#13 Mental Accounting: Why we’ll probably die broke

A hundred dollars is a hundred dollars is a hundred dollars, right? Well, no. Not according to our brains. In this episode, Mel and Dan explore how mental accounting influences the way we spend and save, and how brands can use this knowledge to make bank.

Dan: 00:20 Hey, and welcome to Bad Decisions. The podcast that helps us understand why we choose what we choose.

Mel: 00:24 Why we think what we think.

Dan: 00:25 And how to exploit this stuff for fun and commercial gain.

Mel: 00:28 I'm Dr. Mel Weinberg. I'm a performance psychologist.

Dan: 00:31 I'm Dan Monheit, co-founder of Hardhat, a creative agency built for today.

Mel: 00:34 Let's do this.

Dan: 00:42 Alright Mel, we're gonna get right into this one today.

Mel: 00:44 Sure.

Dan: 00:45 Actually before we do, in this episode, there is a whole bunch of stuff that may be misconstrued as financial advice.

Maybe also nutritional advice, so let's just be very, very clear. Do not do anything with your money or with your body purely off our recommendation.

Mel: 00:59 If you choose to do stuff based on your own idea, that's fine. Just don't blame us for it.

Dan: 01:04 Yeah, this is not financial advice.

Mel: 01:07 It's good that we're aware of our limitations.

Dan: 01:09 Yeah, it's just some people talking about some stuff.

Mel: 01:10 Yeah.  

Dan: 01:11 Alright. I want to ask you two questions.

Mel: 01:14 Okay.

Dan: 01:15 The first one is, you need to imagine that you are going to go and buy a new stereo. Do people still buy stereos?  

Mel: 01:21 No.

Dan: 01:21 Is that a thing? A new iPod?

Mel: 01:21 An iPod.

Dan: 01:22 Alright. You're gonna go buy a new stereo, and you go to the shop, and you park and you go inside, and you look around, and you find a stereo that you want, and the stereo is going to be $550.

Mel: 01:33 That's a big stereo.

Dan: 01:34 Yes, it's a good stereo. Not like a barbecue, but it's still good. You're at the counter you're about to pay. I walk into the store and I see you there and I run over. I'm like, "Hey, Mel, how you doing?" You're like-

Mel: 01:44 "Hey, Dan."

Dan: 01:45 I'm like, "Hey, what are you buying?"

Mel: 01:47 "This massive stereo?"

Dan: 01:48 "Yeah? And it's how much?

Mel: 01:50 "550 bucks."

Dan: 01:51 I was like, "Oh, you know what? I actually just saw this exact same stereo for $400 where I came from, which is about, I don't know, probably a 10 minute drive from here".

Mel: 01:59 "Oh, my God. I'm gonna go get it."

Dan: 02:00 "Yeah. $150 saving."

Mel: 02:00 "Thank you so much."

Dan: 02:02 550 down to 400. You are out the door and you're going to get it.

Mel: 02:05 Yeah.

Dan: 02:06 Right, makes sense? Now, let me put you in another scenario.

You're about to buy a new car. You're at the dealership. You've done all the negotiations. You've managed to get him down to $28,400 for your new car.

Mel: 02:20 Bargain, I think. I don't know. What sort of car?

Dan: 02:20 I don't what car it is. I don't know.

Anyway, it's $28,400 and you're about to pay for it, and what do you know? It's your stalker/friend Dan. I walk into the dealership, I'm like, "Hey, Mel, what's up?" You're like-

Mel: 02:33 "Dan, what are you doing here?"

Dan: 02:34 I'm like, "Oh, I was just stopping by, and I saw you in here. What are you doing?" You're like-

Mel: 02:39 "I'm about to buy this car at $28,400. Great deal."

Dan: 02:42 I'm like, "Wow, that is great deal. Except, believe it or not, I was actually just at another dealership, which would probably be, I don't know, maybe 10 minutes away. And they had this exact same car for $28,250. That's $150 cheaper. What do you reckon?"

Mel: 02:55 "Yeah ... oh, 150 bucks?"

Dan: 02:57 "Yeah."

Mel: 02:58 "Nah. Nah, I'm good."

Dan: 02:59 "Not worth it?"

Mel: 03:00 "Nah, I'm just gonna stick here."

Dan: 03:01 Yeah. Now, that's weird right? Because two minutes ago, you were very happy to drive 10 minutes to go and save $150, and now with some different extraneous variables, you are now not willing to do it.

Mel: 03:15 You know what it seems like?

Dan: 03:16 What?

Mel: 03:16 It seems like I've made a bad decision.

