Last week my husband and I hired a painter to put a fresh coat of paint on our hundred year old home. True to form, my husband negotiated a good deal and got the contractor down $600. When he told me he saved this amount of money, he immediately started to brainstorm about how we could spend this “free money.” In my mind, our expenses went down $600. In his mind, we won the lottery and had $600 to spend. We laughed as we talked about our different perspectives and how mental accounting and behavioral finance theory was in play here.
Mental accounting is a concept in behavioral finance that explains how people tend to put money in separate mental buckets related to certain areas of life. This technique is often encouraged by financial advisors as it allows clients to save for retirement or for a big purchase and consider the money off limits. However, money is really just money and it has equal value. Your retirement money, your savings account and your daily checking account really are all in one big bucket when you look at it from a pure monetary standpoint. However, mental accounting which most of us do, allows us to see these separate buckets of cash as different and therefore, the rules we apply to these accounts vary as well.
The $600 in my husband’s mind was “free money” that could be spent elsewhere. However, it really was just an expense we did not incur. Rational financial law dictates that this amount should just not be spent. But when mental accounting and behavioral finance theory is applied an irrational human being like my husband feels wealthier and ready to spend this “savings.”
How do you treat the money you save when you negotiate a deal? Do you consider it money found and get excited about how to spend it? While this makes life exciting, it does not always make rational financial sense.
Kathleen Burns Kingsbury is the author of “How To Give Financial Advice To Women: Attracting and Retaining High-Net-Worth Female Clients” published by McGraw-Hill, 2012. She is the founder of KBK Wealth Connection, and a wealth psychology expert and behavioral change specialist. She teaches financial services professionals how to connect, communicate, and collaborate more effectively with their clients to increase client retention and improve profitability. Her next book: “How to Give Financial Advice to Couples” will be published in 2013.