Going mental
The (kind of) Jedi mindtrick that may help the Force be with you, money wise.
BY TAREQUE LASKAR
Imagine you are taking the clothes out of the dryer one day and find that there is a slightly crumpled but perfectly usable 200 rupee note peeking out of your favourite jeans’ back pocket. You would be super delighted and probably spend the money on an impulse purchase as if you somehow got the money for free. But, wait, it was your money in the first place.
So why the wide grin?
We are about to find out.
During the time I was a Graduate student at University, there were many term papers to be written, assignments to be submitted and homework to be done. It was usually a tedious job and I needed a booster to help me through the task. Some folks tend to rely on energy drinks for the all-nighters that help them pull such stuff off. But I dislike both energy drinks and all-nighters. My vice was candy. I would munch on Skittles or Nerds, or some licorice, as I toiled away at a spreadsheet, crunching a set of numbers or hacking away at the keyboard trying to conjure up an essay.
This meant I’d need to buy my stash of candy each week and I was worried about spending too much money on it. To prevent that situation, I had a simple solution – there was a box marked ‘Candy Fund’ on my study table, and everyday, if I saved a dollar or even a quarter (25 cents), I would put it in there. I would not spend it on anything else; in fact I wouldn’t even touch the box the entire week, except Sunday evenings, when I went out with the money accumulated to buy candy. The trick I was using to keep within a budget for the candy is known in finance and economics circles as ‘mental accounting’.
In his 1999 paper ‘Mental Accounting Matters’ Prof. Richard H. Thaler of the University of Chicago, who introduced the idea in 1985, explained mental accounting thus:
“[T]he assignment of activities to specific accounts…Expenditures are grouped into categories (housing, food, etc.) and spending is sometimes constrained by implicit or explicit budgets. Funds to spend are also labelled, both as flows (regular income versus windfalls) and as stocks (cash on hand, home equity, pension wealth, etc.)”.
It is a kind of financial shortcut we use, mainly for our discipline’s sake (keeping temptation at bay, just like in my candy habit case) and involves ignoring an important economics maxim under the ‘rational’ model – that money is fungible, which means Rs. 200 should be worth the same to us, no matter what it is being used for.
An experiment Prof Thaler ran, illustrated how that works. He imposed the following situation to a set of people; Suppose they bought a movie ticket for $10 and reached the cinema to find they’d lost the ticket (or, in these days of the internet and apps, maybe the Bookmyshow app messed up the booking; which it usually does). Would they buy another ticket (same price) to watch the movie? A majority (as I am guessing, probably you will too), said no. For another set of folks, he changed the scenario. You reach the cinema, you still have the ticket but you lost a $10 note there somehow. Would they still watch the movie? A majority (again, probably you will say the same, too) said yes. In economic terms, both situations involved ‘spending’ $20 to watch a movie, but people were ok with the second situation but not the first. Remember, if money was fungible, that is $10 is $10 no matter whether you lose it in the form of an extra cinema ticket or because a note fell out of your wallet, there shouldn’t have been much difference between the response to the first situation and the second one.
However, people do not do economic accounting; you and I use mental accounting, for all sorts of finance decisions, from buying candy to buying investments.
At the start of the month, when you receive your salary, you might write down in your budget that Rs. 5000 goes towards entertainment this month and spend from this imaginary account and keep a running mental tab (or, maybe even write it down). In some ways, it is a good thing. It helps with discipline and commitment, essential devices to keep you on track especially for financial goals. A tool like a systematic investment plan (SIP), where you invest a fixed amount in a mutual fund scheme every month, takes advantage of this kind of thinking. If you are spending on your credit card, it is easy to lose track or overspend, but if you mentally assign categories and limits to the spending, it becomes easier to track and control, even if this is not exactly rational or scientific.
Now back to the jeans. That 200 rupee note feels like a surprise gift from your past, forgetful self to your future self, because you had no category in mind for that money [or don’t remember even if you did].
A mental accounting trick just gave you some extra happiness!