How to use “emergency reserves”

Let’s say that you want to set yourself a budget. You have a maximum of £1,200 to spend, but you want to make a few savings.

You could set a hard budget of £1,000 and hope to save the whole £200. People who do this might be successful, but if for any reason you exceed your budget, you are likely to trigger the “What the hell” effect and spend much more of your £1,200. And if you set your budget at £1,200, most people end up spending the full amount – making no savings.

If, however, you set yourself a budget of £1,000 but treat the remaining £200 as an “emergency reserve”, those people who, for whatever reason, need to go slightly over their budget end up spending less than either of the two other groups.

Mentally storing that money to use in emergencies creates a feeling of guilt around using it. By giving yourself a little bit of wiggle-room when setting out your goal, you get all the benefits of a challenging target to aim for, but tapping into those extra funds does not trigger the “What the hell” effect that causes you to spiral out of control.

A key factor when setting your emergency reserve limit is that there is enough guilt in using it up. “There has to be a psychological cost to using it,” says Sharif. “Our intuition tells us not to use up our emergency reserves because we might have a greater need for them later. A lot of the time you don’t end up using them at all. People are resistant to use them unless they really have to.”