I talk a lot about the psychology of money. The reality is that no matter how much something makes sense mathematically, it just may not work for most people because money isn’t just something we move around on a spreadsheet.
One of the most common questions I see are in the form of “What should I do with $5,000,” or “How should I invest $3,000?”
The answer is to put it in your savings unless you currently have enough money saved for your emergency fund and short-term goals, otherwise, put it in one of your investment accounts.
People don’t like this answer. Why? Money psychology.
Use More Accounts to Save
One of the problems with money on a personal financial level is that it comes and goes so easily, often without really noticing or appreciating it.
Consider a man (or woman) age 35. He earns $120,000 per year, has a mortgage, a car payment, some nice hobbies and he puts money away for his kid’s college and his own retirement. Honestly, that’s pretty great and he should be (and is) pretty happy.
Financially speaking, this means that each month he earns $10,000. His company takes out $5,000 for taxes, insurance premiums, and his 401k contribution. The remaining $5,000 get direct deposited to his checking account. From there, $2,000 goes to the mortgage, $300 goes to a car payment, $250 goes to his kid’s 529 college account, another $200 goes to utilities, then there are groceries, fees, classes, meals out, movies, golfing, fun, and… the month is over and he drops a few hundred dollars into savings. The details change a bit here and there, but for the most part, this happens every month.
Now, one day, something different happens.
Maybe, he gets a bonus. Maybe, he sells an old motorcycle. Maybe, he just looks up his bank balance and realizes that he doesn’t really need $30,000 in the money market account. Whatever it is, he has new money, different money. As a result, he wants to do something different with it.
This is where the psychology kicks in. No matter where our guy or gal puts that money, it can do something different. But, the reality is that our lives seem to absorb those differences pretty quickly, and the physiological fear is that the money will not bring any “extra” to his life; it will just be gobbled up with a few extra meals out, a big bar tab, or new toy, when it could be… well something else.
This is where additional bank accounts can do wonders.
For many people, saving money is like throwing money into a hole. It’s a smart thing to do, and it will be there for you when you need it some day, but it really doesn’t do anything, and really doesn’t give you anything. That can be unsatisfying.
Now, imagine that there isn’t just A savings account, but a regular savings account (you know, the responsible adult one), and a vacation savings account.
The reality is that there is no need for a vacation savings account. Money is money, and the money spent on a vacation can come from a regular account or a “special” account without any actual difference. But, mentally, the presence of a vacation account changes the accounting.
Now, that trip to Hawaii isn’t an irresponsible use of the adult savings account, but rather, a perfectly acceptable, frankly expected, use of the vacation account. This makes all the difference in the world.
What happens in this scenario is that now, when our hero gets that bonus, or sells that motorcycle, or whatever else, then the $3,000 windfall has a home. The vacation account means that the money won’t disappear. It will be used for something tangible that can be seen and anticipated. People in this scenario are actually very likely to only put some of the money into the second account. Just knowing that there will be a special reward reduces the need for it to be specially used.
Budgeting and Rewards
You can use this bit of personal financial psychology to help with your own savings and investing. Most banks, or credit unions, will let you open another savings account for no charge. Some of them will even allow you to change the name of it using online banking. Use this second account to work toward your short-term goals. A vacation account is one option, but also an account for a new car, or for a new living room set work too. Change what the account is for whenever you reach your goal.
Need to saving for multiple things at once?
Get another account. I prefer having all of my accounts at one credit union because it allows me to transfer money between them easily. However, for some people that is an issue because they find it too easy to raid the accounts. In that case, get another bank to make it harder. (Sometimes that makes it harder to put money in though, so consider that as well.)
The best part is that by putting money into your goal account you are budgeting, without ever touching a spreadsheet or personal finance computer program.
Try adding a special account for yourself. If it answers the question: What should I do with this extra $2,500, then you know you have it right.