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Ahh so THAT’S what it’s called… “Mental Accounting!”

by J. Money on Tuesday, November 16, 2010

Saw this in Kiplinger Mag and didn’t realize there was a term for it :) I’ve been a poster child for “mental accounting” for the past 3 months! (more on that in a sec). Here’s how Kip explains it:

Mental accounting leads us to hoard money in a savings account that earns 0.3% interest while keeping a high balance on a 15%-interest credit card. We like the psychological comfort we get from having money in the bank, even though transferring cash from savings to pay off a credit-card balance can essentially “earn” us a quick 14.7%”

Or, in my situation, keeping a $1500+ balance on your credit card when you can very well pay it off from your savings ;)  For those who’ve been following my net worth updates you know exactly what I’m talking about.  Esp those who have been challenging me on it each and every month! Haha…

But there really is something to be said about that “psychological comfort” of it all. I am MUCH happier knowing I have more money saved up in the bank for whatever I want, even if I have a little debt on the side.  I feel like it gives me more options ya know?   Once you pay off that debt, the money just evaporates – even if it does save you 4.78% over time. But when it’s sitting in your savings, your possibilities seem so endless!

Of course, I’m not advocating never paying off your debt either (that would be plain stupid), but I just don’t think it’s the end of the world if you choose to mentally divide it up like that. Who’s to say you won’t change your mind next month anyways? We all work our own ways and can’t always expect to pick the most financially savvy paths all the time. Our emotions are there for a reason. – they keep us balanced :)

What’s something you’re currently doing that might not make the most sense? (But you keep doing anyways because it keeps you sane?)

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PS: I’ll give you another quick example of something I do — I tend to think my blog money is worth more than my other money, even though I know very well a dollar is a dollar is a dollar!  It just feels so much more earned than, say, my 9-5 dollars ;) Oh, and also my xmas/bday money.  I can never spend it on things that don’t feel special to me (like groceries, utilities, etc etc)always gotta find something worthy to use it on


{ 22 comments… read them below or add one }

1 Geoff November 16, 2010 at 7:28 am

I can understand the desire and comfort of plain hard cash. We’re doing the same thing with our mortgage prior to our plan of selling at a loss so we can buy a bigger place. We’re racking up a lot of cash at a really low interest rate instead of paying toward the mortgage at a relatively large interest rate. Even with the mortgage interest deduction, it’s quite an interest rate differential. What we are trying to decide is if it’s wiser to have more cash on hand or if not, how much cash to get approved for the new loan next year. There is also the slim chance of system wide mortgage principle reduction so that makes it also a worry to pay toward the mortgage prior to needing to.

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2 E.D. November 16, 2010 at 7:33 am

We’re doing two things we should reconsider even though my husband has been unemployed for 13 months

We haven’t refinanced our 5.5% 30 year mortgage (24 years left and 13 months ahead) into a 7 year fixed mortgage at ~4.0%. We don’t want to spend the cash on the refi and add risk by going to a 7/1 mortgage even though we may have to consider moving away from the Philly area so we can both have a job.

We also have about $20k saved which was earmarked to remodel both full bathrooms. They are hideous and the one that is rarely used has a very slow water leak due to bad tile and grout. If we do end up moving, they will have to be redone. Again, we have a hard time actually spending the cash when he is unemployed, even though we are sitting on a hefty emergency fund and other money (money for a car when his finally dies, etc).

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3 ZFarls November 16, 2010 at 8:42 am

I dont like it, I understand your reasoning but at the same time your throwing money away. You are over thinking the matter and “psychological comfort” is different than actually money in the bank comfort. You still owe the money either way, It makes no sense not to pay it, you still plenty left for an emergency fund.

Automate your systems and think for the long term, that is how people develop large net worths. You have done it well in so many areas, I don’t understand why you can’t pull the trigger on it.

However, I also know that personal finance is only 20% math and 80% behavior/emotion. So, the small amount of money doesn’t really matter, but it just seems inconsistent with the rest of your plan. Maybe that’s too much my inner dave ramsey but you owe the debt money either way and why mess with the CC companies?

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4 ctreit November 16, 2010 at 9:37 am

I am with you. I think of different moneys in different ways even though every dollar is the same. My wife just got a royalty check for a book she wrote a couple years ago. It does not “feel right” to spend this money on groceries or other necessities.

Personal finance is called personal finance because it is personal. Otherwise it would be called “rational finance.” Only classical economists could follow it and then only in theory. I am sure that personal finances of classical economists is also very personal.

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5 Chris Haviaris November 16, 2010 at 9:44 am

Oh J! You are soooo smart in soooo many ways, and yet….sometimes so darned silly! I’m w/ ZFarls on this one. Net/net, money in one pocket and debt in the other is the same as less money period. And yes, you are throwing your money away. Not just on the interest differential, but on the inflated sense of wealth you feel from your little mind trick, which, I think you’ll agree, sometimes leads to spending that wouldn’t have happened otherwise.

