In today’s post I will try to explain you about the meaning of “Mental Accounting” and how it can affect your financial life. Mental Accounting is basically a concept of “Financial Behavior”. Which explains human tendency towards money during special situations.
How to identify that you are suffering from Mental Accounting?
A) You dont think that you are spending more, but trouble in saving or investing.
B) You have savings in your account, but uses credit card for purchase and end in paying hefty interest and penalty.
C) Even though having cash in bank, your credit card bills not paid or you still have outstanding loans.
D) You spend without any plan on your unexpected money.
To simplify this theory I will use few examples which makes you clear.
1) Suppose you decided to go to movie and bought the ticket too by paying Rs.500 and when you are about to enter the movie hall, you lost the ticket. Will you still purchase one more ticket and watch the movie?
In the another scenario, you stand in line to purchase the movie ticket. But before you purchase ticket you found that you lost Rs.500 cash somewhere in middle before purchasing ticket. Will you cancel to watch the movie as you lost Rs.500 which is equivalent to movie ticket?
As per study, in first scenario most people decide not to buy one more ticket. But in second scenario they will purchase the ticket and watch!!! Interesting right? Reason is, in first case they thought that instead of Rs.500 you are spending Rs.1,000 to watch one movie. But in second case, you separate the lost money with movie expenses. Hence you decide to go for movie.
2) You are about to purchase LED TV which may cost you around Rs.1,00,000. But when you enter show room, salesperson tells you that the price of the TV you selected raised and it is now costing you Rs.1,02,000. Will you purchase still? Study shows people compare Rs.1,00,000 with Rs.2,000 which is negligible and they go with purchase. But they not think that Rs.2,000 may be worth of buying 50% of your monthly grocery.
3) You saw one add in newspaper where Shopping Mall declared 60% off on purchase of items worth of Rs.10,000. People rush to encash that offer. End up with purchasing few items which you neither thought to purchase nor it may be useful item for you. The prices listed on store shelves are thus constantly compared against our expectations and biases. Therefore, when an item is spotted at a price substantially lower than we are used to seeing, we can be tempted to buy it for that reason alone, whether or not we had any desire to buy that item beforehand. Malls and Shops uses this tendency of mental accounting to increase their sales.
4) It is always human tendency to spend recklessly when they receive money unexpectedly by the ways of Bonus or cash gifts. But they never think that with the money they received, if used properly can be of huge financial leverage in future or atleast can solve their bad debts. Best example to give is, they shy away from purchasing Term Insurance for their life risk which may cost them around Rs.500 monthly. But they never think twice to spend Rs.500 on bad movie or some health hazard related habits.
5) You want to purchase one single bed sheet which is worth of Rs.150. But you saw discount offer in one shop where they are selling double bed sheet to Rs.200. Will you buy single bed sheet or double bed sheet? Mental Accounting force you to buy double bed sheet as it is cheaper than the actual price. You end up with purchasing double bed sheet by paying Rs.50. But you purchased the unwanted thing and ended in loosing Rs.50 too.
Hope above few examples made you clear about Mental Accounting. Now few tips to fix this problem.
1) Treat your money which comes to you in whatever form like how you treating your earned money.
2) When you are spending with unexpected cash, think twice whether you spend like same way with your earned money?
3) Money is money. Hence either you save Rs.500 or Rs.2,000 in whatever way, do the mental accounting to your advantage.
4) Act yourself consciously with every purchase is it worth and compare with every other purchase you made.
4) Record keeping of each expenses- It makes you to stick to your basics related to your expenses.
Hope above lines made you to come out of Mental Accounting and will focus on your true requirement and spending. Happy Saving !!!