A Dollar Is A Dollar Is A Dollar. Except in Our Minds.
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A Dollar Is A Dollar Is A Dollar. Except in Our Minds.

The form of money—salary vs. bonus, income vs. capital—affects the way we treat that money. Sometimes that helps us financially. And sometimes it hurts us.

By Meir Statman
Thu, Jan 21, 2021 12:24amGrey Clock 7 min

Do you care if an assistant at the chemist gives you change in one $10 note or two $5 notes?

Are you more reluctant to spend hard-earned dollars than windfall dollars?

Do you distinguish the “income” dollars paid as dividends on your stock from the “capital” dollars of the value of the stock itself?

Rational investors answer “no” to each of the three questions. After all, money is money, and rational investors can easily distinguish between the substance of money and its form. Hard-earned dollars and capital dollars are no greener than windfall dollars and income dollars.

Normal investors, however, are likely to answer “no” to the first question, but many are sure to answer “yes” to the second and third questions.

All of us are normal investors. For us, the form of money does make a difference. A dollar may be a dollar may be a dollar. 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:

Framing money into pots

We regularly divide our paychecks into pots. Sometimes they are tangible pots, such as checking accounts or glass jars. Sometimes they are virtual pots, such as Excel sheets or mental pots in our minds. We mark each pot with a label such as rent, food, entertainment, Christmas gifts or emergency funds, and refrain from dipping into pots other than designated ones.

Of course, none of this is rational. Rent dollars aren’t any greener than entertainment dollars. Rationally, they should all be in one pot labelled “money.”

Yet this practice is smart when it makes budgeting easier and prevents bounced checks and disappointed children on Christmas morning. For example, one couple I read about maintained a joint account and two sets of checking and savings accounts—one for daily expenses, such as groceries, and the other for larger expenses, such as taxes. The wife was responsible for paying daily expenses from one account and the husband was responsible for paying larger expenses from the other. The idea was to make sure they always had enough for both groceries and taxes.

Rational? No. Smart? Yes.

Of course, 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 entertainment. One smart way to bolster self-control is to place obstacles in the way of pots other than designated ones.

For example, one woman who contacted me put her money in a bank that is an hour’s drive away, and cut the bank’s ATM card.

Similarly, the government places obstacles to dipping into retirement pots by generally imposing a 10% penalty on withdrawals from defined-contribution retirement saving accounts on those younger than 59½.

Again, none of this is rational. A dollar is a dollar is a dollar. But thinking about the form of those dollars can make us financially healthier.

Except not always. 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.

Rational? No. Smart? No.

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. In one set of experiments, people were divided into two groups, hard-work earners and windfall receivers. People in the hard-work group received an amount of money for completing work requiring physical effort—peeling 25 potatoes or making nine envelopes within 30 minutes. People in the windfall-receiver group received the same amount of money as a gift, with no work requirement. Subsequently, people in the hard-work group made less-risky and less-impulsive choices than people in the windfall group.

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 winning—to fritter away these windfalls on meaningless purchases or risky investments. Then again, it could be smart if you’re a person who is not spending as much as you should because of an unwillingness to tap money from a large account. If thinking differently about “extra” money makes you more likely to spend what you can afford, go for it.

Tripped up by the ‘money illusion’

Money illusion refers to the failure to distinguish dollars framed as “nominal” from dollars framed as “real”—that is, after inflation. For example, a 2% increase in a nominal annual salary, say from $100,000 to $102,000 is a 1% decrease in the real annual salary when the annual inflation rate is 3%.

Rational investors are immune to the money illusion, but many normal investors are not. And that is not to the benefit of the normal investor.

We see the distortions caused by money illusion in the current concern about the low yields of bonds. For example, the average nominal yield on 3-month Treasury bills during the first nine months of 2020 was a meager 0.42%. The real yield is even lower, a negative 0.98%, because the rate of inflation during the period was 1.40%. Indeed, inflation has exceeded Treasury-bill yields in most years since 2002.

Yet there was less concern in 1979 when the nominal yield on 3-month T-bills was 10.07% and the rate of inflation was 12.26%, implying a negative 2.19% real yield. This is because many normal investors are misled by the money illusion, comparing the low 0.42% nominal yield of 2020 to the high 10.07% in 1979, while neglecting to note that the real yield in 2020, while negative, is higher than in 1979.