All that said, however, I do agree, life is a balancing act and at the end of the day the best you can hope for is to have most of your decisions be the wisest possible. Just seems to me this is one you could score A+ on pretty easily, and save the slip up for something harder :-)

Ok, so my confession…..I often keep way too much money in my checking account, even though I have a very easy linked high yield savings. Like you, I tell myself the diff is peanuts, but sometimes I look and realize it’s not peanuts. Thing is I have everything so automated, that I rarely look at my checking acct….so knowing there is more than I need there makes me feel safe. Ok, so we all have silly tendencies….we do the best we can, no?

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6 Doctor S November 16, 2010 at 11:11 am

This has been a large habit for me over the last few years. I feel so much better knowing I have money in my savings account, even tho I may have 60k in student loans and 1k+ sitting on a credit card somewhere. I guess its the piece of mind that we give ourselves when we KNOW that we have some LIQUID cash sitting around gaining some miniscule interest.

I am the same way as you J$…. I treat the money I make from refereeing like it is gold bullion. I just want to keep it in a safe shoebox so I know where it is at all times!

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7 Burnette November 16, 2010 at 12:40 pm

I used to transfer money from my savings and pay off my CC. However, I soon learned that I never saved anything because I used my savings like a checking acct. Now, my savings is in an ING acct which makes it less accessible, and I have a personal mental max amount that I have for my CC and go on “shopping detox” until I pay it down. But yea, I feel “sexy” when I know I have a wad of cash saved up somewhere :)

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8 Briana @ GBR November 16, 2010 at 1:35 pm

I transfer money between multiple savings accounts. I should just have 1 general savings account, but for some reason, I just haven’t taken the time to do it yet.

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9 J. Money November 16, 2010 at 4:18 pm

@Geoff – I hear that brotha! I struggle w/ paying down the mortgages too – feel MUCH much safer w/ a nice stash of cash in the bank, esp if I’m gonna try and go work for myself in the near future. It’s def. a balancing act that’s for sure. You can always throw money against the debt at any time!
@E.D. – I don’t blame you! I’d hold on tight to that money too if I were unemployed, that’s scary :( Got enough problems to worry about in that case. Hope things get brighter soon!
@ZFarls – It just makes us feel a lot better esp if I’m going to work for myself soon ;) And also we’re only talking 6% here (USAA rocks w/ credit cards! along with my credit score on top of that) so it’s literally a matter of $15 or $20 or something a month. Stupid, yes, but worth the price. At least for now… eventually i’ll get tired of seeing that debt there and then just wipe it out.
@ctreit – Hahah, exactly!! That’s a perfect example of mental accounting :) No way in hell i’d spend my royalty money on groceries!! no way, not in a million years.
@Chris Haviaris – Haha, amen to that ;) We all have our quirks but that’s what makes us unique! If we did everything by the books we’d be boring… as long as we’re doing 80% good we’re fine – the rest is just icing on the cake.
@Doctor S – You know it, sir :) That money we work our asses off for so we gotta spend it on something worthy! Just remind me to search for your box the next time/first time I’m over at your place! Haha…
@Burnette – Damn straight! Cash = Sexy.
@Briana @ GBR – I used to do that a lot then got annoying, haha… but hey, if it works great!

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10 Yana November 16, 2010 at 5:13 pm

I guess I’m a mental accountant.

“We like the psychological comfort we get from having money in the bank, even though transferring cash from savings to pay off a credit-card balance can essentially “earn” us a quick 14.7%”

I don’t know about the psychological comfort, but transferring solid, real savings to pay off a credit card is as stupid as using credit in the first place. When you transfer your savings, you won’t have 100% of what you transfer, and you will definitely not be “earning” anything. Of course, I am not one of much faith, and I’d have no sense of security that the money I transferred to pay off a credit card would ever be replaced. We only know for a fact what we have in our pocket at the moment.

Instead of essentially earning 14.7% by spending away your savings, how about earning triple-digit percentages by not paying off the credit at all? LOL. The devil made me say that ;)

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11 Jenna November 16, 2010 at 6:30 pm

Other than not doing auto bill pay and paperless (I need to get on that), I think I’m pretty good.

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12 Josh November 16, 2010 at 7:33 pm

Think of it this way…

If you had no money in the bank, would you borrow the $1500 at 14% interest just so you could have “options”?

If you say NO, then you should realize that’s just what you are doing now by keeping the CC balance.

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13 Kevin November 16, 2010 at 8:04 pm

I never realized there was a name for it either. I know it makes more sense to pay off credit cards but I am more comfortable with the cash in hand as well. I think its good to have an emergency savings regardless because that paid off loan isn’t going to do much good when you’re in a tight spot (a credit card might though).

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14 WR November 16, 2010 at 10:29 pm

“What’s something you’re currently doing that might not make the most sense? (But you keep doing anyways because it keeps you sane?)”

That’s a tough one. I do a lot of things that don’t make sense.

