temperatures start to drop, Quince makes it easy to build on these everyday staples with versatile layers designed to keep you warm and comfortable All season long. Find your next fall favorites at Quince. Download the Quince app for app-exclusive offers or go to quince.com. Get free shipping on your order and 365-day returns. Now available in Canada and the UK too. And when Quince asks where you heard about them, let them know it was Hidden Brain. This is Hidden Brain. I'm Shankar Vedantam. Abby Sussman is a psychologist who studies why people and organizations regularly fail to spend within their means. One driver of exploding budgets has to do with what economists call narrow bracketing. This kind of thinking assumes that one-time expenses can be dismissed as aberrational, ignorable. In reality, of course, although each unexpected expense is unexpected, The general category of unexpected expenses is entirely predictable. In her research, Abby and her colleagues have found that narrow bracketing is one form of a larger phenomenon called mental accounting. Our choices about how and where we spend money are shaped by where we got the money, the size of the expense, and the context. Of course, we may rationally know that a dollar is a dollar, But emotionally, it feels different.

So from an economic perspective, there's a pretty standard assumption that money is fungible. And so it shouldn't matter where you get the money or when you get the money. Money essentially should be all treated the same and all pooled together.

Now, we're going to talk about the many implications of mental accounting, but it may be helpful to explain why we do this in the first place. Our tendency to place money into different buckets— this is my vacation bucket, this is my rent bucket, this is my savings bucket— you say this stems from an underlying tendency of the mind to divide the world into categories. Can you explain this idea, Abby?

Essentially, there is a lot of existing information in the world, and what we use categories for is to help us organize information. So when we think about the category of what is a bird, we'll know that a bird has wings, it has feathers, it can fly. And so when we learn about a new bird, we don't need to relearn all of that information. So categorization is essentially a way for us to simplify and organize the information in our world. And it's a very similar thing happening when we bring this to the financial context.

So one important consequence of mental accounting is that we don't think of the money we receive in a paycheck the same way we think about a bonus or a win at the poker table or an unexpected inheritance. The behavioral scientist Katie Milkman once found that even small windfalls cause people to buy very different things than they typically buy. Can you tell me what she found, Abby?

Absolutely, yeah. So in her work with Jon Beshears, they look at an online grocer who gives out coupons, $10 coupons. Now, from a purely sort of rational economic perspective, people probably shouldn't change their grocery spending as a function of having $10 more in their bank account. But in fact, what they find that people spend more on their groceries than they otherwise would. And not only that, but they tend to be buying things that they wouldn't normally buy.

And I understand that the windfall effect sometimes shows up even when it's not a windfall, but our own money that's coming back to us. Many of us treat tax refunds as a bonanza, even though it's simply a case of the government returning our own money to us. Abby, when you were a graduate student and you had expenses, you would submit them and receive A reimbursement. Can you tell me how you treated this money that was coming back to you?

Absolutely. So there's always something that's sort of special about receiving a reimbursement, and it feels like it's money falling from the sky, I think, similar to the tax refund idea. And so, you know, for me, I think the intuitive feel of receiving a windfall like that, that's not tied to a specific purchase as it is in the grocery store example, is that you can keep spending not only once, but multiple times. So if you're going out to dinner and you're trying to think about, you know, should I buy that more expensive bottle of wine. Well, I just got my reimbursement check. Surely I can spend extra money on the bottle of wine. And then it's not only that one time. I think that the psychology for me at least is that the next time I'm thinking about spending more on something that's also, you know, within the same week or 2 period, I can think back to that extra money and I can say, well, I had that extra money. And so I'll spend it not only once, but I might spend it actually multiple times.

So not only are you spending the non-windfall as a windfall, But you're spending that same windfall many, many times.

Exactly.

All right, so now it would be one thing if windfalls only caused us to splurge on the windfall itself. But research studies find that windfalls often change how we spend money outside of the windfall as well. One study looked at the effect of getting a bonus on the likelihood of people taking out car loans. Can you tell me what it found, Abby?

