A Lenten Challenge: Replace Mental Accounting With Reality Accounting
I gave up mental accounting for Lent. And I’ve already had to start over - twice!
Have you ever watched a game show when the host asks the contestant, "How will you use your prize money?" The response may include "take a real honeymoon to Hawaii, buy my mom a house and pay for my kids’ college."
Call me cynical, pessimistic or a realist, but I am thinking, "you’re going to do all that on $100,000?" To make matters worse, the contestant forgot about the hefty income tax bill coming down the pike.
This is mental accounting. It takes in information and filters it through our brain. Unfortunately, the data is not always processed cleanly. Our hearts, hopes, dreams, past experiences and sometimes even physiological functions get in the way.
Let me offer another example. There is an economic theory on "playing with house money." A gambler wagers $20 on a roulette wheel. She wins $50, now holding $70 of chips. She continues to play, winning some and losing some. At the end of the day, she goes home "a winner" with $30 in her pocket. Is she really a winner?
The gambler would say "yes." She arrived home with $10 more than when she left.
An economist would say "no." Her explanation is that the gambler left the establishment with $40 less than she could have carried home.
A recent newspaper article pointed out another mental accounting scenario. There is a proposal to allow for automatic monthly payments of property taxes directly from a homeowner's paychecks. Some people object to this because payers will no longer clearly realize the amount they are paying for property taxes.
In fact, the objectors are correct. Most employees cannot quote their take-home pay with any accuracy. They will say their health care costs nothing or underestimate the cost because their employer usually pays most of the premium and the employee's share is withheld from his pay. The same is true of payroll (Social Security and Medicare taxes) and income taxes.
Other mental accounting situations are prevalent. As the value of an investor's portfolio or employee's retirement plan increases with market profits, she feels richer and will spend more. This happens even if she doesn't withdraw the money from her investment accounts to spend. She will simply spend more of her earned pay or use credit to spend more. (After all, she has the money - it's just in another account.)
This system of mental accounting works well until the value of the investors' accounts decrease. This scenario is what happened to many homeowners in the past decade. Their wealth was greater as their home values increased and they spent the "house money."
Using reality accounting instead of mental accounting is much healthier for consumers attempting to make spending, saving and investing decisions. Always ask, what will happen if events occur contrary to what assumptions are included in the analysis? Are those results acceptable? Know where all spending goes, including those automatically withheld from paychecks. Calculate the whole cost of any transaction – down payments, repayments, interest if funds are borrowed, current payments and operational costs. And of course, don't forget to include a review of the opportunity costs associated with a choice.
Individuals use mental accounting subconsciously. It's a tool for measuring trade-offs, making gambling wagers and converting paper profits into spendable income.
Mental accounting can occur in our personal decision making too. How many of us keep track of every slight in our lives? Someone else was treated better (remember the laborer who entered the vineyard during the last hour of the day). I only give a gift or a Christmas card when anticipating one. I withhold a well-deserved compliment as it may show weakness in my personality or position. I need to be right rather than loving.
Giving up mental accounting is no small feat. Removing the filters and examining our behaviors in the light is what Jesus calls us to do. It makes for a great Lenten challenge.
