Personal Finance in Paradise – Veteran’s Day – How You Handle Your Money: Mindset

How mental accounting affects your spending

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It’s Veteran’s day!

I want to thank all the veterans who have served our country. Thank you for being able to protect the freedom we take for granted and are able to take part of today.

Let’s talk about how we label money affects our buying decisions as some of us shop online and at the stores.

The Scenario

Let’s say this morning you wake up and start the day off great with a good breakfast, and you even got to sleep in. Then you go online and start shopping at your favorite clothing store site. You see a great looking shirt that you think you would look great in, and you buy the shirt on credit. For the moment, it makes you happy, and you don’t give it a second thought because you can just pay it off later.

Later in the day, you go on a hike with a few friends and you have a blast being in the sun. On the way home, you see your favorite coffee shop, and you haven’t had anything to eat since breakfast. You remember that they the best coffee cake. You and your friends decide to go take a peak. Once inside, you find that your favorite barista is working. You ask him to make a large iced caramel macchiato. You have a few laughs with the barista, and he gets your name wrong again on your cup. You pull out your credit card again, and you notice you have a dollar and some change in your wallet. Feeling generous, you place the money in the tip container as you leave.

Then in the evening, you take it easy and you go to a movie with your friends. You have a great day celebrating veterans, sharing some laughs, and enjoying life. Then later in the month you get your credit card statement, and you are confused on why you spent so much. What happened?

Mental Accounting

Why did we decide to go out and spend more money than we wanted? We’ve fallen victim to mental accounting. It is a concept where we treat dollars differently depending on where it comes from and how we have labeled the use of that money. The difference is that when we pay for merchandise with cash or with checks we see immediate consequences. The obvious answer is that that we have less money to spend.

We place less value on money we put on credit cards because we do not see the immediate consequences. At the same time, we don’t see that buying merchandise on credit is more expensive because of the interest that gets charged when we use the card.

Small Amounts of Money

People who have harder time holding onto small amounts of money, like putting small amounts into tip jars, have a harder time saving money. It’s because that the money we have wasn’t labeled for anything important. I”m not saying that you shouldn’t be grateful and tip your barista, it’s that if money isn’t labeled for a specific use, we will find a way to spend it.

Takeaway

To get around mental accounting, place money in accounts that are labeled for a specific purpose. For instance, a savings account, which was marked for the down payment of a house. We would be placing a higher value on the account because it limits what we are willing to do with the money.

Pre-spend money before you have the chance to spend it yourself. Let me say it this way, have your money sent over to a savings account, or investment account before you have a chance to see it in your account. Psychologically it’s much easier to set your money aside this way than by writing a check to your savings or investment account.

Track your spending at the end of the day, and keep a list of your expenses.

Have a great veteran’s day. Please feel free to comment, and let me know if there’s anything you want me to talk about.