Rational Investing: Paying off credit cards good use of 'found' money

"We're gonna take our $600 and go to the boat. After all, it's money we didn't have before and we're gonna enjoy it."

That was the most unusual reply I got to the question I asked a number of people concerning what they planned to do with the check the government would be sending to them.

"You mean my refund that they're mailing out this month?"

"Your refund or rebate or return of overpayment." I wasn't certain what to call it, having considered it taxpayers' funds that the government didn't deserve to have to begin with. Rather than get into a political discussion, I wanted to know what their thinking was about handling "found" money.

I came across the term, "found money," a couple of years ago in a professional money management publication I had brought with me on a trip to Springfield. Over breakfast at the Country Kitchen, I was skimming through the pages when I saw the article on behavioral finance. It dealt with the various ways people treat money received from different sources; inheritances, gambling winnings, tax refunds, bonuses, etc. I was so intrigued that I went to Barnes & Noble and bought the book "Why Smart People Make Big Money Mistakes and How to Correct Them." (Simon & Schuster Fireside Books, paperback $12)

I recommend it as a very readable presentation of a subject with which we all should be more aware. In it I think you will see a person you know (perhaps yourself).

(I do not agree with the investment recommendations made in the book. They will be discussed in a future column.)

Here's an excerpt from the first chapter:

Not all dollars are created equal

By the third day of their honeymoon in Las Vegas, the newlyweds had lost their $1,000 gambling allowance. That night in bed, the groom noticed a glowing object on the dresser. Upon closer inspection, he realized it was a $5 chip they had saved as a souvenir. Strangely, the number 17 was flashing on the chip's face. Taking this as an omen, he donned his green bathrobe and rushed down to the roulette tables, where he placed the $5 chip on the square marked 17. Sure enough, the ball hit 17 and the 35-1 bet paid $175. He let his winnings ride, and once again the little ball landed on 17, paying $6,125. And so it went, until the lucky groom was about to wager $7.5 million. Unfortunately the floor manager intervened, claiming that the casino didn't have the money to pay should 17 hit again. Undaunted, the groom taxied to a better-financed casino downtown. Once again he bet it all on 17 and once again it hit, paying more than $262 million. Ecstatic, he let his millions ride only to lose it all when the ball fell on 18. Broke and dejected, the groom walked the several miles back to his hotel.

"Where were you?" asked his bride as he entered their room.

"Playing roulette."

"How did you do?"

"Not bad. I lost five dollars."

This story told in some parts of Nevada as the gospel truth has the distinction of being the only roulette joke we know that deals with a bedrock principle of behavioral economics. This view holds that his gambling spree winnings were somehow not real money or not his money, in any event and so his losses were not real losses.

The "Legend of the Man in the Green Bathrobe" as the above tale is known illustrates a concept that behavioral economists call "mental accounting." This idea, developed and championed by the University of Chicago's Richard Thaler, underlies one of the most common and costly money mistakes the tendency to value some dollars less than others and thus to waste them. More formally, mental accounting refers to the inclination to categorize and treat money differently depending on where it comes from, where it is kept, or how it is spent.

It would be presumptuous of me to tell you what to do with your check from Mother Washington; however, here's a no-brainer: If you have an outstanding balance on a credit card that charges more than single-digit interest rate, use the "found" money to pay it down.

With most credit card issuers charging 18 percent to 24 percent, it makes sense to eliminate that quantifiable expense rather than invest in stocks or bonds or mutual funds that have uncertain rates of return.

No credit card debt? You're in the minority. Look at any other outstanding, high interest rate payables. None? Congratulations, you are definitely in the minority! Maybe you do deserve to blow it.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Ques-tions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West, 65806 or by e-mail at sbj@sbj.net.)