Would you pay RM20 for a simple breakfast of eggs and toast? Probably not. But how about when you’re traveling and your hotel offers you the convenience of room service, and you decide, RM20 isn’t so bad. What then, makes it a little more palatable to pay that exorbitant fee on such a plain breakfast?
This, my friends, is what is termed as ‘mental accounting’, which means we tend to think of expenses in terms of specific accounts. For example, Money to spend on food, to spend on travel, to spend on debts. While budgeting our finances this way helps us make quicker decisions, it also (on occasion) fogs the rational part of our brain and we make bad choices aka paying RM20 for eggs and toast!
Many of us are quick to dish out advice – save more, spend less, invest in property, grow your wealth – but you’ll notice that everyone has different spending and saving habits. Essentially, that’s because we have different motivations behind our financial decisions, there is no ‘one-size-fits-all’ approach.
Why are some of us willing to spend so much more when we swipe with a credit card? Why do some of us contribute the statutory limit of 8% to our EPF, while others see value in investing a higher amount at 11%? What makes smart people make money mistakes?
Understanding people’s motivation behind their money habits is termed “behavioural economics”, and mental accounting is a concept that could be a curse to some, and a boon to others.
What exactly is mental accounting?
Let’s take a look at that breakfast example again. Essentially, you’re spending the same amount of money on breakfast, RM20 to be exact. The value of your ringgit has not increased or decreased in value. But, perhaps because of the convenience of having it delivered to your hotel room, it offers the illusion of a value-added experience worth RM20.
This forms the basis of mental accounting; where our brains apply a different value to the ringgit. It contradicts classic economics – where a ringgit is a ringgit regardless of how you spend it.
Though our decisions may seem rational at first, the fact that we perceive the value differently can be detrimental to our investments and financial future.
Money is money
If you find yourself disciplined enough to stick to a financial budget every month, mental accounting can surprisingly be more of a curse for you.
But if you’re a big spender with a very lavish lifestyle, mental accounting can be a boon. Here’s why.
Sticking to a strict budget may sometimes mean you forget to see the bigger picture.
What if you have RM10,000 in a savings account, and you have a credit card debt of RM5,000 with about an 18% interest rate? It may serve you well to use half of your savings to pay off your credit card debt and avoid the high interest rate charges!
If you spend big on your credit card and just never know when to stop, mental accounting might help you curb your monthly expenses.
Before you swipe, ask yourself, would I buy this if I paid with cash instead? Your earned income is sitting in your bank account, and if the answer is yes, buy it with cash instead! You worked hard for your money, so don’t just waste it on more credit card debt. Mentally account first, swipe later.
Money that you think you can afford to lose is an all too common curse of mental accounting.
This includes duit raya, ang pow, bonuses from your company, birthday money, cash prizes, and tax refunds. Because you weren’t expecting to receive this money, you might think it’s okay to spend it. Meanwhile, your debts are still as high! Why not channel your extra income towards reducing your financial burdens?
Remember, money is money and it’s detrimental to your future well-being to have savings which earn little to no interest, while carrying debt that accrues at a higher interest rate annually.
Avoid the curse of mental accounting
You can see why ‘mental accounting’ can be dangerous. It makes no sense to save and accumulate your wealth towards savings or a holiday treat, if you’re accumulating higher debts with lavish spending and high interest rates.
There is no difference between money that has been earned, or money that has been gifted to you. Therefore, spending gifted money on your lavish lifestyle will not make any sense if you still have outstanding debt with high interest rates. Sometimes it makes more sense to forego saving (for now) to pay off debt.
The key takeaway to always remember is that money is money, that every ringgit’s value does not decrease or increase regardless of where it came from or what it is being used for.
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