Have you ever told yourself that money you have set aside in one bank account is only for a certain use? Or have your ever decided to spend an unexpected windfall differently than you would your monthly paycheck? If so, you are not alone. This is a common behavior called “mental accounting”. Our mental accounting tendencies can help us manage our finances, but sometimes they do not produce optimal results. To illustrate this behavior, allow me to draw two alternate scenarios:
Imagine you are on your way to the local theatre to see a movie for which you pre-purchased your $10 ticket. You have almost arrived at the theatre when you realize that you have lost this pre-purchased ticket. Would you buy another ticket at the theatre for $10 or would you accept the loss and not see the movie?
Now imagine you are on your way to the same theatre and this time you have not bought a ticket in advance. When you get in line and pull out your wallet you realize that you’re missing the $10 you had designated for purchasing the ticket. Do you borrow $10 from a friend and buy a ticket or accept the loss and not see the movie?
If in scenario 1, after losing your ticket you purchase another one you are in the minority. Richard Thaler, a behavioral economist at the University of Chicago, found only 46% percent of people would buy another ticket after losing the original. On the other hand, if you said you would purchase another ticket after losing $10, you were in the majority. 88% of people would do the same. (1) This study, as well as others about irrational economic behaviors, were so influential in 2017 that Richard Thaler was awarded the Nobel Prize in Economics.
These mental accounts are impactful. When taxpayers receive a tax refund, it is placed in the “found money” account, assigned less value and spent freely. Money from wages (“earned money”) is spent in a more calculated, budgeted manner. This behavior may not be rational. If money for taxes was withheld throughout the year, that money would be treated as “earned money”, not “found money”, and spent more cautiously.
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