Dan: 03:18 Seems like you made a bad decision. It seems like you made a bad decision around the idea of mental accounting.

Mel: 03:23 Mental accounting. Welcome to the episode.

The questions that you're asking about willingness to spend the same amount of money in different situations is reminiscent of the original questions that Kahneman and Tversky inspired by Nobel Prize winning economist Richard Thaler. I'm wondering, is there a Nobel Prize winning podcaster?

Dan: 03:55 I don't know, but if there is I'm sure they'll call us about it.

Mel: 03:58 Definitely. The questions they posed back in the 80s were with regard to people's willingness to spend money on tickets to see a play. Okay, there's two scenarios. The first is if you imagine that you've decided to go and see a play and you've spent $10 on the ticket. You're walking into the theatre-

Dan: 04:15 It's like a school play. $10 is pretty cheap.

Mel: 04:16 It's the 80s.

Dan: 04:17 Ah, 80s. Okay, cool.

Mel: 04:19 As you're walking into the theatre you realise that-

Dan: 04:21 It was probably Cats, yeah?

Mel: 04:22 Something like that.

Dan: 04:24 Okay. $10. Got it.

Mel: 04:24 You're walking into the theatre, you realise that you've lost your ticket.

Dan: 04:27 Oh, no!

Mel: 04:27 You're already there though. But you've spent $10, you've now lost your ticket. Are you gonna pay $10 for another ticket?

What happened was that about half the people said, "Nah, I'm outta here. I spent my 10 bucks. Well, didn't get to see my play, too bad. My fault. I'm out".

Dan: 04:27 "Lost the ticket. I'm an idiot."

Mel: 04:44 The other situation is that imagine you've decided to see a play and you pay on entry. The admission is $10.

Dan: 04:50 Is this still Cats in 1984?

Mel: 04:52 Yep.

Dan: 04:52 Good.

Mel: 04:54 As you go into the theatre this time, you put your hand in your pocket, and you realise, "Hang on a second. I had 10 bucks in here, and that $10 bill that I had is gone".

Dan: 05:01 Gone. Dun dun dun.

Mel: 05:03 But are you gonna spend $10 and buy a ticket to the play?

Dan: 05:06 Well, it's not the play's fault I lost $10.

Mel: 05:08 Well, and that's what most people say. In this situation 88% of people said, "Heck yeah, I'm here to see a play. I'm gonna pay 10 bucks".

Dan: 05:14 88% of people who lost $10 but were happy to pull out another 10 and buy a ticket, whereas only 50% of people who had already bought the ticket, and then lost the ticket, and had to spend another $10 on a ticket were willing to do that?

Mel: 05:27 Yeah, I think you summed it up there. I'm not sure if you summed it up or if you made it easier to understand or more confusing, but either way.

Dan: 05:33 I'm here to simplify, that's my main thing.

Mel: 05:34 The question is why are so many people unwilling to pay another $10 for a new ticket, when they would pay it if they'd lost the equivalent amount in cash?

Dan: 05:42 Right, because it's the same thing? At the end of the day, you are down $20 and you are up one ticket to Cats in 1984.

Mel: 05:48 Yeah, and the reason has to do with the way that we mentally account for the loss.

In the first scenario, we rationalise that we've paid $10 in exchange for seeing the play. To us that's what the play is worth.

If we have to buy another ticket, we're paying 20 bucks to see the play, and it's not worth that. Everyone else has only paid 10 bucks, so we feel like we're getting ripped off.

Whereas in the second scenario, the loss of a $10 bill from our wallet is totally unrelated to seeing the play.

Dan: 06:15 Yeah, not the play's fault. That's what I said.

Mel: 06:16 Exactly.

Dan: 06:17 I told you I'm helping.

Mel: 06:17 The $10 that we paid to see the play is stored in a separate mental account to the $10 that we lost from our wallet, so even though in both scenarios the net loss is the same, it's the way that we mentally account for it that ...

Dan: 06:29 Messes us up. Let's be honest.

Mel: 06:31 It's the way that we mentally account that predicts actually our future behaviour.

Dan: 06:34 I think that the big, fundamental concept that us silly humans are missing here is this idea of fungibility.

Mel: 06:42 Oh, big word.

Dan: 06:43 Yeah, it's a real word too. Do you wanna say it slowly? Fungibility.

Mel: 06:43 Fungibility.

Dan: 06:47 I'm actually not sure if fungibility is the correct conjugation of the word, but there's an idea that money is fungible.

Mel: 06:47 There's another big word.

