Is a piggybank the answer to your spending woes?

An old-school budgeting technique, combined with the latest in fintech, could hold the key to controlling your spending and saving more, psychologists suggest.

The “piggybanking” method of budgeting (also known as “envelope”, “pots” or the “jam jar” method) involves having different pots of money for different purposes. You take your monthly income, divide it into different categories, and aim to stick to your limit for each category.

Say you allocate £600 a month to rent or a mortgage, £100 to food shopping, £50 to clothes and £100 to the pub. Whenever you spend money, it needs to come out of the relevant pot; you note how much you have left and stop spending in that category when all the money is gone.

This can be much more effective than just looking at your bank balance from time to time – doing so doesn’t give you a clear picture of your finances, as it doesn’t show when bills and direct debits are due. As a result, many people splurge on payday but struggle later in the month.

Jessica Exton, behavioural scientist at ING, says people tend to mentally pre-allocate money into different spending categories, or “buckets”, before they spend it.

“Although we do know that one pound is essentially the same as any other, that is pound coins are fungible or interchangeable, we tend to view and use the money in each bucket differently. We might feel happier splurging what we’ve set aside in the ‘fun money’ bucket, for example, knowing that the essentials have already been accounted for with other buckets,” she says.

“Mental accounting can be an effective habit as by setting tangible, achievable goals across essential spending categories, we are more likely to stick to them.”

Exton isn’t the only behavioural scientist to recognise how mentally, physically or digitally splitting our cash into spending categories can be beneficial. Elisabeth Costa is senior director at the Behavioural Insights Team, a social purpose company that has worked with the Money Advice Service to help people tackle everyday money challenges.

She says: “Putting money in different ‘pots’ for specific purposes can help people manage their spending because it fits with our natural tendency to allocate money into different ‘mental accounts’ based on what we plan to do with it (eg rent vs a summer holiday fund). Experiments have shown that giving people their pay in different envelopes – one for spending and one for saving – helps people to save more.”

A new wave of digital banks means there’s no need to use physical envelopes or pots anymore – technology can do all the hard work for you.

Millennial-favourite Monzo allows account holders to set up spending categories such as groceries, eating out and entertainment, and allocate a set amount of money per category each month. When you use your Monzo debit card, the app automatically subtracts the amount from the relevant spending category. For example, if you buy something in Sainsbury’s, it will categorise this spending as “groceries” – although you can manually change any transactions incorrectly allocated.

Monzo content manager Beatrice Borbon says: “Giving yourself an overall budget then trying to stick to it can be tricky, because it doesn’t really reflect the way we actually live and what we do with our money. Instead of thinking about your money as one big lump you have to live on until next week or next month, piggybanking lets you break things down a bit. Piggybanking is especially useful if you’re trying to keep your spending under control. It means you can decide how much you want to spend on things like eating out, having fun or going shopping, then stay within the limits you set yourself.”

Other digital banks offer the option to separate money into separate sub-accounts for different expenses.

However, you don’t necessarily need an account with a digital bank to start piggybanking – there are other ways too. A popular way is simply to set up a separate current account for your household bills.

To do this, work out how much both your monthly and annual bills come to. Divide the annual amount by 12 to get a monthly figure. Set up a standing order for this amount from your main current account to your “bills” account for the day after payday.

Next, arrange for all your bills to be paid by direct debit from the new account. Don’t do any further spending from this account – leave it alone.

Rachel Wait, consumer affairs spokesperson at MoneySuperMarket, says opening a separate account can also be an opportunity to make money. She says: “Banks such as NatWest and Royal Bank of Scotland offer 2 per cent cashback on household bills with their Reward account, meaning you could earn up to £83 a year on average in rewards. Santander’s 123 account also allows you to earn up to 3 per cent cashback on some of your household bills. Keep in mind, however, that these accounts charge a monthly fee and also require you to pay in a set amount each month.”

Another option is to use a budgeting app to provide digital envelopes and do the maths for you – although you’ll need to manually log your spending. This might be a good option if you use a variety of cash, cards and accounts for day-to-day spending.

You Need A Budget claims it changes people’s lives and makes the bold claim that new users save an average of $6,000 (£4,600) in their first year, making it worth the $84 (£64) a year cost. Good Budget works in a similar way but is free.