Keep this research in mind when you're out shopping.  Signs for a SALE! can confuse your rational thinking.

There are many ways to budget - I use a monthly budget divided into several categories of spending; RB40 and his wife give themselves weekly allowances; Jacob at Early Retirement Extreme pretty much just doesn’t spend any money.

If your budget doesn’t seem to be working for you, and you reach the end of every month realizing that you blew your budget again and aren’t really sure why, don’t give up! You simply need to set your budget up in a way that helps you make better spending decisions.

A bookstore near you has a book for $15, but you know if you drove to a larger shopping center 20 minutes away, you could buy the book for $10. Would you drive out of your way to get the cheaper book?

What if you are looking at buying a textbook that costs $125, but the store 20 minutes away carries the same book for $120? Would you drive out of your way in this case?

According to a study (cited in “How We Decide” by Jonah Lehrer and “Predictable Irrationality” by Dan Ariely), most people were willing to drive out   way to get a $15 item for $10, but were not willing to drive out of their way to get a $125 item for $120. Even though you’re saving the same amount in both cases ($5), it seems more worth it to save the higher percent. Because of how our brains process information and make decisions, we can be tricked into making poor spending decisions.

In Lehrer’s book, about how people make decisions, he explains that people process information by using mental “accounts,” similar to how I have different categories of spending in my budget. This allows us to process information on a less-detailed level, but also results in some irrational decisions.

This is why RetireBy40’s method of a $100/week allowance helps him budget - because every non-budgeted purchase is compared to a $100 cap, rather than say a $2,000 budget for the whole month’s spending.  I like my method of categories, because it helps me track where I’ve been overspending, but I have to remind myself that spending an extra $5 in a category that I haven’t reached my limit on is the same total effect as spending $5 in a category that I’ve already passed my budget on.

Mental tricks to stick to your budget

1. Every time you make a purchase, compare it to smaller purchases you make.  If you’re considering buying a latte for $5, because it just doesn’t seem like much, compare it to how much effort you spent finding coupons to save $5 at the grocery store.  If $5 off your groceries was worth the hassle, isn’t it worth saving $5 to skip the latte?

2. If you have trouble sticking to a monthly budget, try a weekly allocation.  Every time you make a purchase, it’ll be a larger percentage of your limit for the week. If you budget for $100 in eating out at restaurants each month, try thinking of it as $25/week.

3. Be vigilant in your spending on big-ticket items.  If you’re purchasing a high-value item, like a computer, then an upgrade that adds $50 to a price that’s already $1,000 may not seem like a big deal.  Make sure to scrutinize whether these upgrades and add-ons are really worth it before making your final purchase.

Readers: Have you ever noticed your mind “tricking” you into spending more money because, in context, the extra money doesn’t seem like much?

Photo by ahylton via sxc.hu