Dan: 06:54 Fungible means that all money is the same. It's completely interchangeable. The $10 in your pocket is the exact same as the $10 that's now not in your pocket because you lost it.

It's the exact same as the $10 that you spent on a ticket, which is the exact same as $10 you could have spent at the supermarket. All the $10s are exactly the same.

Mel: 07:10 All the $10s.

Dan: 07:11 Yeah, and if we realised that money was fungible and completely portable between all of these different ways we could spend it, we'd probably make much better, much more rational decisions. But we don't. We do this weird form of mental accounting.

Mel: 07:25 We often these things where you'll say things in some language and I'll be like, "Well, here's how we say it my language".

What I'm taking from this is that there's an objective aspect to the amount of money, which is that it's $10, or it's $100, or whatever it is, it's that amount of money.

And yet, subjectively we impose some meaning, or some value, or some interpretation of what that money means to us, and because of that, that directs what we're gonna do with it.  

Dan: 07:51 Exactly. Somewhere between our objective part of our brain and our subjective part of our brain, we decide that all $10s are not the same.

Mel: 07:59 They're actually different. Cool.

In unpacking mental accounting, we're gonna break it down into three different theoretical perspectives on them. The first has to do with the origins of the money. Where this money has come from.

Dan: 08:14 This is a weird thing. Money is money is money, but for some reason, depending on where the money has come from, we tend to think about it differently.

For example, money that we've earned through our normal course of our work, the money that turns up in our bank accounts, fortnightly or monthly, is spent very differently to money that we just happen upon. Things like a one time bonus.

Mel: 08:37 Yeah. Tax returns.

Dan: 08:38 Tax returns. Great example of this. Money that just turns up, maybe if it's money you just found in the street.

Objectively, the $1000 that you just got as a tax return or as a bonus, is fungible. It's exactly the same as any other $1000 that goes in or out of your account, but we seem to grant ourself weird permission to spend it more frivolously than other types of $1000s.

In fact, there's a term for this. It's called house money.

Mel: 09:04 House money? Yeah, I like it.

Dan: 09:06 Yeah, yeah. Money in the house. If you're a gambler or you know gamblers, and you go in with the money that you start with, and then any money you win is the house money.

It's not yours, you never really earned it anyway, so you just spend it differently and more freely.

Mel: 09:19 It's like there's this trade-off, because you didn't really do anything to earn it, you're relieved of the guilt associated with spending it.

Dan: 09:25 Exactly. Even though objectively, it's the same $1000 that probably should go on a credit card, or go in your savings account, or whatever, we think about it differently and we just flutter it away. Flitter it away? We just spend it.

Mel: 09:25 We spend it.

Dan: 09:36 Whatever. I guess there's a political masterstroke, in 2009 on the brink of global financial crisis stuff, and Kevin Rudd, our Prime Minister at the time, just decided, "You know what? We'll fix this. $1000 for everyone! You get $1000! You get $1000! You get $1000!" Provided your tax returns were up to date.

I think it was actually 950, but it was some arbitrary number that just turned up in the bank account of millions and millions of Australians overnight.

Mel: 10:05 And let me guess, they all saved it? They all put into their long term savings account and took good care it.

Dan: 10:11 Not only did we not save it, a lot of actually spent it twice. We got told that we're getting $950 into our bank. For free, for doing nothing. And it's like, "Wahoo!"

Mel: 10:21 Free money!

Dan: 10:23 We went out and spent $950 on something. And then six, eight, 12 weeks later the actual $950 turned up in our accounts, and we're like, "Wahoo! Free money!" And we went and spent it again.

Mel: 10:33 God, we're dumb. But what we did do was stimulate the Australian economy.

Dan: 10:36 Yes. Yeah, and if we had gotten that $1000 as $10 little increments over the following two years, it probably wouldn't have had that sort of an impact.

But getting it as a one-time bank error in your favour Monopoly style, people went out and spent that shit and ... Go Australia!

Mel: 10:56 Well played Kevin Rudd. Well played.

The next theoretical explanation for mental accounting has to do with the intended purpose of the money. We make this determination about what the money is for, and then that guides how we spend it.

Dan: 11:08 Exactly. Again, ignoring fungibility, which is just a word I'm going to try and say as many times as I can in this episode, we designate money to go on different things.

This $5 here, this is going in a holiday account. See this $10 here-

Mel: 11:21 It's not gonna get you very far.

Dan: 11:24 Well, it's saving. It's a long road. Whereas this $5 here, that's actually for groceries, and there's another $10 here and that's going for takeaway food. This causes us to do some weird things.

