The psychology of spending money

Content Type: Article

Understanding behavioral economics may help you get to the bottom of your purchasing habits.

By Tim Gower

Millie, a content program about women and money, is licensed from Dotdash Meredith, publisher of Real Simple, InStyle, Investopedia, The Balance and more.

Have you ever gotten home after shopping, plucked a pricey purchase from the paper bag and asked yourself, “Why did I buy this?” Well, you’re not alone. And it may not be entirely your fault. The field of behavioral economics can offer intriguing insights about the psychology of spending and how the psyche affects your choices.

The basics of heuristics

Much of our spending behavior is governed by heuristics—mental shortcuts the human brain uses to streamline decision-making and rapidly solve problems. “If we had to carefully contemplate every purchase we make, it would be a disaster,” says Ginger Pennington, Ph.D., an associate professor in the department of psychology at Northwestern University. “Using mental shortcuts saves us time and effort.”

In other words, thanks to heuristics, you don’t have to painstakingly ponder over which jar of mustard to buy—you grab the one you like and keep shopping.

But heuristics can also have a downside—one that causes us to overspend. For example, a common mental shortcut is to assume that a high-priced item is superior in quality to an inexpensive product. While that may be true in some cases, “we tend to overgeneralize, so sometimes we end up paying a much higher price for something that’s functionally equivalent to another brand that costs less,” explains Pennington.

These cognitive biases affect our spending in other ways too. For instance, retailers can get you to dole out more cash by using a technique called anchoring, where the first item you see becomes your reference point. If you only plan to pay about $100 to replace your dying coffee maker, the $400 model at the front of the display table will seem far too expensive. However, the $200 model next to it now seems like a relative bargain, causing you to spend twice as much as planned.

The social comparison debacle

Another cognitive bias called social comparison causes us to judge our self-worth by comparing ourselves to others. “Our natural bias is to compare ourselves to people that we perceive to have more, which leads to feelings of ‘I don’t have enough,’” says Jesse Walker, Ph.D., an assistant professor of marketing and logistics at Ohio State University.

And this comparison bias—often spurred by seeing influencers lead extravagant lifestyles on social media—contributes to a problem known as “money dysmorphia” or feeling insecure about your finances even if you’re making a decent salary, Walker explains. A recent survey by Credit Karma found that nearly one-third of Americans have money dysmorphia, including 41% of millennials, many of whom said it causes them to overspend.

A little retail therapy

There’s nothing inherently wrong with shopping, stresses Pennington—some studies even indicate that retail therapy can help lift your mood. Indeed, sadness is often driven by a lost sense of control over your circumstances, which can be restored by deciding to spend a little cash on yourself and making choices, Pennington says. However, she cautions that the emotional boost from buying material items is fleeting, and indulging too often can lead to compulsive spending and financial ruin.

Meanwhile, many studies have found that spending money on experiences—such as travel or concerts—makes people happier than paying for possessions. One reason for this, according to Walker’s research, is that putting money toward experiences leaves people with a greater sense of gratitude, which in turn makes them more generous.

“Our research showed that if you spend on an experience and reflect on it, you’re more likely to give money to an anonymous stranger than if you’re reflecting on an object that you just purchased,” he says. Spending on experiences, he adds, “not only has value to us as individuals but has a ripple effect that spreads out to the larger society.”

The benefits and pitfalls of mental accounting

Understanding another important theory in behavioral economics, known as mental accounting, can help you manage your money better, explains Pennington.

People create separate “accounts” in their minds for their various spending needs, the theory argues, and they tend to focus on the narrow effect of their individual decisions instead of the overall effect on their financial well-being. For example, say you mentally allot a certain amount of money toward necessities like paying rent and another amount toward entertainment. But then a friend invites you to dinner at an expensive restaurant, so you need to mentally transfer funds from the rent account to the entertainment account—which you justify with “Well, I have to eat, don’t I?”

“A lot of research shows just how great we are at justifying expenses to ourselves, partly by shifting around our mental accounting,” says Pennington. By being more mindful of your mental accounts, “you can consciously recognize when you’re rationalizing a purchase,” she adds. “It’s a matter of being more intentional about your spending and asking yourself, ‘Do I really need to buy this?’”

Tim Gower is a freelance writer based in Massachusetts. His work has appeared in many magazines and newspapers, including Prevention, Esquire, Reader’s Digest, Men’s Health and the Los Angeles Times.