We all mentally partition money into “buckets” at least occasionally. There’s the vacation bucket, the entertainment bucket, the car savings bucket, etc. But do those dollars have any idea that they are in those buckets? Of course not.
Meir Statman, well-respected professor of finance at Santa Clara University recently penned an article in the Wall Street Journal entitled, “A Dollar is a Dollar is a Dollar”. In it, he points out that the form of money is often treated differently than the substance of money. Here’s a simple example-are you reluctant to spend “hard earned” dollars like your salary compared to “windfall” dollars like an inheritance? Most people are, but those dollars spend the same and they don’t know where they came from.
In a study quoted by Statman, people who received money from hard work made less-risky and less-impulsive decisions about the money than a group that received a windfall. Rationally, it shouldn’t matter, but it seems to.
We often hear how many investors pigeon hole money they inherit. Maybe the money they got from Uncle Joe is set aside for a house or other good lifestyle enhancement. That type of mental process may be helpful. But to separate inherited money in an investment account can be counter-productive. We hear frequently that a certain stock inherited shouldn’t be sold because Uncle Joe liked it. We doubt whether Uncle Joe’s old stock feels the same way about you.
Even rational investors can get caught up in the framing of money. If a company pays a dividend of $1,000 and you spend it, do you feel better than if the stock you own rose in value by $1,000 and you sold it and spent the money? The company decided when you got the dividend but you decided when you sold. Does that make it different to you? It shouldn’t, it’s the same money, but it’s normal for investors to separate those two pots of money in their head. The pain of regret of selling something only to see it go higher is a common feeling. But if the company didn’t pay the dividend, the stock would be worth more-the same amount as you just sold.
Age of the investor seems to matter. Older investors can recall the days when interest rates were higher than today. Then, investors could make do with just the interest and dividends from their portfolio. Times have changed, and investors should try to avoid their mental biases and change with the times.
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