“Money is meant to be fungible, used interchangeably; that is, money is money is money.”
If you keep a monthly budget (which I hope you do), you’ll know that you’re supposed to take stock at the end of each month and check whether you’ve overspent on any line items. How many different line items and how detailed you maintain this budget is up to you, but the thing I want to focus on this month is what’s known as “mental accounting”. It’s a concept that was first named by Richard Thaler and describes the process whereby we segregate money into different “accounts” and then apply different sets of rules to these accounts.
I find I suffer mostly from this bias when I’m comparing the line items “food” and “entertainment”. The former is managed by me (read: I pay) and includes our groceries, trips to the butcher, and Nespresso pods. The latter is managed by my husband (read: he pays) and pays for eating out, shows, concerts, and those dreadfully over-priced Impi tickets.
Before I’m accused of being a foodie (not necessarily a bad thing), let me not divulge these actual amounts and rather hypothesise that food and entertainment are both budgeted to be R3 000 a month. At the end of the month one of us is always over budget and one of us is always under budget.
It could be argued that one of us is managing the budget better or that the budgets should just be reallocated more accurately, but at the end of the day we are more or less keeping to the total budget for these two items, that is, R6 000 every month.
It makes complete sense – if we’re not cooking (and using the groceries budget to do so), then we’ll go out for dinner and vice versa. The two are negatively correlated. So why are we assessing them separately?
This example is made more extreme by the fact that there are two different people controlling each budgetary item, but consider two items that only you control and I’m sure you’ll find a similar example.
It’s the same when you look at the performance of your investments. We tend to feel pleased with the ones that are performing well and resentful about the ones that aren’t, instead of grouping them together and assessing their performance collectively.
Besides, isn’t that the reason why we diversify our investments, to hedge our risks? Then why don’t we assess them that way?
Money is meant to be fungible, used interchangeably; that is, money is money is money. But ‘mental accounting’ says that we don’t abide by this. Just some food (or entertainment) for thought … ❐
Author: Gizelle Willows CA(SA) MCom Finance is a Senior Lecturer in Financial Reporting at the University of Cape Town
