Bitter Money & Christmas Clubs - Mental Accounting

Bitter Money, Christmas Clubs - Forbes.com article discusses the odd mental gymnastics we put ourselves through to rationalize spending, or saving in particular ways. We see money in vastly different ways based on where it came from and to what use we wish to put it.

The article starts by discussing the Kenyan tribe of farmers known as the Luo and how they label money as "bitter" to differentiate where the income originated and how it can be spent. The author introduces the idea of the Luo in which they believe that "bitter" money must be ritually purified before it can be spent or the purchase will lead to disappointment or loss.

Next comes the concept of "Mental Accounting" which applies to all of us.

In the words of the behavioral economist Richard Thaler, we engage in "mental accounting," putting our money in different accounts based on how we earned it, how easily we can access it, how long we've had it and so on. And that process of mental accounting ends up having a profound effect on the way we spend and invest.

So if we suddenly inherit large sums, win the lottery or receive substantial cash gifts, we are dramatically more likely to blow large sums on things that we previously would have considered outrageously extravagant or even foolish. If we earn money in illicit ways, we are more likely to spend it foolishly.

If we ask the bank to purposely withold money for non-interest bearing Christmas club accounts, we are losing interest, but accept that in order to to have access to that forcible savings only at Christmas - because we don't trust ourselves to save it otherwise. The bank wins because we have no willpower to control our spending.

Americans purposely have the IRS withold more taxes than they owe simply to be guaranteed a refund at the end of the year. We give the government an interest free loan, again - because we lack the willpower to save. This despite the fact that banks also offer to automatically save for us in all manner of other ways that include interest income.

The concept of "Pay Yourself First" has been discussed for years by money gurus and financial advisors. But few of us seem able to convince ourselves to do so, despite the obvious advantages. We rent instead of buying, we use credit cards instead of waiting until the money is saved to make major purchases and we insist on accepting poor terms in nearly every financial transaction in order to convert them to "small monthly payments".