Have you noticed lately that watching Boris and Chris Whitty during the televised Covid briefings is strangely reminiscent of Star Trek? For those of you who don't know, Star Trek was a 1960s science-fiction based TV series. The two main characters were Captain 'James T Kirk' and Science Officer 'Spock'.

Kirk was a fly-by-the-seat-of-his-pants captain who frequently saved the day using his guile & wit and often charmed the girl. His no-longer politically correct catchphrase was - "to boldly go where no man has gone before". He was the emotional one.

Spock, on the other hand, came from the planet Vulcan where people have no emotions yet possess immense logic; therefore, making him the perfect science officer. His catchphrase was - "That's illogical". He was the rational one.

In financial terms, identifying Rational versus Emotional thinking is critical.

A pound is a pound is a pound - right?

1. Do you care if a shop assistant gives you your change in one £20 note or two £10 notes?
2. Are you more reluctant to spend your 'hard-earned' pounds than 'windfall' pounds?
3. Do you distinguish the 'interest' pounds paid on your savings account from the 'capital' pounds in your savings account?
4. Do you distinguish the 'income' pounds paid as dividends on your shares from the 'capital' pounds of the value of those shares?
5. Is your £250,000 home of more value to you than £250,000 in the bank?

The rational investor would answer No to all of the above questions because a pound is a pound is a pound. A normal investor might respond No to the first question but Yes to the others.

The ‘form’ of money (Salary vs. Bonus / Income vs. Capital / Physical vs. Intangible) can affect how we treat that money. All of us are normal investors. For us, the form of money does make a difference. A pound may be a pound … but not in our minds!

Sometimes, such normal thinking helps us in our financial lives. But sometimes, it hurts us. And understanding the difference between the two - that is, knowing when we’re being smart, even if not rational, and when we’re being neither smart nor rational - can make us better savers, spenders and investors.

Here are some examples of our normal thinking and when it hurts and helps us:

Distinguishing hard-earned money from windfall money

Easy come, easy go. We regularly distinguish money earned with much effort, such as salary, from windfall money obtained with little or no effort, such as gifts. We tend to place hard-earned money in one mental pot and windfall money in another, and we spend windfall money more easily than we spend hard-earned money. That distinction also affects our willingness to take risk with that money when investing.

Rationally, of course, it makes no difference whether somebody receives money from a windfall or hard work. It may also not be smart if it leads recipients of windfalls - whether bonuses, bequests or lottery winnings - to fritter away these windfalls on meaningless purchases or risky investments.

Rational? No. Smart? No.

Framing money into pots

We regularly divide our salaries into pots. Sometimes tangible pots, such as bank accounts or glass jars. Sometimes virtual pots, such as Excel spreadsheets or mental pots in our minds. We give them labels such as mortgage, housekeeping, holidays, Christmas or emergency funds, and refrain from dipping into those pots other than designated ones.

Of course, none of this is rational. Mortgage pounds aren’t any greener than holiday pounds. Rationally, they should all be in one pot labelled “money”. Yet this practice is smart when it makes budgeting easier and prevents our home from being repossessed and disappointed children on Christmas morning.

Rational? No. Smart? Yes.

Refraining from dipping into pots other than designated ones requires self-control. Yet this is difficult when we face temptation, such as using money in the emergency pot for holidays. One smart way to bolster self-control is to place obstacles in the way of pots other than designated ones.

Again, none of this is rational. A pound is a pound is a pound. But thinking about the form of those pounds can make us financially healthier. Except not always...

The retirement Paradox

Sometimes self-control is too strong rather than too weak, preventing reasonable dips into ample capital pots. That’s especially true for retirees who have plenty of money but have spent a lifetime cultivating a saving mantra: Never dip into the capital pot. Now at the very time when they should be doing just that to enjoy life, they can’t bring themselves to do it. They continue to spend only the income they derive from their savings, and their lives are more constrained as a result.

Nowhere is this more apparent than with people who cling on to large homes long into old age yet live in relative poverty because they have neither the income nor savings to sustain the lifestyle they want.

Rational? No. Smart? No.

Please think about the above, and the next time we meet, we can help you identify any areas where you are not being as ‘smart’ as you could be.

If nothing else, the Pandemic has reminded us that 'life is for living'!

We hope you enjoy the Summer edition of our newsletter, 'Moneywise'. As usual, please do not hesitate to contact us if you have any questions.