Has “mental accounting” ever influenced your financial decisions?

When faced with money-related issues, do you know how to make rational decisions to protect your interests? Or do you subconsciously make decisions that are detrimental to your interests? If you have never given this much thought, please take the following test.

Scenario 1: Suppose your favourite singer is holding a concert, and you bought a $1,000 ticket. At the entrance, you realize the ticket is missing. Would you go to the ticket office and buy a new one?

Scenario 2: You are going to a concert by your favourite singer, but in this scenario, tickets are available only at the on-site ticket office. At the ticket window, you realize you have lost a $1,000 banknote. Would you buy a ticket to the show anyway?

Whether or not you would still buy the ticket is a personal decision, perhaps depending on how much you like the singer. The focus of this test is not on your answer in each scenario, but whether you give different answers to the two scenarios. In both cases, you would end up spending $2,000 to see the concert. But psychologists found a much lower percentage of people would buy the replacement ticket in scenario 1, because they would feel they had already spent $1,000 on the ticket, and buying another would mean that altogether they would spend $2,000 to see the show. In scenario 2, although losing money is unpleasant, they would be more willing to make the purchase because it was a banknote lost and not a ticket, so the show would still cost them $1,000. In both cases, $1,000 has been lost, but because they have different “feelings” about each scenario, they make different decisions about their spending.

“Mental accounting” influences financial decisions

“Mental accounting” influences financial decisions

This test is related to a theory put forward by a Nobel Laureate in Economics. According to the theory, human brains set up different “accounts” for money from different sources or for different purposes. Even if the actual monetary value is the same, money from different “accounts” can have different personal value because of our psychological biases, thus affecting our financial decisions. Your monthly income, for example, is hard earned, so you spend it carefully. But when it comes to your year-end bonus, you may tend to spend it more easily, viewing it as a reward for your hard work. (You might even spend more from your bonus than you saved from your monthly salary all year.) The same is true for cash coupons won from a lucky draw, or money won from small bets; we tend to spend it more recklessly. These are all behaviours influenced by “mental accounting”. If we take a closer look, we will find that a dollar in hand, no matter where it comes from, is just a dollar that belongs to you, and you should treat each dollar the same.

A friend of mine is keen on stock investment. He puts a lot of effort into managing a portfolio worth $20,000–$30,000 to save for a trip to the Maldives with friends. However, he has never paid attention to his MPF, and doesn’t care how much money he has accumulated or what funds he has invested in. According to the figures provided by the Mandatory Provident Fund Schemes Authority (MPFA) as at the end of December 2017, MPF scheme members had average accrued benefits of about $200,000. That means this friend is regularly checking his “Maldives account” that worth $20,000–$30,000, but ignoring his MPF account perhaps worth $200,000 or more. In fact, whether it is your bank account or your MPF account, it is all money that allows you to achieve your life goals, and should be managed appropriately.

Don't ignore your MPF

Don't ignore your MPF

From now on, try to be aware of “mental accounting” and not let it interfere with your financial decisions. Take extra note of your assets, including your MPF and any other savings and retirement investments. Make it a habit to read your MPF Annual Benefit Statement carefully, so you have a good grasp of your contributions and the performance of your investments over the past year. Regularly review it and consider whether you need to adjust your MPF investments, based on any changes to your personal circumstances. Don’t let psychological biases stall your retirement plans.