Mental accounting

Hi and welcome back to another entry! Today, I am going to talk about mental accounting. Essentially, it's dividing our money into different sections based on various factors, such as its source or what we're spending it on. Richard Thaler, a pioneer in behavioral economics, first introduced this concept in the late 1980s. It challenges the traditional economic view that all money is treated the same, regardless of where it came from or how we will use it.

People tend to organize funds into different accounts depending on their origin or use. For example, you might treat a tax refund differently from your regular income, even though it's all economically the same. This is similar to a concept trending on TikTok or Instagram lately, the idea of "free money." Many people have gone viral online making jokes about how if they return an item they bought previously, whatever they spend the redeemed cash on is technically free. While this is mostly treated as a joke (coined "Girl Math"), many people do think like this, often subconsciously!

Mental accounting also affects how people budget and spend their money, as they organize various budgets for entertainment, dining out, petrol, etc. This sectioning helps us control spending by providing clear guidelines on how much money is available for each purpose, avoiding overspending in one area or another. It promotes smart choices when making purchases and encourages effective budgeting.

On the other hand, poor financial judgments can occasionally result from mental accounting. For example, even when it makes financial sense, people may be reluctant to take money out of their savings accounts to pay for necessities. Their inflexibility may prevent them from making adaptable and flexible financial decisions. Mental accounting can also give people a false sense of security, making them feel they can overspend in some areas because they have "extra" money set aside in those accounts. This can put a strain on one's overall finances.

Another aspect of mental accounting is windfall gains. This refers to money accumulated from sources such as the lottery or gifts, which are often received unexpectedly. Such funds are usually spent much more freely than our regular income because they are categorized as "extra" money rather than part of the usual budget. For example, you might spend a work bonus on a luxurious vacation or a designer item you have been eyeing for a while, even though normally you would view these purchases as risky or unnecessary. Windfall gains have a significant psychological influence because you don't consider this money as necessary for financial security. We frequently feel less guilty about using it for experiences or non-essential items, thinking, "I might as well enjoy this extra money while I have it," leading to more liberal spending habits. Though treating windfall gains as "fun money" can bring short-term happiness, it might also cause you to miss out on long-term financial advantages. Investing or saving windfall gains, for example, can greatly enhance one's financial well-being by serving as a safety net for the future or by helping achieve long-term objectives like retirement. Acknowledging the temptation to carelessly spend windfall income allows us to make more deliberate choices, striking a balance between instant satisfaction and careful financial planning.

Various marketing strategies are used by companies with mental accounting in mind. When online shopping, you often see options like "Klarna" or "Afterpay," which allow you to divide your payment into different breakdowns, to be paid on separate dates, making consumers more likely to spend. Breaking down a large expense into smaller, more manageable payments can make a purchase seem more affordable, encouraging people to make the purchase. Product or service bundling is another marketing tactic. Companies entice customers to overspend by bundling many items into a single package and offering them at a perceived discount. For example, a computer company may offer a laptop, printer, and software package at a discounted cost compared to buying each item separately. Because they think they will save money over time, the consumer views the package as a better value and justifies the higher total cost. Businesses frequently utilize the idea of "mental accounting" to defend price hikes by claiming to provide value. A streaming service like Netflix may increase its monthly subscription cost but also increase the amount of content it offers and add new features. Because we believe we are getting greater value for our money, we are more willing to accept the higher cost after mentally accounting for the additional benefits, and Netflix has prospered.

That's everything for today! Thank you for reading and see you next week :).