5 Scientific Reasons Why It's Harder To Make Money Decisions When We're Broke (2024)

Have you ever been flat-out broke? Not the kind of quasi-broke when we have to let go of little luxuries like a Boxycharm subscription. We're talking the real deal kind of broke: When there's a negative balance in your bank account, overdraft fees are starting to stack up, and you're making trade-offs on which bill to pay and which ones to let go.

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If you're struggling with planning ahead financially, you're certainly not alone. According to the Financial Health Network's 2021 Pulse Report, 29% of folks in the US are unable to pay all their bills on time, 39% don't have enough short-term savings to cover three months of living expenses, and 25% have more debt than is manageable.

If it's a place you've been — or are currently at — your pesky, inner voice might be saying: What is wrong with me? Why can't I just get it together and make better choices about my money?

The thing is: While we all can be a little better about our financial choices, when we're broke, it's not always that easy to make "right" or "good" decisions about our money. And it's not because we don't know better. It's because when our cash flow is lagging, and we don't have enough to cover our day-to-day living expenses, that constant state of being stressed makes it that much harder to get ahead.

To learn more, we talked to some behavioral economists about five reasons why it's so much harder to make money choices when we're broke, plus three simple things we can do to better our finances:

1. For starters, money decisions are complicated.

This might come as no surprise, but decisions we make about our finances are a complex beast. I mean, really complex, explains Dan Ariely, the James B. Duke Professor of Psychology and Behavioral Economics at Duke University and a founding member of the Center for Advanced Hindsight.

"There are lots of things that are tempting us now, like coffee and donuts," says Ariely. "There are lots of things we have to do, like going into a supermarket and paying rent. And the timeline of those things is very complex. And while companies have designated CFOs who manage the cash, the cash flow of individuals is done mostly without help."

On top of that, modern finance tools — money apps, different payment methods — make it harder to make money decisions. "If you have cash, you have $50 a day, you would know what you can do and what you can't do," says Ariely. But on the other hand, when you're making payments using various apps and accounts, he says your thought process might be more like: "Do I have money for this? Do I have money for that? What will I not be able to do? And that stress actually makes things even harder."

2. Being stressed makes it harder for you to focus and make decisions.

Research points out that when we're operating under "stress brain" we're working with a limited capacity. We might be stressed out from not just money, but from work, family, and a bunch of other obligations and demands pulling at us from many directions. Our thinking slows down, and we aren't able to come up with creative solutions as quickly.

Plus, being stressed to the max can warp our perception of potential outcomes. What this means is that we may overestimate the upside of a decision and downplay the downside. For instance, we might think buying a lottery ticket or putting cash in a risky investment could result in huge gains. And we won't think as carefully about the potential loss. Why? So that we can get a release from stress and feel better. It's our brains' way of trying to protect us.

3. You get into a scarcity mindset, which makes you feel like you never have enough.

When you don't have much financial slack, you might be operating with a “scarcity mindset." That's when you're hyper-aware of where every dollar and cent goes, explains Heidi Johnson, director of behavioral economics at the Financial Health Network. And at the same time, this mindset can make you narrowly focus on how much more money you want or need — which can lead you to make a financial decision that could cost you more in the future.

When you need access to money right away, you deal with a cognitive distortion called present bias, explains Johnson. Present bias is when you favor a smaller reward that's in the present instead of a larger one in the future — for example, having quick access to cash that comes with a fee versus saving and letting it grow in the long term. For instance, you're willing to pay high costs that you wouldn’t normally be OK with for expediting funds in the future.

4. Being broke comes with a hefty price tag.

Besides the stress of struggling with cash flow, decision-making is even more difficult when you have to pay high costs to access financial services. In the Financial Health Network's annual analysis of costs to access financial services, it was found that in 2020, financially vulnerable people spent 13% of their income on fees and interest. In contrast, people who are more financially comfortable spent 1% of their income on fees and interest that year.

Think: taking on late or overdraft fees, taking on high-cost credit, or even *gulp* a payday loan, where the average interest rate is an absurdly high 391%. Payday loans have such high interest that they're often considered a predatory form of financing, and are even banned in some states.

What's more, data from the Financial Health Network shows that low- to moderate-income households make up about 70% of the usage of single-payment credit like overdraft, pawn loans, and payday loans.

