This post initially appeared on Moneycontrol.com
Let me narrate a famous story known as the “Legend of the Man in the Green Robe”.
A newly-wed couple head to Las Vegas for their honeymoon. They set aside $1,000 as play money for gambling which they predictably lose. On the last night, the groom notices a $5 gambling chip on the table. Unable to sleep, he gets up, puts on a robe (a green one, of course) and heads to the roulette tables.
Roulette is a game in which a ball is dropped onto a revolving wheel (known as the roulette wheel) which has numbered compartments. The players bet on the number at which the ball will come to rest.
The groom bets on 17 and bingo, that’s where the ball lands. He gets $175 (the odds are 35:1). He lets it ride, which means that the winning chips remain on the table. He soon accumulates $6,125. This goes on till he has a few millions credited to him. Virtually delirious with exuberance and optimism oozing out of every pore of his being, he decides to take one more chance thinking his luck will never run out. He bets it all.
He loses.
Everything!
In a daze, he stumbles back to his room.
“Where were you?” his bride asks.
“Playing roulette,” he says.
“How did you do?”
“Not bad. I lost just $5”.
He logically avoided the horror of his loss by believing that since he began with $5, that is all he lost. But that’s not true, is it? The millions would have been translated into real money if he stopped and cashed his earnings. The story may be fictitious but hits home. A dollar is not always a dollar (or rather rupee, in our case). Money is always viewed differently depending on the source.
If you are not convinced, look at your own behaviour.
Have you not noticed that you view an unexpected bonus at work, a sudden investment windfall, a tax refund, a gift from a relative, a surprise inheritance or a lottery win with a different perspective from how you would view your earnings?
Or, if you got a freelance assignment which did not interfere with your work and the remuneration not clubbed with your monthly salary, you would tend to be more liberal in spending it?
Yet again, if you made a killing in a rampant bull run, chances are you would be more than enthusiastic to put some of the earnings in a stock tip or a volatile sector fund which you would have shirked in your regular monthly investing plan.
John Allen Paulos in his book ‘A Mathematician Plays The Stock Market’ says that we categorise money in odd ways and treat it differently depending on what mental account we place it in. He goes on to give an example.
Let’s say someone lost a $100 ticket on the way to a concert. He is much less likely to buy a new one, unless he is desperate to watch the show.
Let’s say he did not lose the ticket but lost $100 on the way to buying the ticket. Chances are he would still buy the ticket.
Why? In both scenarios he lost $100. In the former, he would tend to think that $200 is too large an expense for entertainment. While in the latter, $100 is for entertainment, $100 just turned out to be an unfortunate loss.
Paulos sums it well: Personal accounting can be plastic and convoluted.
I remember reading an anecdote by psychologist Hal Arkes. Employees of a firm were taken to the Bahamas on a retreat and each were given a cash bonus. Let’s assume it was $100. Almost all of them headed to the casino to blow it up. What was interesting was that none lost more than the allocated amount ($100). The moment it crossed that, they got more cautious and slowed down or stopped altogether because they felt they were playing with their “own” money rather than the “free” money. Ironical is it not? The $100 was their “own” money too.
In ‘Why Smart People Make Big Money Mistakes & How to Correct Them’, authors Gary Belsky and Thomas Gilovich talk about an experiment conducted where 24 students of Harvard University were told they were receiving $25 windfall as part of a research project and could spend as much as they wanted at a particular store. The unspent amount (from $25) would be sent to them by cheque.
Here’s the clincher.
- 12 of them were told that $25 was a bonus
- 12 of them were told that $25 is a rebate
- 84% of them who were told it was a bonus, spent some or all of the amount
- From the group that was told it was a rebate, only 21% spent any money at all
The authors conclude: Like it or not, mental accounting is a powerful driver of our actions.
Mental accounting is a psychological phenomenon that causes us to mentally separate money into different accounts. This in itself is not a bad habit. A vacation kitty is presumably treated with less gravitas than the same amount of money socked away in a retirement account. Even die-hard spenders will tend to halt themselves from recklessly poaching from their retirement kitty.
But don’t be a slave to your thought process. Remember to be responsible for all your money, irrespective of the source. Refunds, bonuses, inheritances, gifts etc are not “free money”. Treat it with the same responsibility you do your salary income.
