How understanding cognitive dissonance theory can help us manage our finances better

Nick Daws takes a trip down memory lane to share the valuable lessons he learned from his Psychology degree. Find out how he uses cognitive dissonance to manage finances effectively and bring a fresh perspective to handling your money.

Here’s something you probably won’t know about me. Back in the 1970s I studied for a psychology degree at Leicester University. 

A lot of what I learned in those days I’ve forgotten, and much is probably out of date now anyway.

One thing that made a big impression on me, however, is cognitive dissonance theory. So today I thought I’d discuss what this is and how you can use it to help manage your relationship with money better.

What is cognitive dissonance?

Developed by psychologist Leon Festinger in 1957, cognitive dissonance theory explores the discomfort we experience when we simultaneously hold conflicting beliefs or attitudes. 

By understanding this, we can gain insights into our financial behaviour, helping us make more informed decisions and achieve better financial outcomes.

Cognitive dissonance occurs when there is an inconsistency between our beliefs and actions. In the context of personal finance, this dissonance often arises when our spending habits conflict with our financial goals or values. 

As an example, consider someone who regards themselves as frugal but nonetheless continues to buy expensive lattes every day. This inconsistency creates dissonance, an internal conflict that makes us feel uncomfortable. To resolve this, the person might:

1. look for cheaper coffee alternatives

2. reduce their latte purchases

3. convince themselves the lattes are a deserved treat and won’t harm their savings goals (self-justification)

As you can see, dissonance creates discomfort which we may seek to resolve in various ways. Ideally these ways will align with our long-term goals, but as you can see from option (3) above, that might not always be the case. I will talk more about this shortly. 

Applying cognitive dissonance theory to finances

Here are some practical steps you can take to apply cognitive dissonance theory to improve your financial situation.

1. Identify discrepancies

Recognizing cognitive dissonance in financial matters begins with self-awareness. Take the time to identify inconsistencies between your financial goals and your day-to-day spending habits.

Ask yourself questions such as “Does my spending align with my long-term financial goals?” or “Am I making impulsive purchases that conflict with my commitment to saving?”

2. Set clear financial goals

Clearly defined financial goals act as a compass, guiding your decisions and reducing cognitive dissonance. Establish both short- and long-term objectives, whether they involve saving for a holiday, paying off debt, or building an emergency fund. Regularly revisit and reassess your goals to ensure they align with your evolving financial situation and aspirations.

3. Track your spending

Monitor your outgoings to pinpoint areas where your actions deviate from your goals. Seeing the gap in black and white can be a powerful motivator for change.

4. Make small, achievable changes

Trying to overhaul your finances overnight is unrealistic. Start with baby steps, like setting aside a fixed amount of savings each week or finding cheaper alternatives. Incremental progress is key.

5. Reward yourself for positive behaviours

Celebrate milestones, no matter how small. This reinforces the positive association with responsible financial choices. 

But be sure the rewards you allow yourself don’t create dissonance themselves. So as a reward for building your savings or cutting your spending, do something you enjoy that’s inexpensive or (preferably) free. Examples might include going for a walk, run or bike ride, playing your favourite music, or visiting a local free attraction.

6. Create consistent habits

Establishing consistent financial habits helps bridge the gap between your intentions and actions. This may involve creating budgets, automating savings, or adopting mindful spending practices.

Consistency in financial habits reduces cognitive dissonance by aligning your behaviour with your financial objectives.

7. Beware of self-justification

As mentioned earlier, there are various ways of responding to cognitive dissonance and some are more constructive (i.e. better aligned with your long-term goals) than others. 

One common way of addressing dissonance is by self-justification. This may be expressed in various ways, e.g. “I deserve a treat” or “I need it for my mental health” or “If I don’t do (=buy) this, my partner/children won’t love me”.

If you find yourself thinking along these lines, it’s important to be honest with yourself. Is this really a good reason or are you simply justifying your decision? Either way, ask yourself if there is a better way to address the dissonance that is more aligned with your long-term financial goals.

8. Challenge and change

Embrace cognitive dissonance as an opportunity for growth. Instead of trying to avoid discomfort in financial matters, use what you are feeling as a spur to reassess your financial decisions.

If you identify conflicting behaviours within yourself that are causing you discomfort (dissonance), challenge yourself to understand what is going on and make positive changes to resolve them.

This might involve finding alternatives to expensive habits, renegotiating bills, identifying potential savings or seeking additional income streams. These are all subjects regularly covered in Mouthy Money, of course!

9. Seek professional advice and guidance

Financial advisors can play a valuable role in helping individuals navigate cognitive dissonance. Very importantly, by providing a detached, objective perspective, they can help you align your financial behaviours with your goals and values.

Closing Thoughts

Harnessing the power of cognitive dissonance theory can be a transformative step towards achieving financial wellness. 

By understanding the conflicts between your financial goals and real-life behaviour, you empower yourself to make more rational decisions and changes that align with your long-term goals. 

Through self-reflection, setting yourself clear goals, resisting self-justification and cultivating positive financial habits, you can minimize cognitive dissonance in your financial life and pave the way to a more secure and prosperous future.

As always, if you have any comments or questions about this article, please do leave them below.

Nick Daws writes for Pounds and Sense, a UK personal finance blog aimed especially (though not exclusively) at over-fifties.