"It’s hard to plan ahead for the next month, let alone for a more distant future like retirement, if you’re making challenging trade-offs in your day-to-day financial decisions," says Johnson. "Our research shows that about 35% of people earning less than $30,000 per year are able to plan ahead financially, while that number skyrockets to 88% for people who earn six figures."

5. And while financial education can help a little, it doesn't necessarily solve these problems.

So why not just educate folks on how to be better about their money? If only it were that simple. It turns out that financial literacy only goes so far. "Let's teach people how to deal with money, you say," says Ariely. "But most of the results on financial literacy show that it doesn't really work. Simply teaching people about money has no impact on people's ability to handle money, just because the world is too complex and has too much temptation."

Just like how we know what we're supposed to do foodwise: get plenty of leafy greens, load up on the low-carb snacks, and drink lots of water. But after the end of an exhausting day at work, we might find ourselves in the drive-thru at our favorite greasy burger chain. Temptation and mental fatigue can lead us to make decisions that aren't always the healthiest.

Now that we know more about the challenges of being broke, here are three practical things we can do for our wallets:

1. Tap into digital tools.

If financial literacy doesn't always help when you're tasked with financial decisions and are stressed out from being broke, look toward tools to help you, says Ariely. What tools can you use? You can check out apps like Dave, which can provide a fee-free microloan when your cash flow is low.

Along the same lines, financial platforms like Earnin, Payactiv, and Even can help you get paid a few days early (you'll need to set it up with your employer, though). Plus, some banks like Varo offer people the ability to access their direct deposit paychecks early, which can help bridge timing gaps between income and expenses, points out Johnson. These days, there's a handful of apps that can help you track your bills and subscriptions, and negotiate for lower bills — like Truebill and Trim help you keep tabs on your cash flow.

A few of my favorite apps include Digit, which is AI-powered and will automatically save small amounts when you can afford to, autosave for goals, and pull money back into your checking account if your balance starts running low. Another favorite of mine is Qapital, where I can set up rules to save, plus there's a weekly Sweet Spot, which is essentially a set amount you can spend on your debit card. It's really helped me stay on track.

2. Avoid overdraft fees as much as possible.

Banks make seriously good money from overdraft fees, so it's a good idea to be mindful of them. In 2020 alone, banks charged $12.8 billion in overdraft fees. Research from the Financial Health Network shows that those on the money struggle bus are getting hit the hardest and the most by overdraft fees. In fact, in 2020, 95% of the overdraft fees were assessed to low-income folks and those who weren't financially healthy.

So how can you bump down the number of overdraft fees? Don't opt into overdraft coverage on your debit card, suggests Johnson. "Most overdraft fees are charged for debit card transactions, which can often be for small purchases," she says. Or do a daily bank balance check and see how much is in your account at any given time. It's easy to turn a blind eye, but by being aware of what's in your bank balance, you can take some steps on what you can do to prevent falling in the negative.

Some good news: Cutting overdraft fees was a bit of a trend in 2021, so more banks are lowering them or nixing them entirely. When looking at banks, see which ones don't charge overdraft fees in the first place. You'll also want to see if they charge fees such as a monthly maintenance fee, ATM fees, excess transfers in a given month fees, or if you need to maintain a minimum balance. A bank that doesn't charge any fees is your ultimate financial friend.

3. Try an envelope-based budgeting system to simplify your cash flow.

A classic trick to bridge the gap between receiving a paycheck and having to pay for expenses is to use the good ol' envelope-based system. You can use physical envelopes, or digital envelopes with a service like Mvelopes.

In the envelope system, you set aside money for various expenses when you’re paid. Each envelope is assigned a "category," and you designate a certain amount of cash to use for that spending bucket. Once the cash is spent, that's it. Of course, this might not work best for certain categories, like bills that you have on autopay. So you can tailor your envelopes to fit your needs.

"This leverages mental accounting, a heuristic that we use to mentally classify our income for different uses, and has been shown to help people save more over time," says Johnson. "It can also help reduce the mental effort of managing money, which in turn can help ease the scarcity mindset that prevents people from being able to plan ahead financially."

Do you have a money tip that's helped you when you're low on cash? Share it in the comments!

And for more stories about life and money, check out the rest of our personal finance posts.