By late 2015, household debt in B.C. had reached record levels. While there are many reasons for this, an inability to plan for the future and track small or irregular purchases is a key part of the problem. What the experts say we can—and must—do about it
Jacqueline Sheppet thinks of herself as reasonably good with money. She is a high-school math teacher, after all. She’s thrifty—didn’t buy her first car until she was 37, after saving diligently for it for five years. And she takes the trouble to look at the automatic expense-tracking tool her bank provides, Mint, to see where she and her husband, who runs a software startup, are spending their money.
So no one was more surprised than Sheppet to discover that she had done a poor job of figuring out how much of a hole her new Mini Cooper was really going to dig in her budget. The routine check-ups and repairs. The gas. The insurance. The engine that blew up within weeks of the warranty expiring and that still cost her $2,500 to repair even after she negotiated to get the company to pay 75 per cent of the replacement cost.
“You think that all you have to save for is the outlay for the car. But you end up paying for the car twice,” says Sheppet, now 43. “I hate those car expenses. They’re always surprising me.”
Sheppet is hardly alone in finding that her mental map of what she’s spending is lacking. In fact, most people are much worse than Sheppet at assessing their expenses, especially in certain categories. Just check the beloved personal-finance stories of the weekend newspaper. People will list plausible amounts they’re paying for their mortgage or rent. The cellphone and cable bills are within striking distance of reality.
But then you’ll see single people claiming they’re feeding themselves on less than $200 a month. Or a family of four will list the monthly cost of groceries as $600. And that same family apparently plans never to buy furniture or a household appliance or to repair their car in the next 20 years, because little or nothing is listed in their expenses for those kinds of items. Even “Eric and Ilsa,” the laughably privileged Vancouver couple who became a Twitter hit with their financial-makeover story of struggling to make it on $25,000 a month, put down the unlikely figure of $260 a month for dining out. That would barely cover one meal at Hawksworth.
What these personal-finance tales show—and what the popular new field of behavioural economics confirms—is that we are far from rational actors when it comes to money. “We like to think we are perfect machines, but we are not very perfect,” says UBC economist Yoram Halevy. “We are kind of short-sighted animals. We have a hard time planning. People have a very strong ‘present’ bias and there is very strong evidence we distort probabilities.”
That means that when people think about their spending, they think about the now, not the future. That’s what Sam Ramos concluded was his problem after a new girlfriend made him look closely at his budget a few years ago. Ramos, a 33-year-old volunteer engagement co-ordinator who works at the YWCA and teaches the subject at colleges, hadn’t paid much attention at all to how he was spending his $40,000 to $55,000 in annual income.
He thought of himself as frugal: he doesn’t have a car, rents an apartment for less than $1,000 a month and is the kind of guy who will buy a bed for $200 from “some guy who I’m pretty sure stole it from somewhere and sold it on Craigslist.” But when Ramos was pushed to track his expenses, he realized he was doing strange things. He would reject the idea of buying a pair of high-quality boots for $250. But he’d go out with friends for a nice meal and drinks on a Friday night and easily blow that same $250 (indeed, he discovered he was spending a lot more on food and particularly alcohol than he had thought).
Ramos’s mental math, before his budget-conscious girlfriend entered his life, was typical of one kind of problem people have: not having a good grasp of the amount of money they’re spending on small items (the so-called “latte” factor). That’s the kind of spending that almost every financial planner will say people need to get under control—the $3 or $4 dropped here and there that isn’t tracked but adds up to hundreds of dollars a month.
People also have a hard time estimating their spending on big once-a-year or once-a-decade items: a replacement TV for the one that broke, a friend’s wedding that entails joining the couple on a cruise or a three-day music festival 500 kilometres away. One study looked specifically at that mental-math problem. “People are fairly adept at forecasting future costs and determining how much to spend on ordinary items, [but] they underestimate future spending on exceptional purchases and overspend on each individual purchase,” concluded the 2012 study by Abigail Sussman and Adam Alter, published in the Journal of Consumer Research.
Their research found that people generally don’t account for those kinds of costs in their budgets, even if they are faithful expense trackers. Worse, they will spend more on each one of those items—20 per cent more on average—than they would if they had a category of “special non-daily expenses,” because they see each one as unique. “They construe each potential purchase as a relatively rare occurrence and consequently they overspend across a series of discretely exceptional expenses,” wrote Sussman and Alter.
Financial planners see both kinds of failures—not tracking the little expenses and not accounting for the irregular big ones—constantly. Jillian Bryan, a vice-president with TD Wealth Private Investment Advice in Vancouver, says her otherwise smart clients will forget to account for how much money they’re shelling out on their children (Halloween costumes, skates, swimming lessons), for hair care and Botox, or even for vacations: “There are all these incidentals that creep in.” Simon Tanner, at Dynamic Planning Partners in Langley, sees similar irrational accounting from his clients. They do well at estimating their static expenses, he notices: mortgage or rent, taxes, even cellphone and cable bills, because they can scrutinize the bill when it comes in each month. But in other areas—food or car expenses that are paid for sporadically—they are wildly out of whack. “We have some sort of denial about what it costs to live,” says Tanner. “When people tell me they spend $400 on groceries and $200 on eating out, I can guarantee it’s the reverse of that and higher in each category.” Tanner estimates his own monthly grocery bill for his family of five at $1,600.
Gwen Chapman, a UBC nutrition professor whose recently published book Acquired Tastes examines the way families eat, says some of the wild variation in what people say they spend on groceries may come from what food means to their social identity. If they are low income or from a particular culture, “frugality is a moral value.” Other researchers have noted that Canadians have always had a slightly less full-blown consume-to-the-max mindset than Americans: we were slower to buy automatic washing machines in the 1960s and still tend to buy smaller cars and live in smaller houses. So there might be more of a tendency in this country to believe it’s moral to be frugal about food—and that could account for some of the strange under-estimates of the grocery bills.
That said, not everyone underestimates. Chapman notes that more middle-class people—who are not strapped and are defining themselves in part by the way they eat—might be happily spending a small fortune for the best olive oil (“Being frugal is not necessarily their goal”). Certainly Jacqueline Sheppet, as surprised as she was about her car expenses, doesn’t kid herself about what it costs to eat. She estimates that her three-person household (the couple has a small child) spends $1,200 a month between groceries, take-out sushi or pizza and the occasional meal out. And that’s after taking the trouble to shop on the east side for groceries, where things are cheaper.
Something that would help people like Sheppet and Ramos is more financial-literacy training at an earlier age. Last year B.C. became the first province in Canada to introduce such training as part of its high-school math curriculum, but it’s still lacking in most of Canada—a fact that both education and finance experts deplore. In the meantime, behavioural economists are discovering ways to nudge people into better financial planning. When subjects of the Sussman and Alter study were told to come up with all the once-in-a-decade expenses they might encounter and budget them together as a special category, they were found more likely to spend less on each item. In another study, published in the Journal of Marketing Research, people shown altered photos of themselves as they aged were more inclined to allocate money for the future when they saw that older self—overcoming the natural tendency to weight the present much more strongly. “When people make important long-term decisions, vivid representations of their future selves should increase their future orientation of saving decisions,” wrote the study’s authors.
For Sheppet, that kind of planning comes naturally. She looks ahead to what she wants for the future, giving up some things to be able to get others. Her family doesn’t buy Christmas presents, for instance: to them, experiences are more valuable, so they spend money instead on trips. But she sees other families who seem unable to make those hard choices and are headed for trouble because they don’t seem to see what’s at the end of the tunnel. “I don’t know how you can enjoy anything if you’re just delaying the debt.”