This Is Why You Always Think Things Will Cost Less Than They Do
For my husband's birthday this year, I dropped by our local artisan grocery store and picked up a couple of premium steaks to grill. We only eat red meat a couple of times a month, but I was still pretty sure I knew what to expect, cost-wise. I generally got the good supermarket steaks for about $6 per pound or less, so I figured the really good stuff would be about $9/pound.
I spent nearly $12 per pound on our strip steaks.
Admittedly, these were among the most delicious steaks I've ever eaten. However, the cost for my husband's birthday meal was quite a bit more expensive than I anticipated.
We've all had this experience, and it is related to the planning fallacy that leads us to underestimate how long projects will take. In addition to underestimating time, our brains also have a tendency to underestimate cost, and we end up with sticker shock once it's time to break out our wallets.
Here are some of the reasons why you always think things will cost less than they do — and what you can do to minimize the hit to your budget.
If I were to ask you to estimate how much you spend on regular expenses like utilities and groceries, you would probably be able to give me a pretty accurate estimate.
But if I were to ask you to tell me about how much you spend on unexpected expenses like wedding gifts, celebratory steak dinners, and replacing a computer that suddenly goes on the fritz, then it's likely that you will seriously underestimate the amount that you spend. A recent study suggests that you will underestimate those expenses by about 40%.
According to researchers Abigail Sussman and Adam Alter, what's going on here is the fact that we tend to view "exceptional" costs like these as existing somewhere outside of our budget. We think of the wedding gift purchase of gold-encrusted gravy boat as a one-time, one-of-a-kind thing. And it is a one-time big purchase if you're only looking at it as one particular wedding. But how many weddings do you attend each year?
These exceptional costs fall into an "it made sense at the time" sort of thinking. Because you view your college roommate's wedding as a one-time event, you'll shell out for the really nice gift and the gorgeous new dress. Then the next week, you splurge on pricey tickets to see your favorite band live for the first time. Then the following week, your laptop dies and you go ahead and upgrade to a new one. Each of these purchases make sense at the time, but added together, they can really hurt your bottom line.
How to Correct Your Thinking
There are really two problems with exceptional expenses.
See Them as Regular Expenses
The first is that you view them as one-time events, rather than as part of a series. By viewing them this way, you will think every exceptional expense is worth splurging on. To turn that thinking off, simply keep a tally of your "exceptional" expenses. Every time you buy something out of the ordinary, write it down. Then make sure you look at your previous exceptional purchases before making any new ones. It will help you to see the regularity of your exceptional purchases and help you put the brakes on overspending.
Budget for It
The second problem with exceptional expenses is that you will often view a purchase as unexpected when you could easily see it coming. For instance, it may seem as though a broken computer is not something you can plan for. But even though you may never know the exact date that your laptop will decide to give up the ghost, you can be certain that a computer you bought back when Paris Hilton was still regularly in the news is not long for this world. So you can plan ahead for your computer's inevitable death by saving for a new one.
Similarly, you can plan on the necessary costs for attending weddings or other infrequent life events by looking at how much you have spent in the past. People you know are going to continue to get married (or have babies, or graduate from college), and you can plan ahead with a special occasion budget to avoid busting your regular budget.
Mental Accounting Errors
I've written before about mental accounting — how humans will value money in different ways depending on where it comes from. For instance, you're much more likely to blow your tax refund than you will a raise.
This affects your mental calculations on the cost of things because you are mentally placing costs in separate categories.
For instance, let's say you budget $2000 for a vacation. You and your family enjoy your time away, and make sure that you spend not a penny more than your budget on lodging, dining, activities, and souvenirs. Relaxed and happy, you come home…only to realize that there's not a scrap of food in the house and you owe your kennel $250 for taking care of Fido while you were away.
Basically, you have forgotten to account for the add-on expenses because they do not fit into your mental vacation account. So your vacation budget is actually closer to $2,300 because you need to buy convenience foods and pay for Fido as soon as you get home.
How to Correct Your Thinking
This particular error is difficult to plan for, since it is so tough to even recognize when you are doing it until after you've made the mistake. That's why it's important to keep track of your expenses on a regular basis. If you are regularly tracking your expenditures, then you have the evidence of what things will really cost right in front of you each time you plan to make a purchase.
