As we head into the holiday season, expenses are on the rise. Many of us spend quite a bit – perhaps, too much – on gifts to vacations, celebrations, and functions. And right as we head into the new year, which is usually a time to focus on new beginnings, some of us might be dreading our upcoming credit card bills.
If this is you, don’t worry, you’re not alone. The good news is, there are ways to deal with having spent too much, or indeed, tips to avoid doing so in the first place. But first, why do we overspend at this time?
Morningstar’s director of personal finance, Christine Benz points out that people tend to overspend because, well, it’s fun! “Obviously, there's a lot going on around the holiday seasons, parties and gift-giving and so forth. And as we earn more, we tend to experience a little bit of lifestyle creep and tend to spend what we earn. Add to that, we've had strong performing equity markets, and that has the net effect of stoking a wealth effect. So if you're looking at your retirement portfolio balance, chances are if you've got stocks in that portfolio, you've seen an enlarged balance. Even if your paycheck hasn't changed, that might make you feel wealthier and more inclined to spend overall,” she says.
One reason for this is our tendency to compare ourselves to others, especially at this time. In her report “The Comparison Trap: How Social Comparisons Affect Our Financial Well-Being,” Morningstar’s Sarah Newcomb finds that certain mental factors—the direction, frequency, and target of social comparisons—had strong associations with financial well-being. “People have a tendency to compare themselves with those who are better-off, and this was strongly associated with negative financial emotions. In other words, most of us seem to be actively making ourselves feel bad about our own financial circumstances by always looking up to those who have more,” the paper finds.
There are things you can do to combat this. One way to feel better about your finances is to redefine who you’re comparing yourself with. Put another way, count your blessings, and see how much better you have it than some others. Another tip the paper provides is to find a new financial role model, preferably someone similar to yourself, as this might help your well-being.
The Importance of a Budget
As with all things money-related, having a budget for the holidays is crucial, but difficult. The reason budgeting is hard is it requires us to give up short-term gratification in aid of long-term gains – in short, it requires trade-offs.
Benz says everyone--regardless of age, life stage, or income--needs a budget. "The key point about a budget is that it helps ensure that your spending syncs up with your priorities," she notes, “Come into the holiday season knowing what you can spend, and really thinking about how much you can realistically spend without having to resort to unattractive forms of financing. You don't want to have to go into credit card debt, so only put as much on your credit card as you can realistically pay off in that month. Definitely don't delve into retirement assets or your emergency fund to cover holiday gifts. Keep within what you can spend within the next month or two. And let that help determine how much you can spend on gift-giving and hosting parties and whatever else you might be doing,” she says.
The Ontario Securities Commission (OSC) in Canada recently released a list of holiday spending traps, and tips to avoid them. Like Benz, the OSC recommends cautious credit card use, and careful evaluation of “Buy Now, Pay Later” schemes, and installment loans.
Here are some of the tips it recommends to avoid these traps:
1. Read the fine print. Know how much interest you’ll be charged and when payments are due.
2. Make a spending plan if you don’t have one.
3. If you need to repay a loan or credit card balance, make a plan to repay and reduce the interest you’ll pay in the future.
Mental Accounting
Plus, we tend to trip ourselves up with mental accounting. “According to the theory of mental accounting, instead of viewing money as completely interchangeable, we see money differently based on its origin or how we plan to spend it. These mental accounts can come in handy. For example, labelling a sum of money as the ‘rent’ can help make sure we don’t spend it on something frivolous. At the same time, these mental accounts prevent us from seeing the full picture of our financial resources,” explains Morningstar behavioural researcher Samantha Lamas.
Here’s how she explains it working in practice. Imagine you created a great budget in preparation for holiday shopping, where each person on your list is allocated a certain amount of money and the rest is set aside for regular monthly bills. Given all these extra gifts, your budget is tight but manageable. On your way to begin shopping, you receive a notification of a great coupon for one of your planned stores. Due to mental accounting, most of us would see that coupon as free extra money to use at that store, placing it into that specific mental account.
“However, what we should do is consider our whole budget and realize that we could (and probably should) put that money toward monthly bills. And this, in a nutshell, is how mental accounting could lead us to the wrong conclusions and actions,” Lamas says.
She has three simple money habits that can help you combat mental accounting, and the good news is that you’ve already done the first.
1. Be aware of mental accounting tendencies
2. Use a mental accounting to your advantage: Another money habit is to create a mental account for any ‘free money’ you receive in a month.
3. If in doubt, unsubscribe: If you notice that you can’t seem to control your spending decisions after receiving promo emails, it’s okay to unsubscribe. Sometimes the best way for us to control our own behaviours is by changing our environment. In this case, Lamas explains you can change your environment by preventing the temptation in the first place.
Experiences Vs. Stuff
“Make no little plans; they have no magic to stir men’s blood and probably themselves will not be realized. Make big plans; aim high in hope and work.”
-Daniel Burnham, 1891
Finally, Benz calls out the research on happiness and spending. “The key takeaway is that spending on stuff by and large does not contribute to happiness. The type of happiness that is insured with spending or is often contributed to with spending, is spending on experiences. And the good thing about that is that that can also be really helpful from the standpoint of budgeting. So, say, you're a parent of young children, maybe you give a couple of gifts that are related to some experiences that you'd like to dole out in the year ahead. If you're going to take a couple of family trips, connect the gifts to the trips. From the standpoint of budgeting, that works really well, because you're not incurring big expenditures just around the holiday season, you're spacing them throughout the year. But the other important thing that we know about happiness is that looking forward to things really contributes to happiness as well. So, you're also giving your family members or your loved ones that gift of something that they may look forward to in the future and that you may look forward to as well” she says.
