by Dr. Charles Alonzo Peters
With the April 18th tax deadline gone, many of us are now anxiously awaiting the arrival of handsome tax refunds. In the US, the average refund check will approach $3,036, but experts agree that much of this money will be spent frivolously.
To understand why, we must realize that our brains are wired to make mistakes with money. Take the concept of mental accounting, for instance. As humans, we spend money differently based on where it comes from.
Rationally, we should treat all money equally. Money is money, isn’t it? But a funny thing happens. Because of mental accounting, we’ll splurge with “found” money, but deliberate more carefully before spending “earned” money.
This explains why as kids, birthday money burned holes through our pockets. We’d rush to spend it, often on the most outrageous or ill-advised purchases.
We’ll pick up five dollars off the sidewalk and consider it “found” money, spending it much less carefully than the $5 we earn from our job.
If someone gives us $50 for our birthday and we have a past due credit card bill, very few of us will use the birthday money to pay the bill. Mental accounting tells us “found” money can be spent impulsively.
In the same way, behavioral economists warn that income tax refunds are frequently viewed as “found” or “free” money, explaining why so many flat screens, iPads, and vacations are purchased in late April.
But we can fight mental accounting by simply realizing that our tax refund is not “free” money after all. I know. Easier said than done. If you’re like me the temptation to have a little fun is too great. Of course you tell yourself you’ll set a little aside for the bills, pay off some debt, or invest. But let’s have a little fun first, and before you know it the money is gone.
But think about it. Your tax refund is not a gift, but money you’ve actually worked for. It just took a long time for you to receive it. If this doesn’t work, try these:
- Consider applying your tax refund to a constructive financial use immediately. As soon as your refund hits your bank account or you receive the check in your hand, immediately pay off a credit card bill or other debt. Fight the urge to splurge.
- Pool all of your money into one account. Combine the mental accounts you have in your brain. “Found” money like your income tax return should go into the same bank account as your paycheck, where it all can be “viewed” as “earned” income.
- Conversely, experts advise that if you don’t use your refund immediately, wait as long as possible before spending it. The longer you have the money in your possession, the more your brain perceives it as “earned” income.
BMWK, what are some of the ways you’ve learned to keep from wasting your income tax refund?
Every Monday you can find great insight and tips on managing your greenbacks by Dr. Charles Alonzo Peters of MochaMoney.com here on BlackandMarriedWithKids.com.