How many times have you noticed Grandma taking out money from a cannister or a jar hidden somewhere in the pantry or kitchen? Most of us have seen our grannys doing so, in some cases, the heritage follows and the mothers also do the same with different jars labeled as Groceries, entertainment, birthday, maid, milk, etc. this is nothing but the cookie jar approach towards saving and investing.
The Cookie jar approach
The cookie jar method is a way of investing which allows you to make savings and investments in different buckets labeled for separate purposes like cookie jars in old days. This method helps people allocate money to different buckets and manage expenses.
The psychology behind the cookie jar method
A phenomenon called Mental Accounting runs behind the cookie jar method of investing. This effect enables individuals to mentally allocate and calculate money as per different buckets and spend further accordingly. Let us consider two cases to understand this;
Case 1: If you bought a phone cover worth Rs. 1000 and you happen to lose it, would you be willing to buy a new one immediately?
Case 2: Consider another situation where you lose Rs. 1000 as cash, will you still buy a phone cover worth Rs. 1000?
Most of us would answer a ‘NO’ in the first case and a ‘YES’ in the second one. This is because we do mental accounting in our brains. We are willing to buy a phone cover in the second case because the lost money wasn’t allocated for buying the case whereas in case 1, the money allocated for the case has already been spent. Hence, your brain debits the money from the phone case bucket and makes you unwilling to buy a new one immediately.
Similarly, while using the cookie jar approach, you spend only the amount allocated for a given purpose. One important thing to consider here is that these cookie jars or buckets are not refillable. You cannot just put some money from another jar to one in order to make a purchase. That would be cheating yourself and your budget.
Cookie jar approach in investing
Now put this concept to investments, you can allocate different buckets as per your financial and life goals. When you identify each goal separately and work with special efforts towards achieving that goal, you will feel realize how simplified and rewarding it will get.
Once you start focusing on your goals individually, you will be paying extra attention to what kind of instruments you are investing in and how will they work, what will be their returns few years down the line and you will find your mental ability working towards achieving the best for each investment. This is called bucketing in terms of investment. Once you align your financial goals with your investment buckets, the returns would be bigger.