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The Psychology of Budgeting

I confess, I am an optimist.

Not a wide eyed and naïve one, rather I am a cautious optimist who tries to plan ahead for things. Sadly, my optimism does someone lead me to underestimate things.

A recent study from the University of Southern California called “Will I Spend More in 12 Months or a Year? The Effect of Ease of Estimation and Confidence on Budget Estimates.” suggests I am not alone in letting optimism lead me to underestimate things, at least in the short term. The research indicated that consumers had a tendency to be over-confident when making estimates for short-term budgets. However, when making long-term budgets, consumers tended to be much more cautious in their estimates, as they acknowledge the greater potential for unexpected surprises.

The study does concede that monthly budgets function quite well for relatively predictable monthly bills, but when it comes to estimating more open-ended costs, our optimism can be our enemy.

Lead researcher Gülden Ülküman says, ‘When budgeting, it seems to be wiser to assume that one’s knowledge is unreliable.’ What are the applications of this? Well, as a starting point, you might see budgeting software asking you questions to make you question your assumptions and feel less confident about the estimates you make when compiling a budget. How can you make use of this knowledge? Well, to start with, let your inner pessimist come out and play when compiling a budget. We’re often taught that a negative attitude can cause us problems later on, but it appears that in this instance, pessimism is the winning strategy. As an optimist, I hate to concede them the point, but it’s hard to argue with science, especially when it matches what I have seen in the real world so very well.