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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, under-save 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?
Such confusion results in overspending across what consumers view as isolated purchases that have no budget constraint. 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 – a Halloween costume can easily be classified as clothing.
“People will actually spend less on an exceptional item if they take a moment to consider how their current purchase is similar to other purchases they have made,” Sussman said in an interview.
To be more mindful, track unusual and infrequent purchases as a single category, even if the items don’t seem similar, Sussman said.
“There’s no better reminder that exceptions are common than having all your exceptional expenses from the past few months listed in one place,” she said.
Tracking will improve budgeting for exceptional expenses and reduce splurging, she said.
Other findings from the Journal of Consumer Research:
Consumers often shop to cope with stressful situations, but they shop differently depending on whether the situation lies in the past or the future, according to researchers Soo Kim and Derek Rucker, both of the Kellogg School of Management at Northwestern University. They will increase consumption in a general way after a stressful episode to distract themselves and forget about it.
But if consumers are anticipating a stressful challenge, they’re more purposeful in their buying. They select products specific to a potentially negative situation. A student may buy “smart water” before taking a math test. Someone may splurge on expensive jewelry before attending a high school reunion to guard against the perception they haven’t been successful.