Same money, different value: the paradox of mental accounting
Behavioural finance
Posted by MoneyController on 28.07.2023
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Mental accounting is a phenomenon that leads us to assign different values to the same amount of money. Let's take a closer look at what it is.
When people talk about mental accounting, they often refer to an experiment conducted by Daniel Kahneman and Amos Tversky. In the experiment, respondents are presented with two situations in which a person is about to attend a theatre performance (but the example could apply to a rock concert, a film, and so on).
In the first case, the spectator has already bought the ticket but finds that he has lost it. In the second case, the spectator realises that he has lost the money he needed to buy the ticket. The amounts are exactly the same. It is therefore surprising to find that respondents are more likely to refrain from spending in the first case than in the second: but why? The phenomenon is not unknown in behavioural finance, where it is known as the 'mental accounting' bias.
The point is that the money in question comes from different places. Or rather, one could say that the same amount of money comes from different mental accounts, a division due precisely to a mental accounting process. As explained on the Crédit Agricole financial education site, in the first case (ticket bought but lost), the money comes from the mental account intended for leisure and entertainment. In the second case (loss of the money needed to buy the ticket), the same amount comes from the mental account intended for unforeseen situations.
It is clear that we are willing to spend much more if the money comes from different mental accounts. This is because the perceived value is radically different from the real value. In the case of unforeseen events, the value of money drops considerably, precisely because of the importance of unforeseen events in life. On the other hand, the value of money increases significantly in relation to leisure and entertainment. This phenomenon also occurs depending on where the money comes from: if it comes from hard work, it is valued more; if it comes from chance (e.g. a win), it is valued much less.
On the Bank of Italy's educational portal, Caterina Cruciani, a researcher in the economics of financial intermediaries at Ca' Foscari University in Venice, explains that different mental accounts are also associated with different degrees of risk: Cruciani cites the example of retirement savings, where people tend to be more risk-averse on average than for many other investments.
Read also:
How to avoid the trap of recency bias
Anchoring: even in finance (unfortunately), first impressions count
