Consumers are typically quite good at estimating the normal expenses in life, such as groceries and utilities. But they’re so bad at estimating unexpected costs that crop up that they regularly overspend, undersave and blow their household budgets.
That’s the conclusion of recent research in the field of consumer behavior, which tries to explain why we make the sometimes illogical spending choices we do.
In one study, the authors, Abigail Sussman of Princeton University and Adam Alter of New York University, ask you to imagine that one of your favorite bands is performing nearby. The ticket costs more than you would ordinarily spend, but you have never seen this band live and decide the experience is worth the cost.
The next week, your television breaks and you buy a pricey replacement because you only buy a new TV once every few years. A week later, you are celebrating your 10th wedding anniversary. Since this is a once-in-a-lifetime event, you decide that the occasion warrants a splurge.
“In each instance, it seems reasonable to make a budgeting exception given the special nature of the spending and the low likelihood that a similar situation will recur any time soon,” says the study in the Journal of Consumer Research.
“Independently, each of the events described puts a temporary dent in a budget; together, they can have substantial consequences for long-term financial planning.”
The study touches on a recurring theme in consumer behavior: mental accounting, which refers to the mental buckets we have for money depending on what we intend to buy with it. Grouping expenses into mental accounts, sometimes illogically, has been shown to influence spending.
In this case, consumers have too narrow a definition of an exceptional expense because they have trouble categorizing it. For example, how should you categorize buying a new suit for a family wedding? Is it part of regular clothing expenses, part of a special occasion budget category or is it so unusual it is an exceptional expense that has no bearing on an ongoing budget?
The study suggests that consumers might overspend by about 20 percent when they view a purchase as an exception rather than part of normal spending.
The solution?
Recognize that most exceptional expenses aren’t all that exceptional. To be more mindful, track unusual and infrequent purchases as a single category, even if the items don’t seem similar, Sussman said.
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