Yeah, so I think this is a really important study. And what it finds Is that when people receive bonuses, even bonuses of less than $500, they tend to take out car loans at higher rates. And when somebody takes out a car loan, it doesn't just have implications for that day's worth of spending, but it typically means that somebody now has taken on this financial obligation that will last them over the course of several years. And what the authors in this paper find is that people who take out an extra car loan as a function of having received a bonus payment are actually more likely to default on their car loans than those who increase the car loans as a function of just their ordinary income increasing.

Why would that be? Why would an increase in salary potentially not have the same kind of increase in delinquency compared to a one-time bonus having this effect?

So I think it ties back to the way that we think about windfalls. So if I get a windfall, I'm going to spend it perhaps on something that's more than I could afford. That it feels like it's extra income, whereas if I'm thinking about it in the context of my standard paycheck, I'm probably not going to overspend as a function of that.

So the differences in how we treat expected income and windfall income is an example of what behavioral economists might call source effects. That is, we treat money differently depending on its source. Source effects also come into play with money that's acquired illegally or unethically. How do people treat money that falls into this category, Abby?

Yeah, so I think that this can be thought of under this broader umbrella of emotional accounting. So thinking about these emotions that are associated with the money that we receive, interesting research finds that people are actually going to be more likely to spend money that they've earned unethically or that they've received from an unethical source on charitable donations or more prosocial opportunities.

This makes me think about a man who was once very well known for his philanthropy, His family foundation gave millions of dollars to hospitals, universities, and the arts. But then one day, we all received some shocking news about Bernie Madoff.

Until this week, Bernie Madoff was a lion of Wall Street. He managed one of the most successful hedge funds. Then yesterday, FBI agents swept into his apartment and arrested him. They say his hedge fund was little more than a Ponzi scheme and that he appears to have lost tens of billions of dollars of his investors' money.

Abby, can you explain what's meant by conscience accounting?

Yeah, so I think that this taps into the guilty response that we have from having received money unethically and helps— might help explain why Bernie Madoff is so focused on engaging in all of these charitable donations and giving money to hospitals and other sorts of institutions in need. And I do think much of this comes down to this perception of guilt. and wanting to cleanse this guilt. And so by taking money that was earned unethically and using it for a particularly ethical purpose, this is something that's going to make people feel better about themselves.

So in addition to the source of the money influencing how we spend it, psychologists and economists also find context effects when it comes to money. We spend money differently depending on where we are. Anyone who's paid an exorbitant sum for a beer at a baseball game or an ice cream cone at an amusement park can testify to this. In fact, some time ago, Sean Kelly, a member of the European Parliament, and tweeted out the price of a hot dog he'd purchased at an airport. He shared a picture of the hot dog and the receipt and said, how much would you pay for a hot dog? Well, at Dublin Airport, it will cost you the princely sum of €12. Now, €12 is more than $13. How do airports get away with charging so much for a hot dog?

There are 2 different factors that are going on. One of them is just that there's limited supply. And so you don't have any place else to go to get your hot dog. And so that's going to be part of it. But the other one is that it feels acceptable to be spending this extra money at this special event. And so even if you weren't buying it in that context, let's say that you were going into just like a high-end grocery store and you were buying a bottle of water, or you were going into a bodega at the corner and you were buying a bottle of water. And in each case, you were, let's say, then taking it out to drink it. People would still feel better about paying 2 or 3 times as much for the same bottle of water at the fancy grocery store than they would at the bodega. And so the point that I think is interesting here is the idea that I'm okay spending based on my expectation is of what I, what something should cost at this particular place. So the reason that I'm willing to spend more at the baseball game is because that's how much I expect it to cost at the baseball game.

So we've seen how the source of the money and the context for spending the money can, can both influence how we, how we spend it. A, a third form of mental accounting has to do with something called ratio Years ago, the behavioral economist Richard Thaler offered this example. He found that most people were willing to travel 10 minutes to a different store to save $5 on a $25 clock radio, but they would not drive the same distance to save the same $5 on a $500 television set. Of course, this is irrational because $5 is $5. At the same time, Abby, even as I mention this example, I feel it makes intuitive sense why I would try and save the money in the one case but not the other. Right.

