Are You a Victim of Mental Accounting?

 Mental Accounting affects how you spend or save money.

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Scenario 1: You visit a TV showroom, along with a friend, to buy a new LED which costs Rs. 50,000. While finalising the deal and about to make the payment for the TV at the cash counter, your friend who went out suddenly comes running in and tells you not to buy that TV from this store! Surprised, you ask why. And her reason for not buying is that the same TV is available at the very next shop for Rs.49,900 only! 
Question: What would you do and how many people do you think would go out and purchase it from the next shop? 

In most cases, people will laugh at their friend and not bother to visit the other store to save Rs. 100, right?

Scenario 2: Instead of a TV, let’s say you were to buy a calculator and you, along with the same friend, visit a stationery shop. The calculator you decide to buy costs you Rs. 500, and once again before you make the payment, your friend stops you buying from that shop because the very next store has it for Rs.400. 
Question: Now what will you or most people do? 

If looked at these scenarios separately, more people would go out of their way to save Rs.100 while purchasing a calculator, but not while buying the LED TV. But both these scenarios involve a saving of Rs.100 only.  

So what does this trait indicate? It establishes the fact that a rupee is a rupee irrespective of the source it is coming from or how you want to use it.  And the saving of Rs.100 in both scenarios would have the same purchasing power, which means that you can buy the same value of stuff with that money. Thus, the behaviour as followed by most people in the first scenario is called Mental Accounting. 

The trap of Mental Accounting!
It affects how you spend or save money. Did you ever watch a movie in a theatre that you felt was a complete waste of your time? But did you ever walk out of the theatre? Mostly no; because very few people would walk out after paying Rs.300 or so for the ticket.

Even if you analyse the share market scenario; you will find investors holding on to stocks and not exiting bad stocks because the current market price is below their purchasing price. Investors know that the stock purchased has turned out to be a bad choice and there are better choices, but they still hold on to the stock hoping that it will break even soon. This mainly happens due to the fact that the moment the human mind foresees a loss, it stops thinking rationally as fear takes over and the ability to cut losses simply goes for a toss.

Similarly you may consider a tax refund as your free money but in reality it was your very own hard-earned money which got deducted in excess. But people do not spend the money received from tax refunds/ bonuses/ birthday gifts/ wedding gifts / lottery on paying off for their essential utility payments like school fees or credit card bills. The same amount mostly gets spent on vacations or buying gadgets.

How to avoid Mental Accounting
Invest the so called ‘free’ money as discussed on essential things. Stay tuned for more detailed examples on how to take better control of your finances by avoiding the trap of mental accounting in your day to day life.