Expense Neglect in Forecasting Personal Finances

Abstract

This paper shows evidence for expense neglect in how consumers forecast their future spare money or “financial slack.” Even though people generally think that both their income and expenses will rise in the future, we find that they systematically under-weigh the extent to which their expected growing expenses will cut into their spare money (Studies 1-9). We rule out the possibility that these findings are due to: measurement error (Studies 2-5); a lack of confidence in estimating future expenses (Study 6); belief in greater flexibility of future expenses (Study 7); or a general optimism bias (Study 8). Study 9 shows that consumers who are chronically attuned to expenses (tightwads) are less likely to show expense neglect than those who are not (spendthrifts). Finally, we conduct a meta-analysis of our entire file-drawer (25 studies, 7,214 participants) and find that across all studies participants place about 2.7 times the weight on income change as they do on expense change when forecasting their financial slack, and that expense neglect is stronger for the distant than near future.

Keywords: Forecasting, Financial Slack, Financial Decision-Making, Expense Neglect

JEL Classification: M31, D81, D84