learn mental accounting and save

Posted on 16. Jun, 2009 by dara in penny pinchin'

Americans and their money behavior is something that’s consistently scrutinized. Why don’t we save enough money? Why is our credit card debt so high? Why do we buy what we know we can’t afford? I read an article today by guest writer Claire on Ramit’s I Will Teach You To Be Rich blog that attempts to address these questions with a simple psychological concept: mental accounting.

Mental accounting is explored in the new book, Why Smart People Make Big Money Mistakes by Belsky and Gilovich. The basic idea is that sometimes we rationalize our spending based on the circumstances. The example the author uses is spending $150 on a concert ticket. If you purchase a $150 concert ticket and show up to the box office only to realize that you’ve lost the ticket, you won’t buy another one. In contrast, if you arrive at the box office to purchase the ticket with cash and you realize that you’ve lost $150 in cash but still have enough cash in your wallet to pay for it, you will purchase the ticket. Interesting…you’re saying “well in either situation I would lose $150.” And you’re right, but in situation #2, you’re more likely to not associate the loss of the $150 with the purchase of the ticket. This my {budget}fab* friends is mental accounting.

Despite the fact that in either situation you would lost $150, in situation #1 mental accounting tells you that you’re losing $300. The author goes on to provide examples of situations where we’re likely to use mental accounting, things we should know about mental accounting, and ways to fix mental accounting. I thought this article was very interesting to say the least. I can assure you that after reading the entire article, I will be more mindful of my spending regardless of where the money came from.

Bonus: Visit Claire’s site for a chance to win Why Smart People Make Big Money Mistakes

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