Mental Accounting: Another Investor and Consumer Behavioral Similarity

Does this make us accountants?

Mental accounting afflicts us all. People are prone to this irrational practice because it helps us categorize information so we can actually open our wallets and spend money, according to researchers. It allows us to evaluate and make basic judgments like “How much can I spend on x?” while we move through life. If we truly had to factor every financial possibility and probability into our daily lives while using money, we’d never leave the house before consulting our portfolio or buy anything without furiously making calculations and weighing future earning opportunities.

Mental shortcut

People are capable of looking at their income, savings etc., and deciding an appropriate amount to spend on a car or bathroom renovation, because these are practical enough calculations. The average person wouldn’t necessarily be able to factor in opportunity cost and anticipate their earnings trajectory over their lifetime to know if that meant they could take a vacation this year or next. Instead, we resort to mental accounting.

Meet you in the middle of the Venn diagram

Consumers and investors converge in this mental arena with the shortcuts we use. Turns out we’re all just people, so our behaviors tend to group us into several predictable categories.

It’s mental accounting to allocate separate money for savings and different capital for risky endeavors. This sounds like the “it’s ok, I can afford to lose it” mentality that’s all too common investor behavior. Having money to “play” on uncertainty isn’t the prudent move many like to argue. Consumers engage in their own version of this behavior with money spent on “wasteful” things they may not need or even really want that much. 

This can happen when we get surprise money (oh, that rebate check I forgot about arrived) or money outside normal income (sweet birthday cash or woo bonus money!). But, the notion of money you’re “ok to lose” would just about fail every financial planning test in the book; especially for the 99% of us. No doubt that’s why they say easy come, easy go.

Steady money

Investopia uses the term “safety capital” as a euphemism for the mental accounting that surrounds the flipside of “fun” money. Some may argue that parking funds in bonds would be a much more steady category than short selling Tesla, for example. Being smart and cautious should always be the financial strategy because any supposed delineating line between money seems fictitious—(ring, ring) it’s a call from your mental accountant. Don’t pick up!

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