Imagine that you're wherever you would normally have lunch. How would you go about deciding what to have?

Would it look something like this?

• Gather all available information about all available lunch options
• Calculate the benefits and costs associated with each option
• Choose the option that maximises your benefits and minimises costs

Or, would you go about it in one of these ways?

• Choose exactly the same as what you had yesterday
• Choose something that seems ‘good enough’
• Choose what your friend or partner suggests

Let’s face it, the type of person in the first list doesn’t really exist - our decisions are almost always swayed by factors or influences from the outside world. This is the core of what behavioural science is used for  - it is the design of systems and processes that speak to the reality of how humans make decisions. 

One interesting example of behavioural economics at work in society, was shared by Owain Service, CEO of CogCo and former Deputy Director of the Prime Minister's Strategy Unit, at our most recent Financial Wellbeing Forum.

In 2017, Service and his team looked at messages sent by HMRC in regards to tax payments - specifically towards those who had outstanding payments. Historically, one standard letter, written in dense and complicated ‘legalese’, was sent to individuals who needed to pay taxes - which had roughly a 33% success rate. With the help of the behavioural insights team, four additional letters were tested among trial groups:

• “Nine out of ten people pay their tax on time. You are in the minority that does not pay their tax on time.”
• “Nine out of ten people in your local area pay their tax on time. You are in the minority...”
• “Nine out of ten people with a debt like yours pay their tax on time. You are in the minority...”
• “Nine out of ten people with a debt like yours, in your area, pay their tax on time. You are in the minority...”

The last letter was most effective - and overall the experiment increased the percentage of recipients who go on to pay their outstanding taxes by 6% (from 33% to 39%) - in context, in the 3 weeks in which this experiment ran, it drove roughly a £3 million increase in tax payments.

The success of these letters comes from introducing a social dimension to the way people pay their taxes, letter one creates a comparison with other tax-payers, letter two introduces the ‘neighbour effect’, letter three creates a sense of community, and so on. Much like the first example of how you choose your lunch each day - by introducing the actions of other people into the decision-making process, individuals are influenced into making certain decisions, whether they’re acutely aware of it or not.

How does behavioural science impact how we manage our money?

‘Mental accounting’ was a term coined by Richard Thaler (Nobel-prize winning economist), to broadly explain the way in which people value money in their minds, based on subjective criteria; according to Thaler’s work - every ‘dollar’ should be valued equally. A couple of examples:

Take an individual who is saving cash in a jar for a dream holiday, but who is also carrying credit card debt; they don’t use the holiday money to pay down their debt, because they have mentally deposited it elsewhere in their budget, and have attached importance to it. This is an example of mental-accounting bias.

Similarly, imagine someone unexpectedly receives a tax refund. They might decide to spend it on non-essential items like a luxury purchase. This behaviour occurs because they mentally label the windfall as ‘extra’ or ‘free’ money, separating it from their regular budget - this is another example of mental-accounting bias.

This concept calls back to the idea that no human makes entirely rational decisions, and demonstrates why it is essential to grasp an understanding of how behavioural science helps us optimise systems and mechanisms to mimic decision-making processes more closely.

Behavioural science can play a significant role in building effective financial wellbeing strategies by understanding and influencing the behavioural factors that impact financial decisions.