A Simple Behavioral Hack for Managing Your Spending

By Markets Fool.com

How much money did you spend on small one-off items last month, like Cokes from the machine, snacks at the convenience store, or a cups of coffee in the morning?

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No idea, right?

Now try this: How much did you spend on basic household expenses, like utilities, cable, and Internet?

Those are a lot easier to calculate quickly -- and it's not just because the amounts are bigger. It's because most of us have a category of expenses in our heads for household bills. There are well-defined items that go into that category, so it's easy to quickly put a total together.

It seems simple and prosaic, but you can use that natural tendency to completely retool your finances.

The mistake we make with categories
From Scattegories to the animal kingdom, we have a human urge to categorize. Think about it: Even if you never had any interest in genus and species, you could probably give me a list of every jerk in the office and your favorite brands of Ginger Ale.

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The same thing happens with our spending: We naturally put things into bins, which behavioral researchers refer to as "mental accounts."

This is great, except that we run into trouble because we categorize the wrong things.

Forget about your old mental accounts
You probably noticed this above: You can easily come up with your monthly household bills, but you can't remember all those little one-off purchases -- even though those are the expenses that are probably blowing your budget.

To fix it, try this: Take any expense that's the same every month and automate it. In other words, take it out of contention for your mental accounts. Gym membership, rent, cell phone -- all of these should be set up to go out automatically. Then, forget about them.

(Of course, this implies that you've already thought about them. If you haven't, take some time to see where you're overspending -- maybe you can lower your cable bill or switch cell phone providers. Once you're set up, all you have to do is revisit every now and again.)

Categorize discretionary expenses
Now, look at your discretionary expenditures. These are the items you need to keep track of, so these are the items that belong in mental accounts.

There are two keys to making useful and sustainable mental accounts.

The first is to be sure that each account is something you "use" regularly. If you have a category that never gets utilized, you'll be tempted to arbitrarily reallocate that money elsewhere, which defeats the purpose.

Second, keep it simple. Having 10 unique mental accounts isn't going to serve you if you can't remember and keep tabs on them all. It'll just get confusing and demoralizing.

Instead, create three to five major expense categories that are broad enough to be useful but detailed enough to capture your habits. For example, I have three: groceries, other household goods, and eating/going out. I don't shop much, so that comes out of savings when it happens, and I don't really spend much money on anything else.

With a few key categories, everything has a home, but you don't get lost in a sea of granularity.

Keeping track for the long run
Now that you have categories, you're ready to manage your money.

Whether it's in your head (not recommended), with cash in envelopes (surprisingly effective), punching it into your phone, or using an online program, assign a budget for each account, and go from there.

Once it's set up, you'll have much less work to do, and you'll rest assured that your big bills are getting paid, and your small bills aren't falling through the cracks -- never again will your credit card bill jump out of the envelope shouting, "Surprise!"

The article A Simple Behavioral Hack for Managing Your Spending originally appeared on Fool.com.

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