Moreover, 1979 investors paid higher taxes on a 10.07% yield than 2020 investors pay on 0.42%. Investors tend to overlook this 2020 tax balm.

Framing money in nominal terms is easier than in real terms because it does not require knowledge of inflation rates and how to use them to convert nominal dollars into real ones. Yet such framing is not smart when it misleads us to act as spendthrifts when high inflation pushes nominal interest rates up, and as misers when low inflation presses nominal interest rates down.

Spending company-paid dividends but not ‘homemade’ dividends

Investors holding shares of a company have two ways to derive money from these shares. Say you need $1000. You can receive a $1000 company-paid dividend. Or you can create a $1000 homemade dividend by selling $1000 of shares.

Rational investors would prefer homemade dividends to company-paid dividends because they can time homemade dividends when it is best for them, whereas timing of company-paid dividends is in the hands of the company. Also, taxes on homemade dividends are likely lower than on company-paid dividends. Homemade dividends do involve transaction fees as investors sell shares, but these fees are now pretty close to zero.

Many normal investors, however, prefer company-paid dividends to homemade dividends.

That can be both smart and not so smart.

Normal investors have two distinct mental pots: “income” and “capital.” Company-paid dividends, like wages, belong in the income pot. Shares, like other savings, belong in the capital pot. The self-control rule many people live by is to “spend income but don’t dip into capital.”

Thinking of the money as being in two distinct pots is smart when self-control is too weak to protect savings from excessive spending. A $1,000 company-paid dividend places a definite limit on the amount that can be spent, whereas a $1,000 homemade dividend opens the door to selling and spending, say, $2,000 of shares when a tempting vacation overpowers weak self-control.

Still, dividing money this way can backfire. To understand why, consider that an anticipated pain of regret is another reason for preferring company-paid dividends to homemade dividends. Imagine that you received $1,000 as a company-paid dividend and used it to buy a TV set. Compare it to creating a $1000 homemade dividend by selling shares to buy a TV, only to find that the price of shares zoomed soon after you sold them. The pain of regret is likely greater with homemade dividends because you bear responsibility for selling shares when you did, whereas you don’t bear responsibility for the company paying dividends when it did.

But the pain of selling stock—and then watching the price rise—should not be determining which form of money we “prefer” when we need $1,000. Stock prices do not zoom after we sell shares just because we sold shares. It’s just bad luck.

Avoiding selling stock and waiting for dividends because of the fear of regret may be what a normal investor would do. But it isn’t rational. And it probably isn’t smart.

Preferring ‘bond ladders’ to bond mutual funds

A bond ladder is composed of bonds of a range of maturities. For example, a $10,000 bond ladder can be built by allocating $1,000 to each of 10 Treasury bonds with maturities ranging from one to 10 years. The alternative is to place the $10,000 into a Treasury bond mutual fund.

In substance, a bond ladder is a “homemade” bond mutual fund with average maturity equal to that of a corresponding bond mutual fund. The value of a bond ladder declines when interest rates increase, as much as the value of a corresponding mutual fund. Therefore, rational investors are, at best, indifferent between the two if their costs are the same (more on that in a minute).

Many normal investors, however, prefer bond ladders because they can manage them in ways that reduce regret.

Imagine that you hold a bond ladder with 10 bonds with maturities ranging from one year to 10 years. You bought each of them at their $1,000 face value. Nine months pass, and you need $1000 to buy a TV set. Meanwhile, however, interest rates increased such that the prices of all 10 bonds are now lower than $1,000. If you sell the one-year bond you’ll receive, say, $995. Adding $5 to the $995 will not squeeze your budget too much, but realizing a $5 loss inflicts the pain of regret. A bond ladder gives you the option to wait three months until the one-year bond matures and receive $1,000, avoiding the pain of regret.

Bond mutual funds do not afford this waiting option. You cannot be assured that you’ll be able to avoid realizing a loss, no matter how long you wait.

None of it makes a difference to rational investors, because they know that a “paper loss” is no different from a “realized loss.” Sure, delaying realized losses may keep regret at bay, but it has no financial benefits. Indeed, rational investors prefer to realize losses, whether in a ladder or mutual fund, because realized losses become tax deductions, yielding them extra money. And waiting three months (or however long) to get the money you need means you won’t be enjoying whatever you need to use that money for.

