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The Psychology of the Tax Refund

The average tax refund is about $3,000. And people do one of two things with it. They either spend it or set it aside for a specific purpose. What’s the distinction between these two groups of people? It all comes down to their expectation.

If the refund was unexpected, chances are it will be spent. This group of people is subject to the Windfall Syndrome in which “found” money is spent more freely than money earned.

If the refund was expected, chances are it will be saved. I’ve heard many people refer to their tax refund as “the money they will use for vacation” or “the money used to pay off last year’s Christmas bills”. This group of people abides by a behavioral finance concept known as Mental Accounting.

The key to all of this is the expectation. It is the single most important factor in determining if the refund will be spent or saved. It just goes to show how powerful a little bit of planning can have.