Managing personal finances?
Saving, spending,
getting into debt
as individuals and
as couples
Economic theories
• Normative theory: rational, utility-maximising
actors
• emphasis on saving=deferred consumption and
optimal patters of saving, spending and
borrowing over time
• Brumberg’s and Mogdiliani’s (1958) life-cycle
theory as most well-known example
“In each year, the consumer should consume the
annuity of his expected wealth”
Brumberg & Mogdiliani
• Underlying assumptions: Individuals..
1...have reasonable estimates of likely future income
2. ..have smoothing consumption as main saving
motivation (e.g., similar lifestyle b/a retirement)
3. ..have average saving behaviour which looks like a
hump-shaped curve
4. .. use whole life as time horizon for saving decisions
(lifetime budget plan)
Amount
of saving
time
Behavioural life-cycle hypothesis
(Shefrin & Thaler, 1988)
• M & B’s life cycle theory failed to receive convincing
support from actual data on households’ saving
behaviour (e.g., older people tend to save too much)
• Economic theory assume that borrowing money is
opposite to saving money
• Shefrin & Thaler (1988) attempt to develop a more
realistic economic theory of saving: behavioural life-
cycle hypothesis
• Theory based on three major (psychological)
concepts:
1. dual self-theory and self-control
2. framing
3. mental accounts
Shefrin & Thaler cont.
• Dual-self of long-term rational “planner” and
short-term emotional “doer”, internal conflict
• Perpetual state of temptation to consume
immediately, will-power to resist is “costly”,
people use internal and external “rules” to achieve
self-control
• e.g., direct debit into saving account
• Framing leads to think different about the same
information or fact, and different behaviours
• e.g., win/loss frames
Mental accounts
• Scenario 1
You are in paid employment and you have been
given a special bonus at work. It will be paid
monthly over the course of one year, such that you
will receive an extra £100 each month from now
• Would you expect your monthly expenditure over
that year to increase? YES or NO.
• If YES, roughly how much per month?
• Scenario 2
You are in paid employment and you have been
given a special bonus at work. It will be paid as a
lump sum of £1,200 (after tax) this month
• Would you expact your expenditure to increase in
the following month? YES or NO.
• If YES, roughly by how much?
• Would you expect your monthly expenditure over
that year to increase? YES or NO.
• If YES, roughly how much per month?
Mental accounts - continued
• Scenario 3
You find out that a distant relative has left you an
inheritance of £1,200, which you will receive in
five year’s time from now (during that time the
money will be invested with interest)
• Would you expect your monthly expenditure to
increase over the next year? YES or NO.
• If YES, roughly how much per month?
This is what you should have decided on:
££s Scenario 1 > ££s Scenario 2 > ££s Scenario 3
• Major classification of mental accounts into
• current spendable income (easiest to spend)
• current assets (more difficult to spend)
• future income (most difficult to spend)
• Depending on how saving/spending is framed –
relating to which type of account – there are
predictable patterns of behaviour
Mental accounts –
empirical findings
• Shefrin & Thaler (1988) report a study with MBA
students where they employed exactly these
scenarios (findings are given below, scaled from
dollars to pounds p/m)
100
80
60
40
20
0
Monthly Lump sum Inheritance
Strengths and weaknesses of
economic theories
• income-based, normative theories
undermined by actual saving behaviour,
including that people save and borrow
simultaneously
• in comparison, behavioural life-cycle
hypothesis has a number of strengths
• mental accounts powerful theoretical addition
where propensity to spend or save over life-
cycle is “account-specific”
• can explain why people save and borrow at the
same time (different mental accounts)
Evaluation of Shefrin & Thaler
cont.
• remaining weaknesses
• assumes universal applicability
• neglect of within-household dynamics in
decision-making about saving/spending (e.g.,
couples)
• neglect of social and cultural factors which
influence saving and spending
Psychological theories
• focus on individual differences in managing
personal finances
• motivation
• example: saver typology according to main
underlying motive
• cash manager (organise money for paying bills)
• buffer saver (for emergencies)
• goal saver (for durables, holidays, house)
• wealth manager (investment, etc.)
• personal characteristics
• ability to delay gratification
• “time” preferences (short-term, long-term)
• money management skills
Psychological theories cont.
• strengths and weaknesses
• shows that people’s financial behaviour can fulfil range
of different psychological functions, making a single
model of explanation unlikely
• personality approaches cannot account for marked
changes in consumer spending in short time span (e.g.,
boom in consumer credit)
• neglects to take account of the influence of attitudes,
shared beliefs and social group membership
Transformation of consumer culture
Approx. amount of
outstanding consumer Approx. number of credit
credit in real terms cards in use
1976 £5.5 billion 6.1 million
1982 £7.5 billion 14.7 million
1992 15.2 billion 27.0 million
• Mushrooming credit facilities
• Increase in personal disposable income
• Changing role and meaning of “consumption”
Social psychological theories
• Mass consumption and personal identity
(Lunt & Livingstone, 1992)
• moral/cultural shared beliefs (e.g., generational shifts)
• group membership and personal history (e.g., life stage)
• Consumption and the “search for self”
(Dittmar, 2000)
• transformation in consumer spending in combination
with social-cultural changes have increased importance
and significance of consumption
• greater psychological role, particularly in the
construction of self and identity
Social psychological variables –
do they improve predictions?
• Recent UK social psychological studies attempt to assess
the relative influence of
• economic (e.g., income)
• socio-demographic (e.g., age, education)
• social psychological (e.g., attitudes)
• Predictions of
• whether or not in debt
• amount of debt
• Technique: multiple hierarchical regression
• Lea, Webley & Levine (1993) vs. Livingstone & Lunt
(1992) discrepant findings
• sample differences, differences in questions asked
When you do not spend your
money on your own..
• neglect of within-household dynamics in
financial and consumer decision-making
% • Relationship between money allocation
systems and power (e.g., Pahl, 1995)
80
70
60
50
40
30
20
10
0
Female FemaleJoint pool Male Male
whole managed managed whole
wage pool pool wage
Further studies
• Longitudinal diary study of Austrian
couples buying consumer goods
• happy vs. unhappy couples
• influence strategies in couples
• How “joint” is the joint account? (e.g.,
Burgoyne, 1991, 1997)
• Psychological owner=earner
• Gender imbalance (e.g., personal spending)
The end