mental accounting

Dollars and Sense: How We Misthink Money and How to Spend Smarter
by Dr. Dan Ariely and Jeff Kreisler
Published 7 Nov 2017

How comfortable we feel about spending it, on what, and how much we have left at the end of the month. MENTAL ACCOUNTING: A VERY SPECIAL PROBLEM Unlike most of the problems we discuss in this book, mental accounting is more complex than just “It’s a mistake to use mental accounting.” Mental accounting—like the others—is not a rational approach to money, but when we take into account the reality of our lives and our cognitive limitations, it can be a useful strategy. This is particularly true if mental accounting is used wisely. Of course, we don’t often use it wisely, which is why the rest of this chapter exists. For now let’s talk about why mental accounting is particularly unique.

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Having limited himself to one cigar a day, he started shopping for bigger and bigger cigars, until he had each one made to such proportions that he “could have used it as a crutch.”4 Social scientists call this type of creative bookkeeping MALLEABLE MENTAL ACCOUNTING. We play with malleable mental accounting when we allow ourselves to classify expenses ambiguously and when we creatively assign expenses to different mental accounts. In a way, that helps us trick the account owner (ourselves). If our mental accounting weren’t malleable, we’d be strictly bound by rules of income and expenses. But, since it is malleable, we manipulate our mental accounts to justify our spending, allowing us the luxury of overspending and feeling good about it. In other words, even though we knew our budget shouldn’t allow it, we found a way to make dinner work.

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For the person with cognitive limitations, with the real-life limits of our brain’s capacity to hold and process information, mental accounting can, however, help. In the real world, it’s extremely difficult to figure out the opportunity costs and multifaceted trade-offs of every single financial transaction. Mental accounting provides us a useful heuristic—or shortcut—for what decisions to make. Every time we buy something like a coffee, we can’t reasonably think, “Oh, this could be a pair of underwear or an iTunes movie download or a gallon of gas or any of an infinite number of other purchases now or in the future.” Instead, we can use mental accounting to think of that coffee as part of our “Food” account.

Misbehaving: The Making of Behavioral Economics
by Richard H. Thaler
Published 10 May 2015

Early on I called this process “psychological accounting,” but in a later paper on the topic Amos and Danny changed the name to “mental accounting,” and I followed suit. I have continued to think, write, and talk about mental accounting for the rest of my career. I still find it fascinating, exciting, and incisive; it is a lens that helps me understand the world. The next few chapters are devoted to mental accounting basics, but the topic permeates the rest of the book. Thinking about mental accounting can be contagious. You may soon find yourself blurting, “Well, that is really a mental accounting problem.” 7 Bargains and Rip-Offs My friend Maya Bar-Hillel was shopping for a quilt to use as a comforter on her double bed. She went to the store and found one she liked that was on sale.

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In the model, it does not matter whether the wealth is held in cash, home equity, a retirement plan, or an heirloom painting passed on from a prior generation. Wealth is wealth. We know from the previous chapters on mental accounting that this assumption is no more innocuous or accurate than the assumptions about cognitive abilities and willpower. To relax the assumption that wealth is fungible and incorporate mental accounting into a theory of consumption and savings behavior, Hersh Shefrin and I proposed what we called the behavioral life-cycle hypothesis. We assume that a household’s consumption in a given year will not depend just on its lifetime wealth, but also on the mental accounts in which that wealth is held. The marginal propensity to consume from winning $1,000 in a lottery is likely to be much higher than a similar increase in the value of a household’s retirement holdings.

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The examples discussed in chapter 13 are also relevant. 52 failing to act in accordance with the rational agent model is not fatal: For a thorough analysis of these kinds of arguments see Russell and Thaler (1985), Haltiwanger and Waldman (1985), and Akerlof and Yellen (1985). 53 “An Economic Theory of Self-Control”: Thaler and Shefrin (1981). Section II: Mental Accounting 55 “mental accounting”: My paper was Thaler (1980), and they suggested the term “mental accounting” in Kahneman and Tversky (1984). Chapter 7: Bargains and Rip-Offs 62 Macy’s: Barbaro (2007). 62 surprisingly candid press release: Tuttle (2012). 63 JC Penney claimed the end price consumers paid was effectively the same: Chernev (2012). 63 Johnson was ousted and coupons returned: Clifford and Rampell (2013). 63 [Walmart’s] “savings catcher” app: https://savingscatcher.walmart.com.

No Slack: The Financial Lives of Low-Income Americans
by Michael S. Barr
Published 20 Mar 2012

If there are similarities in these outcomes across the portfolio allocation groups, then it is less likely that the heterogeneity in overwithholding preferences across the portfolio allocation groups proxies for differences in mental accounting. 4. More generally, the mental-accounting framework holds the view that not all sources of income are the same and that different types of windfall gains result in different changes in consumption (Thaler 1990). That is, the mental-accounting framework need not be completely nested within models of dynamic inconsistency. Tax refunds may finance different types of consumption, such as durable goods purchases, if mental accounting plays a role in individuals’ decisionmaking. In addition, individuals may be loss averse to the point that they will overwithhold their taxes to avoid having to write a check to the IRS.

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To avoid this particular problem of inference owing to these omitted variables, the study attempts to control for both risk tolerance and time preference with survey measures also used by Robert Barsky and his colleagues (1997). The study also explores whether mental accounting explains individuals’ desire to overwithhold. An attractive feature of the dynamically inconsistent model with present-biased preferences is that it allows for a mental-accounting framework (Thaler and Shefrin 1981; Thaler 1990). As David Laibson (1997, 1998) shows, windfalls to liquid wealth result in different changes to consumption than do windfalls to illiquid wealth: present-biased individuals splurge more, given changes to liquid wealth. In this “mental-accounting” framework, having a preference for overwithholding may represent a preference for receiving a liquid windfall upon receiving one’s refund rather than for using overwithholding as a precommitment device.

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While those with assets are generally less likely to think of their refund as windfall income than those without assets, there is no statistical difference in this mental-accounting measure across the portfolio allocation groups. Similarly, the likelihood of purchasing a durable good, such as an appliance or car, with a tax refund is not statistically different across the portfolio allocation groups. With both of these mental-accounting measures, the correlations in the data suggest that mental accounting is unlikely to explain the relationship between portfolio allocation and overwithholding preferences. Given that the average refund size in this sample is large, at roughly $1,700, the loss-aversion explanation for tax filers’ preference for overwithholding is not particularly compelling.

Retirementology: Rethinking the American Dream in a New Economy
by Gregory Brandon Salsbury
Published 15 Mar 2010

For example, if she is paying 16% a year in interest on her credit card but earning only 2% on her emergency fund, that’s a yearly loss of $140 for every $1,000 spent. It adds up. The way we mentally account for our money, however, can prohibit us from parting with the safety net. The good news is that mental accounting can be used in a positive manner. I’ll discuss how you can turn the pitfalls of mental accounting into a benefit, and for the sake of this discussion, I’ll refer to that as mental budgeting. One measure that proves useful in understanding how we mentally account for money is how transparent or opaque the given question is. The more transparent the money question is, the more conscious we are in our decision making.

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I took my son’s party to the amusement park a few weeks ago...should’ve taken out an installment loan. Wow! Jack: Yea. I’m going to miss the neighborhood. Jim: Well, don’t lose touch. Jack: I won’t. Let’s get a beer. Jim: Or two. The Retirement Brain Game Mental Accounting—So we spend too much and save and invest too little. And when we do this, we often make mistakes, even though our intentions are good. Behavioral finance studies show that some financial errors can be attributed to a behavior known as mental accounting. Imagine an inbox inside your head where you store accounting files, and you label your mental folders, assign them values, and make financial decisions based on them.

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Imagine an inbox inside your head where you store accounting files, and you label your mental folders, assign them values, and make financial decisions based on them. For example, emergency money, bill money, birthday money, gas money, fun money—you get the idea. In and of itself, categorizing money is not a problem; however, as we will see, mental accounting can become a detriment when it influences the way we spend, save, and invest money. Mental accounting can influence decisions in unexpected ways and can keep us from maximizing the dollars in each account. Layering—In behavioral finance, layering refers to the way people treat their money when they’re not dealing with actual money, but rather proxies for money. Using checks, credit cards, or room numbers at the hotel while lounging about the pool are all ways that consumers can create psychological layers of distance between themselves and their money.

Thinking, Fast and Slow
by Daniel Kahneman
Published 24 Oct 2011

The ultimate currency that rewards or punishes is often emotional, a form of mental self-dealing that inevitably creates conflicts of interest when the individual acts as an agent on behalf of an organization. Mental Accounts Richard Thaler has been fascinated for many years by analogies between the world of accounting and the mental accounts that we use to organize and run our lives, with results that are sometimes foolish and sometimes very helpful. Mental accounts come in several varieties. We hold our money in different accounts, which are sometimes physical, sometimes only mental. We have spending money, general savings, earmarked savings for our children’s education or for medical emergencies.

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Often we pay for self-control, for instance simultaneously putting money in a savings account and maintaining debt on credit cards. The Econs of the rational-agent model do not resort to mental accounting: they have a comprehensive view of outcomes and are driven by external incentives. For Humans, mental accounts are a form of narrow framing; they keep things under control and manageable by a finite mind. Mental accounts are used extensively to keep score. Recall that professional golfers putt more successfully when working to avoid a bogey than to achieve a birdie. One conclusion we can draw is that the best golfers create a separate account for each hole; they do not only maintain a single account for their overall success.

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An ironic example that Thaler related in an early article remains one of the best illustrations of how mental accounting affects behavior: Two avid sports fans plan to travel 40 miles to see a basketball game. One of them paid for his ticket; the other was on his way to purchase a ticket when he got one free from a friend. A blizzard is announced for the night of the game. Which of the two ticket holders is more likely to brave the blizzard to see the game? The answer is immediate: we know that the fan who paid for his ticket is more likely to drive. Mental accounting provides the explanation. We assume that both fans set up an account for the game they hoped to see.

