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Are you like one of the millions of Americans that hit the Tax Refund Lottery?!?
Swwwwwweeeet! But now what?
I am NOT going to talk about how you should adjust your withholdings so that you have more money in your paycheck each week but let’s talk about what you CAN do with this winfall…
First a warning… we are going to go SERIOUS BUDGET NERD in this article…
You can abort now…
Ok I really didnt make up that word. I PROMISE…
Fungibility is the idea that money has NO labels and can is interchangeable. That means 10 dollars is worth 10 dollars regardless of how you received it or lost it.
The problem is that people have developed this process called Mental Accounting.
What is Mental Accounting?
Mental accounting is an economic concept established by economist Richard H. Thaler, which contends that individuals classify personal funds differently and therefore are prone to irrational decision-making in their spending and investment behavior. Mental accounting is subject matter in the field of behavioral economics.
Wait! Say what?!?
Yeahhhhh….Let’s break this down a bit.
People create imaginary buckets of money in their head. Even though 10 dollars is equal to 10 dollars, because money is fungible… People don’t tend to see it that way.
Take for example an experiment done by Thaler in 1983… I know 1983… Dinosaur days!!!
He asked people one of the following questions:
You set off to buy a new radio. At the store where you expect to buy it, you find that the price is $35. A clerk informs you that the same item is available at another branch of the same store for only $25 dollars.. The store is a 20-minute drive away and the clerk assures you that they have what you want there. Do you buy here or go to the other store?
You set off to buy a new tv. At the store where you expect to buy it, you find that the price is $650. A clerk informs you that the same item is available at another branch of the same store for only $640. The store is a 20-minute drive away and the clerk assures you that they have what you want there. Do you buy here or go to the other store?
From a money standpoint you are saving the EXACT same amount of money… but guess what?
The majority of people responded that they would drive to the other store for the Radio but NOT for the TV. People had the perception that they were getting a better deal with the radio versus the small amount of savings they were getting on the overall cost of the TV.
So what does this have to do with my Tax Refund Lottery???
Well a lot actually.
To MOST people, when you get your weekly or biweekly paycheck you create some sort of budget in your head. You know you need about 100 dollars or so for food, 50 dollars for gas, etc. The most extreme people even WRITE DOWN a budget… hint hint…
Anyways. We generally know how much money we are going to have each week and have an idea how it’s going to be spent.
Then we get a tax refund….
Wooooo Hoooo FREE MONEY!!!
Honestly that’s how a lot of people look at windfalls such as Tax refunds, lotto tickets, and some amounts of inheritance. What Thaler found was that if people looked at the windfall as a small amount of money then people treated it as extra money or “free” money but if it was a large amount, people tended to invest it.
Let’s say for instance you received $2,000 back from your taxes.
That $2,000 is NO different than $2,000 dollars earned. But in your head you label this as “Extra” money or “Free” money. Money that doesnt have a purpose so it cant be spent on ANYTHING.
Why this matters?
You see. Businesses understand mental accounting WAYYYYYY better than you and I ever knew. Not only do they understand mental accounting they MARKET to it!!!
During tax refund season look at all the advertisements that INCLUDE mention of your tax refund. From cars to appliances, everyone is trying to put a label on your new “FREE” money.
Here check out some of these ads:
First step back and look at your tax refund.
Hi tax refund!
Transfer the entire amount into your savings account.
*Now if you have bills that you need to pay, please PAY them off! Dont just blindly follow some guy on the internet…
Just like the business and stores trying to get your money, putting your money into your savings account does a similar thing in your brain. It puts a label to your money. When you transferred the money into your savings account, your brain mentally transferred that from FREE to SAVINGS.
And guess what??
Its WAYYYYYY harder to spend money in the SAVINGS category on useless crap you dont need.
I am not saying DONT spend your savings because honestly that it was savings is for. You are saving for “something”. But by putting it into savings forces you to think about how you are going to spend your money rather than treat it as “FREE” money.