Frances Woolley is a professor of economics at Carleton University, where she teaches public finance. Her recent Economy Lab posts can be found here.
November is financial literacy month, and Canadians are being showered with good advice. Pay more than the minimum amount on your credit card bills. Invest in RRSPs, TFSAs, and RESPs. And, above all, keep a budget.
Budgets are to saving what diets are to weight loss. To lose weight, “calories out” has to be more than “calories in.” To save, “money out” has to be less than “money in.” The logic behind budgeting and dieting is exactly the same: if you can monitor and control what’s coming in and what’s going out, you will be able to achieve your savings (or weight loss) goals.
Our study explored the savings decisions of 9,899 Canadian households between 25 and 65 using data from Statistics Canada’s 2008 Canadian Financial Capability Survey. We found that a slight majority of Canadians -- 54 per cent -- have a household budget. Most people with budgets say that they usually stick to them, but only a third are always able to live within their budgets.
The question we examined in our study was: do people with budgets accumulate more wealth? We began by looking at the effect of budgeting on the probability of having different types of assets. Are people with household budgets more likely to hold RRSPs, for example? We used a regression analysis to control for the fact that, for example, couples with young children are more likely to budget and more likely to have mortgages.
Having a budget makes little difference to the probability of holding most kinds of financial assets. People who budget are no more likely to invest in RESPs or RRPSs than anyone else. The major difference we found is that budgeters are more likely to have tangible assets -- homes, for example -- and are more likely to have debts. This is over and above any correlation between budgeting and liabilities arising from other factors.
We then went on to consider the impact of having a household budget on the amount of assets held. We found similar patterns: budgeting is associated with having a relatively expensive house and a relatively large mortgage. But in our sample we found no statistically significant difference between the net worth of people who did, and people who didn’t, budget.
On the other hand, people who are always able to stick with their budgets do see an economic payoff. They have significantly lower levels of liabilities than other budgeters, and are more likely to hold financial assets outside of an RRSP.
Financial solvency is simply a matter of “money out” and “money in.” Budgeting helps some people control their money flows -- that’s why so many people have household budgets. But our research suggests that simply having a household budget does not guarantee that a person will be able to accumulate financial, RRSP and RESP assets.
Behavioural economics can explain our findings. Even with a budget, most people find it hard to resist temptation. Yet people can do things to change their own behavior. For example, the new Pooled Registered Savings Plans allow for automatic savings via payroll deduction. This works because it is the financial equivalent of putting the potato chips on the top shelf, or banning them from the house entirely -- if you can’t see your money, your aren’t tempted to spend it.
So, while having a budget can help, spending your free time at the mall and hoping to stay within budget is like spending your free time at the pub and hoping to lose weight: it just is not going to happen. My advice for financial literacy month is: Don’t go shopping.
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