As days grow shorter and holidays approach, the expenses of the coming months weigh on the minds of many. Tickets to buy to visit loved ones, gift shopping and hosting expenses loom, even as sales, such as Black Friday, approach.
So, how do you best take advantage of sales without overspending? And why is it so hard to budget accurately?
“People have two general tendencies that can get in the way of accurate financial planning. They are underpredicting future spending and overpredicting future income,” said Ray Charles “Chuck” Howard, associate professor of business administration at the University of Virginia’s Darden School of Business.
In a 2021 study, Howard and co-authors researched the financial phenomenon, which they call “expense prediction bias.” He said the reason we underestimate upcoming spending is a quirk of cognitive psychology.
We base our judgments on the information that most easily comes to mind. So, when it comes to budgeting, we’re thinking about rent and gas but not always factoring in days we get sick or unexpected car repairs.
Darden School of Business professor Ray Charles Howard studies financial decision-making. (Photo by Emily Faith Morgan, University Communications)
“It’s why we make these optimistic expectations,” Howard said. “So, when we help people account for that missing information, all of a sudden, their judgments improve markedly.”
To avoid underpredicting future expenses, Howard encourages people to think of a few atypical or unexpected expenses and factor them in. And, to help accurately predict future earnings, he encourages people to base their expectations on average past earnings.
When it comes to the holiday season, he recommends setting a firm budget and trying your best to stick to it. If you are buying presents, for example, identify the people you need to buy gifts for and set a fixed amount per person you want to spend.
Throughout the year, budgeting is a powerful tool that can help reduce expenses. His research has found that even when people don’t stick to their budget, consciously thinking about spending will help them save money.
“If someone typically spends $500 a week and wants to save for a trip, they can set a $300-a-week budget,” he said. “They will likely overspend and, say, spend $400 instead, but that is still less than they would have spent otherwise.”
