Young Investor

The colour of money

B. Venkatesh | Updated on February 26, 2011

Consider this. You receive a significant amount as tax refund from the Income-tax department. You are no doubt excited to see the cheque. Will you invest or consume this money? Most people are, likely to consume it. Why?

Accountants would tell you that every transaction has a debit and credit. We would interpret this to mean that transactions generally have pain (debit) and gain (credit).

You feel the pain (debit) when you pay your income tax every year. It hurts even more when you realise that you have paid more than is required. Suppose you receive the tax refund three years later.

The cheque will come as a pleasant surprise because you would have long forgotten about the excess payment you made three years ago.

Interestingly, this credit (gain) does not have a corresponding debit; the debit occurred three years ago when you paid your taxes. The cash inflow is, hence, viewed as windfall. And what is viewed as a windfall is typically consumed, not invested.

House money effect

Your behaviour is similar to the house money effect. Here's how. Picture yourself in a casino with an initial capital of Rs 50,000. If you win Rs 20,000, you are likely to take a higher risk with Rs 20,000 than with Rs 50,000. Why? You believe that the Rs 20,000 belongs to the house (casino).

We tend to view the tax refund mostly the same way, even though the Income-tax department is refunding our money. We get this feeling because the pleasure of receiving it has been separated by time from the pain of paying it. And it is not uncommon to splurge ‘house' money or windfall.

You are, hence, most likely to spend the tax refund on an impulse purchase, say a fancy mobile phone or a HD TV. It is highly unlikely that you will use the refund to buy mutual fund units or pay your insurance premium. We often behave likewise when we receive cash from our employer for our medical reimbursement expenses!

(The author is the founder of Navera Consulting. He can be reached at >enhancek@gmail.com)

Published on February 26, 2011

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