We tend to underestimate our future spending – here’s a way to avoid it – St George News
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FEATURE (THE CONVERSATION) — When asked to estimate how much money they would spend in the future, people underestimated the total amount by over C$400 per month. However, when asked to think of unexpected expenses in addition to typical expenses, people made much more accurate predictions.
These are the main results of a series of studies and experiments that we have carried out and which have just been published in the Marketing Research Journal.
In our first study, we started by asking 187 members of a Canadian credit union to predict their weekly expenses for the next five weeks. Then, at the end of each week, we asked them how much they had actually spent.
For the first four weeks, people underestimated their weekly expenses by about $100 per week or $400 for the month.
During the fifth and final week of the study, we ran an experiment to see if we could improve the accuracy of people’s predictions.
Specifically, we randomly assigned participants to one of two groups. In the first group, participants estimated their expenses for the following week as they had done in previous weeks. These people have once again dramatically underestimated their expenses.
In group two, participants were asked to think about three reasons why their spending for the next week might be different from normal before making their estimate. This led them to make higher and much more accurate forecasts – just $7 of what they actually spent.
It’s important to note that participants in each group spent roughly the same amount of money that week, on average. The only difference between the two groups was whether they accurately predicted this amount.
Next, we ran nine experiments to better understand why people underestimate their expenses and whether being prompted to think about unusual expenses helps improve accuracy. In total, more than 5,800 people participated in these experiments, including a representative sample of US residents.
These experiments revealed two important insights.
First, people mostly base their spending forecasts on typical expenses like groceries, gas, and rent. They typically don’t account for irregular — though still common — expenses such as car repairs, last-minute concert tickets, or one-time healthcare bills. This is what leads to underestimation.
Second, getting people to think about irregular expenses in addition to typical expenses helps them make more accurate expense forecasts. In our studies, people didn’t take atypical expenses into account unless we asked them to.
why is it important
Helping people improve the accuracy of their spending forecasts could help improve their financial well-being.
Underestimating expenses can be costly. For example, 12 million Americans take out a total of over $7 billion in payday loans every year because they can’t meet their monthly expenses. These loans usually have extremely high interest rates – over 250% in some states.
Payday loans also mature so quickly that about three in four borrowers end up borrowing again to repay the original loan.
If consumers could better anticipate how much money they will spend in the future, it could motivate them to spend less and save more in the present.
In fact, one of our studies shows that our suggested prediction strategy not only increased the expense estimatesit also increased intentions to save.
Members of our research team are currently studying if, when and why underestimating your expenses can be beneficial. For example, if a person sets an optimistic budget and actively tracks their expenses, does this help them reduce their expenses?
We also investigate whether people who work in the gig economy show a corresponding tendency to mispredict their future earnings.
This article is republished from The Conversation under a Creative Commons license. Read the original article here.
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