“Make and follow a budget,” is probably the first piece of advice you’ll receive when trying to manage your finances. However, if you’ve ever tried budgeting, you know it is easier said than done. A common experience is that after exerting considerable time and effort developing said budget, you seem to overspend it anyway. You may have ended up wondering, “All my expenses appeared to fit when I created this budget, so why can’t I seem to stick to it?”
Fortunately, research from behavioural science can help explain why our budget predictions and spending behaviors so often seem misaligned and what we can do about it.
The Problem with just “creating a budget”
Let’s start with the actual process of creating a budget. Most people start by listing each regular expense they can think of (e.g., “Groceries are about $200, electricity is $100, $100 for dining out at restaurants, …”) and then add them up.
Unfortunately, this leads to a budget that tends to underestimate our actual expenses because it overlooks the many unanticipated, atypical expenses that occur every month – last month the car needed a new battery, this month a surprise visit from a friend meant a fancy dinner, and next month gas prices will spike. These seemingly one-off expenses aren’t the first thing to come to mind when making a budget and, when they do, it’s easy to say they won’t happen again next month without considering that some other surprise expense will inevitably take their place.
How can this discrepancy between your budget and your spending be reduced? One option is to adjust your budget to account for atypical expenses in an emergency fund. Alternatively, you could attempt to control your spending to better fit your budget. However, psychological barriers can stand in the way of either of these approaches.
Making a realistic budget
Of course, many of us recognize the uncertainty in predictions about next month’s expenses and attempt to pad our budgeting goals accordingly. However, research explains that our adjustments are often inadequate due to overconfidence in our initial estimates – we anchor our budget estimates to them too heavily. So, what can we do to form more realistic budgets?
Two strategies have been shown to be effective. First, pause to think about and write down reasons why your upcoming expenses may be different from the usual. Second, consider making budget estimates for the coming year rather than the coming month. Both strategies have been shown to reduce bias in budgeting estimates.
Stop trusting your willpower
Controlling spending is another way to bring budget and spending into alignment. Unfortunately, we are often overly confident in our own willpower. It’s easy to think you’ll hold strong to cooking at home when creating your budget, but dinner at your favorite restaurant sounds better than spending time cooking after a long day. One reason we’re overconfident in our willpower is that it’s hard to truly imagine how strong your future emotions will feel if you’re not experiencing them currently – the hot-cold gap.
Psychological research shows the best self-control strategies often avoid relying on sheer willpower. Instead, it pays to be proactive – planning to avoid situations where temptations will be present or making it easier to avoid falling to temptation. So, rather than counting on your ability to resist the temptation to dine out after a long day, a more effective strategy would be to make sure you have some easy-to-prepare, microwavable meals available at home for busy days. Another strategy is to plan your indulgences rather than letting them occur on a whim (e.g., every other Friday is take-out night).
Budgets are overly optimistic on purpose
There is one more possibly obvious reason that our spending exceeds our budgets – we often purposely set optimistic spending goals to motivate ourselves to spend less. These spending goals are meant to be ambitious and challenging – reducing monthly dining out expenses from $200 to $100 is a tough goal and most of us would fall short. We shouldn’t let ourselves be discouraged when we fail to meet our budgeting goals though. Research has shown that even though setting an ambitious budget makes it more likely that you’ll miss the mark, having that aspirational target still leads to spending less overall. So even if you don’t always meet your budget, having one to guide your spending is still better than not.
References
Howard, R. C. C., Hardisty, D. J., Sussman, A. B., & Lukas, M. F. (2022). Understanding and Neutralizing the Expense Prediction Bias: The Role of Accessibility, Typicality, and Skewness. Journal of Marketing Research, 59(2), 435–452. https://doi.org/10.1177/00222437211068025
Loewenstein, G. (1996). Out of control: Visceral influences on behavior. Organizational Behavior and Human Decision Processes, 65(3), 272–292.
Lukas, M. F., & Howard, R. C. C. (2023). The Influence of Budgets on Consumer Spending. Journal of Consumer Research, 49(5), 697–720. https://doi.org/10.1093/jcr/ucac024
Rishika, R., Feurer, S., & Haws, K. L. (2022). Really Rewarding Rewards: Strategic Licensing in Long-Term Healthy Food Consumption. Journal of Consumer Research, 49(2), 268–287. https://doi.org/10.1093/jcr/ucab059
Ülkümen, G., Thomas, M., & Morwitz, V. G. (2008). Will I spend more in 12 months or a year? The effect of ease of estimation and confidence on budget estimates. Journal of Consumer Research, 35(2), 245–256.
Williamson, L. Z., & Wilkowski, B. M. (2020). Nipping Temptation in the Bud: Examining Strategic Self-Control in Daily Life. Personality and Social Psychology Bulletin, 46(6), 961–975. https://doi.org/10.1177/0146167219883606
Ian is an associate at BEworks, a behavioral science consulting firm, where he develops strategies for improving people's financial, physical, and social well-being. He holds a PhD in social psychology from Ohio State University and has published research in top academic journals on interpersonal decision-making and emotion.