Exactly. And so this is something that happens all the time where I think it's hard for us to know exactly if you're going to save, let's say, $5 an item and you're going to have to travel 10 minutes to get there. One way of thinking of it is, well, how much is $5 worth? Is $5 worth 10 minutes? Yes or no? That's sort of the objective way of thinking about the question. But often, if you're not extremely budget constrained, you don't really know what $5 should be worth in terms of your time. And so you have to look to the context to try to figure that out. And so the cue of saying, well, this is going to be 30% savings, that seems really valuable. This is 1% savings, all of a sudden doesn't seem very valuable.

Abby has firsthand experience of this form of mental accounting from her own childhood.

My parents actually, in particular, when I was growing up, I think there was always a really strong desire to save money on gas. And so When you could save a couple of cents on gasoline by driving, let's say, 10 minutes, that was something that you would definitely do 100% of the time, even if it meant that you were worried about that you might run out of gas on the way. And so you'd essentially be saving less than a dollar. And so you could think about this, I think, in 2 different ways. One of them is the percentage difference, or you could think about it also just as there are certain types of things that it seems Just worse to be spending money on.

Psychologists have also observed that once we've decided to spend big on something we want, whatever restraint we would normally apply goes out the window. They even have a term for it, the what the hell effect. Can you explain this to me, Abby?

Yeah, so the what the hell effect occurs often when we've set very concrete goals for ourselves and we don't meet those goals. Let's say that I was hoping that I would only spend $1,000 on discretionary items over this month. And I've already spent $950. And now let's say my TV breaks, right? And now I'm planning on, on getting a new TV. I can't get that for $50, so I'm gonna go over my budget no matter what. And so now once I'm going over my budget, I might as well buy the most expensive TV I can find.

Right. Because once you're breaking the budget, you might as well really break it instead of just simply marginally breaking it.

Exactly.

So in its most extreme form, people entrusted with spending the public's money— this is legislators— can become inured to the huge numbers they're dealing with. Everett Dirksen was a congressman from Illinois who served as the US Senate minority leader from 1959 to 1969. Famously, and perhaps apocryphally, Dirksen said of congressional spending, a billion here, a billion there, pretty soon you're talking about real money. It feels like that's the same idea, except magnified on a huge scale.

Absolutely. I think that's exactly right. And it just depends on what scale you're starting with. And so many of the behaviors and the psychology underlying how individuals think about money scales up to the way that governments and organizations think about money as well.

When we come back, how smart marketers use mental accounting against us and how we can deploy it for our own benefit. You're listening to Hidden Brain I'm Shankar Vedantam. Support for Hidden Brain comes from Instagram. Instagram Teen Accounts automatic protections limit who can contact teens, the content they can see, and the time they spend on the app. Teens are automatically placed into Teen Accounts. Teens under 16 will need a parent's permission to change any of those settings to be less strict. Learn more about Teen Accounts and Instagram's ongoing work to protect teens online at instagram.com/teenaccounts.

Working as a dedicated Fidelity advisor, I always ask, what's important to you? I'll look at those priorities and goals alongside your full financial picture financial picture to build a comprehensive plan designed to help grow and protect your wealth. With proactive portfolio insights and an eye on taxes, I'm here to help you make the most of your money. I'm Laura Maxwell, and I'm a dedicated Fidelity advisor. Learn more at fidelity.com/wealth. Investment minimums apply. Fidelity Brokerage Services, LLC, member NYSE SIPC.

Support for Hidden Brain comes from Air France. Air France business cabin offers comfort throughout the journey, With priority check-in, boarding, and lounge access. Onboard, enjoy menus from renowned French chefs, wines and champagne selected by a sommelier, and free high-speed Wi-Fi. When it's time to rest, settle into a fully adjustable lie-flat bed with added mattress comfort. The art of travel elevated, because Air France Business Cabin goes further in every detail to make your journey exceptional. This is Hidden Brain. I'm Shankar Vedantam. Psychologist Abi Sussman studies how the feelings we have about money— feelings tied to things like where the money came from and where we're spending it— influence the way we manage our finances. Her research has shown that these feelings can lead us to make irrational and ill-advised decisions. Companies know this, and they sometimes take advantage of these foibles in our thinking. Abi, you recently experienced this firsthand when you took your 2 children to the aquarium in Chicago. Can you walk me through what happened?

