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The Psychology Principle That Made Me Realize Why I Could Never Stick To A Budget (& How I Changed My Ways)

Confession time: I’ve always enjoyed budgeting. Ever since I was a little kid, I’ve been fascinated by the many diverse ways that people make and spend their hard-earned dough. When I was five years old, I won $20 in a bingo competition. I decided to use $10 to buy myself a stuffed animal and save $5 for a rainy day, but the last $5 was a mystery to me. After much consideration, I decided to splurge on some sidewalk chalk, but immediately regretted my decision when I realized that I could have saved that money for the school book fair.

Here’s a second confession: Budgeting hasn’t always been easy for me. That sense of indecision about how to assign my funds, and why, has impacted my budgeting strategies ever since. Accounting for necessary expenses is simple — there are some bills that you know will always be due on the same day, and always the same amount. Where I (and many other people) stumble is budgeting for unexpected expenses. After all, you can’t know how much to save if you don’t know what you’re saving for. Anticipating the unknown has been a problem for me since I was a kid, and budgeting only became more difficult after I started managing my own expenses in college.

To address my problem, I turned to the work of psychologists Daniel Kahneman and Amos Tversky (which was, interestingly, popularized by Donald Rumsfeld). They suggested a simple rule: we understand the world in terms of known knowns, known unknowns, and unknown unknowns. Naturally, we can account for the information that we are sure that we know, but are less comfortable with information that we are unsure of.

When I first learned about this principle (thanks to an undergraduate psych class), it immediately appealed to my desire for structure and foresight in financial planning. At the time, I had a consistent part-time job to cover my living expenses, but I always felt like I blew my budget on surprise expenses. Just when I thought I had my expenses under control, I’d realize that I needed new work shoes, or that my sorority dues were due, or that the price of my monthly medications had changed.

As I began working and earning my own money, I saw my classmates and friends living paycheck to paycheck (or student loan disbursement to disbursement).  I’ll be the first to admit I was lucky to have the income streams and savings to cover those costs when they popped up. Many of my friends had to unenroll from semesters of school, skip meals, or decline internship opportunities in order to manage their finances. Bouncing back from financial setbacks can seem insurmountable when schedules and resources are stretched thin. For those with already tight budgets, pop-up expenses can lead to undeserved stress and missed opportunities.

For me, an unexpected expense was an inconvenience that I had to begrudgingly manage. I’ve been budgeting (with varying degrees of success) for around a decade. I began incorporating Unknown Unknowns into my budget about 5 years ago. Doing so has helped me focus on my goals, and kept me on my feet as I dealt with seemingly catastrophic financial setbacks. I felt, and still feel, that being proactive in times of financial security is the most important step I can take to protect myself from future insecurity.

So how do I account for my expenses, known or otherwise? I’ll use my own finances as an example.

  • Known Known: Rent.
    • Always due on the first of the month. Always $600.
  • Known Unknown: Coffee.
    • Spend throughout the month. Sometimes I spend as little as $0, and sometimes as much as $60. This month, I’ll exercise some self-control and budget $20.
  • Unknown Unknown: ???
    • This month, it was an extra ticket to a fundraiser for a local arts organization. $85 for event registration. This was money that I definitely didn’t plan to spend. I had budgeted $100 for unknown unknowns, and I’m grateful that I didn’t have to scramble to cover the cost. (I’m rolling over the extra $15. Last month, it was a $115 car detailing after I spilled soup on the passenger seat. Keeping little more in the budget can’t hurt, right?)

There’s no telling what an Unknown Unknown will be, or what it will cost. Maybe it’s a surprise birthday brunch for a friend at a trendy restaurant, administrative expenses, or an unusually high medical co-pay. This could fall into any budget category, so having a separate line item helps me avoid the stress of overspending, and gives me a helpful cushion if I ever need it.

Now that I’m out of college, my finances have become more predictable. I have a steady paycheck, insurance, and a health emergency fund in case of any major setbacks. Having those safety nets in place is an incredible privilege, and I’m beyond lucky that I can consider a birthday brunch an emergency expense. On the occasions when I do have an Unknown Unknown, I’m so glad that I accounted for it to prevent myself from dipping into my savings for something serious (vet bill) or fun (impromptu holiday road trip with friends). Incorporating it into my financial planning has made me think more critically about how I manage my money and how lucky I am to spend it on things I enjoy.

I’ve come a long way from since I made my living playing bingo (it was a good side hustle for kindergarten). I’ve learned to expect the unexpected. Although I still think that the unknown can be intimidating, budgeting for it now gives me the flexibility to plan for fun. Although nothing in my adult life has quite compared to the sheer joy of an elementary school book fair, I know for certain that I have a budget ready when the opportunity arises.

Dinah Adams is a data analyst living in the Midwest. She loves coffee, cats, and compound interest.

Image via Unsplash

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