Get Rich by Thinking in Buckets
How adopting different mental accounts for your money can take you one step closer to financial independence.
It doesn’t take much reading in the personal finance blogosphere before you come across the envelope method of budgeting. MoneySavingExpert Martin Lewis is a strong advocate of this proven way to control spending and consciously allocate your income. This article will look at how you can bring the technique into the 21st century and some of the underlying psychology of why it works.
What is the envelope system?
The process is simple at the start of each month you draw out the money you think you will need to meet your monthly commitments across various categories including bills, groceries and entertainment. In 2021 unless you are a tradesman it is unlikely that you are being paid in cash. However, don’t despair with a little forward planning and upfront work you can tweak the strategy and make it work as a PAYE earner.
Monzo
I’m a big fan of Monzo so much so that I invested in the late-2017 crowdfunding round where it raised a whopping £2,470,780. The company has a great platform and a philosophy to match, all built around making mastering personal finance simple. They even write in plain no-frills English.
The app has lots of features. It is a couple of clicks to pay a contact which means no more fumbling around for account numbers and sort codes. But our focus here is Monzo Pots. These allow you to split your money into mini-accounts. Think of it as a smaller version of savings accounts at your brick-and-mortar bank, without the paperwork!
You can read the full guide here but in a nutshell, there are four steps:
- Balance your budget. Basically, this is where you bite the bullet and check if you are spending more than you earn.
- Choose your categories. Shopping, holidays or the particularly fun if you are self-employed. Tax. (There is no limit on the number you can have.)
- Decide on how much you want to spend in each category.
- Create your virtual envelopes.
This method is effective from the get-go because it focuses your attention and makes you mindful of where you are spending. Where your LifeEnegy is going. The clever folks at Monzo have also added the ability to lock pots adding another element of friction to protect you from overspending.
A by-product of the method is that you maintain a low current account balance. It is easy to find your salary stack up each month and as this figure grows often our spending increases also known as lifestyle inflation. £1000 or so available balance will provide a natural mental handbrake on your discretionary spending. It also means that those Little Green Men can work harder for you in your savings or investment accounts.
Ditch and switch
For years the High-Street-Banks thrived on the inertia many customers had for shifting bank accounts. They made it as onerous as possible to switch, eventually, the government stepped in and implemented a guarantee that current accounts are moved within 7 days. To date, 6 million accounts have been switched and 40 banks are now playing ball. The last 5 years have seen the arrival of so-called ‘challenger banks’ like Monzo, Starling and Revolut. There is now little excuse not to switch.
The app only banks allow you to take the envelope system a step further. Here is what I do:
I have accounts at three different banks and three different debit cards.
Bank A I use for essential spending things like the mortgage, cash withdrawals and yes, toilet rolls.
Bank B is used for discretionary spending.
Bank C money earmarked for my latest side hustle.
I’ve created physical accounts which mirror my mental accounts.
Here’s what Claudia Hammond says:
Economist Richard Thaler who developed the behavioral theory nudge suggests that we have different mental accounts. We assign different characteristics and purposes to different portions of our money.
This is something we can all relate to — money in our emergency fund is different from spending money. A £10 which falls out of a card from granny feels different to a note from the cash machine.…’’
She goes on to illustrate this with gin. Organising a party at home? You will nip out to the supermarket and pay £20 for a bottle at the very most. While a couple of weeks later on holiday in the Algarve you will agree to pay half that for a single small glass. You don’t resent the mark-up because the money is coming from a different mental account.
Giftcards
Let’s dig into an example from my own life. A good friend of mine recently hit ten years in his finance job. His reward for length of service was a £250 gift voucher. It got me thinking, why a gift voucher? After all he could spend regular cashmoney on anything, chose to invest it or overpay his mortgage. Instead, he was confined to spending at John Lewis, Decathlon or Sainsburys.
Naturally, we discussed where the gift card was going. Groceries were immediately ruled out- which if we think about the above makes perfect sense. Food shopping is essential spending and often mundane, (Even with the middle aisle at Aldi).
Rightly so the gift card balance is earmarked for a yet-to-be-decided treat ideally something to crystallize the hard work and endurance of a decade at the major firm. The company understands this on some level. Even a larger amount in his monthly pay packet wouldn’t feel as special as the gift card*.
Do you already think of your money in different mental pots? I’d like to hear if adopting this strategy has been helpful to your wealth-building quest. Feel free to drop me a message.
*Giftcards for a single restaurant or retailer make rubbish, birthday, Hanukkah or Christmas presents as we have seen recently- large retailers can and do go bust. In any case, I still love getting book tokens!