Nudge: Improving Decisions About Health, Wealth, and Happiness
by Richard H. Thaler and Cass R. Sunstein
Published 7 Apr 2008

Your Planner may have set the course for the yogurt and fruit stand, but the Cinnabon outlet blasts the aromas from their ovens directly into the walkway in front of the store. Care to guess which of the two stores always has the longer line? Mental Accounting Alarm clocks and Christmas clubs are external devices people use to solve their self-control problems. Another way to approach these problems is to adopt internal control systems, otherwise known as mental ac- counting. Mental accounting is the system (sometimes implicit) that households use to evaluate, regulate, and process their home budget. Almost all of us use mental accounts, even if we’re not aware that we’re doing so. The concept is beautifully illustrated by an exchange between the actors Gene Hackman and Dustin Hoffman in one of those extra features offered on DVDs.

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At the household level, violations of fungibility are everywhere. One of the most creative examples of mental accounting was invented by a finance professor we know. At the beginning of each year, he designates a certain amount of money (say $2,000) as his intended gift to the United Way charity. Then if anything bad happens to him during the year—a parking ticket, for example—he mentally deducts the fine against the United Way gift. This provides him “insurance” against minor financial mishaps.* You can also see mental accounting in action at the casino. Watch a gambler who is lucky enough to win some money early in the evening.

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When investments pay off, people are willing to take big chances with their “winnings.” For example, mental accounting contributed to the large increase in stock prices in the 1990s, as many people took on more and more risk with the justification that they were playing only with their gains from the past few years. Similarly, people are far more likely to splurge impulsively on a big luxury purchase when they receive an unexpected windfall than with savings that they have accumulated over time, even if those savings are fully available to be spent. Mental accounting matters precisely because the accounts are treated as nonfungible.

Lying
by Sam Harris
Published 31 Aug 2011

One of the worst things about breaking the law is that it puts one at odds with an indeterminate number of other people. This is among the many corrosive effects of having unjust laws: They tempt peaceful and (otherwise) honest people to lie so as to avoid being punished for behavior that is ethically blameless. Mental Accounting One of the greatest problems for the liar is that he must keep track of his lies. Some people are better at this than others. Psychopaths can assume this burden of mental accounting without any obvious distress. That is no accident: They are psychopaths. They do not care about others and are quite happy to sever relationships whenever the need arises. Some people are monsters of egocentricity.

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[11] http://healthland.time.com/2011/01/06/study-linking-vaccines-to-autism-is-fraudulent/ Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris

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Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris Lying Sam Harris Among the many paradoxes of human life, this is perhaps the most peculiar and consequential: We often behave in ways that are guaranteed to make us unhappy. Many of us spend our lives marching with open eyes toward remorse, regret, guilt, and disappointment.And nowhere do our injuries seem more casually self-inflicted, or the suffering we create more disproportionate to the needs of the moment, than in the lies we tell to other human beings.

A Mathematician Plays the Stock Market
by John Allen Paulos
Published 1 Jan 2003

Why investments should generate excitement is another issue, but it seemed that many people were genuinely enjoying the active management of their portfolios. So when I received a small and totally unexpected chunk of money, I placed it into what Richard Thaler, a behavioral economist I’ll return to later, calls a separate mental account. I considered it, in effect, “mad money.” Nothing distinguished the money from other assets of mine except this private designation, but being so classified made my modest windfall more vulnerable to whim. In this case it entrained a series of ill-fated investment decisions that, even now, are excruciating to recall.

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It’s something of a truism that the attempt to cover up a scandal often leads to a much worse scandal. Although most people know this, attempts to cover up are still common, presumably because, here too, people are much more willing to take risks to avoid losses than they are to obtain gains. Another chink in our cognitive apparatus is Richard Thaler’s notion of “mental accounts,” mentioned in the last chapter. “The Legend of the Man in the Green Bathrobe” illustrates this notion compellingly. It is a rather long shaggy dog story, but the gist is that a newlywed on his honeymoon in Las Vegas wakes up in bed and sees a $5 chip left on the dresser. Unable to sleep, he goes down to the casino (in his green bathrobe, of course), bets on a particular number on the roulette wheel, and wins.

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He hesitates and then decides to bet it all one more time. This time he loses. In a daze, he stumbles back up to his hotel room where his wife yawns and asks how he did. “Not too bad. I lost $5.” It’s not only in casinos and the stock market that we categorize money in odd ways and treat it differently depending on what mental account we place it in. People who lose a $100 ticket on the way to a concert, for example, are less likely to buy a new one than are people who lose $100 in cash on their way to buy the ticket. Even though the amounts are the same in the two scenarios, people in the former one tend to think $200 is too large an expenditure from their entertainment account and so don’t buy a new ticket, while people in the latter tend to assign $100 to their entertainment account and $100 to their “unfortunate loss” account and buy the ticket.

Against the Gods: The Remarkable Story of Risk
by Peter L. Bernstein
Published 23 Aug 1996

Loss-aversion combined with ego leads investors to gamble by clinging to their mistakes in the fond hope that some day the market will vindicate their judgment and make them whole. Von Neumann would not approve. The failure of invariance frequently takes the form of what is known as "mental accounting," a process in which we separate the components of the total picture. In so doing we fail to recognize that a decision affecting each component will have an effect on the shape of the whole. Mental accounting is like focusing on the hole instead of the doughnut. It leads to conflicting answers to the same question. Kahneman and Tversky ask you to imagine that you are on your way to see a Broadway play for which you have bought a ticket that cost $40.14 When you arrive at the theater, you discover you have lost your ticket.

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Prospect Theory suggests that the inconsistent responses to these choices result from two separate mental accounts, one for going to the theater, and one for putting the $40 to other uses-next month's lunch money, for example. The theater account was charged $40 when the ticket was purchased, depleting that account. The lost $40 was charged to next month's lunch money, which has nothing to do with the theater account and is off in the future anyway. Consequently, the theater account is still awaiting its $40 charge. Thaler recounts an amusing real-life example of mental accounting.15 A professor of finance he knows has a clever strategy to help him deal with minor misfortunes.

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Anything untoward that happens in the course of the year-a speeding ticket, replacing a lost possession, an unwanted touch by an impecunious relative-is then charged to the charity account. The system makes the losses painless, because the charity does the paying. The charity receives whatever is left over in the account. Thaler has nominated his friend as the world's first Certified Mental Accountant. In an interview with a magazine reporter, Kahneman himself confessed that he had succumbed to mental accounting. In his research with Tversky he had found that a loss is less painful when it is just an addition to a larger loss than when it is a free-standing loss: losing a second $100 after having already lost $100 is less painful than losing $100 on totally separate occasions.

Portfolios of the poor: how the world's poor live on $2 a day
by Daryl Collins , Jonathan Morduch and Stuart Rutherford
Published 15 Jan 2009

Particularly in recent years since the rise of microfinance, rural Bangladeshis have made less use of ASCAs. 19. For a fascinating account of attitudes toward RoSCAs, see Vander Meer 2009. Vander Meer studied 60 rural RoSCAs in Taiwan over a 21-year period. 20. Studying “mental accounts” has become a central part of behavioral economics; see Thaler 1990. People who use mental accounts may designate a specific savings account or device for a particular purpose (like sending money to relatives) and designate other accounts for other purposes (household needs, say, or school fees). Doing so may add costs, but it can help instill the discipline to keep some pots of money safe for their intended purposes. 21.

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At one level this is a mental battle waged inside the head of the user: we all know we should save regularly, but we also know how difficult it is to carry out our good intentions. We seek external help—automatic payments, accounts with penalties for early withdrawal or missed payments—or we devise mental tricks, keeping the rent money in a special place (the teapot that belonged to grandma) and erecting taboos against dipping into it. These “mental accounts” have been the subject of much recent enquiry.20 But at another level this is a practical matter. In Bangladesh, to keep things simple, the microcredit lenders offered only one loan term— a year—and only one repayment schedule—equal invariable weekly installments. Such a tight schedule is wonderful for discipline— but quite tough on borrowers with very small and very variable cash flows.

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Working Paper 56, Finance and Development Research Programme, Institute for Development Policy and Management, Manchester University. Stiglitz, Joseph. 2005. Globalization and Its Discontents. New York: Norton. Swibel, Matthew, and Forbes Staff. 2007. “The world’s top 50 microfinance institutions.” Forbes, December 20. Available at www.forbes.com. Thaler, Richard H. 1990. “Anomalies: Saving, fungibility and mental accounts.” Journal of Economic Perspectives 4 (1): 193–205. Thaler, Richard H., and Cass R. Sunstein. 2008. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale University Press. Thomas, Duncan. 1990. “Intra-household resource allocation: An inferential approach.” Journal of Human Resources 25 (4): 635–64.

The Bogleheads' Guide to Investing
by Taylor Larimore , Michael Leboeuf and Mel Lindauer
Published 1 Jan 2006

Since most believe they're above average, they conclude that their returns are above average, too. Mental Accounting This emotional trap causes us to be poor savers, rather than poor investors. Nevertheless, since you can't invest what you don't save, it's a habit to be aware of. Mental accounting is the habit of treating money differently, based on where it comes from. Of course, all money is money regardless of how we obtain it. But not being totally rational, we tend not to treat it that way. For example, when you get an income tax refund, do you think of it as found money and a nice windfall with which to reward yourself? If you do, you're practicing mental accounting. The truth is, you should kick yourself for giving the government an interest-free loan.

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The truth is, you should kick yourself for giving the government an interest-free loan. Tell your employer to reduce the amount of income taxes withheld from your paycheck. That money should have been compounding in your account for the past year. If it had been, you would have more. As another example of mental accounting, you buy a nonrefundable air ticket for a trip you are planning to take. Circumstances change and you don't want to take the trip but feel obligated to go because you don't want to waste the ticket. So, you go on the trip, spend more money on meals and lodging, and have a miserable time. The truth is that the airfare is a sunk cost that should be ignored when deciding whether to take the trip.

