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When Mental Accounting Backfires...

I have already written some articles about mental accounting before, but those articles mainly focused on explaining how it worked, and how it came to be a popular concept within behavioural economics. In this article, I will quickly recap on its definition and some of the research done, but I will mainly focus on one of my own experiences I had recently when going to Amsterdam, where my British bank account was left alone, but my Dutch bank account was spending money left and right.

Income into Jars Let's refresh our memory. Mental accounting is a type of categorisation where, in our heads, we distribute money into different jars. This system is very similar to how in the previous century, housewives divided up the family income into different jars as well. A jar for the rent or mortgage, one for food, one for clothes, one for savings etc. Given that currently most of our money is no longer physical but online, this real-life division has turned into an online and mental division. This seems very orderly, but research has pointed out that this system can backfire. Let's look into this first.

Immobile Money Thaler is one of the people who has, in great detail, explained mental accounting and its possible consequences. He mainly focussed on two pitfalls: co-holding and immobile money. The former I have written multiple articles about, which you can read here. As such, it is the latter I will delve into. One of the drawbacks of mental accounting is the rigidness of the system. Once people have made up their “jars”, they won’t move money in between them. For example: some people have a jar for a rainy day. It’s not really long-term savings, but rather for when things go awry financially: say, when the washing machine breaks, or something else that is rather expensive needs to be replaced. Now, imagine a person who has had a very expensive month. Lots of eating out, dinner parties, expensive grocery shopping trips, a typical December some might argue. As a result the “food jar” has run out before the month has.

Now comes the flabbergasting behaviour that raises questions with so many (behavioural) economists: Instead of dipping into a different jar (or multiple jars) that does have money left in it, and replacing this money the next month, without much consequence, this individual pulls out the credit card or another type of loan. It seems as if once money has been entered into one jar, it can only be used for one purpose and one purpose only. This is insane, because at the end of the day, we are talking money. The one exchange value we have that can turn into anything. But not with mental accounting! So one drawback of mental accounting can be that people go into debt, rather than spend money they do in fact have. This behaviour is costly. Debt isn't exactly cheap. But I have recently discovered a consequence of mental accounting I did not know existed before, and it has cost me a lot of money already! When Money doesn't Register Now my own experience has very little to do with co-holding. I am quite pleased to say that I do have savings, yet I have no debt to balance them against (thanks mom and dad!). What I do have however, is two very different bank accounts: Dutch and English. The former is from when I lived and home, so it was the very first I had. This account only gets used when I am back home. The latter gets used all the time, because I live and work in the UK, and as such spend most my time (and money) there. Now why is this relevant? Because it shifts your perspective. I am quite careful when it comes to spending and keeping track of my money. I check my daily (British) account often, to account for all my in- and outgoings. This is the account I live off. But this is also the account that does not get used when I am in a Euro zone country, such as the Netherlands. Then my Dutch account gets used. And that account I do not track on a daily basis. That is not living money. So somehow, somewhere in my mind, this account has turned into "play money." And when you don't consider money at its true value, it just flies out of your wallet. Now there are associations to take into account here. When I am in the Eurozone, I am often on break. I go home to see family, or to a nice location such as Budapest just to chill (ironically Budapest still has to Hungarian Florint (HUF), but I still run into similar issues as when using Euros). So break for me just means turning from a tightwad into a spendthrift. But if you're trying to ball on a budget, this is guaranteed to backfire. You need to make sure this different source of money keeps registering. And I am saying this to you as much as I am saying it to myself. Because when I run out of Euros, I am just as out of money as if I had drained my British account. So broke does mean broke. It just seems so odd that having used mental accounting, this does not register. So, when going abroad, or using any account that is not your day-to-day account, be careful. Track it well, set yourself a budget, or just use cash exclusively. When you run out of physical money, you're done! Now I am curious to know whether I am the only person experiencing this drawback of mental accounting, or whether you struggle as well. Leave a comment down below, or tweet!

Behavioural Science

Personal Finance



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