“A budget tells us what we can’t afford, but it doesn’t keep us from buying it.”
— William Feather
It’s almost tautological to say that Monkey Brain doesn’t like budgeting. He wants to spend now and get what he wants now because if you don’t get that 183” flat screen TV into the man cave by dinner time, you might MISS THE GAME! (gasp!) Budgets? Fuggedaboutit. That’s something you can deal with in the future.
After all, you’ll get pay raises, and you’ll make more money, and then you can afford to pay off whatever it was that you bought on credit in the first place. It’ll be all good in the end.
Sure, there’s the obvious part of doing a budget. Doing a budget allows you to spend within your means so that you don’t go into debt paying for your out of control lifestyle, which will cost you even more once you tack on interest and, if you’re not careful, late fees. So, budgeting, and sticking to your budget, saves you money.
But, there’s another reason that nobody really talks about which, for me, is almost as important as not shipping a bunch of money to your credit card company.
One day, you won’t go to work. The days of working longer hours, climbing the corporate ladder, reaching for the brass ring, and getting those Christmas bonuses will be behind you. You won’t be able to project into a future where you’re earning more money.
You’ll be subjected to the limitations placed on you by the yields of your investments.
If you’ve invested intelligently and consistently throughout your work career, then you’re going to be in good shape. You should have more than enough saved up so that you’ll never have to worry about running out of money when you get old and becoming a cat food connoisseur.
However, in reality, you’re probably going to have some limitations to what you can safely withdraw during your retirement. Withdraw too much, and you’ll deplete your assets faster than capital gains, dividends, and interest can replenish them, and by the time that happens, your job prospects will be limited to being the WalMart greeter. At that point, you’ll be left to live on Social Security, which, for most people, will represent a significant decrease in the standard of living. After having had an adult lifetime of hedonic adaptation, suddenly being forced to downsize into living only off of Social Security will come as a real shock to the system.
Budgeting while you still earn an income from working or from your entrepreneurial ventures gives us lots and lots of practice of living within a set of boundaries. Unless you live in a truly tight personal financial situation, if you goof up occasionally now, you basically get a free pass. You still have plenty of years until retirement, and you can make up the mistake somewhere along the way. You might have to tap into some other funds to make up for the mistake, but, even cumulatively, a series of small mistakes probably won’t have an enormous impact on your life, except maybe to delay retirement for a year or two.
That’s where Monkey Brain fails to take the importance of budgeting into account. The consequences of missing a budget just aren’t all that big when you’re working. It’s not like you’re going to spend $53,000 in one month on some crazy bender when your usual monthly budget is $4,500. Instead, you’ll miss it here and there. You’ll spend $4,700 one month and $4,800 another month and tell yourself it’s no big deal.
What is happening is a phenomenon that Harvard professor Daniel Gilbert and others describe as the region-β paradox.
The region-β paradox occurs when we have a small amount of pain, but it’s not enough pain to actually trigger a response to mitigate the pain. I’ll use a personal example. I will refuse to go to the doctor when I have a head cold that turns into an upper respiratory infection that turns into goodness knows what else. So, because of my obstinance, I wind up suffering from head symptoms for a month or more before I finally decide to go to the doctor to get a prescription for a Z-pack. However, the moment I felt a pop in my knee, I decided to go to the doctor right away to do something about it.
Our perception of how long the pain will last is inaccurate because of the actions we take to mitigate the big pains and our inaction when it comes to doing something about small pains. We predict the big pains will last a long time (“My knee popped. Something is wrong. I’m going to be messed up for a long time.”) and predict that the small pains won’t last as long (“It’s a cold. No big deal!”).
The same holds true when we miss out on our budgets. Back to the example I previously used, if you did go on a $53,000 bender in a month and had to dig deep into your accounts to pay for that transgression, you’d be pushing every emergency panic button you had to make sure that it never, ever, ever happened again. You’d review your spending, disconnect the spark plugs from your car, freeze your credit cards in ice, and do everything that you could to take away the temptation which led you to such a fall from grace.
But, when you miss the budget by a small amount, you use the wrong metrics to measure the pain. If you miss by $200 out of a $4,500 budget, spending $4,700, you think to yourself that it’s not a big deal because $200 is such a small proportion of $4,500.
YOU: “Yikes. We went over in the budget this month by $200.”
MONKEY BRAIN: “$200 ONLY 4.4% OF $4,500. ROUNDING ERROR. NO WORRY. GO SHOPPING.”
YOU: “Good point! Thanks!”
As Dan Ariely points out in his book Predictably Irrational, we are willing to drive 15 minutes to save $8 off of a $25 book, but would never consider making the same drive to save $8 on a $25,000 car. We’ll agonize over buying a $3,000 leather couch, but don’t think twice about installing $3,000 leather seats in our car, even though we’ll use the leather couch much more than we will the car seats. We make these irrational decisions because of the ratios involved in the decision-making process. If we can save $8 off of a $25 purchase, that’s a 32% discount. Big number, so good. However, saving $8 off of a $25,000 car is a .032% difference – not even worth getting out of bed in the morning. Even though the numbers are the same, the perceptions of the importance of the numbers is vastly different.
The problem is that we have to convince Monkey Brain that these numbers matter now because, once we’re no longer earning an income and have to live off of our investments, they will most certainly matter. The impact of mistakes becomes magnified. Budgeting while we’re working is a trial run for budgeting when we’re retired, where it becomes a balancing act between what you want and what you can afford.
The key to convincing Monkey Brain to put down the bananas and wait is to contemplate opportunity costs. Every purchase decision you make has an opportunity cost – even the spending that you think you have to make. You could pay the mortgage now, or you could spend that money on something else and either pay late fees later or pay the price of being foreclosed on. However, most choices aren’t that drastic.
As research from Yale University shows, it’s still useful to prime yourself before you make a discretionary purchase by thinking about what you could buy instead of what you’re about to buy.
For example, if you are looking at buying a table that costs $300 and you want to take a $1,500 trip to Disney World, you could frame the decision as:
- Buy the $300 table
- Be 20% of the way to my Disney World trip
By framing up the opportunity costs – what you could be buying – in terms of things which are important to you, you force yourself to consider the tradeoffs between a potential impulse purchase now and an intentional, considered, and potentially more meaningful purchase later.
I do not mean to imply that if, in retirement, you miss your budget by a dollar, ZOMG! YOU’RE GOING TO GO BROKE!!!! No, but misses which occur when you’re no longer working can become more painful more quickly because of your lack of opportunity to make that cash back up. Each dollar you spend in consumption is a dollar which could be working as an investment for you.
Instead, look at your budgeting efforts while you’re working as a trial run, the opportunity to build up good habits so that you can sensibly enjoy your retirement. It’s also a chance for you to contemplate your spending and to evaluate your opportunity costs and think about what else that money could be used for. That 183” flat screen TV isn’t all that important after all, is it?
A little over a year ago, I wrote about why you shouldn’t try to keep up with the Joneses. If you haven’t read it, go check it out!
- John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.
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