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Do you keep all of your retirement money in very safe investments but carry credit card balances? Do you spend more when you pay by credit card than when you pay with cash? Do you think of yourself as a good money manager but have trouble saving? All of these are symptoms of someone who practices mental accounting. Anchoring Do you stick with a money manager, broker, or financial planner without knowing if they earned you more or less than the market return? Do you hold on to an investment that has lost value, vowing only to sell it when it rises to a certain price? Do you cling to investment habits without making an effort to find the true facts?

The Social Life of Money
by Nigel Dodd
Published 14 May 2014

Others suggest that emotional issues may also be involved: mental accounting becomes emotional accounting when particular monies are given “affective tags” (Levav and McGraw 2009). As Zelizer points out, however, this approach fails to treat social relations as playing a constitutive—as opposed to merely contextual—role in money’s differentiation. Even apparently selfish forms of mental accounting take others into consideration; indeed, they invariably emerge from social interactions—and social histories—of one kind or another. This consideration is why Zelizer prefers the notion of relational accounting to mental accounting, because monetary differentiation is closely linked to the ways in which we manage our ties to others.

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This, essentially, is culture shaping money. As Zelizer herself has noted (Zelizer 2012: 14–18), there are some suggestive parallels between the process of monetary differentiation that takes place through what she calls earmarking, and the phenomenon that is known by behavioral economists as mental accounting. Mental accounting—defined by Richard Thaler as “a set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities” (Thaler 1999: 183)—takes place when individuals allocate different portions of the monies they possess to distinct cognitive spaces according to how those monies will be used.

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The Origin of German Tragic Drama, London/New York, Verso. Bernstein, P. L. (2004). The Power of Gold: The History of an Obsession, Chichester, U.K., John Wiley and Sons. Berry, S. (2001). Chiefs Know Their Boundaries: Essays on Property, Power and the Past in Asante, 1896–1996, Portsmouth, NH, Heinemann. Besharat, A. (2012). “Essays on Mental Accounting and Consumers’ Decision Making.” Ph.D. thesis, Tampa, FL, University of South Florida. Binswanger, H. C. (1994). Money and Magic: A Critique of the Modern Economy in the Light of Goethe’s “Faust,” Chicago, University of Chicago Press. Blackburn, R. (2010). “Socialism and the Current Crisis.”

Scarcity: The True Cost of Not Having Enough
by Sendhil Mullainathan
Published 3 Sep 2014

Adelson, “Lightness Perception and Lightness Illusions,” The New Cognitive Neurosciences (1999): 339. Imagine you are lying on the beach on a hot day: This is based on Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science 4, no. 3 (1985): 199–214. Data collected with Anuj Shah in 2012. The well off showed a significant difference between frames, whereas the poor did not; p < .01 (N = 148). when gasoline prices go up: J. Hastings and J. M. Shapiro, Mental Accounting and Consumer Choice: Evidence from Commodity Price Shocks (Cambridge, Mass.: National Bureau of Economic Research, Working Paper No. 18248, 2012). The poor should be less prone to show this effect: Data collected with Anuj Shah in 2012 support this prediction.

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(Think about it—if money were the problem, you could just as easily save by buying cheaper cookies or by golfing less.) This is because money is kept in local accounts: a negative shock to the gas account (higher prices) leads to penny pinching (and lower quality) in that account. This idea of mental accounting has many implications. For example, it is the reason we might spend a $2,000 tax refund very differently from a $2,000 increase in the value of our stock holdings. We are wealthier by $2,000 in both cases, but we treat the two accounts (“free money” versus “retirement account”) as separate and unequal, often with very different propensities to consume from the two accounts.

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Imagine you have spent the day shopping: This is a slightly updated (for inflation) version of Tversky and Kahneman’s famous “jacket-calculator” problem; A. Tversky and D. Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–58. See also R. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12 (1999): 183–206. one can change the value of an hour: Ofer H. Azar, “Relative Thinking Theory,” The Journal of Socio-Economics 36, no. 1 (2007): 1–14. college students, MBAs, professional gamblers, and executives of all stripes: Some studies have found similar effects using incentives.

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History
by Alexis Stenfors
Published 14 May 2017

As a trader, I always felt more like a loser following a day when I had lost $10,000 or $100,000 than I felt like a ‘winner’ when I had made the same amount. The fact that losses loom larger than gains is called ‘loss aversion’. Nobody likes losing, of course, but a potential loss (or ‘negative’ reward) changes the way we approach risk taking. Another bias that complicates standard economics and finance theory is called ‘mental accounting’.3 In a nutshell, it refers to the way in which we often segregate different gambles into different accounts, and in so doing use very different criteria to assess how we utilise the various accounts. The brain acts like a chest of drawers, with different types of problems sorted into different compartments.

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For instance, we might count the pennies when shopping for groceries, but when celebrating a birthday or a special occasion we are often less sensitive to the shockingly high price of a bottle of champagne. Likewise, an individual might speculate on a volatile stock market yet be extremely careful when saving for a future retirement. Traders also do a lot of mental accounting. An FX trader watches every minuscule currency movement in the dealing room during the day, yet when on holiday in Spain will withdraw euros from the nearest ATM, oblivious to the outrageous bank fees and commissions. A standard question I used to be asked when being interviewed by another bank was to describe my trading style.

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My answers to such questions might provide clues as to whether I took my own initiatives or largely relied on my current employer’s customer base. They therefore also hint at my risk appetite. Proprietary trading often involves more active risk taking, whereas customer flows less. However, the main question also involves a form of psychological self-assessment on the part of the interviewee, essentially asking: ‘What kind of mental accounting do you perform within your environment?’ A trader might do hundreds of deals during the day in an attempt to profit from tiny short-term price movements and customer deals. Depending on the market in which the trader is active, there might also be arbitrage opportunities from which to profit.

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded)
by Michael J. Mauboussin
Published 1 Jan 2006

This means aligning incentives at all levels of the firm with the appropriate value drivers is central in getting the execution managers and owners demand.7 Managers often trumpet an “ownership culture” and seek to distribute equity widely throughout the organization. While employees are pleased to be shareholders, I suspect that most think about their stake using “mental accounting.” They consider the stock in a mental account that is separate from their cash income, don’t count on the stock for day-to-day budgeting, and don’t consider it when they do their jobs. Another critical judgment is whether managers are paid to deliver accounting or economic performance. In the cases where there is a large owner-manager, this potentially huge agency cost rarely arises.

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Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” The Quarterly Journal of Economics 110, no. 1 (February 1995): 73-92, available from http://gsbwww.uchicago.edu/fac/richard.thaler/research/myopic.pdf, write: “Specifically, the theorem says that if someone is unwilling to accept a single play of a bet at any wealth level that could occur over the course of some number of repetitions of the bet, then accepting the multiple bet is inconsistent with expected utility theory.” 2 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91. 3 Nicholas Barberis and Ming Huang, “Mental Accounting, Loss Aversion, and Individual Stock Returns,” Journal of Finance 56, no. 4 (August 2001): 1247-92. 4 Elroy Dimson, Paul Marsh, and Mike Staunton, “Global Evidence on the Equity Risk Premium,” Journal of Applied Corporate Finance 15, no. 4 (Fall 2003): 27-38. 5 Benartzi and Thaler, “Myopic Loss Aversion.” 6 This and following exhibits closely follow William J.

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The Great Mutual Fund Trap. New York: Broadway Books, 2002. Bak, Per. How Nature Works: The Science of Self-Organized Criticality. New York: Springer-Verlag, 1996. Barabási, Albert-László. Linked: The New Science of Networks. Cambridge, Mass.: Perseus, 2002. Barberis, Nicholas, and Ming Huang. “Mental Accounting, Loss Aversion, and Individual Stock Returns.” Journal of Finance 56, no. 4 (August 2001): 1247-92. Batten, David F. Discovering Artificial Economics: How Agents Learn and Economies Evolve. New York: Westview Press, 2000. Batty, Michael. “Rank Clocks.” Nature 444 (November 2006): 592-96. Bazerman, Max.

When to Rob a Bank: ...And 131 More Warped Suggestions and Well-Intended Rants
by Steven D. Levitt and Stephen J. Dubner
Published 4 May 2015

More generally, the economist Richard Thaler coined the phrase mental accounts to describe the way in which people seem to treat different assets as non-fungible, even though in principle it seems like they should be. Although my economist friends make fun of me for it, I definitely use mental accounts myself. For me, a dollar made playing poker means much more than a dollar earned from the stock market going up. (And a dollar lost playing poker is likewise far more painful.) Even people who deny that they are affected by mental accounts often fall prey to them. I’ve got a buddy in that category who won a big bet on NFL football (big relative to his usual football bet, but very, very small relative to his overall wealth) and the next day he spent the proceeds on a fancy new driver.

