As a child…

Let me start that again.

As an OCD child, I went through a phase of taking my pocket money and splitting it between pre-labelled envelopes – envelopes which were then scuttled away under the old clothes in my cupboard. I can’t remember what all those labels were, but they included things like “holidays” and “books” and “long-term savings”. I think there was even one designated as “for charity” – and I know that because it was always the first one to be dipped into whenever the pog-buying temptation became irresistible.

As I posted this, I was already on eBay looking to see if I could source any complete sets #hotflushofaddiction

But this did not continue. Mainly because hyperinflation started, and my savings were taxed into nothingness. At which point, I may as well have burnt them on POGs. Because at least then I’d have satisfied the deep-rooted acquisitive part of my self that just wanted to complete the set*.
*If I’m completely honest, the only real saving that was taxed into nothingness was the small balance that I had in my starter bank account, because I had long given in to that inner collector-hoarder. But it’s fun to talk as though my world view was jaded by being taxed as a teenager.

Also, I think I stopped getting a monthly allowance – and instead got spending money when we were on holiday. Which was a much sweeter deal #thankyouparents

But as it turns out, the whole “partitioning” and “earmarking” thing, with the envelopes, acts as a serious behavioural motivator.

A study: “Earmarking and Partitioning: Increasing Saving by Low-Income Households“, by Dilip Soman and Amar Cheema.

The Experiment

The participants were low-income workers in India who did not have access to formal financial services (like banking):

Participants were 146 labourers earning weekly wages who received financial advice in return for their participation. None of the participants in the study had any banking experience; they earned and spent cash. Only 20 participants had previously pawned possessions for cash, and another 8 participants were aware of the existence of moneylenders and pawnshops. Although all participants could converse fluently in the local language and understand simple written instructions, many could not read beyond a few lines of prose. However, all participants could count, add, and subtract with ease and could bargain when buying at their local markets.

The basic gist:

The planner gave participants a target savings amount and told them that the social worker would help put aside the target savings amount each week in sealed envelopes. Although participants could open the envelopes if needed, they were encouraged to try to keep the envelopes sealed. Furthermore, it was emphasized that if the participants needed to open the savings envelopes for everyday expenses, they should try to draw only as much as they needed and put away the rest. Both the financial planner and the social worker explained these details several times to ensure that the laborers and their spouses understood the advice and the specific method of earmarking the savings in envelopes.

For each of the next 15 Saturdays, the social workers visited the 146 households, put the prescribed (earmarked) amount in savings envelopes, and sealed and dated the envelopes. The social workers also recorded whether the savings envelopes from the previous weeks were sealed or opened, along with the exact amount saved in the previous week.

The catch:

Some households were advised that their target savings should be 40 rupees, and other households were advised that their target savings should be 80 rupees. These targets, approximately equal to 6% and 12% of the participants’ weekly income, respectively, were much higher than the previous savings of this group (average savings rate of .75%). For half the households, the earmarked savings were sealed in plain white envelopes. For the remaining households, the savings envelopes had photographs of their children printed on them. [The experimenters] expected that printing the children’s pictures on the envelopes would increase the guilt associated with using the savings money for other expenses and highlight the savings goal, thereby increasing savings. [They] also manipulated the number of envelopes between subjects. For half the participants, the savings amount was pooled into one envelope. For the remaining, the amount was partitioned equally into two envelopes.

Finally, the findings (some of which I think are quite funny):

  1. The main effect of the children’s picture was significant, with participants saving more when pictures were present.
  2. Opening an envelope, which indicates a failure to follow a rule, seems to lead to easier subsequent spending from the envelope. This is consistent with the “what-the-hell” effect (Cochran and Tesser 1996; Soman and Cheema 2004).
  3. Partitioning is more effective when the guilt associated with using the earmarked money for mundane expenses is emphasized by placing pictures of the household’s children on the earmarked envelope.
  4. Households that are given high savings targets are quite likely to open a savings envelope, possibly because the amount is too large to spare from everyday expenses.
  5. Households that have this large earmarked amount pooled into one envelope save less than those who have this amount partitioned into two envelopes.

Here’s a summary picture:

Screen Shot 2015-11-11 at 11.07.24 AM

Why I bring this up

Essentially, the study shows that mental-accounting is a really good strategy for saving money. That is – it improves your saving habit.

But this actually runs contrary to standard financial investment advice – which says that mental accounting, or the practice of compartmentalising your investments into separate groupings, is inefficient. The technical explanation is that splitting up your wealth and investing each portion of it separately can expose you to more risk than you would otherwise normally take on (that is: your total investments aren’t necessarily streamlined to your overall risk profile).

In practice, however, not mentally accounting means that most people will have less to invest.

And for my money, I’d prefer to save more and invest less efficiently, rather than save less.

Just a thought.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at Or both.