Would you pause before spending $1,000 dollars from your paycheck on a weekend getaway? I know I would.
But you would probably be more likely to splurge on that trip if the money came from your tax returns.
It’s the same amount of cash either way, but it doesn’t feel the same because people tend to value money differently based upon where it comes from.
A paycheck feels hard earned while tax returns almost feel like a gift.
Nobel-Prize-winning Economist Richard Thaler named this cognitive bias “mental accounting” because people tend to categorize money into multiple accounts in their heads based upon where funds come from.
It’s irrational and we are sometimes irrational creatures, especially when it comes to money, but by turning mental accounting on its head, we can use this bias to our advantage.
This is why creating a budget capitalizes on our natural mental accounting tendencies. By categorizing our expenses, we make it more difficult for us to misallocate them.
We might hesitate before a big purchase if it means dipping into our Christmas savings. We are more likely to stop eating out if we know it’s coming from our car payment.
I use Excel to allocate my savings into budgeted categories, but there are a bunch of other online tools that you can use.
The next time someone asks you what the value of a dollar is, ask them where it’s coming from. I’m willing to bet the money you set aside for rent is worth more than the money you set aside for shopping.
Adam Lucas holds a Finance degree and an MBA from the University of Kentucky. His work has appeared in many major outlets including AARP.org and GoBankingRates.com.