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Taking Advantage of Mental Accounting

I was asking my buddy N. how he invests his money and stays on track with savings. As a successful owner of a startup he is a little less worried about 5% investment returns, his sights set on bigger goals. Nevertheless, I learned that even at his level he was setting money aside and needed to use some mental accounting tricks to maintain his goal of saving.


Mental Accounting

Mental accounting his how we keep track of numbers such as the balance of our checking account, how much money we have in our wallets, and our net worth.

I’m obsessed with these numbers and I still can’t tell you accurately how much money I have in each of my investment accounts and which particular investment I hold.

However, one thing that I learned a long time ago is to constantly move money out of my reach so that it disappears from my mental accounting.

If I take $1,000 and invest it in my brokerage account then it’s no longer in my checking account and I will no longer miss it.

Proximity of Money

One recent thing I did which will probably help me in the long-run is that I got rid of Personal Capital. I will now go back to my old mental accounting model and only keep track of the money which I have the most immediate access to.

In this case, it’s my checking account. I pay my bills out of there, buy my coffee with that account, and my earnings and income is deposited there.

This checking account has a balance of around $10k. Right now it’s sitting at around $19k only because I’m a little uncertain as to where my income might come from in the future.

False Sense of Security

Another problem with having a large revolving checking account balance is that it gives you a false sense of security. With a lot of money in your checking account you might think that you are doing fine financially.

It’s the classic poor-person problem. As soon as a lot of money comes into the checking account, a poor person will feel like they are doing well financially. They then will spend more because their checking account balance is higher and save less because they don’t feel the need to save with a high floating balance.


Keeping a Lean Checking Account

I asked N. how much he usually has in his checking account and he said it floats somewhere around $4k. This dude has thousands of dollars coming in and makes million dollar deals but only keeps <$5k in his checking account.

The reason he does that is that all things flow into his checking account. He knows that if he doesn’t move the money out of easy reach and into an investment, he will spend it. In fact, he used the term mental accounting to explain to me why he keeps his checking account low.

He has several automatic investing algorithms built which means that as soon as some money comes in, it gets invested in a particular fund or goes to another account which he tries to build up in order to meet a minimum investment level.

He wants to feel just a bit of financial stress to push him to invest.


Financial Stress

It can get a little stressful if your checking account is uncomfortably low but apparently that’s what serious investors do.

They understand that they need to feel a bit of financial pressure or else they will take the path of least resistance. A $15k checking account balance gives you a lot more wiggle room but means that $10k is sitting around idly collecting dust.

Buffer Amount

The more you spend from your checking account the more of a buffer you’ll need. But if your spending is predictable, as in, mostly bills, then it’s still possible to account for the money with a buffer amount while still diverting all extra cash to an investment account.

If you have a lot of spontaneous spending such as dining out, shopping, and spending on entertainment then you need an ever larger buffer amount.

It might feel stressful to run your checking account very lean. But someone recently taught me something very interesting. They said that it’s okay to force some stress on yourself as long as your mind knows that it’s merely perceived stress.

For example, if you have a $300k investment account but you’re running a lean $4k checking account, then sure, you’ll feel some financial stress. But your mind can resolve this. It knows that you have plenty of cash overall so the stress doesn’t affect you the same way.


Automatic Investing

My financial advisor is happy to know that I invest $250 into my brokerage account automatically every week. It may not seem like a lot but $1k invested every month could grow to $700,000 over the next 25 years.

I don’t feel this $250 at all. The only time I notice it is when I go to reconcile my YNAB budgeting software. And I am pleased knowing that I am doing something good for my financial future.

In order to keep myself motivated, I do check on my investments from time to time. Just enough to evaluate my performance but not so much that I mess with my mental accounting model.

I would recommend being much more aggressive with your automatic investing, especially if you have more predictable income coming in regularly and aiming to retire early.

Back in 2013 I had automatic investing amounts of $5k every 2 weeks. At times I pushed it too much and my checking account got way too low for comfort. There is a fine balance and you’ll have to figure that out for yourself.

The point is to have the money disappear out of your checking account and leave your mental accounting.

Investing Accounts

I have $250 go towards securities investments every week but I also set money aside regularly to invest in other ventures. But this hasn’t been as successful because I raid such accounts regularly.

From talking to N. I learned that it has to be a one-way flow. The money you transfer regularly to an investing account should never flow back into your pockets unless it comes to you in the form of an investment return.

For example, you might have an investing account such as a savings account with an online bank in order to have enough money to invest in a hedge fund or a real estate deal. Once you reach the minimum you need, you should invest the money right away.

So it’s not just automatically transferring money out of your checking account but also taking the next uncomfortable step of doing the actual investing.


List of Investing Accounts

From talking to N. and another friend we met up here in Barcelona, it seems that money should be set aside for all sorts of different investments. Here are the things that I could identify:

  • money to go into a CD account
  • money to go into securities investments
  • money into a savings account to have available for real estate investing
  • money set aside to invest in learning (courses, conferences, classes)
  • money to invest in weird speculative shit (cryptocurrencies)
  • money to invest in private businesses
  • money to invest in intellectual property development (books, music, art)
  • money set aside to start your own business

From making this list I realize that I have a good idea of what I have needed to do and have taken some steps towards execution but have been a little timid about pulling the trigger.

In the past, I’ve gotten distracted too easily by other events in my life. Moving forward, I will try to continue moving money towards various investment ideas and take advantage of mental accounting.

But, more importantly, I’ll give myself a little more of a friendly nudge to actually invest the money once iI hit my minimums.

Previously, if I saved up $30k to use as a down payment for a real estate investment, I would raid it and put it towards another investment – whatever seemed easier, offered less resistance. This throws off my global asset allocation plans which I will remedy┬áby utilizing the mental accounting trick more.