How To Manage ‘Free’ Money

Since the onset of this recent health and economic crisis, governments around the world have been handing out cash payouts directly to individuals as part of the stimulus packages aimed to help people whose livelihoods have been affected by lockdowns caused by COVID-19.

For those of us affected severely by COVID-19, this money is gladly welcomed as a temporary financial relief during this difficult time.

For some of us who are minimally affected, particularly many here in Singapore, we seemed eager to donate the payout money away.

To quote from the news article linked aboved: ‘Donations on fund-raising website Giving.sg reached a record $13.6 million between April 1 and April 19’. This timeframe was around the time of the payout from the Singapore government.

Why were we so generous? Why were we so eager to donate?

Mental Accounting

A concept first named by Richard Thaler, a Nobel-prize winning economist awarded for his pioneering work in behavioral economics, mental accounting might explain why we are suddenly so generous with our giving.

Mental accounting states that individuals tend budget money into mental accounts for expenses or expense categories. While this mental model helps with organizing our finances, it sometimes causes us to think in boxes (expense categories) and make irrational decisions – not maximizing the value of our money.

For example, you might have money set aside for investments, savings, essential spending and discretionary spending. So every month, you set aside money allocated for specific purpose.

What happens when we suddenly receive additional money that we had not worked for? Or what happens when we receive unexpected sources of money?

That additional money is treated differently in our minds. Suddenly, we are more willing to donate to charities or spend on something we would normally not. e.g. a fancy takeout from an expensive restaurant, designer clothes or shoes etc etc…

If we had to work two full days for the money, would we still give it to charity or treat ourselves with something indulgent? Or would we just save the money or use it to invest or pay down our debt?

Here is the funny thing: if the money comes easy we tend to spend it more frivolously compared to hard earned money.

Fungibility of Money

Money is fungible, meaning it is replaceable by another identical item and is mutually interchangeable.

I can pay you with a $50 dollar note or 5 $10 dollar notes. It does not matter because they are of the same value.

$600 from government is the same as $600 from hard earned money you had worked overtime on a Friday night for your employer.

To illustrate how this leads to irrational behavior, let’s assume you normally will not indulge yourself in a $300 meal from your hard earned money because you do not value the meal enough to pay the full price for it. However, if you suddenly receive $300 as a gift, you may be willing to go for the meal since it is fully paid for by the gift.

The price of the meal did not change. Your decision should only be influenced by the price and the value you perceive from the experience. It should not change whether the meal is funded by free money or money from your sweat and blood.

If you truly value something, you will buy it regardless of whether you had earned the money or received the money for free.

Tax Refund

Actually the handout money is not free from the government – it came from the taxes paid by us to the government.

Tax refunds are also a common example of mental accounting where people tend to treat it as ‘found money’ and spend it more easily.

Businesses know about this irrational behavior and tend to advertise tax refund sales to capitalize on the people’s willingness to spend this money.

But if you think of it more carefully, tax refund is actually your hard earn money – money that belonged to you which you had paid in excess to the government.

I suspect that policy makers and governments understand mental accounting very well when approving direct cash handouts to individuals. They hope that individuals will treat this money differently and will be more willing to spend the money to spur the economy.

After all, what good will the cash do if people just saved it up.

Conclusion

I am not arguing that people are donating more generously because of the cash handouts from the government.

I am sure the main reason for the giving is also a sense of compassion and a sense of solidarity with people struggling through this really tough period.

People will give whether they had received the cash payout or not. However, I do think that the cash payout does have an impact on the amount given or raised for charity because we tend to view this money differently from our hard earned money.

The bottom line is: money from stimulus packages should be the same as hard earned money. There is no difference. However, in reality, we treat tend this money differently.

Author: Fatty's Finance

Finance is like health. It becomes an issue if it is not well maintained. I want to help you get back in shape!

2 thoughts

  1. Lucky for us that humans are irrationally rational. Else govts won’t be giving free money to individuals — they’d give it to companies instead (not like they haven’t been doing, but they’d give them more if they didn’t have to give some to us plebs).

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