Mental accounting influences financial choices from "summary" of Advances in Behavioral Finance by Richard H. Thaler
The concept of mental accounting refers to the tendency of individuals to categorize their money into different mental accounts based on various factors such as the source of income or intended use. These mental accounts can influence individuals' financial decisions by affecting how they perceive and evaluate different financial options. For example, individuals may be more willing to spend money from certain mental accounts than others, even if the money is fungible and could be used for any purpose. Mental accounting can lead to suboptimal financial decisions because it can create artificial barriers between different types of money, leading individuals to make choices that they would not make if they viewed all their money as part of a single account. This can result in individuals spending money on less important expenses from one mental account while neglecting more essential needs in another account. One example of how mental accounting influences financial choices is the phenomenon of "earmarking," where individuals allocate different amounts of money to specific purposes based on mental accounting principles. This can lead individuals to overspend on certain categories, such as entertainment or dining out, while underinvesting in more critical areas like savings or retirement planning. Moreover, mental accounting can also influence individuals' perceptions of gains and losses. For instance, individuals may be more willing to take risks with money that they perceive as "found money" or gains from investments, while being more risk-averse with money from their regular income. This can lead to inconsistent risk-taking behavior and suboptimal investment decisions.- Mental accounting can significantly impact individuals' financial choices by influencing how they categorize, evaluate, and allocate their money. By understanding the principles of mental accounting and recognizing its effects on decision-making, individuals can make more informed and rational financial decisions that align with their long-term goals and priorities.
