Last year, my wife and I bought a run-down old house. Termites had eaten through the main joists of the house, cracks ran through the brick walls, and the wallpaper was what we affectionately called “1960’s Burlap”. It was once a beautiful place – but that time was long ago. It took us about six months before it was habitable and we could move in. But the work to fix it up hasn’t stopped.
A few weeks ago, we added up all of the money we’ve spent on our home after we moved in. Home related stuff from Home Depot, Lowe’s and Costco ate up more money than all of our mortgage payments so far. Ok, we set aside money for repairs, and the mortgage isn’t too bad because the house was beat-up. Still – it was more than the mortgage.
I’m not talking about buying gold plated chandeliers. I’m talking reasonable, fix-up-your-house stuff. So, what the heck was going on? We kept track of it all in our heads, and we thought we were doing just fine.
In retrospect, here’s what happened. We tried to aside one of our credit cards for home-related purchases, so we could better track them (good). We made a list of the major things we wanted to do to repair the house (good). We then started from the top of the list, and went to Home Depot (or wherever) to get what we needed. When we got there, we saw lots of Cool Stuff. Kitchen Furniture. Curtains. Power tools. Toilet Seats. We remembered our list, found that almost everything we saw in front of us was somewhere on the list (bad!). Then, we tried to remember what we’d bought recently, which never seemed like a lot (bad!). And so we picked up the new supplies – and a nice big credit card bill too.
We forgot about mental accounting.
“Mental accounting” means the tricks and shortcuts our brain uses when dealing with money. The mental accounting literature (and the broader behavioral economics literature), for example, warns us that we’re bad at accepting the true cost of our purchases: we don’t clearly consider what we’re losing by not using the money for something else or by saving up to buy it later. But, most importantly for the moment, we’re just not that good at adding up lots of small things in our heads, especially when it means remembering them first. We remember the most vivid things we’ve bought (that pneumatic nail gun!) and not all of the little stuff.
The problem isn’t just that remembering small purchases is difficult; it’s that we often don’t realize that we’re not remembering everything correctly. Ever been surprised at how much you spent on a trip, or on groceries, or even on Christmas presents? That’s our mental accounting playing tricks on us.
Here are some techniques that can help fix our mental shortcuts, based on the behavioral economics literature and our experiences here at HelloWallet:
- Set a clear limit. That may mean a “budget”, or it may mean an envelope that holds your cash. Either way, provide a clear bright line to tell you when you’re ok, and when you’re in trouble.
- For day to day tracking, don’t try to remember it all it. Use an electronic tool, especially one that adds up the purchases automatically. There are lots of online tools for this stuff (HelloWallet and others), but an excel spreadsheet works fine too if you record every purchase immediately.
- Speaking of which, don’t rely on remembering to check your budget. Have your budget remind you when you’re in trouble. (That’s one cool thing HelloWallet does well).
- Use separate accounts for separate purposes, when possible. Mentally, we think of money as having specific purposes ($ for the kids, $ for fun, etc.); if you reinforce that with your bank accounts and your budget, that helps.
Ah, one more thing. Repairing a beat-up old house costs a whole lot more that you’d think. But it’s fun, too.