Definition - “an information processing bias in which people treat one sum of money differently from another equal sized sum based on which mental account the money is assigned to”
I do not understand what the book is saying. Can someone help me out with this definition with an example?
you set up multiple bank accounts. say this account is for retirement, this is my current checking account. then say I will spend from my current checking account, will not touch my retirement money. e.g. so you are looking at money as something that exists in different accounts and therefore by that nature they are separated. However the Mental accounting bias (or lack of that bias) indicates that money is non-fungible. money is money, irrespective of the account you spend it from.
Look at your funds more holistically - as here is the total funds.
There was a woman at a university at which I was teaching who had three retirement accounts: her “safe” account, which would fund her minimum retirement needs, her “moderate” account, which would fund her wants, and her “risky” account, which would fund her extravagances.
The funny thing is that I analyzed the three accounts: the “safe” account was, in fact, the riskiest of the three, and the “risky” account was, in fact, the least risky of the three.
^ Really magician, thats hilarious
“ignores that money is fungible, and treats it differently depending on categorization” - Kapaln.
I find it’s helpful.
Another example is a windfall (bonus, tax refund) being treated differently than a regular cash flow (base salary).
My mother has a separate pot for education money, month expenses, savings, home improvements etc. When one pot runs out before the month end, she would rather borrow from some small lender than touch the savings account or any other pots. Obviously she incurs large interest expense on the borrowings and a small interest income on savings. The more rational and optimal approach is for her to look at the portfolio as a whole – this will obviously cut down on interest expense. Money is fungible – there is no point in having separate pots. No matter how I explain this to her, she prefers it this way for easiness!