Yes, sure. So this was our first trip to the museum since the beginning of the pandemic, and we were very excited to be at the aquarium. And we were walking into a particular exhibit, I think it was stingrays, and there was an opportunity for you to have your picture taken. And as we're walking by, I'm thinking to myself that I'm definitely not going to buy this photo. We have so many photos at home. And so we walked through the exhibit and on our way out, There was then somebody who was now selling you back these photographs for $25 or $30. And my son said, Mom, can we please have it? And all of a sudden there I was having purchased this photo that I probably didn't need.

In some ways it seems like the aquarium had taken advantage of context effects to get you to loosen your purse strings.

And of emotional accounting, right?

And of thinking about this visit to the aquarium as this I asked Abby if there were other ways businesses set traps for us or take advantage of our mental accounting blind spots.

Well, one interesting thing that stores do actually is they offer around the time when most people are getting their tax refunds, there are companies that will actually offer sales that are associated with these tax refunds. And so the stores realize that people are going to be happy to spend. And picking up on that, rather than saying to a lot of these people what might be best, which is maybe take that money and put it in your savings account or use it towards things you would have bought otherwise, stores are taking this as an opportunity to realize that when people do have extra money in their pockets, it's a time when, when maybe they would be more likely to spend on something that they wouldn't buy otherwise.

I'm wondering if a discount in some ways can work the same way as sort of a windfall. I know a discount is not the same thing as a windfall, but it can feel the same way, which is suddenly you feel like someone's handing you free money. And stores routinely put out discounts to attract customers and shoppers. Do you think that discounts can essentially work the same way as a windfall?

Discounts and windfalls can both make you feel good and feel rich when you're spending money. And so in that case, I think there's a lot of similarity. You can feel good or you can benefit from the purchase itself. And then you can also benefit from the way that the purchase makes you feel and the sort of the act of spending. And so when you see a discount, particularly a discount that was larger than you expected at a store, it's going to make you feel good about spending.

Yeah.

And presumably then, once you feel like you've saved 25% on this, you feel like, okay, now I have that extra 25% to spend. And perhaps you might even exceed that 25% if you see something else that costs a Absolutely.

And there's interesting research on this that looks at this idea of double mental discounting, where one form of a discount would be giving you essentially a gift card or a credit to spend later at a store. And so in this research, what they find is that if you get, let's say, a $50 rebate on a purchase, that when you're buying the original purchase, you feel like it costs less. But then when you go to spend this $50 later, you also feel like the subsequent purchase is cheaper.

So in some ways, the store has basically got you feeling like you've gotten 2 discounts instead of one.

Exactly.

Your own research, I understand, has found a particularly tricky way that mental accounting can be used against us. Companies— and this can be universities as well— sometimes break down the prices of products in the interest of being transparent. So you have a detailed breakdown, not just of the final sticker price, but how that sticker price was arrived at. And at the surface, it sounds like a very good and very helpful idea. But you found that this produced a surprising result. Can you walk me through the study?

Absolutely. So in some cases, what companies will do is that they'll provide this detailed breakdown, in many cases, actually, without even a summary total of what the cost will be. And so rather than saying, let's say, on your cell phone bill that the total cost is going to be $100 a month, They're going to say there's an administrative fee that is $5, there's a service fee that's $2, there's an other fee that's $6. And what happens is that people, when they look at that breakdown, they think that the company is being more transparent with them. They think that they're giving them more information, for example, about what their costs are, when in reality the information is not useful. It just has to do with the way that the marketing firm that was designing the price disclosure decided to display the prices. And so people tend to like these types of disclosures that have this additional detail. But in particular, in cases when they don't include the summary total, it leads people to make more mistakes in choosing the lower cost option, right? It's harder to add up a list of more numbers than it is to add up a list of fewer numbers. And so people think that They like the company more. They think the company is more transparent. And they think that the additional detail will help them make a better choice, when in reality, it's exactly the opposite.

I'm wondering if some of this is also because now instead of focusing on the large total price, which is actually what matters to me, I'm now focused on the individual details. And at some point, my brain simply doesn't have the capacity to process all of the individual details. It's like that home renovation. If I think about the home renovation as being one bill, then I can come up with a number that seems reasonable. But if I have to essentially make a separate calculation for the tiles and a separate calculation for the sink and a separate calculation for the faucet, and each of them basically I'm evaluating on its own, it's easy for each of them to end up exceeding the price and then for the whole project to cost astronomically more.

