Mental Accounts

Another experiment I did at my workshop on 26th March was about something called mental accounts.   You might like to try it.  It’s one of the most looked at, least understood habits we have about money.  But if you understand it, you could save a lot of money.

Imagine that you buy a ticket to the Cup Final or a hit show.  At the stadium or theatre you realise that you have lost the ticket that cost you £120.  You have another £120 to buy a new ticket.

Do you buy a new one?

Think about that, and decide before you read on.

Imagine the same situation, you are going to the Cup Final or a hit show, but this time you are planning to buy the £120 ticket when you get there.  At the stadium or theatre box office you realise you have dropped the £120.  You have another £120 to buy a new ticket.

Do you buy a new one?

Think about that, and decide before you read on.

What normally happens is that in the first case, only about 30% of people say yes, they will buy a ticket.  Most people will not buy a new ticket if they have lost the ticket.  But about 70% say yes in the second case.  If they have lost the money, they’ll buy a ticket.

How about you?

Obviously, in both cases you’ve got the same situation – you’ve lost £120, it doesn’t seem logical to buy a ticket in once situation and not the other.

The usual reason we do this is that most of us have “mental accounts”.  The same money (money inherited, money on credit card, money spent on tickets, money found in the street) is all money, but we think of it as different.  We put it into different accounts in our heads.  So most of us think that when our “ticket money” is gone, we have no more money and can’t buy a ticket, but if we have “general spending money” we can use that for anything we want.

Which gave rise to an interesting result.  When I did the experiment at the workshop, about 60% said they would buy if they had lost the money, but only 50% if they had lost the ticket.  So we got the same sort of result, but with much less difference.  Apparently this group were not normal.  Why?

One of the audience actually suggested the solution.  There were a lot of psychologists there.  They’d studied decision making and knew the “logical” result.  Because that is always supposed to be better (It isn’t.) they went for the “logical” result and tried to think of all the money as being equal.  Of course, that didn’t work completely for everybody, but even if it had, being logical isn’t all it is cracked up to be.  It’s better to be aware of how you think.

For example it is often supposed to be “logical” to have an emergency fund.  So people in one study in the US had an average of $5.000 on deposit as an emergency fund earning them 3% and $3,000 on a rolling balance on credit cards costing them 19%+.  They were losing 16% a year for their emergency fund.  But that – I’ve heard- is because people think of the emergency fund as a mental account, so it is still better to be logical.

Think about another situation.  You want to save, and leave the money to build up, but keep raiding the saving to cover small bills, the extra credit card expenses, the new tyre for the car etc.  Imagine that you were left the money by Great Aunt Gertie, whose favourite you always were.  If you had that money, could you spend it on trivia?  Or would you save it for something important, like a new house or the children’s college fund?  That’s illogical, isn’t it?  But it is a good way of saving.  If you can make the money “sacred”, imagine it is Auntie Gertie’s or whatever, you’ll get to the position that you’d rather sell a kidney than spend that money.  So you won’t fritter it away, will you?

There are lots of applications of this – mental accounts are one of the easiest mental habits to use to your own benefit (there’s a lot more about using them to help you in my book).  But you can only do that if you understand what you’re doing.  Trying to be “logical” doesn’t work anyway (human beings are not like that) and it actually limits your options when dealing with money.


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