9/24/2013 5:45 PM ET|
5 reasons budgets fail -- and how to fix them
Few orders can sound as ominous as 'stick to your budget.' But it's not that difficult to stay on the budget bandwagon.
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 happiness.
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:
No. 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 of food?
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 costs.
"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 rigid."
To make it work: Be flexible.
"Prioritize your expenses and rethink the system every few months, making adjustments as needed," Oster suggests.
No. 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 study 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.
No. 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.
Research published in the Journal of Consumer Psychology (.pdf file) 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.
No. 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 research 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 financial distress.
No. 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.
In a study published in the Journal of Consumer Research (.pdf file), participants were off target as much as 40% with a monthly budget compared with 3% 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.
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Remember something, When someone tells you how much you will need to retire, DOUBLE IT.
When My Wife and I got married back in 1971 we went shopping and we bought everything that we needed to start, Coffee, Sugar, Milk, Juice, Flour, You Name it we had to Buy it. We filled TWO BUGGIES and it cost us$119.00 for BOTH. Today $119.00 won't fill one Shopping Bag. Houses were about $30,000. to $40,000. to day that same House would Sell about $250,000.
It all depends on your Age. Be careful.
If someone tells you that you need about$500,000, you better have Twice as much if not more.
The Government tells us that they have the Cost of Living under control. NO THEY DON'T>
Besides a fixed amount of savings, I include a sort of slush fund for those unexpected minor things.
And if its a surprise major expense - like when a hit-a-run person totaled my parked car last New Year's Eve and resulted in my buying a new car sooner than expected - there's no "budget" that accounts for that: that comes under building up your savings and/or credit through the years to handle emergencies.
My budget includes initially saving a certain amount each year and half of that goes into "permanent" savings. The other half is what I have to use for hobbies, overseas travel, and similar stuff. If I overshoot my spending plans, the half for hobbies and travel is what suffers. That makes me motivate myself to stick to my budget as closely as possible.
I also divide my variable spending into categories that are necessities or luxuries so that if I need to cut back, I can see how much is going into luxuries. For example, food is divided into groceries, snacks, beverages. I take the time to go through my receipts and sort it into the three categories. Restaurant expenses are a separate item.
When I retired in 2006, I estimated how much my annual initial saving would be this year and am pretty close. So budgets can be built with flexibility.
Too bad Congress hasn't practiced this in the past and now. They feel they can give themselves raises and benefits even though they are servants to the American people. They are actually paying themselves for doing nothing. We need to get rid of lobbyists, Congress and the IRS and then our country will be in a lot better shape than it is now. They are the do nothing groups but spend our hard earned tax dollars frivolously.
For some people, being rigid with their budget is the only way they're going to get out of debt. I was taught to be good with money from my parents, so I have enough of a cushion that if i'm shopping for a laptop, I buy what I want, but I shop around for the best price. People in a lot of debt have to buy only what they absolutely need. Their challenge is determining the difference between a want and a need, so they need a rigid system. They may want a Mac because of the look, feel & performance, but if all you do is homework and use the internet, then you dont need to spend that much.
I highly suggest the course, it's already gotten me out from under $20,000 of credit card debt, and now it's working on my student loans.
" #3: Tracking spending is exhausting."
Oh please ! Excuses, excuses, excuses. If tracking your spending is so painfully exhausting, I think that's a sign that you're spending WAY TOO MUCH.
Never buy Met Life group disability insurance policy. They will not pay legitimate claims. Claims will be denied, appeals will be denied. Only a long drawn out law suit will get Met Life to pay and then you will owe 1/3 of the benefit you paid for and Met Life rightly owed you to a lawyer. Met Life does not care about you if you are sick and disabled. They don't care if you go bankrupt and homeless. They will not pay. Snoopy does not care! Met Life sucks!
Are you one of 'those' who believe that if you were a millionaire you'd do much differently?
Thought I was too until I realized I probably wouldn't. Do you decide to keep and make a
budget only when you want something new that's physical/tangible, say a vacation,
television or wardrobe change? If so, reconsider yourself from a CHANGED attitude.
A while back "owning" one's job became a favorite Vogue attitude; that is, we didn't just
have a job which we performed quite well but rather we behaved as though we were the
proprietors of the shop having absolute control over all events which issued from the job,
or, we 'owned' the job; we became pro-active where previously we'd been BUT competent.
Draft a budget because you want to control cash-flow of your funds as the only tangible
reward sought which won't include obtaining a new something (larger tv?) but rather to
build a reserve savings account, open a business, increase continuing educational
tuition funds or open your son's first 529 fund. Adults shouldn't toy with money -- ever.
Adults from backgrounds less than modest should maintain their lower-class habits if
they hope to retain even partial earnings. Unfortunately, once we start working and
claiming income, we rise to the occasion spending every cent we get plus go into
debt to acquire even higher 'class'. Make a budget to know you've matured and can
stay on a budget, to know where your money goes and doesn't go, to advance in the
future when only cold cash secures desired objective. OWN your budget, revise it
again and again. Stay 'in-class' or down-grade to achieve future goals. Prediction:
unexpected expenses surface sooner than we'll admit, bad times come callin'
far too often, and inflation, bond-voting or national legislation issues (mandatory
health care coverage) or global supply chain economics (higher rents or mortgages
due because internationals bought America's peak housing bargains with their
reserved cold, hard cash advantages) reduce our resources. Budget records don't
lie, but memory wanes vague becomes unreliable over time and recalled reality
blurs. Make an adult budget and adhere to it. When it cries "'no" behave correctly
-- stop spending; when it yells '"watch out" pull-back; when it's caught with its
pants down (without provision for event) don't panic and borrow to stay afloat; but
rather, withdraw funds from reserved resources or take advantage of no-interest
short-term loan terms (you've earned but ignored) to bridge the unexpected.
Control and manage effortlessly to ascend.
We have always been a one income family ( we have two kids). My husband is a regular joe working for the phone company, and in all the years of raising kids, we've never sat down and budgeted. We knew what our expenses were, paid them, and the leftovers went into the bank. We drove quality used cars, rarely went out to eat but when we did, it was a real treat. We got creative with entertainment to keep the cost down, consumed very little alcohol (very expensive in Canada), and the popular name brand clothes and gadgets didn't exist in our house. We comparison shopped for everything, and never bought anything we didn't need. We went on a vacation once every two years that we as a family saved up for and during the summer holiday, we were tourists of our own city. So, basically, we learned to stretch the dollar and in the meanwhile educated our kids to do the same.
Today we are very close to retirement and our retired life is secure. We've made good investments with the money we saved (on one income remember?), and we are better off than most of our friends with 2 incomes.
Now, I didn't say all this to toot my horn, but to say that no matter what your income, it's all about seeing the bigger picture from the beginning and "making the sacrifices" needed to get there. Screw the budgets, just know what your expenses are and you buy only what you truly need. You may have to get creative to make life enjoyable. It takes work, but lazy people will never get ahead.
I don't think budgeting is a hard and fast rule. What works for one may not work for another. I also believe in what my family calls the "money gene." You either got it or you don't. I got it, my sister doesn't... although after some major money problems, she is finally realizing the error of her ways (credit cards) and has become quite frugal. Every time we go shopping or even talk about shopping, her standard response is, "I've got a coupon for that!" I'm getting her a T-shirt with that on it for Christmas!
Bottom line for me is that you have to play with different techniques to fit your style. And some people are just a lost cause when it comes to money. Seems like common sense to me, but I realize that it's not that easy for everyone, regardless of how much money they make.
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