Absolutely. I think that's a really nice connection. And it speaks to other research on price partitioning, which shows that when you break down the price in this way, people also tend to recall a lower total price.

Abby has come up with several hacks to avoid falling into some of the traps of mental accounting. One of these hacks is to find ways to reclassify unexpected expenses.

So in, in one paper, actually, we take this case of birthday gifts. And the idea is that a birthday gift is something that it's predictable, and it's something that we probably buy birthday gifts with some frequency. But we often don't draw the connection. We don't think of a birthday gift category. We think of them as individual expenses. And so as a result, when we think about them as individual expenses, we want to spend more on them. What we're able to do is by getting people to think about all of the times in the year when they've spent money on birthday presents, we can actually lead people to choose less expensive birthday presents.

So in other words, do you have a category then which just sort of says birthday presents for the year is going to be X dollars? And therefore, if I have to give out, you know, 10 birthday presents in the course of the year, each birthday present is approximately 10% of that total budget?

Yeah, when I think about making sure that, that I don't spend too much money on exceptional expenses, I think one of the most important things is just to be tracking everything and to be recording everything. And so ideally, you can create And so you can do that if there's a type of expense like birthday presents or money that you spend on celebrations. So you might spend it on Christmas or Halloween or Easter, or you can aggregate across all of these expenses. And so having sort of a special occasion budget is going to be really useful. And that allows you to think about how much money do I spend across these special occasions?

What do you find happens when people actually categorize these exceptional items, these exceptional purchases, or this exceptional spending? Does their spending actually change?

Yeah, so I think consistent with this example of getting people to think about their birthday presents as part of a larger category of birthday presents, that they're spending money on, what we see is that this does lead to reduced spending. And so in the examples that we have in the paper, it's around 20% difference, although I would imagine that that would vary a lot depending on the context.

So when you embark on planning a project, say a big trip or a home improvement effort, you have a simple rule of thumb to apply that helps you to be prepared for unexpected costs. Can you tell me what this rule of thumb is, Abby?

Yeah, I typically assume that it's going to cost me about 20% more than whatever I initially think it's going to cost me. And the other thing that I think is actually useful for anybody to do is to actually keep track of what they're spending. And then you can look back on your own spending and you can say, is the right amount to add 20%? Is it 50%? Maybe actually I'm really good at estimating exactly what I'm going to spend. And from that perspective, maybe I don't need to add anything. And so in some sense, the 20% is also a little bit of me being lazy because I don't have to think through what is every single expense going to be because I can just add 20%.

So in other words, if you're going on a summer vacation, for example, you basically say, whatever my calculated costs are, I'm just going to add 20% to that.

Exactly. And if I can't afford to go, if it's 20% more, then that's probably not something I should be doing.

And I'm wondering if one reason many of us don't do this, Abby, is because once you add in the 20%, you actually realize you might be able to afford less on your home renovation project or less on your vacation, and we don't want to hear that.

I think that's exactly right. I do think that some of this is motivated reasoning, and I think we have particular goals around savings, but we also have goals around spending, and it's not always obvious that the savings goals are more important than the spending goals.

If adding 20% to the cost of a home renovation project or a summer vacation sounds like no fun, one way to make this approach more appealing is to say the buffer will allow you to relax. Abby cites a paper by the researcher Marissa Sharif that examines the benefit of building in a buffer for your exercise regimen.

Yeah, so this paper is really nice. It shows essentially that you can think about setting different types of goals. So you can think about setting an easy goal for yourself. She often looks at this in the context, let's say, of exercise. So my easy goal for myself is, let's say, I'll go to the gym 5 days a week. My hard goal for myself is, let's say, I'll go to the gym 7 days a week. And so in this context, you can also have a hard goal with a buffer. So I'm going to have the goal of going 7 days a week, but I'm going to tell myself that I have 2 emergency skip days.

So in some ways, these cheating days might actually help you maintain your overall goal by basically planning for those cheating days in advance.

Exactly, because it allows you to still strive for this hard goal, but if you end up using one of your emergency reserve days, you're not going to then just say, well, I missed my goal, who cares? And then have this what-the-hell effect happen.

