Wednesday, 13 May 2009

Mental accounting

Funny isn’t it, how money can take on more than its face value? Most people feel justified blowing a tax refund but not money they’ve diligently saved. 

As fallible humans we're all susceptible to what behavoural enonomists call mental accounting. That's the tendency to categorise and treat money differently depending on where it comes from, where it is kept and how it is spent.

One of our readers sent in a Q&A that illustrates this problem perfectly. Having struggled with debt for years she suddenly received an inheritance when her grandmother died. She wanted to repay her debts but felt this wasn’t proper use of her grandmother’s money. See what we said here.

Money has the same value in absolute terms regardless of where it comes from. Yet, as Belsky and Gilovich point out in their book Why Smart People Make Big Money Mistakes, it doesn’t always feel that way.

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