What We Think of When We Make Financial Decisions

Financial decisions form the basis for most consumer choices because they have consequences for well-being and downstream purchases. Yet scholars may ignore important features of the financial decision-making process, according to a review of the consumer psychology literature of the last decade conducted by Bocconi's Adam Eric Greenberg and UCLA's Hal Hershfield.

In a thorough, but enjoyable review of the consumer psychology literature mainly focused on ways to promote savings and household debt reduction, the scholars show that less-than-rational decisions often turn out to be more effective than seemingly rational ones in helping consumers attain their financial goals. In the case in which consumers have multiple debt accounts (as is often the reality of credit card debt holders in the US), for example, starting to repay debts with the highest interest rates typically represents the rational choice. It turns out, however, that motivation is important, and that consumers who repay smaller debts first get out of debt faster: the sense of self-efficacy that comes from the disappearance of a debt account tends to keep consumers on the right track.

This strategy of focusing on smaller chunks rather than larger goals also works well in promoting savings. Those that reframe large saving goals as smaller ones (e.g., weekly goals) attain their longer-term goals more frequently.

Another hot topic in the last decade has been financial literacy. «There is strong evidence that financial literacy is connected to well-being», says Prof. Greenberg, «but the results of experiments promoting financial education are mixed. It appears that information aimed at improving financial literacy is most useful at the time of the relevant financial decisions. We may want to encourage just-in-time interventions in lieu of more general literacy campaigns».

In reviewing the literature, the two scholars single out at least two widespread research gaps. First, Prof. Greenberg says, «not all types of savings are the same. The way a consumer considers saving money for a new TV set is likely to be different from the process that leads to accumulating retirement savings». However, the literature to date fails to emphasize these nuances.

Second, and perhaps even more important, we are largely in the dark about some of the most important financial decisions of people's lives, such as buying a house or choosing a college. «These are complex decisions», Prof. Greenberg concludes, which are «difficult to test in an experimental setting. Unfortunately, consumer researchers have devoted limited attention to these crucial financial decisions thus far».

Adam Eric Greenberg, Hal E. Hershfield. Financial Decision Making, Consumer Psychology Review, 2 (1), 17-29, 2019. DOI: 10.1002/arcp.1043.