Compartmentalization and its effect on financial decisions.
by Mr Credit CardOne of traits that we have to look at ourselves is how do we think about money. Some of us do not really think about it, while others compartmentalize. What do we mean by that?
Well, instead of having one checking account, you may have one checking account for paying your utilitise, another for paying your mortgage. You may even have a seperate money market account.
In your investment portfolio, you may have a retirement account, a seperate account for your kids college education savings, another account for save for your home downpayment or your second home.
While such actions show how organized you are, it may also lead to sub optimal financial decisions. How can this be? Let us take a look at a couple of examples. We’ll start with the simple seperation of bank accounts. While you may want to have seperate checking, savings and money market accounts, the danger is that you may be sacrificing yield you can earn simple by having seperate accounts. You may get better rates on some accounts if you have a larger deposit.
The same thing can happen in your investment portfolio. You may have an IRA account, a seperate college savings account for your kids and even a seperate brokerage account. Once again, while having seperate accounts may make you fee better, you have to constantly check your asset allocation with your financial advisor to make sure your “whole portfolio” is managed properly.
The danger with having seperate accounts is that your entire portfolio may be either too risky or too conservative. And the culprit is that by having too many seperate accounts, they are not looked at as a whole.
If you find that you like to have seperate accounts, get some advice and make sure your asset allocation is in line with your financial goals. If you find that it is not, chances are that the mentality of seperating accounts is the reason for this. You can either consolidate many accounts together (this will likely to result in a better allocation and higher yields) or if you keep your accounts seperate, make sure that your entire financial picture and asset allocation is looked at as whole. Otherwise, you may find that your portfolio is either too conservative (which may delay the time frame for you reaching your goals) or too risky.
January 22nd, 2007 at 13:26
[...] Mr Credit Card presents Compartmentalization and its effect on financial decisions. posted at Ask Mr Credit Card’s Blog. [...]
January 22nd, 2007 at 13:26
[...] Mr Credit Card presents Compartmentalization and its effect on financial decisions. posted at Ask Mr Credit Card’s Blog. [...]
January 25th, 2007 at 20:39
There’s something to be said for keeping seperate accounts, as long as it’s done within reason and with an eye to functionality. Seperating retirement and college savings makes sense for tax reasons. Seperating long-term savings/investment from short-term operating funds makes sense because the higher-yielding vehicles one wants for longer-term savings generally have monthly transaction limits that make them unattractive for regular-bill-paying purposes, while the account for one’s monthly expenses should seldom carry enough of a balance month-to-month for long-term yield to be a meaningful factor.
But you’re right, of course, that one can easily overdo it, and that overall asset allocation on one’s savings and investments is a crucial ongoing consideration.