Budgeting — tracking expenses and planning how much to spend in specific categories — is often heralded as invaluable. It’s considered a basic of financial literacy by many and countless financial apps use it in one way or another. But how valuable is it, really?
To test whether budgeting actually helps people reach financial goals, we partnered with a large fintech to run an experiment. We randomized over 9,000 people into three conditions: one control group; one group that set a single budget for the week; and one that set an overall budget as well as sub-categories.
We then tracked how budgeting affected spending.
The results? People in the two experimental groups looked at their budgets more. However, did that help them stick to said budgets? In a word, no.
We found no statistically significant difference in spending across conditions.
In addition, budgeters were overly optimistic. They made budgets 25% lower than their regular spending, then continued spending exactly as they had.
This begs the question: If budgeting doesn’t help, what does? What can banks, credit unions, and others do to help people save money and meet financial goals?
Solutions based on behavioral science.
Our experiment clearly demonstrates that while budgeting is touted as critical to financial health, it doesn’t change spending habits. We recommend that banks and credit unions test other approaches and base innovative approaches on these. Here are some examples of tactical success based on our experience at Common Cents Lab.
1. Create Short-Term Savings Opportunities Using Defaults
We already know retirement savings increase through defaults — when people are auto-enrolled in a savings plan through their company, contributions skyrocket.
Financial institutions can help gig workers and others do the same. Automatic deposits is a behavioral approach that can and should be replicated to increase short-term savings as well as long-term retirement.
- Self-Help Credit Union‘s retirement savings account automatically deducts money from new members’ paychecks. It’s a “transparent default” — it opts people in automatically but immediately presents the option to change their deposit. The same can be done with short-term savings.
- The Latino Community Credit Union built a savings product attached to a loan product. Members only submit payment once, but simultaneously pay down debt and build a safety net. By coupling these actions, the credit union decreases complexity and increases their members’ financial wellbeing. And by the end of a loan, members save on average over $1,000.
2. Have People Pre-Commit To Healthy Financial Behaviors
We conducted a study with fintech startup Digit on helping people save money from their tax refunds. Users were asked how much of their refund they wanted to save before they received it. We found that this increased their savings 58%, versus those consumers who were asked the same question when they received the refund.
As human beings, we’re biased to the present and generally lack self-control. Once money hits our account, we think about how to spend it. By pre-committing to saving future money, we avoid temptation.
Digit’s low-cost text intervention helped thousands of people save more of their refund, totaling over $1 million in savings. Moreover, three months after the intervention, approximately 85% of savings were still in the savings accounts.
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3. Have People Align Their Paychecks with Bills
Research shows that financial shortfalls resulting in payday loans and checking overdrafts are more common when the timing of someone’s income and bills is mismatched. Prompting people to line up their paydays with bills can work wonders, and financial institutions can be instrumental here.
We worked with Beneficial State Bank on process changes to make it easier for people to make auto-loan payments in smaller amounts, timed with when they got paid. This included:
- Allowing changes to the loan due date before the first loan payment.
- Encouraging users to change their loan due date to align with income at onboarding.
- Text message payment reminders.
- Pre-populating known data on the automatic payment forms sent by email.
- An experiment with automatic payment forms sent via SMS during the welcome call that matched loan repayment timing with income.
The result: Our experimental group paid sooner, on average 1.4 days before the due date, compared to 2.75 days after the due date in the control group. By the study’s end, the experimental group had paid 100% of their loan payments while the control group had only paid an average of 94.2% of their total loan payment.
4. Design And Test Rules Of Thumb To Help People Make Smart Financial Choices
Rules of thumb are heuristics that help people make decisions (i.e., “Never eat after 8 P.M.” or “Don’t wear white after Labor Day.”).
They’re also helpful in financial management. One study showed that teaching rules of thumb to small business owners improved their accounting, bookkeeping, and even revenue relative to a standard accounting course. However, existing research doesn’t provide guidance on how to design financial decision-making rules for optimal adoption and impact.
We tested which rule of thumb might be most effective in budgeting. We chose dining out for our experiment, since it’s frequent and consistent. In addition, our qualitative interviews and auditing of financial education courses suggested that eating out was a category people felt they should cut down on.
We surveyed over 1,300 people and tested several variations of rules of thumb:
- “Only spend a maximum of $ each time you eat out.”
- “Only spend $ per week eating out.”
- “Never eat out.”
- “Only eat out [two] times per week.”
- “Only eat out on the weekends.”
We found that the number of times per week rule (e.g. “I’ll only eat out only once this week”) generally outperformed the others in terms of:
- How confident people felt that they’d follow it.
- The amount of money people felt they’d save if they followed it.
- Whether they’d recommend it to others.
Based on this initial research, we suggest testing the impact of products that both provide and help monitor simplified but effective rule of thumb-based spending decisions.
Behavioral science shows that when it comes to money, small changes can have a big effect. And when users see their savings account grow, their rates of default plummet, and their financial goals being met, you can bet they’ll be loyal to the bank or credit union that helped them get there.
Financial tools like these are both a competitive advantage and a way to make your institution sticky. The more that banks and credit union help members make these smart changes, the more they — and the people they serve— will be richly rewarded.
The Common Cents Lab is a financial and behavioral-science based research program out of Duke University associated with the Center for Advanced Hindsight.