Mental Accounting Influences How We Spend Our Time

Mental accounting, a theory introduced by Richard Thaler who is a founding father of behavioral economics, is an example of a common bias in finance² that describes the tendency for people to categorize their money into separate non-fungible accounts — or accounts that distinct from each other. Common accounts include savings accounts, chequing accounts, and retirement accounts, which have funds allocated to them based on their source or intended use and often result in irrational decision-making. 

Mental accounting: how it hurts, how it helps

We have all, at least at one point in our lives, surrendered to mental accounting bias. For example, people often spend money earned unexpectedly — such as lottery winnings or gift money — faster than steadier streams of income, and on items of less importance. People also have a tendency to delay purchases for important items because their mental account for them is depleted all while they continue to spend money on less important things. Undoubtedly, these decisions violate economic rationality, which posits that money is a fungible resource whose value remains constant irrespective of its source or intended use. 

Nevertheless, mental accounting bias can also be helpful in some instances; it’s often what allows people to save money in their emergency, retirement, or children’s education funds. By refusing to use money from these highly important accounts regardless of the circumstances, people are able to protect their futures at a small temporary cost.