Why ‘optimistic’ budgets and thinking about unusual expenses could transform your finances

Imagine looking at your bank statement and wondering how you could have spent even more than you planned. You’ve tried budgeting apps, spreadsheets, the envelope system, and even zero-based budgeting, but nothing works. Sound familiar? If so, you’re not alone—and surprisingly, the solution may be to loosen up your financial planning instead of tightening it up.

Our research challenges conventional wisdom about personal finance and offers insights that could revolutionize the way you manage your money. Two key strategies emerge: setting optimistic (i.e., stricter) budgets and considering atypical spending. While these strategies may seem counterintuitive, the data suggests they could significantly improve your financial health.

Traditional financial advice often focuses on realistic or conservative budgeting. However, our 2023 study suggests otherwise. We analyzed over 350 million transactions from 70,000 users of a personal finance app in the UK and made a surprising finding: optimistic budgeting led to a 21.9% reduction in spending compared to no budget at all.

Surprisingly, this effect persisted even when people did not strictly adhere to their budgets. The influence of these optimistic budgets on spending was still evident six months later, despite the imperfect spending management.

Let’s take the example of Audrey, who spends an average of £300 a month on groceries. Instead of setting a ‘realistic’ budget of £280, she could set an optimistic target of £240. Even if she ends up spending £260, she will still have saved more than if she had set a conservative budget or no budget at all.

“Atypical” expenses

Our second finding concerns another aspect of financial management: forecasting future expenses. We found that a simple mental exercise—thinking about why your expenses might be different in a given month—can dramatically improve the accuracy of your expense forecasting.

In a series of studies with over 6,000 participants, we found that prompting people to think about atypical expenses reduced their spending forecasting errors by an average of 40%. This approach helps people remember often-overlooked costs, leading to more realistic financial forecasts.

Imagine Paul planning his monthly budget. He easily remembers common expenses like rent and utilities. But when he considers non-standard expenses, he remembers that his car is due for an MOT this month and that his sister’s birthday is coming up. This more comprehensive view allows him to create a more accurate financial plan.

Interestingly, our research suggests that optimistic budgets and realistic forecasts serve different purposes. Optimistic budgets are most effective at reducing everyday discretionary spending. They act as a motivational tool, prompting you to cut back on small, frequent expenses.

On the other hand, realistic forecasts are essential for major financial decisions. Take the example of Theo, who wants to buy a house. To determine how much he can afford to pay in monthly mortgage payments, he must forecast the total amount of his other monthly expenses.

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Read more: We tend to underestimate our future expenses – here’s a way to avoid it

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By factoring in unusual expenses, he can make a realistic forecast and avoid taking out a mortgage that is larger than he can afford. The same principle applies to other major purchases like cars or appliances.

Here’s how you can apply this knowledge:

1. For daily expenses, set ambitious budgets: aim for around 20 to 25% less than your usual expenses.

2. For major financial decisions, make realistic forecasts. Factor in unusual expenses to get the big picture.

3. Write down your optimistic budget and keep it visible

4. Don’t give up if you spend too much – use it as a learning experience

5. Before you make any financial plans, take five minutes to think about potential unusual costs.

6. Review your list of unusual expenses every month and update it if necessary.

Behind these strategies lies a psychological dimension. The effectiveness of optimistic budgets is linked to the concept of reference points in behavioral economics. Even if we do not reach the exact goal, having an ambitious goal influences our decisions, pushing us to spend less.

The success of accounting for atypical expenses relies on “cognitive accessibility”—how easily a certain fact (or, in this case, an amount) is remembered. By deliberately bringing up less common expenses, we create a more complete mental picture of our financial landscape.

These findings challenge long-held beliefs about personal finance. Some might argue that optimistic budgets set people up for failure. However, our research suggests that the motivational benefits outweigh the potential downsides of missing goals.

Similarly, some might worry that factoring in atypical spending could lead to overly conservative planning. Yet our research shows that this approach leads to more accurate, not overly conservative, forecasts.

These findings have implications beyond personal finance. Financial education programs could incorporate these strategies into their curricula. Budgeting apps could be redesigned to encourage slightly more optimistic goals for daily spending and to encourage consideration of atypical expenses when making major financial decisions.

In these uncertain economic times, effective financial management tools are more valuable than ever. While these strategies aren’t a magic solution to every financial problem, they offer evidence-based approaches that can help people take greater control of their finances.

Managing your money effectively doesn’t always mean following conventional wisdom. By strategically using optimistic budgets and realistic forecasts, you could end up with a stronger, more effective financial strategy. In the complex world of personal finance, sometimes the most powerful tools are also the most surprising.