Personal Benchmark: Integrating Behavioral Finance and Investment Management

Chapter 5The Power of Buckets

Dr. Daniel Crosby

It is always the simple that produces the marvelous.

—Amelia Barr

Given the seeming complexity of the problems that beset investors, it has made some intuitive sense that the proposed solutions to what ails us have been equally convoluted. But as Dhirendra Kumar (2012), CEO of Value Research points out in his piece for the Economic Times, part of the answer may lie in something to which we are naturally prone. He says of this tendency,

So what's the solution? Some sophisticated analytical tool that will give us an insight? No, actually, it's something that someone in your family probably already practices, or at least used to in the decades gone by.

The solution is bags. I had this aunt who used to have a set of little bags which would close with a string around their necks. When her husband's salary would arrive, she would divide up the money into heads like vegetables, milk, dhobi, etc…and put each in a bag. Curiously, as a principle of budgeting, this is known to most of us, but few apply it to financial investments.”

The phenomenon to which Mr. Kumar is referring is formally known as “mental accounting” and was first documented by Dr. Richard Thaler of the University of Chicago. Mental accounting “refers to the tendency for people to separate their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account” (Phung 2014). More simply, the way in which ...