For example, we will set up a savings account, because that feels like a good thing to do. A savings account might be getting ... say 4% interest. We do that at the same time as we have a mortgage, which we're paying 7% on.

Instead of putting say five grand into our mortgage, and not paying 7% interest, we put into a savings account where we do get 4% interest, basically costing us 3% interest.

Mel: 11:54 But at least we feel like we're saving.

Dan: 11:56 We feel like we're saving, but we're not. We're damaging ourselves.

An even worse example of this, at least that example you're getting 4% but you're paying 7%, worse example is where people have a coin jar. A savings jar, which is earning 0%, and they have that instead of paying off a credit card, which they're probably paying 17% on. That little savings jar is actually costing you way more than you realise.

Mel: 12:20 It's an interesting irony there to look at the cost of actual saving.

Dan: 12:24 Yeah, you're saving money but it is costing you 3%.

Mel: 12:28 Right. The last explanation that we're going to give for mental accounting is called category spends, and it's the idea that we're gonna artificially create different categories within which we'll hold our money.

We're gonna have a category that we allow for holiday. We'll have a category that we allow for spending on food. We'll have a category that we allow for indulgences. We'll have a category that we allow for entertainment. And we're really rigid in our willingness to shift money or move money between these categories.

Dan: 12:52 Yeah, and what's weird about this is that they're completely arbitrary, and the same thing could maybe fit into a few different categories. Let's say you were the zoo, and you-

Mel: 12:58 I'm the zoo?

Dan: 13:00 You are the zoo. And you want to promote yourself. Knowing that these category spends exist, you might have trouble positioning yourself as a form of entertainment, knowing that well, people have a mental bucket for what they'll spend on entertainment. And if you wanna be in that bucket, then if they went to the movies last week, you're probably not gonna get a look in this week.

Mel: 13:17 You're determining who your competition is essentially.

Dan: 13:19 Exactly. You might say, "Well actually, people probably have a less indulged in mental bucket for cultural experiences or educational experiences, and so maybe they'd be less competition and less pressure for the same person's money, if we put ourselves in that bucket".

Mel: 13:33 Right, and going back to what we were talking about before, you were talking about people having literally different bank accounts, and having a savings account, you might have five grand that you keep in your savings account, but meanwhile you've got 11 grand on your credit card earning interest.

There's something though about people feeling good about having that buffer of five grand savings, whereas I'm willing, I know that there's 11 grand on my credit card and I know that that is actually costing me, but it feels good to me. I feel safe, and I feel like I'm in control of my world if I have that five grand in savings sitting there as well.

I think that this idea of control comes into play a lot with mental accounting. The reason that we break our money and our accounts up mentally is because it's really hard to think of our overall net wealth, and so one way that we do it is to break it down into more manageable, smaller components. Little artificial buckets, if you will.

Dan: 14:24 Which is all well and good, expect for the fact that when you go on holidays, it's not just the Mel that's saved five grand that goes on holidays, it's the Mel that saved five grand, but also has 11 grand on her credit card that goes on holidays.

It is your net person and your net wealth that is the recipient or the beneficiary of all of this stuff.

Mel: 14:41 It's a way more fun holiday if we can keep that Mel in debt behind.

Dan: 14:43 That is true.

Mel: 14:43 She can just stay at home.

Dan: 14:44 She can stay in Melbourne and do some work, and I'm gonna go shop up a storm over here.

Mel: 14:49 Alright, let's talk about what the implications are for brands. If we understand mental accounting, if we know that this something that happens then, basically if you're a financial institution then one of the things that you can do is you can allow your customers to store their money in ways that mimic what their brain is doing.

If you know that your customers are mentally dividing their money into different categories, there are financial institutions that will let you break down your accounts into subcategories that reflect exactly what your brain's thinking.

Dan: 15:14 Yeah, which I think it's a pretty new thing that banks are letting you do that. I always used to find it weird that they wouldn't. That they couldn't let you artificially split one savings account into three or four things. You'd have to go and open completely separate accounts. It's good to know that they've fixed that.

Something else for brands to consider is where are you gonna position yourself? And even within that positioning, how you're going to break down your offering. We talked about the zoos just a minute ago, about whether the zoos wanna be in the bucket for entertainment or the bucket for education.

But if you think about say a online retailer example, the conventional wisdom is give people free shipping, and just work it into the overall costs of things. But if charging $10 for shipping and handling lets you reduce the price of say a pair of shoes from 160 to 150, you're probably gonna have a better chance of fitting in that acceptability threshold for that category, and the $10 that they're spending on shipping and handling is a separate-

Mel: 16:04 It comes from a different bucket.