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Scott, 171–72 McCain, John, 35–36 McDonald’s, workers in, 273 McKibben, Bill, 179–84 McLaughlin, Dan, 202–4 McWilliams, James, 175–78, 179–84 meat, eating, 179–84 media: and charitable giving, 324–28 fears caused by, 113 medical care, limitations of, 297 medical system, interactions with, 289 medicine, and statistics, 280–82 memoirs, fake, 146–48 mental accounts, 68–69 Merton, Robert C., 336 Mickelson, Phil, 73–74 Miles, Tom, 130 military draft, 23–25 Minty, Jessica H., 326 Moonen, Scott, 47 morality vs. economics, 288 Morgan, Yourhighness, 40 morphine, value of, 297 Moscowitz, Toby, 209–12 motorcycle accidents, 102–3 Mullainathan, Sendhil, 347 Mumbai train system, 140–41 Murphy, Kevin, 59 Myanmar, cyclone in, 324–28 Myers, Mike, 306 Nadal, Rafael, 74 names, 37 aptonyms, 43–47 first, 40, 41 heavenly, 41 middle, 38–40 unpredictability of, 42–43 National Health Service (U.K.), 26–29 National Highway Traffic Safety Administration (NHTSA), 249–50 National Violent Death Reporting System, 250 natural field experiment, 322 Neckermann, Susanne, 338 negative externality, 87 Newark-Liberty airport, 21–22 New York state senate, 233–36 New York Times, The, 3, 8, 11, 41, 96, 109–16, 167, 276 Nielsen ratings, TV viewing, 322–24 “No Gas Day,” 311–14 Noll, Chuck, 218 Noll, Thomas, 228–29 Nostradamus, 109 Obama, Barack, 33, 214, 278–80 obesity, 116–19 oil, “peak,” 109–16 Oliver, Eric, 118 online dating, 268–69 OPEC, 111–12 Oportunidades, 138–39 opportunity cost, 349–50 orange juice, 174–75 Osgood, Daniel, 165 packaging, 175–78 Pacquiao, Manny, 72–3 Pakistan earthquake, 325–27 panhandlers, 328–37 Pape, Robert, 10 paper vs. plastic bags, 167 Pardo, Bruce, 130–32 Pareto efficiency, 30 Pariah (TV show), 253–55 Parker, Susan W., 138–40 Pataki, George, 119 Paulos, John Allen, 286 Paulson, Henry, 236 Peltzman, Sam, 166 penny, 61–65 penny floor, 65 Pepsico, 59–60 perfect substitutes, 60 petroleum extraction, 109–16 Pettitte, Andy, 149–50 Pham, David “the Dragon,” 193 pilots, 83–86 pirates, 314–19 Pittsburgh Steelers, 212–19 Plack, Les, 47 Planned Parenthood, 65–67 Pledge-a-Picket, 66 poker: cheating, 154–58 how not to cheat, 153–55 Internet, 127–30, 157 one card away from final table, 192–95 record that can never be broken, 192 shootout tournament, 193 World Series of Poker, 187–88, 192–95 Polamalu, Troy, 216 Poland Spring bottled water, 3–4 Pollan, Michael, 169 postage, exemption from, 141–43 practice, ten thousand hours, 199, 201–2 praise, 351 Pre-Implantation Genetic Diagnosis (PGD), 280–82 prices: anchoring, 309 of autographed baseballs, 80–81 bounty on bin Laden, 57–59 of cars, 54–57 of chicken wings, 75–77 and corporate sponsorships, 81 discrimination in, 173 of food, 116 of gas, 86–90 for hate mail, 49–51 housing, 67–69 of kiwifruits, 77–80 peak oil, 109–16 of a penny, 61–65 of prescription drugs, 52–54 rising, 110, 111 of shrimp, 344 of songs, 69–71 and substitutes, 113 supply and demand, 78–80, 110, 112, 115, 128, 341–44 of voices in animated films, 306 priming, 228–29 principal-agent problem, 209 Prius Effect, 185 procrastination, 121 profits, going green for, 172–74 pro-life movement, 65 prostitution: Berlin brothel, 173 escort service, 261–67 legalization of, 255–56, 265–67 race: in the marketplace, 315–22 TV viewing habits, 322–24 rain forest, saving, 174–75 randomization, 322 rational addictions, 92–94 Reeve, Christopher, 102 Reilly, Barry, 225–26 Rickman, Neil, 225–26 RICO (federal racketeering statutes), 232 Rios, Brandon, 72 risk-aversion, 125–27 risk-taking, 121 Rochambeau (Rock, Paper, Scissors), 188–89 Rodriguez, Alex, 149 Roethlisberger, Ben, 103 Roe v.

The Gone Fishin' Portfolio: Get Wise, Get Wealthy...and Get on With Your Life
by Alexander Green
Published 15 Sep 2008

Studies show, for example, that most people are willing to drive five blocks if they can buy a $100 cell phone for half price. But they are far less willing to drive five blocks to save $50 on a $1,000 plasma TV. Why? After all, fifty bucks is fifty bucks, no matter how you spend it—or save it. But, according to Shermer, mental accounting makes us reluctant to make the effort to save money when the relative amount we’re dealing with is small. Or take the sunk-cost fallacy. Objectively, a company with lousy business prospects is not worth holding, no matter what you paid for it. Yet many investors will hold on to a losing stock for years, even when it’s clearly unprofitable.

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Yet many investors will hold on to a losing stock for years, even when it’s clearly unprofitable. Shermer correctly points out, “Rationally, we should just compute the odds of succeeding from this point forward.” Yet investors who have sunk a lot into a stock—including a fair amount of ego—have trouble doing this. Mental accounting and the sunk-cost fallacy are just the tip of the iceberg. Shermer shows that consumers and investors also fall prey to cognitive dissonance, hindsight bias, self-justification, inattentional blindness, confirmation bias, the introspection illusion, the availability fallacy, self-serving bias, the representative fallacy, the law of small numbers, attribution bias, the low aversion effect, framing effects, the anchoring fallacy, the endowment effect, and blind spot bias.

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(mutual fund research) DeMuth, Phil Earnings, share prices (relationship) Efficient market hypothesis (EMH) advocacy Efficient portfolio Emerging market stocks Emotional Intelligence (Goleman) Emotional quotient (EQ) European stocks Exchange-traded fund (ETF) advantages weighing expenses open-ended characteristic performance, cash drag portfolio ranking State Street Global Advisors initiation tax problems, avoidance WSJ/Morningstar study Expense ratio composition level Expert Political Judgment (Tetlock) Experts, knowledge Faugere, Christophe (money manager performance research) Fidelity Magellan Fund track record Financial advisor, requirement (absence) Financial freedom importance requirement step one Financial future, planning responsibility Financial goals, meeting Financial independence calculation proximity Financial markets, understanding (degree) Financial responsibility Fishing, truth Foreign markets diversification reasons risk Forsythe, Greg (emotions comment) (k) contribution disadvantage usage (b), usage Four Pillars of Investing, The (Bernstein) Future, prediction (problem) Global economy, U.S. proportion Gold movement returns shares inclusion, reasons proportion usage Graham, Benjamin investment advice investor problem Great Depression Greenspan, Alan (LTCM buyout) Growth portfolio Hand, Learned (tax management comments) Hedge fund ownership, eligibility High Expectations and False Dreams (Otar) High-grade bonds, investment High-grade corporate bonds, taxable income High-quality stocks, exposure High-yield bonds proportion stocks, correlation tax inefficiency usage Historical asset returns, understanding Historical averages, usage Historical data, examination Humility, wisdom (relationship) Index funds reliance Indexing, power Index mutual funds, WSJ/Morningstar study Individual Retirement Account (IRA) contribution usage percentage Inflation impact increase Inflation-adjusted Treasury bonds proportion usage Intelligent Asset Allocator, The (Bernstein) Investment advisors, usage (decision) aggressiveness, problem aims annual return automation compound timing confusion conservative approach, problem criticism decisions delegation, problems diversification argument expectations factors importance goals humility, impact knowledge mistakes objective philosophy pitfalls portfolio long-term value determination, factors usage principles understanding process, knowledge reality check risks, elimination seriousness stability/returns, relationship strategy problems, avoidance success system, steps Investors long-term financial requirement target taxes/expenses, reduction iShares iBoxx $ High Yield Corporate Bond Fund description holdings iShares Lehman TIPS Bond Fund description holdings Jensen, Michael (mutual fund manager analysis) Junk bonds, inclusion (criticism) Kaderlis, Billy/Akaisha (retirement example) Keogh, usage Large-cap stock, market capitalization Legg Mason Value Trust Lewis, Michael Life philosophy, presence Lifestyle, calculation Little Book of Common Sense Investing, The (Bogle) Long Term Capital Management (LTCM), crash Long-term core portfolio, short-term trading portfolio (separation) Long-term financial goals, meeting Long-term investment portfolio, personalization Long-term investment success Long-term portfolio, recommendation/ criticism Lynch, Peter investment advice market prediction Management fees Market capitalization declines outguessing, problem timing absence avoidance Market-impact cost Market Vectors Gold Miners ETF description holdings Markowitz, Harry Mental accounting Milken, Michael Miller, Bill Miller, Merton Millionaire Next Door (Stanley/Danko) Millionaires, characteristics Mind of the Market, The (Shermer) Modern portfolio theory (MPT) advocacy Money investment management managers, performance stocks division truth Mutual funds advantage Bogle research costs, shareholder absorption industry, size managers, benchmark underperformance principle stock trading behavior types Net asset value (NAV), divergence Net worth, result No-load bond funds, usage No-load index funds, usage Overseas markets, earnings growth Oxford Club Communique, Hulbert Financial Digest ranking Pacific Rim stocks Peer pressure, perspective Perma-bears recommendations Personal risk tolerance, assessment Phantom income, taxation Philosophy:Who Needs It (Rand) Portfolio annual return balance blend breakdown goals implementation market timer, impact net return, concern rebalancing process setup strategy tax management test tracking process volatility, reduction Precious metals index, assembly mining stocks Prediction, difficulty Pre-tax returns, post-tax returns (contrast) Private pension plans, disappearance Prosperity, stock market creation Raskob, Jacob Real estate investment trusts (REITs) proportion tax inefficiency usage Rebalancing emotions, avoidance process timing usage usefulness Recessions, predictability Redemptions, impact Retirement goals/plan steps Retirement Confidence Survey Rich, SEC definition Risk elimination level, acceptability Sacrifices, making Samuelson, Paul Savings amount importance priority proportion spending, balance Securities, pricing efficiency Self-interested parties, impact Share price, fluctuation Sharpe, William Shawky, Hany A.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies
by Jeremy J. Siegel
Published 18 Dec 2007

Often the reference point is the purchase price that investors pay for the stock. Investors become fixated on this reference point to the exclusion of any other information. Richard Thaler from the University of Chicago, who has done seminal work in investor behavior, refers to this as mental accounting.18 When you buy a stock, you open a mental account with the purchase price as the reference point. Similarly, when you buy a group of stocks together, you will either think of the stocks individually or you may aggregate the accounts together.19 Whether your stocks are showing a gain or loss will influence your decision to hold or sell the stock.

