If people understand mental accounting's limitations and actively think about its impact, they can forget past financial actions and dedicate their time to making well-informed decisions in the future. As a result, they may place themselves in an even more difficult financial situation. It often makes people dwell on poor financial decisions in the past and attempt to make up for them. The sunk-cost fallacy is the habit of continuing to engage in a behavior for longer than is sensible. Related: Consumer Behavior: Definition, Types and Strategies It can support the sunk-cost fallacy This way of thinking can lead to someone developing patterns of buying things they don't really need and paying premium prices willingly. For example, they may pay more money for products that marketers label as "high-end" or "luxurious." People may spend more on a designer handbag because one of their mental "accounts" has funds available for high-end items. ![]() If an individual engages in mental accounting, they may be more likely to believe marketing tactics. ![]() ![]() It can cause people to believe marketing tactics They may continue to pay the cost of a restaurant-prepared meal each week without evaluating if they're paying a sensible price. While this mental "account" makes decision-making easy, it can prevent a person from truly thinking about their purchase. For example, an individual may have a mental "account" for going out to dinner once a week. They may view all the money they have exclusively in categories, and they may be unable to view their financial circumstances on a holistic level. Mental accounting can cause an individual to have a limited view of their finances. Understanding mental accounting's impact is important because: It limits an individual's view of their finances Related: FAQ: What Is Consumer Spending? (and Why It's Important) Why is mental accounting important? If an individual relies on these limiting categories exclusively, they may fail to optimize their available funds. They also help people control irrational or irresponsible spending, stay within their budgets and minimize consumer debt. The first use is that they promote sensible compromises between competing uses of limited funds. This way of thinking stems from the disbelief that money is fungible, meaning that its value remains the same no matter where you store it.Įven though mental accounting can prevent people from transferring money when necessary, the mental "accounts" that people create can have practical uses. People partake in mental accounting when they assign money to different spending categories or "accounts." They refuse to move money between accounts because they categorize their funds so that only specific sums can belong in each account. The concept explains how beliefs and thought processes about money can lead to less-than-helpful financial behaviors. Well-known economist Richard Thaler first described this concept in a 1999 paper that appeared in a peer-reviewed journal called the Journal of Behavioral Decision Making. Mental accounting is the process of how people decide to save, spend and invest their money. In this article, we define mental accounting and explain why it's important to understand. Understanding the concept of mental accounting can help you change the way you think about money and make wiser financial decisions. They take the limited funds they have and restrict their use to specific spending and saving categories. ![]() People think about money in different ways, which causes them to have different spending and saving habits.
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