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Why Your Budget Estimate Is Almost Always Too Low

The budget fallacy

Johanna Peetz and Roger Buehler published "Is There a Budget Fallacy? The Role of Savings Goals in the Prediction of Personal Spending" in Personality and Social Psychology Bulletin in 2009. Participants underestimated future spending, predicting they would spend substantially less in the coming week than they actually spent, or than they remembered spending in the previous week. The authors traced the bias to savings goals: participants who reported, or were induced to experience, a stronger savings goal predicted lower spending. Crucially, those savings goals were not related to actual spending, so they contributed to prediction error without changing behavior.

Wanting to save is not the same as saving

That last detail is the sharpest finding in the paper and the easiest to skip. The desire to save money made forecasts more optimistic without making outcomes better. Anyone who has ever written an aspirational budget will recognize the pattern: the number on the page reflected the intention, and the intention did not show up in the transactions.

Expense neglect

Jonathan Berman, An Tran, John Lynch, and Gal Zauberman documented a related asymmetry in the Journal of Marketing Research in 2016. People generally expect both income and expenses to rise, but they systematically under-weight the extent to which growing expenses will cut into their spare money. Across their studies, participants placed roughly 2.7 times the weight on income change as on expense change. They also report that tightwad consumers, who are chronically attuned to costs, showed less severe expense neglect than spendthrifts.

The time frame changes the answer

Gülden Ülkümen, Manoj Thomas, and Vicki Morwitz reported in the Journal of Consumer Research in 2008 that budget estimates depend on the temporal frame of the budget period. Budgets planned for the next month were much lower than recorded expenses, while budgets for the next year were closer to recorded expenses. Their account is that the difficulty of estimating a yearly budget imparts low confidence, which leads to upward adjustment. When confidence was increased, beliefs about accuracy were reversed, or cognitive resources were constrained, that upward adjustment disappeared.

The practical reading

Three independent findings converge: forecasts are biased low, expense growth is the part people discount, and the framing of the budget period moves the estimate. That is a reasonable case for checking a budget against recorded past spending rather than against intention. It is not evidence that any particular tracking tool corrects the bias, which none of these studies tested.

Sources

Every source below was retrieved and checked. Findings are reported as the source states them.

• Is There a Budget Fallacy? The Role of Savings Goals in the Prediction of Personal Spending — Personality and Social Psychology Bulletin, 2009
  Participants underestimated future spending relative to actual and remembered spending; stronger savings goals predicted lower spending forecasts, but savings goals were not related to actual spending and therefore contributed to prediction bias.
• Expense Neglect in Forecasting Personal Finances — Journal of Marketing Research, 2016
  Participants placed roughly 2.7 times the weight on expected income change as on expected expense change when forecasting financial slack; tightwads showed less severe expense neglect than spendthrifts.
• Will I Spend More in 12 Months or a Year? The Effect of Ease of Estimation and Confidence on Budget Estimates — Journal of Consumer Research, 2008
  Budgets planned for the next month were much lower than recorded expenses while budgets for the next year were closer; the difficulty of yearly estimation imparted low confidence and led to upward adjustment, which disappeared when confidence was raised, beliefs reversed, or cognitive resources constrained.
• The Exception Is the Rule: Underestimating and Overspending on Exceptional Expenses — Journal of Consumer Research, 2012
  People budgeted ordinary purchases fairly accurately but underestimated exceptional spending in aggregate and overspent on each exceptional purchase.

Common questions

Why is my monthly budget always lower than what I actually spend?

Peetz and Buehler found people predict lower spending than they actually incur, driven partly by savings goals that shape the prediction without changing behavior. Ülkümen, Thomas, and Morwitz separately found that monthly budget estimates ran much lower than recorded expenses, while yearly estimates were closer.

Should I budget by the year instead of the month?

The research does not make that recommendation. It reports that yearly estimates were closer to recorded expenses, and explains this as an artifact of low confidence prompting upward adjustment. That mechanism disappeared when confidence was raised or cognitive resources were constrained, so it is not a stable trick.

Does being naturally frugal protect against this?

Partially, in one study. Berman and colleagues report that tightwad consumers, who are chronically attuned to costs, showed less severe expense neglect than spendthrifts. Less severe is not absent.

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