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In 1982, Leroy Gross wrote a manual for stockbrokers in which he called this phenomenon the “geteven-itis disease.”21 He claimed get-even-itis has probably caused more destruction to portfolios than any other mistake. 18 Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, no. 3 (Summer 1985), pp. 199–214. 19 Richard H Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making, vol. 12 (1999), pp. 183–206. 20 Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” Journal of Finance, vol. 40, no. 3 (1985), pp. 777–792. 21 Leroy Gross, The Art of Selling Intangibles, New York: New York Institute of Finance, 1982. 330 PART 4 Stock Fluctuations in the Short Run It is hard for us to admit we’ve made a bad investment, and it is even harder for us to admit that mistake to others.

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., 61 McKinley, William, 226–227 McNees, Stephen K., 216 McQuaid, Charles, 346 Mean aversion, 30 Mean reversion, of equity returns, 13 Mean-variance efficiency, 354 Measuring Business Cycles (Mitchell), 209 Melamed, Leo, 165, 251q, 274 Melville, Frank, 61 Melville Shoe Corp., 59i, 61 MENA (Middle East and North Africa), 179 Mental accounting, 329 Mercantile Exchange, 256 Merck, 59i, 177 Merrill, Lynch, Pierce, Fenner & Smith, 45 Merton, Robert, 35n, 266n Metz, Michael, 86, 253 Meyers, Thomas A., 295–296 Michelin Group, 49 Microsoft, 38, 57n, 118, 144, 156, 158, 176i on Nasdaq, 44 Middle East: growing market share of, 178 oil reserves of, 178 Millennium Chemicals, 48 Miller, Bill, 348 Miller, G.

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism
by George A. Akerlof and Robert J. Shiller
Published 1 Jan 2009

Subjects’ median response was that none of the inheritance would be spent this year.3 Rational economic theory would imply that the subjects would spend the same portion of the extra money in all three framings. Shefrin and Thaler interpreted these results as confirming that people behave as if they put different kinds of income or wealth into different “mental accounts”—in this case current income, asset, and future income accounts—and view these accounts with such sharply different psychology that they spend very differently from each of them. How much they wish to spend depends crucially on how they frame the question “How much should I save?” Generalizing from these results, it is clear that context and point of view are crucially important in determining saving.

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The contribution of savings to GDP growth will be between 1/36 and 1/27. 22. The information that follows comes from Andy Di Wu’s personal interviews. 23. Feinberg (1986, p. 355). 24. Prelec and Simester (2001). 25. Laibson et al. (2000, p. 38) argue that people “appear to be of two minds” about their savings. They have separate mental accounts for retirement savings (which they put in liquid assets) and credit card debt. This can help explain the widespread practice of running up a substantial credit card debt that has a higher interest rate than is earned on the retirement assets. 26. Barenstein (2002). CHAPTER ELEVEN WHY ARE FINANCIAL PRICES AND CORPORATE INVESTMENTS SO VOLATILE?

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., 191n6 Maharashtra, India, 34 Malaysia, 126 Mao Zedong, 26, 126 marginal propensity to consume (MPC), 14–15 Mark, Rebecca, 34 mark-to-market accounting, 33–34 marriage, stories in, 52 Marsh, Terry A., 193n6 Martin Luther King Day, 163 Mason, Joseph R., 181n18 Massachusetts Institute of Technology (MIT), 113, 141 Matsusaka, John G., 179n9 Meadows, Dennis L., 194n29 Meadows, Donella H., 194n29 Melino, Angelo, 191n9 mental accounts, 120–21, 192n25 Merrill Lynch, 133 Merton, Robert C., 84, 193n6 Meston, Lord, 71 Mexico, 53–54, 109 Miami, Florida, 36, 169, 198n8 Michigan Consumer Sentiment Index, 16–17, 179n2,9 Milken, Michael, 31–32 Mincer, Jacob, 19 minorities, 6, 157–66, 174, 196–97n1–24; anger in, 161–62; characteristics of those left behind, 161–63; education and, 165–66; importance of trying to assist, 166; real estate market and, 154–55; remedy for economic problems of, 163–66; why they are left behind, 158–60 Minsky, Hyman, xxiv, 177n2,7,8, 186n3 Mishkin, Frederic S., 180n9, 187n9, 191n9, 193n15 MIT.

Priceless: The Myth of Fair Value (And How to Take Advantage of It)
by William Poundstone
Published 1 Jan 2010

Journal of Economic Behavior and Organization 1, 39–60. ———(1983). “Transaction Utility Theory.” Advances in Consumer Research 10, 229. ———(1985). “Mental Accounting and Consumer Choice.” Marketing Science 4, 199– 214. ———(1988). “Anomalies: The Ultimatum Game.” The Journal of Economic Perspectives 2, 195–206. ———(1997). “Irving Fisher: Modern Behavioral Economist.” The American Economic Review 87, 439–41. ———(1999). “Mental Accounting Matters.” Journal of Behavioral Decision Making 12, 183–206. ———, and Cass R. Sunstein (2008). Nudge: Improving Decisions About Health, Wealth, and Happiness.

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The infomercials that succeed are those best at pushing consumers’ buttons. However different the products, human nature is pretty much the same. Central to the infomercial industry is a principle that Richard Thaler calls “Don’t wrap all the Christmas presents in one box.” In a 1985 paper in the journal Marketing Science, “Mental Accounting and Consumer Choice,” Thaler presented an original view of how consumers decide what’s worth buying and at what price. Thaler applied prospect theory to typical transactions, in which one side surrenders a price (a loss) to acquire something of value (a gain). There are diminishing returns to both gains and losses.

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Steak” at www.bigtexan.com. 144 Questions about meat consumption: Jacowitz and Kahneman 1995, 1163. 145 35 percent discount on a Nikon camera: Hermann Simon interview, Feb. 24, 2009. 145 “willingness to pay”: Simon 2008, 214. 146 “Imagine that you are about to purchase a jacket”: Tversky and Kahneman 1981, 459. 146 “Why are we more willing”: Thaler 1999, 186. 147 “What we’re saying”: Transcript of 2008 Edge Master Class, www.edge.org/3rd_culture/thaler_sendhil08/thaler_sendhil_index.html. 147 Professional Pricing Society, founded in 1984: See the PPS website, pricingsociety.com/Page4782.aspx. 147 Skeptical about the application of behavioral theory: See Simon 2008, 212, where he calls Thaler’s “mental accounting” model a “flop” for business applications. 147 Pack of Wrigley’s gum first item scanned: See Wikipedia entry for “Universal Product Code,” en.wikipedia.org/wiki/Universal_Product_Code. 147 Simon-Kucher & Partners history: Hermann Simon interview, Feb. 24, 2009. 148 “Indeed, retail pricing software”: Michaud n.d., 5. 148 “Pricing is a dangerous lever”: Tacke and Luby n.d., 9. 148 increases profit margins by about 2 percentage points: Simon 2008, 215. 148 1 to 4 percent: Michaud n.d., 5. 25.

Expected Returns: An Investor's Guide to Harvesting Market Rewards
by Antti Ilmanen
Published 4 Apr 2011

Thus, many people focus too much on asset-specific risks (volatility, default) and underappreciate correlation effects. The more general finding in experimental studies is that framing matters. People make different choices depending on how a given problem is presented to them [3]. Mental accounting refers to the process by which people formulate problems for themselves. It involves assigning gains and/or losses related to decisions into separate mental accounts (e.g., expenditure accounts and investment accounts) which may be broad or narrow (narrowness in the extreme being to view each trade in isolation) and which may have different evaluation periods. Decisions may be influenced by the extent to which their outcomes are mentally integrated with, or segregated from, the outcomes of other choices—with other assets in the portfolio or across time (i.e., with the outcomes of past trading).

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Kahneman and Tversky do not specify this but note that in many cases the status quo (doing nothing, one’s current asset position) is a natural reference point:• For investments already made, the buying price becomes an important reference point against which gains and losses are measured. The disposition effect refers to investors’ tendency to hang on to losers, hoping to see the price recover back to the buying level. Prospect theory and mental accounting may explain such reluctance to realize losses. (I recall from my days as a young bond portfolio manager how hard it was to resist this bias even though my colleagues warned me on my first workweek to ignore the purchase price! “The stock does not know that you own it, let alone at what price

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Such a difference could reflect incomplete adaptation to recent changes in wealth, so past experiences can matter: “A person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise.” Standard PT is sometimes mistakenly interpreted to say that people become risk seeking after they have lost money but this really depends on framing (as discussed next). More risk preferences The house money effect is an important example of mental accounting. Gamblers tend to become less loss averse and more willing to take risks when they are ahead (“playing with house money)”. Greater willingness to gamble after recent gains suggests that losses are easier to take when they can be mentally added to earlier gains. At first blush, this may sound inconsistent with PT.

The Four Pillars of Investing: Lessons for Building a Winning Portfolio
by William J. Bernstein
Published 26 Apr 2002

But enough of these companies will rebound in price, making up for the ones that fail. In fact, Thaler has found that stocks that have recently fallen have, on average, higher expected returns than the market. This should not surprise anyone, since these tend to be value stocks. But it highlights a much more serious problem, which is known as “mental accounting.” This refers to our tendency to compartmentalize our successful and unsuccessful investments, mentally separating our winners and losers. This is particularly dangerous because it distracts us from what should be our main focus: the whole portfolio. A perfect example was the advisor I mentioned earlier who was extremely proud of his “ability” to pick successful active domestic and foreign stock managers but who ignored the fact that his overall portfolio performance was poor.

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Summing It Up In the words of Walt Kelly, “We have met the enemy, and he is us.” I’ve described the major behavioral mistakes made by investors—the herd mentality, overconfidence, recency, the need to be entertained, myopic risk aversion, the great company/great stock illusion, pattern hallucination, mental accounting, and the country club syndrome. This shopping list of maladaptive behaviors will corrode your wealth as surely as a torrential rain strips an unplanted hillside. 8 Behavioral Therapy In the last chapter, we examined the many sins to which the frail investment flesh is heir. In the next pages, we’ll formulate strategies for defeating the enemy in the mirror.

