Day 8: Step 2

 

MASTER IT

 

Don’t Be a Victim of Mental Accounting


There’s a common money habit to which we all fall prey: mental accounting. Many of us keep running tallies in our heads of how much money we are saving for various things. For instance, say your short-term savings goals are to:

  1. Flesh out your emergency cushion to a full six months’ worth of living expenses.
  2. Pull together $1,200 for your upcoming trip to Belize.
  3. And buy a digital SLR camera so you can take gorgeous photos of your vacation.

If you’re automatically having $200 transferred out of checking and into savings every single time you get paid, brava! That’s a great first step. But mental accounting may lead you to believe that every month, $200 is going to the emergency fund, another $200 toward Belize and another $200 toward the camera. But in reality, $200 per paycheck is only going to one of these goals.

The way to prevent mental accounting from making a mess of your finances is to create separate line items for each goal in your budget and to also set up separate accounts for each goal. As you begin to use your rules of thumb to improve your spending, you’ll start to see even more room available in your budget for your goals. Even now, if you have already committed to spending $100 less a month on, say, dining out, and you’ve figured out a plan for doing so, you can go into Priority Goals and allocate $100 toward one of your goals.

You should also create new savings accounts for each goal if you didn’t do so the other day. If your bank requires a high minimum deposit for each savings account, look for a bank that allows you to create several accounts with a low minimum.

 

GET INVOLVED

  • http://www.facebook.com/robynjenna Robyn Rodgers Klein

    PNC’s Virtual Wallet allows you to make several line items within the same savings account.  Smarty Pig does the same thing, except the added bonus of allotting different deposits to each item.

  • LMT

    When you suggest having a full six months’ worth of living expenses saved up for an emergency cushion, does that mean six months of liquid cash held in a savings account, or does that include savings that you’ve invested?

    • Anonymous

      Hi LMT,

      You are correct. It is six months’ worth of living expenses in liquid cash in a savings account. I’ll update the post to specify that. Thanks for asking!

      Laura

    • Katherene

      I believe they’re referring too six month of liquid cash held in a savings account, and not your savings that you’ve invested.  That’s separate altogether. 

  • Isheeta Thakral

    I live in india but I have been following the bootcamps and they have been
    extremely helpful in streamlining my financial life. iinstead of seperate
    accounts i have created recurring deposits for two of my savings buckets. each
    month a certain amount is deducted from my paycheck and directly debited to the
    recurring deposit. The deposit is set to mature in nine months when I need that
    money and guarantees me a certain interest rate on my savings as well.