Definition: The inclination to categorise and treat money differently wdepending on where it comes from, where it is kept, or how it is spent.
Reference:Richard Thaler: outlined one of the most common and costly money mistakes: mental accounting - the tendency to value some dollars less than others and therefore waste them.
Example: When gift or rebate income is valued differently to earned income.
Insight: Mental accounting goes against the concept that money is "fungible" - money should hold the same significance regardless of where it comes from.
Insight: Mental accounting can have benefits - particularly for saving or financial goals.
Insight: Mental accounting becomes a problem because of human self-control.
Insight: Signs of someone prone to mental accounting: (1) doesn't think they are a reckless spender but has trouble saving; (2) has saving in the bank but revolving balances on credit cards (3) more likely to spend a tax refund than savings (4) spend more when paying on card than cash.
Principle: Regularly audit your personal accounting systems.
Principle: Pause before spending "found" money.
Principle: Treat all income as earned - before spending imagine how long it would take to earn.
Principle: Use mental accounting to your advantage for savings - automate savings and put into hidden accounts.
Definition: The preference for keeping things the way they are.
Examples: Leaving money in a bank account rather than investing it at a higher return, staying in a lower paying job rather than switching, failing to sell an investment before a price drop, delaying a purchase only to see the price rise.
Insight: The status quo bias is in part a demonstration of satisfaction or happiness with the present situation.
Insight: Most people want to avoid the pain of regret. Decisions to change impart a higher level of responsibility that doing nothing, as a result people are averse to sticking their neck out.
Definition: One of the most common behavioural-economic mistakes that leads to financial decisions based on previous investments or expenses.
Example: Most people would risk travelling to a concert of sports game in dangerous weather if they had paid for an expensive ticket, while most would pass if they had been given the ticket for free.
Reference: Richard Thaler: described the Sunk Cost Fallacy in 1980, as a form of loss aversion.
Insight: We often throw good money after bad, because we cannot let go of money already spent.
Insight: We make poor decisions when we take into account money, time, or effort that we have spent in the past.
Insight: People may fall prey to the Sunk Cost Fallacy because they do not want to appear wasteful.
Insight: It is common for governments to spend as much money as possible on a project before it can be analysed, to exploit the sunk cost fallacy.
Insight: Money already spent shouldn't matter in financial deciision making.
Insight: The sunk cost fallacy can explain why people stay too long in unhappy careers.
Principle: When making decisions, we should ignore money already spent, and focus on future costs and benefits.