What’s more, rational investors would ask themselves: Why build a Rube Goldberg bond ladder, when low-cost index bond mutual funds are simpler and likely cheaper, don’t require homemade construction, and don’t have the extra trouble of monitoring and replacing bonds that reach maturity with new bonds?

In other words, it is normal to try to avoid the pain of regret, but such avoidance can be costly.

Normal? Yes. Smart? No.



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Tech Giants Double Down on Their Massive AI Spending

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Tech giants projected tens of billions of dollars in increased investment this year and sent a stark message about their plans for AI: We’re just getting started.

The four biggest spenders on the data centers that power artificial-intelligence systems all said in recent days that they would jack up investments further in 2025 after record outlays last year. Microsoft , Google and Meta Platforms have projected combined capital expenditures of at least $215 billion for their current fiscal years, an annual increase of more than 45%.

Amazon.com didn’t provide a full-year estimate but indicated on Thursday that total capex across its businesses is on course to grow to more than $100 billion, and said most of the increase will be for AI.

Their comments in recent quarterly earnings reports showed the AI arms race is still gaining momentum despite investor anxiety over the impact of China’s DeepSeek and whether these big U.S. companies will sufficiently profit from their unprecedented spending spree.

Investors have been especially shaken that DeepSeek replicated much of the capability of leading American AI systems despite spending less money and using fewer and less-powerful chips, according to its Chinese developer. Leaders of the U.S. companies were unbowed , touting advances in their own technology and arguing that lower costs will make AI more affordable and grow the demand for their cloud computing services, which AI needs to operate.

“We think virtually every application that we know of today is going to be reinvented with AI inside of it,” Amazon Chief Executive Andy Jassy said on Thursday’s earnings call.

Here is a breakdown of each company’s plans:

Amazon said a measure of its capex that includes leased equipment rose to a record of about $26 billion in the final quarter of 2024 , driven by spending in its cloud-computing division on equipment for data centers that host AI applications. Executives projected it would maintain the fourth-quarter spending volume in 2025, meaning an annual total of more than $100 billion by that measure.

The company—which gets most of its revenue from e-commerce and most of its profit from cloud computing—also projected overall sales for the current quarter that missed analysts’ expectations. Its shares slid about 4% in after-hours trading Thursday. The stock rose more than 40% in 2024 and was up nearly 9% this year before its earnings report.

Jassy said AI has the potential to propel historic change and that Amazon wants to be a leader of that progress.

“AI represents for sure the biggest opportunity since cloud and probably the biggest technology shift and opportunity in business since the internet,” Jassy said.

Google shares are down about 7% since its earnings report Tuesday, which showed disappointing growth in its cloud-computing business. Still, parent-company Alphabet said it is accelerating investments in AI data centers as part of a surge in capital expenditures this year to about $75 billion, from $52.5 billion in 2024. The spending will go to infrastructure both for Google’s own use and for cloud-computing clients.

“I think part of the reason we are so excited about the AI opportunity is we know we can drive extraordinary use cases because the cost of actually using it is going to keep coming down,” said CEO Sundar Pichai .

AI is “as big as it comes, and that’s why you’re seeing us invest to meet that moment,” he said.

Microsoft has said it plans to spend $80 billion on AI data centers in the fiscal year ending in June, and that spending would grow further next year , albeit at a slower pace.

Chief Executive Satya Nadella said AI will become much more extensively used , which he said is good news. “As AI becomes more efficient and accessible, we will see exponentially more demand,” Nadella said.

Growth for Microsoft’s cloud-computing business in the latest quarter also disappointed investors, leaving its stock down about 6% since its earnings report last week.

Meta, too, outlined a sizable increase in its investments driven by AI, including $60 billion to $65 billion in planned capital expenditures this year, roughly 70% higher than analysts had projected. Shares in Meta are up about 5% since its earnings report last week.

CEO Mark Zuckerberg said investing vast sums will enable it to adjust the technology as AI advances.

“That’s generally an advantage that we’re now going to be able to provide a higher quality of service than others who don’t necessarily have the business model to support it on a sustainable basis,” he said.

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This stylish family home combines a classic palette and finishes with a flexible floorplan

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