Even if you are allergic to the idea of tracking your finances, you can still protect yourself from nasty surprises in the future. The blog See Debt Run suggests that you "write things down the first time [you] fail to account for them, so that the next time, [you] remember to include those add-ons and contingencies in the budget."
The 19.99 Effect
Retailers are a canny bunch. They know that most of us rely on mental accounting and other shortcuts to determine costs. They also know that most of us stink at those kinds of abstract calculations.
For instance, take psychological or "charm" pricing. You have no doubt noticed that many stores will offer their goods for prices ending with $0.99 in the hopes of fooling customers into thinking things are cheaper than they are. You've probably also assumed that it's the retailers who are foolish for thinking they can trick anyone with those kinds of shenanigans.
The thing is, they can.
While the rational part of your brain is completely capable of recognizing that a price of $19.99 is really 20 bucks, it tends to be slower than the portion of your brain that is trying to make a decision about a price.
According to 2005 study, "humans tend to be bad at thinking in absolute terms like dollars, distance, or dimensions. Instead, we tend to think in terms of comparisons on an analog scale. Thus $2.00 is seen as less than $3.00 — naturally. [What happens is that] the fastest-moving part of our brain actually starts to encode the information before we actually finish the left-to-right process of reading a price. Thus $59.99 is seen as meaningfully less than $60.00."
Basically, the decision-making portion of our brain sees the left-most number in a price and stops there.
In another study, participants were asked to estimate how many products they could purchase with $73. The participants thought they could buy significantly more products when the prices ended with $0.99 than they did with comparable even dollar prices.
How to Correct Your Thinking
Always carry a calculator.
You may believe that you are immune to the psychology of pricing, but as with any other cognitive bias, you are more likely to fall victim to the $0.99 effect if you are distracted or tired. You take that completely out of the equation if you use a calculator to determine the cost of your shopping trip as you go.
In addition, we often tend to forget about the effect of sales tax and a calculator can help you figure out exactly how much you'll pay once you reach the register.
Scope Creep — or "While We're At It…"
About two years ago, I decided to clean out the pantry in our dining room because it had become a catch-all mess. Once I had everything removed, my husband came along and suggested that "while we're at it" we should replace the particleboard shelves that were sagging, paint the interior, and replace the nasty flooring that had been bothering him since we had moved in.
My totally free, three-hour clean, purge, and organize project had suddenly ballooned into a real DIY project that ultimately cost $160 (and took three weeks).
This is what's known in project management as scope creep: The phenomenon wherein you have trouble recognizing what the real end of your project is. (Home renovators are more likely to call it "while we're at it.")
The problem with scope creep is that it is next to impossible to plan ahead for its costs because you start your project unaware that the scope will continue to grow. Sometimes that's because you uncover a problem that you didn't know existed and must deal with it immediately. And sometimes scope creep occurs simply because you want to take care of several issues at once rather than waste time in the future.
Scope creep can wreak havoc on a renovation budget, as any regular watcher of This Old House can recognize. But it can also ruin any number of other types of budgets. For instance, how many times have you gone to the market for a single item, then decided that you ought to stock up on other things "while you're at it?"
How to Correct Your Thinking
Decide on a hard line budget limit ahead of time.
In terms of home renovation, going into such a project knowing the absolute limit you can spend does prompt some difficult questions. You will need to decide ahead of time what will happen if you encounter a budget-busting problem. Will you simply scrap the project altogether, live with an unfinished project until you can scrape together more money, or take money from elsewhere in your budget? Figuring out how you will handle these issues ahead of time will make the decision-making process much less difficult when you are in the midst of a stressful renovation hiccup.
As for other "while we're at it" moments, it's a good idea to stop and think about whether you are truly saving time or money by allowing scope creep. Take a moment to jot down another possible time to take care of the additional purchases. It will help you stay on track when you really do only need a gallon of milk.
Don't Trust Your Brain to Estimate
Things always cost more than we think they will because we rely on mental estimates. But no matter how good you are at arithmetic, your brain will take shortcuts, forget to include add-ons, race to an answer, and otherwise lead you astray.
A better bet is to do math the old-fashioned way: use a pencil and paper, show your work, and actually crunch the numbers.
Your budget will thank you.
Has your budget ever been hit by any of these quirks of cost estimation?