B. Venkatesh | Business Line | November 30, 2013|
This cookie jar method is about earmarking expenses and keeping money for each expense separately.

You are more likely to achieve your objectives if you follow goal-based investing.

You may have seen your grandmother manage her household budget using the cookie jar method. This method is about earmarking expenses and keeping money for each expense in a separate jar. That is, money for monthly grocery is kept in one jar, rent in another jar and so on. An important rule was that the money can only be spent on the expenses for which it was earmarked. Grocery money, for instance, cannot be used to pay rent. This behaviour, called mental accounting, is well-documented in behavioural economics. The question is: Can you use mental accounting to your advantage?

So, what does mental accounting actually mean? Classical economists would consider, say, Rs 10,000 as cash that can be used for spending. But behavioural economists documented evidence that our spending habits can be governed by the source of the money; you are more likely to indulge with Rs 10,000 if the money came from lottery winnings than if it came from your salary.

That said, the truth is that we cannot often resist spending. So, the question is: Will you spend less if you separate your money into various expenses and follow the cookie jar method? It appears you can! Research in neuroscience has shown that you exert more self-control when you feel guilty of spending. And your guilt is more when you spend on luxury products with cash earmarked for grocery or rent.

But is your grandmother’s cookie jar method practical in today’s world? It can be. And you do not have to maintain jars for each expense. You can instead earmark cash in envelopes at the beginning of each month, especially for expenses for which you want to exert self control — entertainment expenses, for instance.

Interestingly, the cookie jar method can work for savings as well. Picture each mental account or cookie jar as a goal, and invest accordingly. This will help you stay focused on your life’s goals. In fact, you are more likely to achieve your objectives if you follow such goal-based investing than if you have a single investment portfolio for your life’s goals.

Consider that you have a goal to create an education fund for your children. Suppose, you have two children, and one will enter college in 10 years and the other in 14 years. You should create two mental accounts or investment jars, one with a portfolio to suit an investment horizon of 10 years, and the other with 14 years.

Finally, you can also use the cookie jar method to teach children to handle their weekly allowances wisely, by creating three cookie jars for spending, saving and gifting.

(The author is the founder of Navera Consulting. Feedback may be sent to [email protected])

Source: http://goo.gl/MIJeHM