What might surprise is that when making decisions, the mind works like a suitcase. The limits of the mind are not size and weight but mental energy, or cognitive resource, as academics call it. This can influence decisions about personal finances, particularly in pressured situations.
However, there are several techniques that might help.
We may not always think of making decisions as being mentally tiring, but this use of mental energy becomes more apparent in certain situations, such as when there are too many options to choose from and when many decisions are required in a row or there is time pressure. Importantly, the pressure is also increased when subject to tight constraints, such as having to stick within a budget.
The budget and the small suitcase
A tight budget is similar to trying to pack a small suitcase with too many items. When the suitcase (or budget) is small, and there is a lot to pack (or we have many bills and expenses to cover), making decisions about what to “pack” becomes difficult. Choosing between buying all the essentials on the grocery list or paying the heating bill is a difficult decision indeed.
Conversely, the larger the suitcase or the less stuff we need to bring, the easier it is to pack. And the larger the budget or the less we need to pay for, the easier it is to cover all our expenses.
As explained by economics and psychology professors Sendhil Mullainathan and Eldar Shafir in previous research, being subject to scarcity forces us to make complex decisions to juggle everything to fit within these constraints. The pair – co-authors of upcoming book Scarcity: Why having too little means so much – show that the tighter the constraints, the more trade-offs have to be made. This idea is very important for understanding some of the difficulty of moving out of poverty, because people with a limited budget are particularly vulnerable to decision fatigue.
I’m tired, so I’ll go with the easy option
In general, it is a good idea to conserve cognitive energy. So when we encounter this decision fatigue and are mentally tired, we tend to opt for the simplest choice – but the simplest choice is not necessarily the best.
This is the case for retirement fund options, finds research, as well as situations that range from buying junk food and splurging on clothes through to life changing choices, writes science journalist John Tierney in the New York Times.
The simplest choice sometimes means acting impulsively and favouring a small return now over a larger return in the future, picking the default option, or even making no decision at all. In other words, having the stresses and strains of needing to juggle many expenses on a fixed budget may actually prevent us from making decisions that are in our own best interest. This, in turn, could worsen our financial position even further which could trigger a downward spiral of tight budgets and sub-optimal financial outcomes.
Improving your “financial suitcase”
What might be done to ensure effective decision-making even when confronted with challenging circumstances such as those described above?
If you recognise that you are being asked to make many decisions one after the other, and you have the opportunity to take a break, take it! Give yourself some time to recharge and revisit the options later.
Many contracts have a cooling off period of several days. If you’ve felt overwhelmed by choice or pressured by the clock, schedule into your diary a time within that period to review your decision with a fresh stock of mental energy (although it is possible that an attachment to the original decision, known as the endowment effect, might influence your likelihood of changing your decision).
For some, income really just does not cover essential outgoings; the metaphorical suitcase is too small for everything needed. In these cases, it may be beneficial to ask a friend or family member who is somewhat more removed from the stresses of constantly juggling finances for a second opinion when making important decisions.
For others, it may be beneficial to try to make “packing the suitcase” easier by cutting down on extravagant or unnecessary outgoings to help increase the ratio of income to expenses. While this might require some restraint in the short term, it may help to reduce the need to make difficult tradeoffs and improve your decision making, reaping future financial benefits.