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Most importantly, ignore market strategists who use financial and economic data to forecast market direction. If we have learned anything over the past 70 years from the likes of Cowles, Fama, Graham, and Harvey, it’s that this is a fool’s errand. Barton Biggs’s job is to make Miss Cleo look good. Unify Your Mental Accounting I guarantee you that each month, quarter, year, or decade, you will have one or two asset classes that you will kick yourself for not owning more of. There will also be one or two dogs you will wish you had never laid eyes on. Certain asset classes, particularly precious metals and emerging markets stocks, are quite capable of losing 50% to 75% of their value within a year or two.

Skin in the Game: Hidden Asymmetries in Daily Life
by Nassim Nicholas Taleb
Published 20 Feb 2018

But you cannot possibly ignore all the other financial risks he is taking: if he has a car parked outside that can be scratched, if he has a financial portfolio that can lose money, if he has a bakery that may risk a fine, if he has a child in college who may cost unexpectedly more, if he can be laid off, if he may be unexpectedly ill in the future. All these risks add up, and the attitude of the subject reflects them all. Ruin is indivisible and invariant to the source of randomness that may cause it. Another common error in the psychology literature concerns what is called “mental accounting.” The Thorp, Kelly, and Shannon school of information theory requires that, for an investment strategy to be ergodic and eventually capture the return of the market, agents increase their risks as they are winning, but contract after losses, a technique called “playing with the house money.” In practice, it is done by threshold, for ease of execution, not complicated rules: you start betting aggressively whenever you have a profit, never when you have a deficit, as if a switch was turned on or off.

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In practice, it is done by threshold, for ease of execution, not complicated rules: you start betting aggressively whenever you have a profit, never when you have a deficit, as if a switch was turned on or off. This method is practiced by probably every single trader who has survived. Now it happens that this dynamic strategy is deemed out of line by behavioral finance econophasters such as the scarily interventionist Richard Thaler, who, very ignorant of probability, calls this “mental accounting”fn2 a mistake (and, of course, invites government to “nudge” us away from it, and prevent strategies from being ergodic).fn3 I believe that risk aversion does not exist: what we observe is, simply, a residual of ergodicity. People are, simply, trying to avoid financial suicide and take a certain attitude to tail risks.

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CHAPTER 19: THE LOGIC OF RISK TAKING fn1 As with my “Fat Tails” project, economists may have been aware of the ensemble-time problem, but in a sterile way. Further, they keep saying “we’ve known about fat tails,” but somehow they don’t realize that taking the idea to the next step contradicts much of their work. It is the consequences that matter. fn2 Mental accounting refers to the tendency of people to mentally (or physically) put their funds in separate insulated accounts, focusing on the source of the money, and forgetting that as net owners the source should not matter. For instance, someone who would not buy a tie because it is expensive and appears superfluous gets excited when his wife buys for his birthday the same tie using funds from a joint checking account.

Why Stock Markets Crash: Critical Events in Complex Financial Systems
by Didier Sornette
Published 18 Nov 2002

This violates the law-of-one-price that one drink is worth the same as another, and it suggests that people care as much about being treated fairly as they do about the actual value of what they are paying for [227, 228]. An important discovery, extending the framing principle of Kahneman and Tversky, was “mental accounting” [423, 373]. “Framing” says that the positioning of choices prejudices the outcome, an issue that received a lot of publicity in the 2000 U.S. presidential election. “Mental accounting” says that people draw their own frames, and that where they place the boundaries subtly affects their decisions. For instance, most people sort their money into accounts like “current income” and “savings” and justify different expenditures from each [425].

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For instance, if investors are used to a stock market growth of 10% per year, they expect their capital to appreciate from $100 to $110 in a year. If during the following year, the growth rate rises to 20%, their capital rises to $120 instead of the expected $110. They can thus spend $10 without having the impression of eating their capital, a psychological process associated with mental accounting [423, 373] (see the section titled “Behavioral Economics” in chapter 4). On the other hand, if there is not acceleration of stock market prices, capital gain only makes a one-time addition to the stock of wealth without changing the future flow of income. If the market is not accelerating, capital gains have only a transitory effect on expenditure.

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M. (1997). The Internationalization of Securities Markets Since the 1987 Crash, Papers presented at the October 1997 conference, published in Vol. II of the annual Brookings-Wharton Papers on Financial Services, http://wrdsenet.wharton.upenn.edu/fic/wfic/papers/97/b6.html. 423. Thaler, R. H. (1985). Mental accounting and consumer choice, Marketing Science 4, 199–214. 424. Thaler, R. H., Editor (1993). Advances in Behavioral Finance (Russell Sage Foundation, New York). r efe rences 417 425. Thaler, R. H. and Johnson, E. J. (1990). Gambling with the house money and trying to break even: The effects of prior outcomes on risky choice, Management Science 36, 643–660. 426.

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing
by Vijay Singal
Published 15 Jun 2004

Even though the real change in salary is –6 percent for the first worker and 2 percent for the second worker, the pay raises are framed and compared separately from inflation rates. Consequently, the first worker is likely to be happier than the second. In the same vein, investors look at each stock individually, not as part of a portfolio as traditional economists assume. As a result, investors engage in mental accounting. They tend to value stocks that pay dividends more than stocks that pay capital gains. They tend to be loss-averse rather than risk averse. Some experiments find that investor behavior is consistent with frame dependence. For example, investors are known to hold losers for too long because they are averse to realizing a loss.

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Individual security decisions, underdiversification, and too much risk. As investors study and learn about a small subset of all stocks, they become overconfident in their evaluation of those stocks. Consequently, they invest in a few stocks, resulting in underdiversification and excessive risk. In addition, mental accounting causes investors to examine each security in isolation without looking at the overall portfolio, again creating inefficient portfolios. Research has found that a typical individual investor account holds only four stocks, with a median of three stocks, and nearly one-quarter of all individual accounts hold only one stock.

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Unfortunately, that is only half the story. Not all good companies are good investments. In addition to being a good company, the company should also be attractively valued before it is considered for investment. Another common error is that investors tend to pay too much for dividendpaying stocks. This is a case of mental accounting. When returns are examined, it is necessary to look at the total return rather than at dividends and capital gains separately. Though dividends are more certain than capital gains, that certainty is already reflected in the risk of that stock and should not be counted twice. HOW TO OVERCOME BEHAVIORAL BIASES The behavioral biases arise from fear and greed associated with investing.

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies
by Jeremy Siegel
Published 7 Jan 2014

Often the reference point is the purchase price that investors pay for the stock. Investors become fixated on this reference point to the exclusion of any other information. Richard Thaler from the University of Chicago, who has done seminal work in investor behavior, refers to this as mental accounting or narrow framing.19 When you buy a stock, you open a mental account, with the purchase price as the reference point. Similarly, when you buy a group of stocks together, either you will think of the stocks individually, or you may aggregate the accounts together.20 Whether your stocks are showing a gain or loss will influence your decision to hold or sell the stock.

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See Nassim Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and the Markets, 2005. 18. Dreman, Contrarian Investment Strategies. 19. Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, no. 3 (Summer 1985), pp. 199-214 and Nicholas Barberis, Ming Huang and Richard H. Thaler, “Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing,” The American Economic Review, vol. 96, no. 4 (Sep., 2006), pp. 1069-1090. 20. Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making, vol. 12 (1999), pp. 183-206. 21. Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” Journal of Finance, vol. 40, no. 3 (1985), pp. 777-792. 22.

Survival of the Richest: Escape Fantasies of the Tech Billionaires
by Douglas Rushkoff
Published 7 Sep 2022

Behavioral economists are most interested in pinning down the ways in which people diverge from acting in what should be their selfish economic interests, for these are the “exploits” or levers through which consumers and investors can be manipulated to spend money irrationally. For example, thanks to the irrational process of “mental accounting,” people tend to consider their money as existing in separate buckets—some of which feel worth more than others. Loyalty schemes such as credit card points and airline miles encourage mental accounting, leading people to spend more of those assets than they would otherwise. “Anchoring bias” refers to our tendency to rely on the first information we hear. Marketers exploit this by telling us an “original price” before the “sale price,” making consumers believe they are getting a bargain.

Walk Away
by Douglas E. French
Published 1 Mar 2011

Dražen Prelec and George Lowenstein believe that people do an accounting in their heads that affects their behavior. The linkages tying together specific acts of consumption with specific payments “generates pleasure or pain depending on whether the accounts are in the red or in the black.” In an article entitled “The Red and the Black: Mental Accounting of Savings and Debt” which appeared as a chapter in Exotic Preferences: Behavioral Economics and Human Motivation, the authors’ modeling predicts that most people are debt averse and show “that people generally like sequences of events that improve over time and dislike sequences that deteriorate.”

How Music Got Free: The End of an Industry, the Turn of the Century, and the Patient Zero of Piracy
by Stephen Witt
Published 15 Jun 2015

On the seventh day he rested—but only because plant regulations required him to take a day off. His gross take-home was more than a thousand bucks a week. It was good money for an unskilled laborer with no college education, but it wasn’t enough. There were just so many things to buy. Glover had a remarkable facility for mental accounting. He didn’t budget or keep records, but tracked his cash flows in a mental ledger. On one side was earnings, where, going all the way back to his days as a dishwasher, he could quickly estimate what he had earned in a given week in a given year. On the other side was living expenses, which contained entries for things like utilities, groceries, and rent.

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But the net bottom line was a terrific influx of physical cash. Working every available overtime shift from a management position meant he pulled in nearly $1,500 a week in legitimate earnings. On top of that came another two grand in cash sales from the barbers, plus whatever he moved himself. By his mental accounting, in 2004 and 2005 he made more from bootlegging than he did from more than 3,000 hours a year of legitimate work. All told he was pulling in almost four grand a week—nearly $200,000 a year. He began to make extravagant purchases. He bought rims for his girlfriend Karen Barrett—“Rims on a Honda,” he said, shaking his head.

