How much do you know about the way your friends and family spend their money? Though our behavior can sometimes be influenced by cultural or social-economic status, it is likely that a sample of those you know around you would yield a wide range of attitudes and behaviors towards spending and saving money. Some people just love spending money and buying things while others save and invest. For some, money is sacred, for others, it’s just a number. Have you ever wondered why some of us find it so easy to spend money while others cannot fathom the sight of wasting a dollar?

Let’s take a typical example. Every day you arrive at work with a $3.50 latte. Yes, your office has an espresso machine that you can use for free but you think to yourself “Hey, do I look like a barista? I don’t get paid to make coffee!” Anyway, after a year, you’ve actually spent nearly $1000 on your morning delight but your fellow coffee drinking co-worker Mandy is booking flights to *insert exotic location*. Mandy makes her own coffee, and after a year, she can even make latte art. Now, some people will say, the paid coffee is totally worth it, and they would rather have that over a vacation. Many of us will regret the choice and wish we were holding $1000 in our hands instead.

What’s happening here? Is Mandy more ‘rational’? Well, not exactly. Both you and Mandy made the optimal choice at the time from your perspective. You can both do the calculations but the difference is Mandy placed more value on being able to travel in the future, and less pain on having to make her own coffee in the present. This behavior is known as Temporal Discounting, which is the tendency for us to discount value (either gain or pain) that occurs in the future. However, not everyone applies the same discount over identical periods of time which leads to the difference in choice.

When we are comparing a vacation to coffee, there isn’t much at stake. But where the problem lies is when many seemingly innocuous purchases leads to credit card debt and lack of financial security. Sometimes, credit card debt due to unforeseen situations are out of our control (here’s where an emergency fund will help, but again, saving for the future is hard). At other times, we may deliberately choose debt because the associated pain of paying occurs in the future and is therefore discounted when rationalized. This is just the way we naturally make decisions but those who struggle at comparing future value are more susceptible to falling into a deep financial hole.

So how can behavioral economics and decision making assist in making good spending choices? One way is by altering the way we rationalize our purchases so that we place more emphasis on the future. Here are a few behavioral economics principles and how they can be applied to the coffee situation:

Loss Aversion: People would typically try and avoid loss rather than make gains.

Instead of thinking: I’ll gain $3.5 from avoiding the coffee!

Think: I’ll be losing part of my vacation fund by buying this coffee!

Hedonic Framing: Lumping losses or gains together reduces their effect compared to separate events. In other words, multiple losses lumped together won’t feel as bad as treating them individually.

Instead of thinking everyday: I’ll skip coffee today

Think at the start of the week: I’ll skip coffee this week.

Status Quo Bias/Defaults: Defaults are more preferable and easier to side with, and often we would rather resort to a default choice rather than having to decide.

Instead of: Walking past or directly to the coffee shop every morning

Try to: Take a different route, so you actually need to make a deliberate choice to buy coffee

Certainty Bias: We’re more prone to choose outcomes that are certain even when the expected outcome is greater for the alternate choice. For example, most would choose to take $200 now rather than take a lottery ticket that gives you 25% chance of winning $1000. Similarly, we are certain to get the coffee if we buy it, but getting that vacation if we save is not guaranteed.

Instead of thinking: I might be able to go on a vacation if I don’t buy this coffee.

Think: I certainly won’t be able to afford a vacation if I keep buying this coffee.

Does thinking about the choice using differently help you become more like Mandy? Is the decision to save your coffee money any easier than before? If you think this approach to financial responsibility is interesting, check out Keep, an experiment we are building on to nudge you towards good spending decisions using behavioral economics principles.