I have zero CC debt, zero consumer debt (other than a bunch of mortgages but technically those fall under assets of an LLC)

My biggest mistake is probably not delegating. I am currently installing a wood floor, writing a book, coaching soccer, raising a family and about 1,000 other little things that go along with a job, family, entrepreneurship and life in general. I have been spending lots of time streamlining (i.e selling some assets, aggregating accounts into a single investment house – Vanguard got my vote in case you were wondering ) but my simplification efforts, I feel, are not enough. I need to let go and hire some good help.

As a result, I have neglected the exercise and health stuff (My mental accounting tells me that installing the wood floor is somehow equivalent to jogging 5 miles). Not even close but I tend to let little pressures get in the way of what I know is best for me.

I have found that I need to have at least one or two real, physical projects going on. My job and my business life is built on pixels and ideas. It’s hard to define a solid finish-line. It’s nice to finish a tangible, lasting project. As an example, I recently built a fireplace mantle out of 150 year old barn wood. It was an absolute blast.

@J – btw, the ‘entrepreneurship’ money is better than ’9-5′ money and should be treated as such. Profits are better than wages. All money is simply a measure of value and that money in particular represents Values that you hold dear. Do something special with your blog profits. (I donated $200 this A.M. from some of my business profits. A colleague of mine is running a great charity campaign: Build a well, win an ipad http://www.mycharitywater.org/p/campaign?campaign_id=9627 )

-WR

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15 Cassandra Gardner November 16, 2010 at 10:40 pm

I agree with the thought that there are certain windfalls that should be spent on non-essentials. I receive birthday and Christmas money from family and I feel that this money should be spent on fun things. I understand that if there are pressing bills that are important to be paid immediately, these funds should go to them first. However, I like to consider this guilt free money, meaning I can blow it on a massage or a new dress without guilting myself over the things that it could have been spent on.

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16 StackingCash November 17, 2010 at 2:45 am

At first I was thinking you should never give a penny to those evil credit card companies. Then I read your response saying it was a USAA credit card. LOL! As much as I envy your ability to use USAA, I think your love of the company is a bit to much.

My financial set up would make everyone but the retired cringe. No investments, just strictly cash. Just remember that there is someone crazier than you :) Even though I feel sane…hmmm…

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17 Sarah November 18, 2010 at 4:16 pm

Having money in the bank is about having an emergency fund that you can tap without having to get more debt in the event something were to happen. This way you can avoid the endless cycle of almost paying off your credit card, and then racking it back up for some unexpected expense.

I wouldn’t say put money into a savings account and not pay off your debt, but try to do a little of both.

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18 J. Money November 19, 2010 at 1:08 am

@Yana – Lucky for me I only pay 6% or something w/ USAA ;) Should I be saving it? Of course. Will it make me happier though? Nope. So at that point it doens’t matter.
@Jenna – Sometimes it’s good not to do auto-pay though, like with utility bills (cell phones esp!) and other variable things (credit cards). This way you’re always in controll and will consciously think about it before you go and pay off.
@Josh – It’s true, I wouldn’t pay to have the options, but I’m not in that situation right now. My only two options are “Pay the bill off” or “don’t pay it off” (well, also “pay some off” but you get the point). If it were at 14% for me it would have already been gone. But 6% isn’t enough to justify the lack of happiness.
@Kevin – Yup! Can’t go back to your mortgage company or utility company and ask for your money back. But you’re right with credit cards.
@WR – You are a busy bee!! That’s awesome though. Much better to have too much going on than too little at least for me. And you’re right – I will be using my blog money for something special: QUITTING my 9-5!!! Haha… no, I’m not joking.
@Cassandra Gardner – Yup! I always think my family would be happier if I bought something for myself with their money than pay a bill. Unless I was in loads of debt and would be idiotic of me not to.
@StackingCash – I’ve said it before, and I’ll say it again: I’d marry USAA if it were a chick and I were single! I bet she’s hot ;)
@Sarah – That probably would be a nice balance, eh?

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19 Sarah November 22, 2010 at 4:07 am

What’s something you’re currently doing that might not make the most sense? (But you keep doing anyways because it keeps you sane?)

Mine’s a little different.

I am a full time student, and I come from a well to-do family. I don’t need to pay for tuition, books, rent, living expenses, but I work 3 jobs and take a full load of classes. Why don’t I just not work (or at least just quit 2 of my jobs)?

Because I can’t stand the thought that people think I am born with a silver spoon in my mouth. I don’t want people to think I got anywhere in life just because of my parents. I work dang hard at school and at work because I’ve seen my parents’ work ethic, not because they pay for my grades.

I would way rather have everyone think I’m a poor starving college student than some rich beezy who has never worked a day in her life.

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20 J. Money November 26, 2010 at 1:30 pm

good for you, girl! a strong work ethic is no joke, appreciate you sharing with us :)

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21 Catherine January 26, 2011 at 11:52 am

I never really thought of this as “a thing” but you’re right – we all do that. Or 99% of us do. We’d rather keep some money in the bank than clear our debt. An urge and type of behaviour I’m trying to push against within myself right now. Sure there’s no money in the bank, but the credit card balance is a lot smaller!

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22 J. Money January 30, 2011 at 9:06 pm

yep! pros and cons to both sides really :)

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