So it's clear there are a number of ways in which mental accounting can be used against us. And we've also seen how becoming aware of mental accounting can keep us from making some errors. But it turns out we can also turn our tendency towards mental accounting into a kind of superpower. If we think about the mental buckets we have as distinct or separate, putting money into a savings account feels like it's in a different bucket, and that makes it a little harder to touch. Perhaps this is especially true when it comes to retirement accounts. The money that you set aside in your retirement account, especially if it goes directly from your paycheck, feels like it's set aside in a way That makes it harder to raid.

One of the things that we haven't talked about as much is that one of the main purposes of mental accounting in the context of budgeting is as a self-control device, right? So the reason that we set up these categories for ourselves in the first place is to help us understand what are our spending goals and what are our savings goals and how can we separate those two. So by having money in different buckets, right? So, so some of that plays out in the context of budget categories. But that can also play out by having different buckets of money that are farther away from what we normally interact with. And so by having money that's, for example, automatically deposited into an investment account or into a savings account or a 401 account, by not seeing that money in the first place, that's gonna make it much easier for you to save that money.

I'm wondering if mental accounting can also help us spend our money in ways that can support our values —or bring us pleasure. We've seen how we tend to treat unusual expenditures differently. But we can also frame expenditures that we want to make, like supporting a good cause, as exceptions, and therefore make it easier to give. Abby, I understand you've conducted research in terms of how mental accounting might shape charitable contributions. Can you explain that research to me?

Yeah, so often research in charitable donations is very much focused on getting people to emotionally connect with the charitable cause or focused on the cause itself. And so what we're thinking about here is, well, people aren't going to give money if they don't feel like they have money to give. And so in this research, we look at framing an exceptional donation opportunity as more or less exceptional. And so, for example, if you describe an annual donation drive, you can describe that as occurring every year. That makes it seem like it's very frequent and recurring. Or you can describe it as occurring only once a year.

Right.

And what we find is that when people think of this as occurring only once a year, it seems more exceptional. And correspondingly, people are willing to give more.

One of the interesting things that you've looked at, Abby, is how much people choose to save their money versus how much they choose to pay down debt. Can you talk about this research? Because it has some really surprising findings.

There's an interesting pattern that's been documented in the econ literature, which is often referred to as co-holding. In this pattern, people essentially will be saving more money than they need in savings, let's say, and at the same time, they're building up high amounts of credit card debt. So the savings account is probably earning less than 1% in interest, and they're paying something like 15% to credit card debt. So this is a pattern that's very costly, and one of the reasons in my research That we think this occurs is because essentially people are so focused on the importance of building savings as an element of being financially responsible. And so as a result, people would rather borrow money on debt at a high interest rate than draw down money from their savings account. And this is particularly true when the savings is set aside for something that's deemed as responsible. So if you're saving for education or for retirement, People really don't want to touch those savings accounts. And so as a result, it will lead them to take on even more debt than they otherwise would.

What do you think the answer to this problem is, Abby?

I think that there are 2 different potential solutions to this problem. I think one of them is to help people understand what is a reasonable amount for them to have in their savings account and to help people understand that more savings isn't always better. And the other intervention that we find is effective is to help people understand that they're not depleting their savings forever. They're depleting it temporarily to be used for the specific purpose of repaying their debt, and that's a fiscally responsible thing to do.

Now, research in behavioral economics has also found that we feel differently about forking over cash to buy something as opposed to using a credit card. Now, a dollar is a dollar, so the dollar you spend in cash ought to be the same as the dollar you put on a card, but they somehow feel different. I'm wondering if this is another example of mental accounting at work and how we might be able to take advantage of this.

Yeah, so there's also interesting research looking at— this is called sort of the pain of payment. And so when you're parting with your cash, it's very salient to you how costly it is, exactly how much money you're parting with. On the credit card, it's a lot easier to spend money actually without even Realizing what the total cost is, right? So if you go to the supermarket and you're paying with cash, you probably know how much you spent. If you're paying with a credit card, you might not. And there are other aspects of the payment process that can be harder or easier and more or less painful as a result. And so more recent forms of payment, things like Apple Pay or these mobile payments, are going to be even lower in pain of payment. So it's going to be even easier. And less painful to spend money as the payment mechanism becomes less concrete.