Dan: 16:05 Absolutely. The other things that brands can think about. Number one, if you can, open at the casino.

The casino is just filled who have got money in a short term windfall kind of way, and they're happy to suspend their normal rules for spending and go out and buy new watches, and shoes, and suits, and whatever it is because it's house money. Why wouldn't I spend it?

Mel: 16:26 Capitalise on the fact that people have just come into house money?

Dan: 16:29 Yeah, exactly. We talked about how to exploit this stuff for fun and commercial gain.

Mel: 16:33 It's consistent with our overall theme, isn't it?

Dan: 16:35 That's what we promised, and we deliver what we promise. Look, this last one might be a little bit tricky, but depending on your customer base, you might have groups of people who all get paid bonuses at a really similar time of year.

That's a thing you might see in law firms, or in financial advisory services. Quarterly or end of year bonuses. You know that bonus money is gonna get spent like it's hot, so position yourself to be there.

I'm not saying you should be trawling the condolence messages in the local newspaper to find recent widows-

Mel: 17:01 "Hey, I've just got a massive inheritance! Let me see what I can buy."

Dan: 17:04 That is a great time to get somebody into the showroom.

Mel: 17:07 Let's move to the individual now.

Dan: 17:09 Respectfully.

Mel: 17:09 Respectfully. But moving to the individual level now, what do you do as an individual consumer if you know that mental accounting exists?

Well, the first thing is you can question your own behaviour. With this understanding that maybe I'm not willing to ... maybe when it comes to petrol, I'm willing to spend up to $1.40 on petrol.

Dan: 17:27 That's your arbitrary limit.

Mel: 17:28 That's my arbitrary limit, but if I see that petrol's at $1.44 per litre, well, you know what? I'm actually gonna go for a half hour drive somewhere a little bit further out of the city where I know that it might be about two cents a litre cheaper, and I'm gonna go out there and I'm gonna do that. Stupid decision! Bad decision, Mel. Again.

Dan: 17:47 You would fail first year economics, because this is a thing called opportunity costs.

Opportunity costs says, there's no such thing as a free lunch because while you're at the free lunch, you are foregoing all sorts of other value creating activities you could do.

In your example, driving around for half an hour is probably gonna cost you more than the four cents a litre that you were hoping to save.

Mel: 18:04 But it just feels so good to save it.

Dan: 18:06 And you've got the buckets, you didn't violate your rule of buckets, of $1.40 per litre.

Mel: 18:11 And I stick to the rules, goddammit.

Dan: 18:12 Yeah, exactly.

Mel: 18:14 The more that we understand about this then the more that we can catch ourselves in the process of making bad decisions, and we can think about, "Do I really wanna go ahead and make that bad decision? Hell yes, I do," or, "No, I've listened to Dan and Mel, I know the Bad Decisions podcast, and I'm smarter than my brain".

Dan: 18:29 Exactly. Look, really I think at the end of the day this is about zooming out.

When we're zoomed in, or we're in the category or in the purchase decision we're trying to make, we have these rules, but if we just zoom out a little bit and think about stuff in the broader context, often we'll realise that, you know what? Paying two bucks to withdraw $500 from an ATM is not the worst thing that can ever happen.

Mel: 18:48 Zooming out is probably a good idea in other parts of our life as well, right?

Dan: 18:52 Absolutely. We're not gonna get all spiritual on you people, but if we think about things like nutrition and diet, I read something really interesting that said if you're trying to lose weight or get into shape or whatever, what you ate for lunch today doesn't matter, what you ate this month matters.

I think it's the same thing. What you spent on coffee today doesn't matter, but what you spent on everything in the last month matters.

Mel: 19:11 A bit of context and bit of perspective goes a long way here.

Dan: 19:13 Exactly. Context, perspective, but not financial advice. We are not giving financial advice.

Mel: 19:19 But if you do want any advice from us in general, please feel free to hit us up on social media. You can find me @DrMelW.

Dan: 19:25 You can find me @danmonheit, and we are both all over the internet.

Mel: 19:30 We're all over it.

Dan: 19:32 Everywhere.

Mel: 19:32 We basically are the internet.

Dan: 19:33 Everywhere.

Mel: 19:34 We're not.

Dan: 19:35 What? I think it's time.

Mel: 19:37 You know what I think we did today? You know what I think you did today, Dan?

Dan: 19:37 What?

Mel: 19:40 I think you put the "fun" in fungibility.

Dan: 19:42 Ah, good one! Alright, that's a wrap. We're done.