Beyond the 4% Rule: The Science of Retirement Portfolios That Last a Lifetime
by Abraham Okusanya
Published 5 Mar 2018

It’s hard to argue against the positive impact it has on managing the cognitive and behavioural biases that damage returns if retirees panic during market stress. The knowledge that they always have six to 12 months’ income in cash, which is not subject to the whims of the market, is an effective ‘framing’ and ‘mental accounting’ technique to help people sleep better at night during market declines. To quote Wall Street Journal columnist Jason Zweig, when markets fall, ‘an investor who has courage but lacks cash is as powerless as one who has cash but no courage.’ Yet it’s important not to be overly conservative, as a lower allocation to equities invariably reduces a portfolio’s longevity.

Phishing for Phools: The Economics of Manipulation and Deception
by George A. Akerlof , Robert J. Shiller and Stanley B Resor Professor Of Economics Robert J Shiller
Published 21 Sep 2015

They report that, while median household income was $47,040, median household holdings of cash and checking, savings, and money market accounts was $2,640 (or about two-thirds of one month’s income) according to the 2010 Survey of Consumer Finances. 7. David Huffman and Matias Barenstein, “A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption between Paydays,” Institute for the Study of Labor (IZA) Discussion Paper 1430 (December 2005): 3. 8. FINRA Investor Education Foundation, Financial Capability in the United States: Report of Findings from the 2012 National Financial Capability Study, p. 23, last accessed May 14, 2015, http://www.usfinancialcapability.org/downloads/NFCS_2012_Report_Natl_Findings.pdf. 9.

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My Life in Advertising and Scientific Advertising: Two Works by Claude C. Hopkins. New York: McGraw Hill, 1997. Horowitz, Joseph. Dvořák in America: In Search of the New World. Chicago: Cricket Books, 2003. Huffman, David, and Matias Barenstein. “A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption between Paydays.” Institute for the Study of Labor (IZA) Discussion Paper 1430 (December 2005). Interactive Advertising Bureau. Internet Advertising Revenue Report: 2013 Full-Year Results. Conducted by PricewaterhouseCoopers (PwC). Accessed March 7, 2015. http://www.iab.net/media/file/IAB_Internet_Advertising_Revenue_Report_FY_2013.pdf.

Cheap: The High Cost of Discount Culture
by Ellen Ruppel Shell
Published 2 Jul 2009

., 7. 122 to buy the product: Carrie Heilman, Kyryl Lakishyk, Sonja Radas, “The Effectiveness of In-Store Free Samples on Sample Takers,” 2006, available online at http://www.commerce.virginia.edu/faculty__research/Research/Papers/FreeSa- mples__July26__2006.pdf. 123 “five shillings besides”: From the essay “Advice to a Young Tradesman Written in the Year 1748,” in Autobiography of Benjamin Franklin (New York: Macmillan Company, 1921), 188. 123 “an opportunity cost”: Diip Soman, “The Mental Accounting of Sunk Time Costs: Why Time Is Not Like Money,” Journal of Behavioral Decision Making 14, no 3 (2001), 169-85. 123 we tend to underestimate its value: Richard Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12 (1999), 183-206. CHAPTER SIX: DEATH OF A CRAFTSMAN 125 “let’s pull the legs off”: Oliver Burkeman, “The Miracle of Almhult,” The Guardian, June 17, 2004. 125 among the world’s richest men: In March 2008, Forbes magazine estimated Kamprad’s fortune at U.S. $31 billion, making him the seventh richest person in the world, while other sources, such as the Swedish business weekly Veckans Affärer, argue that he is in fact the wealthiest.

Uneasy Street: The Anxieties of Affluence
by Rachel Sherman
Published 21 Aug 2017

Like spending reasonably, as we will see in chapter 3, requiring themselves to work is a way of setting limits on their own entitlements. The earners I described earlier saw their earned money as precious, to be saved, while imagining that they would spend inherited money more freely. Inheritors reversed this “mental accounting”: they felt they had to be restrained with the money they didn’t earn, whereas they could spend that which they had earned.16 Nicholas, an inheritor who also had a salaried job, said of the money he earned, “I feel a little bit more entitled to blow that money.” Donovan, who was in a similar situation, told me, “I’m more willing to spend money I’ve made myself, on whatever I want to.”

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Never Done: A History of American Housework. New York: Pantheon Books. Streib, Jessi. 2013. “Class Origin and College Graduates’ Parenting Beliefs.” Sociological Quarterly 54: 670–693. ———. 2015. The Power of the Past: Understanding Cross-Class Marriages. New York: Oxford University Press. Thaler, Richard H. 1999. “Mental Accounting Matters.” Journal of Behavioral Decision Making 12: 183–206. Tichenor, Veronica. 2005. Earning More and Getting Less: Why Successful Wives Can’t Buy Equality. New Brunswick, NJ: Rutgers University Press. Treas, Judith. 1993. “Money in the Bank: Transaction Costs and the Economic Organization of Marriage.”

How I Invest My Money: Finance Experts Reveal How They Save, Spend, and Invest
by Brian Portnoy and Joshua Brown
Published 17 Nov 2020

She is developmentally disabled with a genetic condition called Fragile X and will always need my help. It is stressful to know I will need to care for her for the rest of her life, but it also a deep source of contentment that I am on target to have the money to do so. My dad has long supported her, but in due course, it’s all on me. In funding all of this, mental accounting is my friend. I love the line that all models are wrong but some are useful, as it reflects the pragmatism I want to bring to managing my money life. So first, as described above, there are categories of things I need to underwrite, ranging from big lump-sum payments like college to regular cash flows both for life now and in retirement.

Work Rules!: Insights From Inside Google That Will Transform How You Live and Lead
by Laszlo Bock
Published 31 Mar 2015

Thanks to 30 Rock, we call these instances of perfect anticipation “french fry moments.” Take the $500 we give each Googler after childbirth to spend on home delivery of meals. The first few days and weeks after bringing a new child home are exhausting. The last thing anyone wants to do is cook. Even though Googlers can afford to order a pizza for dinner, the mental accounting is different when someone gives you $500 specifically for takeout meals. And new parents tell us they love it. Ironically, our first executive development programs like the ones I had proposed to Eric in our initial meeting turned out to be a classic french fry moment. When Evan Wittenberg (then a member of our learning team and now SVP of People at Box, an online data-storage company), Paul Russell (an early leader of our learning team, now retired), and Karen May (at the time a consultant and our current VP of People Development) created Google’s first Advanced Leadership Lab in 2007, it was intensely controversial because Google at the time was organized by function—engineering, sales, finance, legal, for example—and the groups didn’t interact unless necessary.

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Jeffrey and Victoria Shaffer, “The Motivational Properties of Tangible Incentives,” Compensation & Benefits Review 39, no. 3 (2007): 44–50. Erica Mina Okada, “Justification Effects on Consumer Choice of Hedonic and Utilitarian Goods,” Journal of Marketing Research 42, no. 1 (2005): 43–53. Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12, no. 3 (1999): 183–206. 187. This finding is consistent with the academic work, which focuses on purchases rather than gifts. People are happier when they buy experiences (trips, dinners) than when they buy things (clothes, electronics). Travis J.

Trend Following: How Great Traders Make Millions in Up or Down Markets
by Michael W. Covel
Published 19 Mar 2007

Futures, Vol. 21, No. 1 (January 1992). Taleb, Nassim Nicholas. Fooled By Randomness. New York: Texere, 2001. Teweles, Richard J. and Frank J. Jones. The Futures Game. Who Wins? Who Loses? Why? New York: McGraw-Hill, 1987. Thaler, Richard H. Mental Accounting Matters. Journal of Behavioral Decision Making, 12 (1999): 183–206. Thaler, Richard H. Saving, Fungibility, and Mental Accounts. Journal of Economic Perspectives, Vol. 4, No. 1 (Winter 1990): 193–205. Tharp, Van K. Trade Your Way to Financial Freedom. New York: McGraw-Hill, 1999. Thorp, Edward O. Beat the Dealer. New York: Vintage Books, 1966. Toffler, Alvin.

The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life You Want
by Diane Mulcahy
Published 8 Nov 2016

Christensen asserts that we need to resist the allure of shorter-term gratification and make an explicit effort to keep our longer-term priorities “front and center” so that we allocate sufficient time and energy toward them. Like the exercises you did previously in chapter 1, explicitly identifying our priorities and values and reminding ourselves of them can be an effective way to overcome this bias. Do You Know How Much Time Your Stuff Costs You? We also have a less-rigorous model of mental accounting for time than money, which means that we don’t track time investments as closely as investments of money. We keep a closer eye on our checkbook than our calendar. For instance, if we make $75,000 per year, after subtracting 30 percent for taxes, etc., let’s say for ease of math that we bring home about $1,000 per week, or around $25 per hour.

The Great Economists Ten Economists whose thinking changed the way we live-FT Publishing International (2014)
by Phil Thornton
Published 7 May 2014

Chapter 9 • Gary Becker199 Becker abandoned the typical assumptions that employers only considered the productivity of potential employees; that workers ignored the characteristics of those that they worked for; and that customers only cared about the qualities of the goods and services provided. He devised ‘discrimination coefficients’ that incorporated the impact of race, gender and other personal characteristics on tastes and attitudes. At its core the analysis is based on the idea that people mentally account for a cost – albeit a non-monetary one – when they do business with someone against whom they hold a prejudice. The immediate cost falls on the minority individual, whether as a potential employee, employer or retailer as they bear the cost of prejudice. This is especially so when the victims of discrimination are in the minority.

The Joys of Compounding: The Passionate Pursuit of Lifelong Learning, Revised and Updated
by Gautam Baid
Published 1 Jun 2020

Evolution has programmed our brain to seek loss minimization instead of gain maximization. In investing, narrow framing, a variant of the framing effect, is our inability to zoom out in a given situation. We like winning more than losing, and we keep an internal score for each stock in our portfolio. We maintain a separate mental account for each of our stocks, and we want to close every future sale transaction only with a gain. Instead of looking at overall portfolio performance, we try to gain from every single stock. This narrow framing is known as the disposition effect, and it results in selling winners and holding on to losers.

