Mental Accounting

Professor Simko

Effective Composition 100 - 064

Say someone you know who works a well paying job tells you the news that they received a rather high paying bonus from their work. After hearing the news, you might ask what they plan to do with the money. Chances are, you expect to hear that the bonus money will be used to pay off their student loans or put it towards buying their weekly groceries, maybe even into their savings account. Instead, they tell you the money will be used to buy luxury items and their recent wants, but not any of their needs. Rightfully, you question the choice they’re making and have a conversation with them hoping to change their mind for the better, but in the end they still chose to spend the high paying bonus on expensive items that are not necessarily needed, such as two purses and perhaps even some decorative pillows for their fancy sofa. Once they bought everything they wished for they decided to show you the items, yet you still have the desire to ask them why they made the choice to buy what they did with their work bonus. Their response was because they viewed it more as free money instead of anything valuable like their paychecks. This is a prime example of the habit known as mental accounting.

Mental accounting is the endangering habit that describes the giving of subjective and individual values to money depending on its origin or maybe even its amount. This habit goes back to behavioral economics, the attempt to comprehend human decision making and behavior science. The practice of mental accounting can be harmful in many different ways, as it can slowly deteriorate a person’s ability to make proper and efficient decisions with their money, but also in general. If a person were to always allow mental accounting to influence their decisions, it would be nearly impossible for them to make rational judgement under any circumstance. This is because it becomes harder for that person to find value in any kind of decision they are faced to make. Considering it comes from behavioral economics, mental accounting differs from person to person as well as per situation they might be in. Sometimes you may see a teenager buy a new video game with their allowance money instead of putting it towards something they know they need for school. This is because emotional thinking easily masks any rational thinking when someone who has the habit of mental accounting goes to make any decision whatsoever. Unfortunately it is rather easy for humans to give individual amounts of money their own value. This is commonly seen when a college student receives their refund money from financial aid or also from their taxes. A lot of people will call the money they receive from these situations free money or extra money and use it to buy their wants they have on the top of their head, not anything they truly need. No matter where a chunk of money comes from, it will always have the same value. This consistent value money holds is forgotten when someone is in the habit of mental accounting, which makes them quick to forget that their money, no matter where it came from, can go towards their larger financial picture.

When a person begins to categorize their payments of any kind and allow it to become a habit, it swiftly blocks their judgement in reaching rational verdicts. In The Decision Lab article, ‘Why do we think less about some purchases than others?’, it states, “Mental accounting can lead to irrational financial behaviors, such as overspending, misallocating resources, or making riskier decisions with “found money”. What this shows is that the routine and practice of mental accounting can greatly affect a person’s ability to make positive financial decisions and can even result in more unhealthy monetary habits. Besides the other toxic habits that can be brought forward whilst exercising mental accounting, another thinking process that roots from biases in psychology also appears in some situations. This thinking process is known as confirmation bias. Confirmation bias explains how people will sometimes only seek and listen for any information that supports a belief or opinion they already hold, and instead of retaining any information that may oppose what they think, they throw it out the window. An example of confirmation bias could be if a teenager went to their friends asking for an opinion on what shirt they should buy. The one asking is already leaning towards buying a pink shirt, but their friends pitch in the idea of buying either the light blue one or the red one. Even though none of the friends encourage the pink option, the friend that asked still buys only the pink shirt. Thinking like this makes it more difficult to make rational and harsh decisions, just like mental accounting does too. The mixture of both mental accounting and confirmation bias can become a consistently unpleasant issue for both the person struggling, but also the people around them. When someone notices another struggling because of nasty thinking habits, it is an instinct to wish to help and assist them the best they can. However, when a struggling person is plagued by both mental accounting and confirmation bias, it becomes extremely difficult to assist them as much as someone may want to. It’s a tougher situation to get out of when the two processes work together, which is why experts suggest treating each individual dollar you receive with the same value. It is no lie that the value of money stays the same no matter the situation or origin, but it relies on how a person chooses to think of it and how they use it to their benefit.

The next time you receive any amount of money you may think of as extra, try not to be tempted to use it on small wants you have at the moment. Instead, think about your future self. Consider what you and maybe even your family might require within the next month, or if you have any big plans in the coming weeks. The money you may view as extra could help your bigger financial picture in the long run instead of becoming extra spending money. If someone you know struggles with the habit of mental accounting, it is encouraged to have a thorough conversation with them. Let them know how this habit can quickly worsen not only their thinking and decision making, but also their financial situation. Support will always help in the end, and it is the main way to manage through any unhealthy habits someone could have.