Money Hacks: you don’t need to win the lottery to get bitten by the windfall effect
Money Hacks is a series exploring Behavioural Economics concepts, illustrating how unconscious biases influence the decisions we make with money. By understanding these biases and learning to avoid them, we can spend smarter, save more, and make better financial decisions overall.
While most of us dream of winning a lottery one day, we’ve also heard the cautionary tale: Someone wins millions of dollars and immediately quits their job. They go on a spending spree, buying cars, boats and vacation properties. They give money to family and friends. Before long, the money’s gone and they’re back to where they started. They’ve fallen victim to what’s known as the windfall effect.
What is the windfall effect?
The windfall effect states that people receiving a large lump sum of money may temporarily forget or ignore previous spending constraints, which can harm their longer-term financial health. In other words: when we get a lot of money all at once, our budget can go out the window.
It’s not just for lottery winners
The windfall effect can impact anyone with periodic income. We often feel richer on payday, when we see our bank account balances suddenly swell. We may temporarily ignore our budget and treat ourselves to a fancy dinner or that new pair of shoes we’ve had our eye on. If we didn’t budget for these payday purchases, they can do long-term damage to our finances.
How to overcome the windfall effect
There are a few simple things you can do to prevent yourself from falling victim to the windfall effect:
- Pay yourself first: the best way to save money for something – whether it’s retirement, an emergency fund or your kids’ education – is to set up automatic transfers from your bank account. And the best time to make those transfers is on payday, so the money’s gone before you can spend it.
- Budget for treats: this starts with understanding what you’re currently spending money on. Figuring this out will take a bit of work. Don’t worry – it’s worth it. Track all your expenses for a couple of months so you understand how much you can afford to spend on “treats.” Once you’ve got that information, you can treat yourself, guilt-free.
- Treat yourself before you get paid, not after: if you’re not sure how much you can afford for “treats”, hold off until the day or two before payday. Once all your normal expenses and savings have been looked after, treat yourself with what you have left.
Setting up automated transfers is easy
Manulife Bank makes it easy for you to set up automated transfers.
- Online: from the left navigation, select “Recurring fund transfers”
- Mobile app: select “Transfers” from the bottom navigation, then “Transfer money”