As humans, we tend to think about things within a set of predefined, sometimes unperceived boundaries. This vastly increases our speed of processing information in this world; but in pursuit of efficiency, we sometimes give up precision. For example, if you suddenly encounter an unknown animal, your brain will process its features within the categories that you know. If it looks more like a sheep or domesticated animal, you would more likely be willing to pet it. On the other hand, if it looks more like a lion or tiger, your sub-conscience will tell you to stay away, even if you don’t know for sure if the animal is dangerous.

We often make our financial decisions in the same way. In 1980, Professor Richard Thaler coined the term “Mental Accounting” to describe the way we make financial choices through introducing notional but non-fungible boundaries. Or in layman’s terms, we tend to put things in “buckets”.

One area where this tendency exhibits itself is in budgeting. First, we track all of our spending; and second, we designate a category for each expense, such as for food or for vacation. The benefit of creating these categories is that we may put a cap on the categories we most enjoy spending money on, preventing us from overspending. However, these “non-fungible boundaries” also provide the basis for some irrational behavior, such as accelerating spending in certain categories by year’s end to meet the maximum because we haven’t spent as much as we allotted – a common inefficiency that occurs in large organizations with pre-approved budgets that don’t carry over to the next year.

Since putting things in a bucket and processing information within the confined boundaries is our natural tendency, how can we utilize this human decision making process to our advantage and not succumb to its shortcomings? Obviously, the way frame the purchasing decision has a huge impact on the choices we make. How should we draw up these boundaries?


I must admit that I have never lived by a budget. I am generally good at keeping track of things, but I found bookkeeping extremely time-consuming. I may be aware of all the major monthly expenses coming out of the checking account, but there is no way I can keep track of every $10 my husband withdraws to buy gum. I also have trouble keeping a consistent categorical system. Does the popcorn we bought at the movie count as food or entertainment?

Even if I could get my family ledger straight, I don’t find the information from conventional budgeting systems useful in helping me adjust my behavior. I could be spending $1,000 a month or 10% of my budget on groceries. Is it too much or too little? Moreover, our globally mobile lifestyle introduces another layer of complexity. Our expenses sometimes change drastically depending on where we move to. It is cumbersome to constantly reevaluate our budget because of the changes in the cost of living.

On the other hand, I was always able to save roughly 20% of my income without specifically budgeting to do so. (I save more if I have a particular saving goal.) You can say that I have been fortunate that I never had to survive in a situation like living in New York City getting paid minimum wage while raising children on my own. However, I did save 20% even when I was earning $12,000 a year in Mumbai, or even when I was on an allowance as a student.

As I set out to understand why I was able to save in my sleep when so many people in a similar situation didn’t, I realized that subconsciously, I was also applying the basic “bucketing” system in Mental Accounting. It just happens that my buckets are a little bit different. I call it my “Value-Driven” Budgeting.

With further exploration, I found that my mental buckets are constructed with three dimensions- who is it for, what is the purpose, and when do I need it. They are listed in the table below. In addition to simply having the buckets, I assigned priority to each of the buckets. Usually in my mental process, I would make sure I deposited more in the higher priority buckets before depositing in the lower priority bucket. However, that doesn’t mean I don’t spend on things in my lower priority buckets until the top ones are full.

Priority Who What When Example
1 Government Obligation Now Taxes
2 Church / Charity Obligation Now Tithe
3 Me / Spouse Necessity Now Food, Housing
4 Me / Spouse / Dependents Emergency Now Insurance; Emergency Fund
5 Me / Spouse Necessity Future Retirement security
6 Me / Spouse Pleasure Now Expensive concert tickets
7 Me / Spouse Pleasure Future Second home
  Debtor Obligation Now Student Loan
  Dependents Necessity Now School, Nursing Home
  Dependents Pleasure Now New cell phone
  Dependents Necessity Future College Education

For example, my weekly grocery expenses go into the bucket labeled “for me, a necessity, now”. During the same grocery trip I might pick up a bottle of wine that is more expensive than the ones I normally would get. This would go into my mental “pleasure” bucket. I might do it once in a while, but I would notice if I started depositing more into my pleasure bucket than I usually do, then I would cut back.

In this thought process, every dollar I spend or save has a purpose, and I keep my spending in check even before it happens, contrary to the conventional budget keeping that alerts you after the fact. In working with people on their budgets, I found that creating a budget is usually too late if you have a spending problem. Your consumption pattern is set and it takes enormous effort to change your behavior, and it usually comes with a mental toll that you are “cutting back”. By assigning a value bucket before each purchase, it actually makes you think hard before each splurge. Depositing too much into the current pleasure category when you think providing for future necessity (retirement security) is more important creates a cognitive dissonance between your beliefs and actions that compels you to adjust one or the other. (I hope it’s your actions in this case.)

On the flip side, this thought process should also help you relax a little bit more with your financial life if budgeting tends to induce your Type A personality and forcing you to keep track of every single dollar. Life is short and our time should be better spent enjoying the result of our financial decisions rather than stressing over those decisions.

Furthermore, you can make your own value judgments. Your priority list and which bucket each purchase belongs in would be different from mine. I will not tell you that buying a Mercedes SUV is a pleasure, not necessity; but if you find that much of your income is going into current necessity even when you make a good salary, then it’s time for you to redefine what is necessary. You may also think that providing for your children’s future necessity (if you regard college education as such) is more important than your current pleasure. I would think it’s a noble priority, but your purchase decisions must reflect your values.

Lastly, I believe the more you adopt this thought process, the happier you will be when you faithfully put your money toward what you value most. It is a positive reinforcement that will propel you to continually put action behind your words (or thoughts). An inner guidance is always more effective than outward rules telling you what you should and should not spend on. I think this is why people with frugal personalities are happier, because they let their values guide their spending, not the price or neighbors to guide their values.

Even though this is mainly an ingrained mental exercise for me, I would encourage you to write your buckets and priorities down so you have a visual reference when you first try it out. Go ahead and track your purchases mentally for a couple weeks. If you have the itching sense that you are not putting money according to your priorities, you may want to consider tracking your expenses on a spreadsheet to see if you are actually contributing a higher percentage of your spending in low priority buckets.

With this now decoded thought process, I was able to naturally save without thinking about it. Do you think it will work for you? How would you modify it? Would you try it and let me know if it works?

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