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What Behavioural Science Says About Budgeting

New year, new me, new money? Or at least more money. Or just a better grip on your money. Yes, let’s go with that. A better grip on your money. One of the most popular New Year’s goals is to figure out your personal finances. Find out where the money is going, and how to make it go longer. This is also known as budgeting. Knowing what comes in and out, and plan accordingly. Maybe even with some to spare! But when it comes to budgeting, there’s still a lot to learn.


How do you start to budget? You can do it manually or via an app. There’s lots of apps available with many additional features to help you do this, but the reality of budgeting is that it’s rather basic: you need to know what comes in, and what goes out. Income should be pretty basic: wage, government support, subsidies, investment returns etc. (don’t forget to work with netto numbers). Outgoings will likely be a lot more, and in different categories (e.g. groceries, eating out, clothes, insurance, travel, you name it). When it comes to most budgeting apps, they have a default of analysing your expenses per category (if they have this feature at all). They’ll tell you how much you spent on clothes. Some apps will let you set a goal: reducing clothes expenditure by 10% or $50 per month. And in some of those apps (even rarer) you might be able to cap this number, not allowing monthly clothes expenditure to cross the $100 mark. This has become the default for a lot of financial tracker apps. So should you be tracking your expenses that way as well? According to behavioural science, probably not.


When it comes to actually changing your spending behaviour, you first have to figure out what’s going on. So track your spending before you change it. Fair enough. But after that stage, does it matter whether the expenses are predominantly in the clothing or eating category? Not really. Sure, if you’ve just realised that you spent half your wages on getting take away food, you can do the basic mental arithmetic of figuring out that that’s not ideal. However, you’d be one hell of an outlier; most people won’t find this in their finances. What they will find is that they continue to exceed their initial budget, because they hadn’t planned for all expenses. People are quite good at figuring out their ordinary expenses (rent, insurance, groceries to some extent), but suck at properly estimating and accounting for exceptional expenses. And those exceptional expenses might occur more frequently than their name suggests. Research by Sussman and Alter (2012) found that while people are fairly adept at budgeting and predicting how much they will spend on ordinary items, they both underestimate their spending on exceptional purchases overall and overspend on each individual purchase. It doesn’t help here either that they found that many of the exceptional expenditures are some of the largest expenses (e.g., electronics, celebrations). So what happens here? Sussman and Alter explain that people fail to properly account for exceptional expenditures as the definition they use for exceptional may be too narrow: construing each as a unique occurrence and consequently overspending across a series of discretely exceptional expenses. This finding is not unique to the finance literature either. In a podcast interview Abby Sussman explains how she initially came across this form of “exceptional underestimation” from the health literature, more specifically the behaviour change diet literature, in which people actively engaged in the process of losing weight through calorie counting, would count the calories of their regular meals, but wouldn’t count the calories of their cheat meal if they had fallen “off the wagon”, because that wasn’t part of their “regular diet”. If we extend this finding to the personal finance literature it is easy to see how people forget to budget for their “cheat meals”, or in this case: the splurge on that new pair of shoes (because you deserve it), or upgrading your PC to have the newest specs (because you need it). Or much less fun: repairing the bloody washing machine, again… (although I feel that if your washing machine breaks, say, about every other month, this expense should almost become ordinary). It’s easy to see that people also don’t budget for infrequent trips or birthday celebrations. The latter may come around every year, but not every month. And that seems to be the kicker.


So what can you do to budget properly? Sussman and Alter propose a strategy which reminded participants of the frequency of an exceptional expenses. Specifically, they examined whether participants would spend less on birthday presents when reminded of how often this kind of purchase occurs (more frequently than not if you have a large (chosen) family or friend group). To test this, they assigned participants to one of three conditions: the present debiasing condition, the birthday control condition, or the spending control condition. In the present debiasing condition, participants were asked to list the times last year when they gave people presents. This prime was intended to subtly remind participants that any one birthday present is part of a larger class of goods (i.e., “presents”) and that they do make purchases from this larger category with some frequency. In the birthday control condition, participants were asked to think of which month most people they know had birthdays, and to list the names of the people you know who have birthdays in that month. This condition was intended to encourage participants to think about the same topic (i.e., birthdays) as in the experimental debiasing condition, but without considering spending on presents specifically. Finally, the spending control condition instructed participants to list the times last year when they bought tickets for travel. After responding to this listing task, participants were given a distraction task before moving to the decision about purchasing a watch for a friend’s birthday. They were asked to select a watch from six different sports watches, presented in a random order, varying in price from $15 to $75, and quality, as indicated by a short product description (fewer than 10 words). So what did they find? Well, you may have expected this, but there was no difference in willingness to spend across the two control conditions, but participants’ birthday present choice was significantly less expensive after the subtle reminder that the specific birthday present is part of a larger group of presents that they purchase with some frequency than in either of the control conditions.


Can you work with this yourself? Yes, you can! Work by Huebner, Fleisch and Ilic (2020) found that the inclusion of both ordinary and exceptional expenditures in a feedback report on credit card spending was the only means of intervention that actually reduced credit card spending. The intervention was run on an app as well, providing the consumer with an overview of their total expenses, total ordinary expenses, total exceptional expenses, and feedback on their expenses as compared to the goal the consumer set themselves (otherwise there very likely wouldn’t be any behavioural change), per week. What we see here is that people need a clear overview, feedback on their goal attainment and preferably, a rather short horizon (weekly rather than monthly), to be able to understand their own behaviour, and to adjust it in such a way that they can still meet their long(er)-term goals (e.g. monthly, annually). This finding that weekly updates and adjustments help people manage their budgets better has also been replicated by Pocheptsova Ghosh & Huang (2020). Out of six different interventions to make people stay in budget, the most effective ones were to take a shorter time horizon (weekly instead of monthly) and adjust the budget with the previous week in mind. It also helped if people gave themselves a bit of wiggle room (e.g. instead of saying “this week I’ll spend $200 and no more”, to be a bit more liberal and work with ranges: “this week I’ll spend between $180 - $220”. However, it has to be mentioned that if you’re on a super stringent budget, the latter method won’t work, because if $200 is all you have, it’s all you have.


So budgeting needn’t be that hard, if you can sit yourself down and figure out, on a weekly basis, what comes in and what goes out. And that you make sure that in the latter category you account for everything: is there a birthday coming up? Has any of your household appliances been acting up lately? Do you have a rainy day fund – if not, maybe time to budget for that too? It doesn’t help that a lot of the current budgeting tools don’t get a lot right when it comes to implementing behavioural science. But that’s a topic for next week – when we discuss how to design the perfect personal finance management (PFM) tool, according to behavioural science!


Behavioural Science

Personal Finance



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