The conventional advice for reining in spending and prioritizing
saving starts something like this: Create a budget.
"Having an external tool to constrain your spending can be
valuable," notes Emily Oster, associate professor of economics at
the University of Chicago Booth School of Business. "But the added
restriction can cause you to make mistakes."
The problem: A typical budget's list of checks and balances on a
spreadsheet fails to account for, well, real life. Expenses change,
prices fluctuate, impulse purchases beckon and the budget goes off
the rails. Some studies have even shown that creating a budget
might increase spending.
Ditching the budget and spending with abandon isn't the answer.
In fact, the kind of fiscal restraint that budgeting is supposed to
inspire has been linked with
smarter spending decisions and increased
Instead of skipping out on creating a spending plan, focus on
understanding the five biggest reasons budgets backfire and have a
plan in place to overcome the pitfalls.
1. Budgets are inflexible
You create a budget to limit spending, right? What if the price of
groceries goes up and the price of gas goes down? Is it OK to use
the leftover funds from the gas column to cover the increased cost
Oster believes this scenario is all-too-common in the envelope
system of budgeting, which allocates specific amounts of cash in
each budget category into separate envelopes to cover monthly
"Instead of spending a little more on groceries and a little
less on going to the movies, the envelope system only lets you use
money within a specific category," she explains. "It's too
To make it work:
"Prioritize your expenses and rethink the system every few
months, making adjustments as needed," Oster suggests.
2. Budgets put a focus on price
Need a new laptop? Decide on a budget before going to the store and
you're likely to spend more than you planned, according to a 2012
published in the Journal of Marketing Research.
Researchers discovered that shoppers who set a budget for an
individual item were more apt to choose an item at the top of their
budget instead of a lower-priced item with the same features.
"Setting a budget puts the focus only on the price of an item,"
explains Jeff Larson, assistant professor of marketing at Brigham
Young University and co-author of the study.
To reverse the effect:
Focus on features over price: Instead of setting a budget, decide
on the optimal screen size, hard drive speed and RAM before
shopping for a laptop.
"Comparing items with similar features and making a final
decision based on price helps curb spending," notes Larson.
3. Tracking spending is exhausting
Tracking your spending takes discipline. You might start the month
with the willpower to succeed but constant vigilance to avoid
blowing the budget leads to mental exhaustion.
published in the Journal of Consumer Psychology notes that the more
energy it takes to stick with a budget, the more likely you are to
succumb to a spending spree.
The researchers note, "The capacity for self-control and
intelligent decision making involves a common, limited resource
that uses the body's basic energy supply. When this resource is
depleted, self-control fails and decision making is impaired."
To get it right:
Practice makes perfect. That old adage applies to budgeting. You're
more apt to exercise self-control and avoid unplanned purchases if
you continue committing to your spending plan.
4. Budgets require a best guess
While expenses such as rent, car loans and health insurance
premiums remain stable month-to-month, some costs fluctuate -- and
most consumers struggle to estimate their spending.
Shoppers who tried to calculate the exact price of the items in
their baskets at the supermarket were more apt to overspend on
groceries, according to 2010
published in the Journal of Marketing.
"The shoppers who tried the hardest to track their expenses
ended up losing track, getting frustrated and giving up," explains
Koert van Ittersum PhD, study co-author and assistant professor of
marketing at Georgia Institute of Technology.
To cut down on the guesswork:
Take a long view. Average out those fluctuating costs over a longer
period of time, and pad the average a bit on the high side.
When it comes to estimating the total cost of the items in the
shopping cart or the number of kilowatt hours the electric company
will bill you for this month, most consumers struggle to make an
accurate guess. To accommodate for price fluctuations and variable
expenses, van Ittersum suggests padding the budget to avoid
5. Budgets don't incorporate surprise expenses
Your budget might include a column for emergency expenses alongside
recurring payments like the mortgage and utilities but your monthly
estimates are likely not very accurate.
published in the Journal of Consumer Research, participants were
off target as much as 40 percent with a monthly budget compared
with 3 percent for a yearly budget.
"People feel quite confident about what their expenses are for a
given month and don't think about unexpected expenses, which they
do factor in if they're budgeting for a longer period," says Vicki
Morwitz, professor of business leadership and marketing at New York
University Stern School of Business and co-author of the study.
To soften the blow:
Look with a long lens. Set aside money for an "undefined" emergency
expense. Since it's impossible to predict the cost of car repairs
or factor in one-time expenses such as wedding gifts into a monthly
budget, there is more room for error.
"Take a long-term approach, plan for the unexpected and build
emergency funds into your budget," advises Morwitz.
Your first budget, in 3 easy steps