How To Put Your Money Into The Right Boxes
We treat money differently based on the source of its inflow, and the purpose we assign to it. Here’s how to tackle that bias.
When young Geeta Phogat started winning dangals and collecting prize money, her father, Mahavir Singh, kept the money in a file in order to celebrate her victories. While the amounts were small, the emotional value was enormous.
Mahavir Singh’s behaviour was not surprising. One tends to get emotional about such things. However, keeping the money in a folder may not have been one of his best ideas. Mahavir Singh needed quite a fortune for his daughters’ training. And that money could have helped him.
We tend to treat money differently based on the source of its inflow, and the purpose we assign to it. In Mahavir Singh’s case, since it was prize money won by his daughter, he treasured it greatly. On the other hand, money won in a lottery is often squandered easily.
It speaks of a bias that mentally compartmentalises money that comes from different sources of income, and assigns it to serve varying outcomes.
The objective here is not to criticise Mahavir Singh or many other parents like him; but to highlight the fact that such a bias exists. Whether it is good or bad may depend on a specific situation.
Let us look at two examples, when this works against the interests of an individual, learn how to avoid such biases, and turn it into a thought process that works to an investor’s advantage.
1. ‘Sudden Money’
The money that we win at a lottery or comes from an unexpected source is called ‘sudden money’. Most often, this goes directly to the ‘leisure or entertainment money’ box in our head and it is splurged in the most unnecessary ways.
While winning a lottery is a rare event, some people treat a salary hike, a bonus or even money coming from the sale of a property in a similar way. A few even put money received as an income tax refund in the same mental box. This blurs the line between one-off ‘sudden money’ and that which is a step up a ladder.
An income tax refund is a refund of the excess money that we had paid to the tax department. It is not a sudden, unexpected receipt of money.
A recipient of sudden money usually gets euphoric, especially when the sum received is large, as the bounty was unexpected. It is this euphoria that leads one to see this money differently. A wise approach would be to immediately put it in a short-term fixed deposit, say for a month or so. This way the immediate euphoria will wane and buy you time to think about what you eventually want to do with it.
A salary hike is often well-deserved and the same should be treated at par with your regular income. Such an occasion is an opportune moment to either sign up for a systematic investment plan, or add a top-up option to an existing SIP. This feature immediately notifies your fund house to increase the SIP by a fixed amount or a fixed percentage. Since, features differ for different products, it is always advisable to check with your fund house before you put the money in. Also, you can meet with a financial advisor who can take stock of the situation and help you take an appropriate course of action.
2. Product Bias
The second example pertains to certain investments and insurance products available in the market. These assets are relatively illiquid compared to the cash-flow changes just discussed. But like the earlier examples, it is important to anticipate any bias that may creep in.
Often, people end up buying investments products without evaluating alternatives, or without checking their suitability to specific financial goals. For example, several schemes come with a long lock-in period, taking away the liquidity the investor may desire from that asset. This ensures that the money cannot be touched before the maturity date, allowing the investment to work over a period. While this may sometimes be a good idea, when the scheme does not perform to one’s satisfaction, the investor is stuck with an inefficient product.
A few years back, several insurance companies launched child plans that typically looked like life insurance products. Children don’t have any income, and no one is dependent on them, so life cover for a child is not quite required.
Now, if the same product is bought with a goal in mind, then it can be used to the investor’s advantage. For example, if a parent buys a child plan to support his/her child’s higher education, then the investment is not hurt or disturbed by short-term distractions. Such distractions could be on account of sudden leisure-related expenses, or even adverse market movements. This would help the money grow in the longer term. Many financial advisors recommend such an approach. They guide their clients to invest towards a financial goal.
Many psychological biases are a result of the mind taking short-cuts. A clearer thought process about the nature of any change in the money we make, and what we wish to do with it, helps put it to better use.
Amit Trivedi is an author and trainer, owner of Karmayog Knowledge Academy and author of Riding The Roller Coaster, Personal Finance Lessons from the ICU, and The Whole Thing Is That Ki Bhaiya Sabse Bada Rupaiya.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.