Planning matters

Mental Accounting: There’s More to Thinking Than You Think

We’re back with the next post in our behavioral bias series: There’s More to Thinking Than You Think. Today we explore the behavioral bias of mental accounting.

Cash is cash, right? But sometimes, we treat money differently depending on where it came from or what we intend to do with it. When that happens, mental accounting may be at play, and that can add up to trouble for your financial goals.

Take, for example, money that has been saved in a child’s college fund. Even if the accumulated college savings would be better used to pay off high-interest debt, a parent using mental accounting would consider this savings to be “too important” to relinquish to put toward other purposes, even if doing so would be the most logical and financially beneficial move.

Mental accounting shows up in investor portfolios, too. A fairly common issue is being emotionally tied to certain stocks, especially if the stock was inherited, received as a gift, or if it’s from a former employer. People may feel disinclined to sell a holding that was received from one of these situations, even if it’s a bad investment or not diversified.

A related aspect of mental accounting suggests that people tend to treat money differently depending upon the source of that money. “Found” money, which may include things like tax refunds, work bonuses, prizes and gifts, tends to be spent more freely than money earned through normal paychecks. Again, logic would suggest that these monies should be treated in the same way, but real-world scenarios show otherwise.

To break away from the mental accounting game, aim to treat all money with the same careful consideration, no matter where it comes from or how you plan to use it. And as always, use your financial planner as a resource to provide objective guidance and long-term perspective to help you reach the full potential of your financial plan.