Money tip: Budget exceptions can happen too often

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 some illogical spending choices.

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 it.

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 a 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.

"Exceptional events of all kinds happen more frequently than people might think — it's worth keeping that in mind when you think that you're likely to make an exception 'just this once,' " Sussman said. Tracking will improve budgeting for exceptional expenses and reduce splurging, she said.

Other findings from the Journal of Consumer Research:

• Retail therapy: 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 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 only products specific to a potentially negative situation. Someone may buy a designer suit before presenting at an important meeting where their business savvy may be scrutinized.

• Emotional oracles: If you trust your feelings, you are better able to predict the future — from the weather to the stock market to the winner of "American Idol," write researchers Michel Tuan Pham and Leonard Lee of Columbia University and Andrew Stephen of the University of Pittsburgh. The authors hypothesize the "emotional oracle effect" found in their experiments arises because trusting your feelings opens yourself up to a "privileged window" into predictive information people learn, mostly unconsciously, about their environments.

Two conditions, though: The predictive power applies only to people who have sufficient background knowledge about the topic, and the effect dissipates when the topic becomes inherently unpredictable or unknowable.

• Just trust: People who believe the world is a just place trust salespeople more than consumers who don't, according to Andrew Wilson of Saint Mary's College of California and Peter Darke of York University.

The upside is that people who showed "optimistic trust" ended up more satisfied with their purchase decisions. The downside is they might be more vulnerable to salespeople who have ulterior motives, the authors say.

By Gregory Karp Chicago Tribune

By Gregory Karp
Chicago Tribune