The temptation to overspend is extremely strong when people do their holiday shopping. The truth is that some shoppers have more self-control than others. It's easy to come up with all kinds of anecdotes to illustrate this point, but only research can paint an accurate picture of what is going on.
Why should we care? There are two reasons. First, consumers plan to spend a significant portion of annual pre-tax income on their holiday purchases -- for most, between 0.5 percent and 1.5 percent. Second, many will be able to learn from history in order to make better holiday shopping decisions. Doing so will place them under less stress when the holiday season is over and bill-paying time arrives.
In past posts, I have emphasized that setting budgets is the key to disciplined holiday shopping. If the past provides any hint about the future, research shows that about 55 percent of consumers will have set holiday budgets. Before the holiday shopping season began, a paltry 1.6 percent of budget-setters would admit to lacking confidence about sticking to their budgets because they have poor self-control. After the holiday shopping season, that 1.6 percent will jump to 4 percent.
Now 4 percent is still small, but is it realistic? Are most holiday shopping budgeters that disciplined? Or do they instead delude themselves into thinking that they are? Here is what the data tell us about shoppers, who in November gave some thought to the magnitude of their planned holiday spending, set holiday budgets and subsequently shopped.
The simple facts are these: 36 percent of shoppers will overspend their budgets, not 4 percent. Shoppers who claim they will stick to a budget will spend 7 percent less than their counterparts who did not set a budget. In contrast, shoppers who actually keep to their budgets will spend 63 percent less than those who will spend more than they planned, not 7 percent. The accompanying chart of "Actual Spending vs. Planned Spending" displays the inaccuracies in most shoppers' plans.
Who will overspend this holiday season? The short answer is those who don't set budgets. At the end of this post, I will provide a ridiculously easy tip for getting started on a holiday shopping budget.
Some holiday shoppers will overestimate how much they will spend, and others will underestimate. And sometimes, the averages come out close, as we shall now see. In November, four out of five holiday budgeters plan to spend between $100 and $749. For those who plan to spend between $250 and $749, average actual spending will be within 1 percent of average budgeted spending. That is pretty good! For budgeters who plan to spend between $100 and $249, average actual spending will exceed budgeted spending by 5 percent; so not quite as good, but still not bad.
The least accurate holiday budgeters will plan to spend either less than $100 or more than $749. And on average they will overspend by about 30 percent. This is not so good. In this regard, there is something else that distinguishes these less effective budgeters from their more effective counterparts. In November, the more effective group has a much clearer idea about how much they will budget and spend than those who are less effective. Shoppers spending less than $100 set budgeted amounts that are more than 10 times their planned amounts from November, and those who plan to spend $750 or more set budgeted amounts that are less than half their planned amounts from November. The accompanying chart "Spending: Planned in Nov, Budgeted, Actual" summarizes the story for the averages in connection with shoppers who set budgets.
In the last two paragraphs, I have only been talking about the 55 percent of shoppers who set budgets. What about those who do not set budgets? How do they fare relative to their budget-setting counterparts, and what else do we know about them?
For shoppers who, in November, plan to spend between $100 and $749, there are roughly 18 percent more budgeters than non-budgeters. This is relatively good news. The worst news is for shoppers who plan to spend between $750 and $1499, where non-budgeters outnumber budgeters by more than two-to-one. At the extremes, where shoppers plan to spend less than $100 or more than $1500, there are far more budgeters than non-budgeters: 62 percent more for the low spenders and 33 percent more for the high spenders.
Not surprisingly, annual income is a factor in spending, be it planned, budgeted, or actual. For example, the group of shoppers planning to spend more than $1,500 features a high concentration of those with incomes between $100,000 and $150,000. Still, even for shoppers with incomes below $25,000, most plan to spend between $100 and $500. About 64 percent of those planning to spend between $750 and $1499 on holiday purchases have incomes between $25,000 and $75,000. The accompanying chart "Frequencies of Planned Spending and Annual Income Combinations" provides a visual depiction of the connection between incomes and holiday purchase amounts.
As I promised, here is an easy tip for how to begin to set a holiday budget. Take your annual income and multiply by a number between 0.5 percent and 1.2 percent. The number you compute will give you a ballpark estimate for the average amount people with your income spend on holiday shopping. If your income is $25,000 or less, use 1.2 percent. If your income is more than $150,000, use 0.5 percent. If your income is between $25,000 and $150,000, interpolate between 0.5 percent and 1.2 percent. For example, if your income is $100,000, you might multiply by 0.85 percent to arrive at $850. Now that you have that number on the table, begin to think about how you would spend $850 to achieve your holiday shopping goals. If your goals are easily accomplished, reduce your planned spending below $850, by enough so that you can just achieve your goals. If the task seems impossible, raise the limit above $850, again by just enough to achieve your goals.
Christmas is about a week away, and many holiday shoppers are still looking to buy gifts. Typically, 13 percent of consumers wait until the week before Christmas to start their holiday shopping, more than twice the 6 percent who were planning to do so. Historically, a disproportionate number of the last minute shoppers do not set budgets. The good news for them is that it's still not too late to put a budget together. Doing so will help them exercise self-control and avoid overspending.
Hersh Shefrin is a behavioral economist who holds the Mario L. Belotti Chair in the Department of Finance at Santa Clara University's Leavey School of Business.
He recently authored Born to Spend? How Nature and Nurture Impact Spending and Borrowing Habits.