And I'm wondering, is it possible that if you actually want to get a better grip on your spending, to actually use cash more often? I mean, it seems strange to say, but it feels like that actually might be sensible advice.

I think absolutely you can use cash. I think the world has moved so far over in terms of internet purchases. That I think that there are other recommendations that actually would be relevant as well. So things like just not having your computer save your credit card information, for example, that might not be as far over as using cash, but within the confines of still maintaining the convenience of being able to use your credit card in cases where it's not feasible to use cash. For me, I think there's just, there's no reason to have the payments be so easy. That you can buy something without even necessarily realizing you're buying it.

So Abby, you've spent all these years thinking about mental accounting and the foibles that we humans have. And I'm wondering, has it changed the way you yourself make financial decisions, the way you yourself save and spend money?

One of the ways that I think it's changed my thinking is in generally making me pretty confident that I should be tracking my expenses more closely than I do. Another way that it's affected my thinking in the opposite direction is that it's made me realize how important it is both to save money on big expenses where there's the ability through a single decision to save a lot of money, but also when thinking about very small purchases that are quite routine, something that I might buy at the supermarket. If I really want to buy the organic strawberries instead of the regular strawberries, even though they cost an extra 50 cents, This is something that I think I'm increasingly allowing myself to do and trying not to feel too bad about it. And this comes back to this idea of context effects where you can think about what's the percent of the total purchase that you're saving versus what is the absolute amount that you're saving. And so I'm trying to save a lot of money on bigger purchases rather than trying to save a little bit of money on smaller purchases that actually matter matter a lot for how happy you are going through your day.

So basically, don't sweat the small stuff.

Exactly.

Psychologist Abby Sussman works at the University of Chicago's Booth School of Business. Abby, thank you for joining me today on Hidden Brain.

Thanks so much for having me.

Hidden Brain is produced by Hidden Brain Media. Our audio production team includes Bridget McCarthy, Annie Murphy-Paul, Laura Querelle, Kristin Wong, Ryan Katz, Autumn Barnes, and Andrew Chadwick. Tara Boyle is our executive producer. I'm Hidden Brain's executive editor. This week, we turn our Unsung Heroes segment over to our listeners and bring you a story from our sister podcast, My Unsung Hero. Today's story comes from Lesha Day. In 2017, after a long battle with Alzheimer's, Lesha's mother Stephanie passed away. But years before that, before anyone knew about her disease, Stephanie was living a pretty normal life. She would often make the 45-minute drive to visit Lesha and her 2 granddaughters in another part of Connecticut. It was a route she had driven hundreds of times. But one day, when she was supposed to come to Lesher's house, Stephanie didn't show up.

By the time she realized that she was lost, it turns out she was in Rhode Island. So when she realized, she pulled over to a gas station. And I think she approached a young man at one of the pumps. And, you know, she must have explained to him that she was lost. And I think it probably in the conversation that she had with this stranger, he must have realized that my mother suffered from memory loss. So this perfect stranger did something I think is pretty remarkable. You know, he could have done nothing at all, but instead he told my mother to go ahead and get back in her car and follow him. And so, he drove from wherever they were in the state of Rhode Island all the way into the middle of Connecticut, to central Connecticut where she lived. And he kept her in his rearview mirror the entire time. And my mother was, you know, a pretty slow and careful driver. So, I'm guessing that that trip one way probably took him—

2 hours.

Easily an hour and a half just to get her back home. My mother did show me a slip of paper that this man had given her, and all it said was his first name, Jason, and there was a 401 telephone number, a Rhode Island exchange. And eventually that slip of paper disappeared. I don't know if, you know, if my mother threw it away or if I, in cleaning out her house eventually, maybe— Maybe I somehow misplaced it. So if I knew who Jason was and if I could— if he were standing in front of me today, I would say thank you. Thank you for saving my mother's life. Thank you for preserving her dignity that day. Thank you, Jason.

Lesha Day of Old Saybrook, Connecticut. If our work has given you food for thought or helped you with some aspect of your life, please consider making a donation to support us at support.hiddenbrain.org. Again, that's support.hiddenbrain.org. I'm Shankar Vedantam. See you soon.

Thank you.

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