Saturday, June 25, 2011

Budgeting: Part 25: The Cherry Picking Fallacy

"There are two kinds of statistics: the kind you look up and the kind you make up."
- Rex Stout

"Statistics are no substitute for judgment."
- Henry Clay

(This is the last post in this series where I am walking though 12 different examples of household budgeting mistakes and how they can all be corrected with accrual accounting techniques. Accrual accounting recognizes income when it is earned and expenses when they are incurred. An alternate definition is that accrual accounting records events that change your net worth.)

The symptom:
Anything under budget target is free money.

The example:
Your local sports team is doing well and has made the playoffs! Suddenly you think how much fun it would be to actually attend the playoff game. The only problem is that a ticket is $150 and you don't really think you can afford that. So you sit down with your budget to see if you can find some savings. You notice it's the 25th of the month and so far you're under your monthly budget in a few categories. You're $60 under for food, $30 under for gasoline, $40 under for haircuts, and $20 under for household items. You reduce your budgeted amount in each of those categories for this month and then resolve not to buy anything in those categories for the next 5 day. Problem solved. Now you have $150 for the ticket. It didn't turn out to be so difficult after all.

You probably recognize the above reasoning as nothing more than cherry picking of budgeting numbers. On any given month, many categories are over their target and many are under their target. Taking a slightly different perspective, half the time the monthly grocery bill will be over target and half the time it will be under. But when we need more money, we tend to focus on all the good numbers and forget the bad ones.

Looking back over the past dozen posts, you can see many variations of cherry picking. We look at the inflows into one account and ignore the outflows from another. We crow about the categories under budget and brush off those over budget. We highlight the time periods of low spending and dismiss the periods of high spending. In fact, it's quite easy to imagine all of our finances are doing well as we create a "parallel universe" budget where we isolate gains and integrate losses.

Accrual accounting is designed to normalize these numbers so that realistic comparisons can be made. This helps avoid cherry picking. It's true that one could simply analyze the numbers a little bit and conclude that all is not well, but human nature seems to want to spin these numbers in a positive light. Not having cash flow outliers from which to cherry pick increases the chances that we will be honest and objective about our finances.

And again, I would point out that even if you don't formally use accrual accounting for small budget items, you can still improve things by simply thinking in accrual terms. In the example above, you know that you are consuming a certain amount of food and gasoline and household products each day. The price of the items you consume is your cost in accrual terms and is probably relatively constant. It certainly doesn't change just because you happen to eat everything in the refrigerator during the last week of the month or wait another week to stop at the gas station.

Hence, if you think in terms of the accrual numbers, you won't be tempted to imagine that you "found money" or "cut your budget" by not going to the store for a week. If you didn't decrease your consumption, you probably didn't save any money relative to your budget baseline.

And that concludes this whole accrual accounting rabbit trail I've been on for quite some time in these very infrequent posts. I've personally done about as much writing on accrual accounting as would like to do for one lifetime!

1 comment:

  1. Excellent article. I am one of those that often do cherry picking on my budget to afford me some "luxury", that obviously I can't afford. :)
    After reading your article, I realized the reason why I always couldn't save enough, or save any.
    Thanks a lot. This is truly helpful. :)


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