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Figure 32.3 shows what happens if you invest the same sum of money in a portfolio of high-quality stocks with an average annual earnings growth of 15 percent and a 2 percent dividend, for a total of 17 percent return. FIGURE 32.3 This is compounding wealth in action. Instead of treating dividends as “free money” and engaging in mental accounting, investors should resist instant gratification and always immediately reinvest their dividends. Reinvesting your dividends through a dividend reinvestment plan (DRIP) is a great way to take maximum advantage of the power of long-term compounding. A DRIP automatically uses your dividends to buy more shares of the holdings in your portfolio.

Are You Smart Enough to Work at Google?: Trick Questions, Zen-Like Riddles, Insanely Difficult Puzzles, and Other Devious Interviewing Techniques You ... Know to Get a Job Anywhere in the New Economy
by William Poundstone
Published 4 Jan 2012

Letter to the editor. American Statistician 29 (1975): 134. Stone, Dianna L., and Gwen E. Jones. “Perceived Fairness of Biodata as a Function of the Purpose of the Request for Information and Gender of the Applicant.” Journal of Business and Psychology 11 (1997): 313–23. Thaler, Richard. “Mental Accounting and Consumer Choice.” Marketing Science 4 (1985): 199–214. Tierney, John. “Behind Monty Hall’s Doors: Puzzle, Debate, and Answer?” New York Times, July 21, 1991. Time. “An Eggalitarian Education.” May 18, 1970, 50. Torrance, E. Paul. Guiding Creative Talent. Englewood Cliffs, N.J.: Prentice-Hall, 1962.

The End of Money: Counterfeiters, Preachers, Techies, Dreamers--And the Coming Cashless Society
by David Wolman
Published 14 Feb 2012

Legally they are, sure, but they don’t exactly circulate. A store of value? Practically nil. Medium of exchange? Only if you have a boatload of them, which won’t exactly endear you to whomever you’re transacting with. A unit of account? Technically, but I don’t know anyone who uses the hundredths place in his mental accounting. Marketing types will be quick to tell you that consumers treat $2.99 differently from $3.00, but that’s because of the hypnotic power of the left digit. No one cares about the right one anymore. It’s no wonder then that people so willingly pay the usurious 8.9 percent fee to use one of Coinstar’s 20,000 kiosks to convert unwieldy jarfuls of metal into paper money.14 In the United States, the question of killing at least the penny and nickel surfaces whenever the price of metals spikes.

The Behavioral Investor
by Daniel Crosby
Published 15 Feb 2018

Being a behavioral investor is less about adhering to some textbook notion of rationality and more about understanding and bending the idiosyncrasies of human nature to our advantage. Consider the work of Nobel Prize winner Richard Thaler who first discovered and named what we now refer to as “mental accounting,” the tendency to separate money into different buckets and spend or save it differently depending on how it is labeled. Studies have shown that people are apt to save money labeled as a rebate but to spend money labeled as a bonus. Barack Obama and his advisors, Richard Thaler among them, used framing to position the stimulus given out after the Great Recession as a bonus to incent recipients to buy big screen TVs rather than hoard it.

The Paradox of Choice: Why More Is Less
by Barry Schwartz
Published 1 Jan 2004

.), Choices, Values, and Frames (New York: Cambridge University Press, 2000). On the endowment effect, see D. Kahneman, J. Knetsch, and R. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias.” On decisions to sell stock, see T. Odean, “Are Investors Reluctant to Realize Their Losses?” On sunk costs, see R. Thaler, “Mental Accounting Matters,” and R. Thaler, “Toward a Positive Theory of Consumer Choice.” On health insurance decisions, see E. Johnson, J. Hershey, J. Mezaros, and H. Kunreuther, “Framing, Probability Distortions, and Insurance Decisions.” On health plans and pension plans, see C. Camerer, “Prospect Theory in the Wild: Evidence from the Field” [the original research on this is in W.

The Power of Moments: Why Certain Experiences Have Extraordinary Impact
by Chip Heath and Dan Heath
Published 2 Oct 2017

New me isn’t going to make these mistakes.’ ” In other words, New Year’s resolutions are not really about the resolutions. After all, for most people, the resolutions haven’t changed. Most people wanted to lose weight and save money on December 31, too. What we’re doing on New Year’s Day is more like a mental accounting trick. Our past failures are left on the ledger of Old Me. New Me starts today. New Year’s resolutions should really be called New Year’s absolutions. Milkman realized that if her “fresh start” theory was right, then the slate-cleaning effect shouldn’t be confined to New Year’s Day. It should also be true for other landmark dates that would give us an excuse to reset our record, such as the start of a new month or even a new week.

The Strange Order of Things: The Biological Roots of Culture
by Antonio Damasio
Published 6 Feb 2018

The experience that the mysterious species would have of its feelings would be formally akin to ours, albeit not the same, because the substrate was not exactly the same. If you change the substrate of feelings, you change what gets to be interactively imaged and so you change the feelings as well. In brief, substrates do count because the mental process to which we are referring is a mental account of those substrates. Phenomenology counts. There is plenty of evidence that artificial organisms can be designed so as to operate intelligently and even surpass the intelligence of human organisms. But there is no evidence that such artificial organisms, designed for the sole purpose of being intelligent, can generate feelings just because they are behaving intelligently.

The Happiness Industry: How the Government and Big Business Sold Us Well-Being
by William Davies
Published 11 May 2015

.’, online.wsj.com, 18 March 2006. 7Keith Coulter, Pilsik Choi and Kent Monroe, ‘Comma N’ Cents in Pricing: The Effects of Auditory Representation Encoding on Price Magnitude Perceptions’, Journal of Consumer Psychology 22: 3, 2012. 8Drazen Prelec and George Loewenstein, ‘The Red and the Black: Mental Accounting of Savings and Debt’, Marketing Science 17: 1, 1998. 9Jonathan Crary, Suspensions of Perception: Attention, Spectacle, and Modern Culture, Cambridge, Mass.: MIT Press, 2001. 10Robert Rieber and David Robinson, eds., Wilhelm Wundt in History: The Making of a Scientific Psychology, Dordrecht: Kluwer Academic Publishers, 2001. 11See James Beniger, The Control Revolution: Technological and Economic Origins of the Information Society, Cambridge, MA: Harvard University Press, 1988. 12Robert Rieber, ed., Wilhelm Wundt and the Making of a Scientific Psychology, New York: Plenum Publishing Company Limited, 1980. 13Ibid. 14The American psychologist Edward Thorndike wrote in 1907: ‘Psychology supplies or should supply the fundamental principles upon which sociology, history, anthropology, linguistics and the other sciences dealing with human thought and action should be based … The facts and laws of psychology … should provide the general basis for the interpretation and explanation of the great events studied by history.’

Lift: Fitness Culture, From Naked Greeks and Acrobats to Jazzercise and Ninja Warriors
by Daniel Kunitz
Published 4 Jul 2016

I’ve since come to understand that the old canard about choosing between the life of the body and the life of the mind (a bastardized version of the ancient and more valid distinction between the via activa and the via contemplativa, the active, political life versus the contemplative way) sets up a false distinction. It’s a bias based on the assumption that energy expended physically must be deducted from our mental account. Contrary to what I believed in high school, jocks need not be stupid, while eggheads, to the extent that they deny their physical lives, are fools. In the New York literary world of the nineties, almost everyone—though not George—remained still gleefully stuck in that high school mentality.

Moonwalking With Einstein
by Joshua Foer
Published 3 Mar 2011

In Hebrew, each letter of the aleph bet corresponds to a number, a quirk that Kabbalists have used to seek out hidden numerical meanings in Scripture. Nobody knows whether these systems were ever used to memorize numbers, but it’s hard to imagine that some Mediterranean businessman who had to do mental accounting wouldn’t have stumbled onto such an obvious idea. 166 advance the sport of competitive memory by a quantum leap: Ed gave me the following example of his Millennium PAO system at work: “The number 115 is Psmith, the stylish character from the P. G. Wodehouse books (the P is silent, by the way, as in ‘phthisis’ or ‘ptarmigan’).

Wait: The Art and Science of Delay
by Frank Partnoy
Published 15 Jan 2012

Evidence from a Consumer Credit Marketing Experiment,” Quarterly Journal of Economics 125(1, 2010): 263–306. Shafir also has studied, with economist Richard Thaler, some of the puzzles of how and why we delay gratification. Eldar Shafir and Richard Thaler, “Invest Now, Drink Later, Spend Never: On the Mental Accounting of Delayed Consumption,” Journal of Economic Psychology 27(5, 2006): 694–712. 3. Nassim Taleb in particular has demonstrated that human beings make all sorts of cognitive mistakes in assessing risk. See Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and Markets (Random House, 2008), and Taleb, The Black Swan. 4.

The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing
by Michael J. Mauboussin
Published 14 Jul 2012

In one study, researchers asked people which new employee was happier, the person making $36,000 in a firm where the average starting salary is $40,000 or the one making $34,000 in a firm where the average starting salary is $30,000. Eighty percent of the respondents said the employee earning $34,000 would be happier.33 In investing, the reference point is what you paid for a stock. When you buy a stock at $30, for instance, you effectively open a mental account. You have a gain if the stock rises above $30 and a loss if it drops below that price. Rather than viewing the value of the stock in the context of a larger portfolio, the natural tendency is to consider each stock relative to its reference point. Loss aversion is another feature of prospect theory.

Decisive: How to Make Better Choices in Life and Work
by Chip Heath and Dan Heath
Published 26 Mar 2013

The cookie study is from Dilip Soman and Amar Cheema, “The Effects of Partitioning on Consumption,” Rotman, Spring 2008, pp. 20–24. The day-laborer study is from Dilip Soman, “Earmarking Money,” Rotman, Fall 2009, pp. 96–98. 7 Mental budgets and escalation. See Chip Heath (1995), “Escalation and De-escalation of Commitment in Response to Sunk Costs: The Role of Budgeting in Mental Accounting,” Organizational Behavior and Human Decision Processes 62: 38–54. 8 Lucile Packard, rapid-response teams. The quotes in this article are from interviews of Kit Leong and Karla Earnest by Chip Heath in March 2012. The paper reporting their work is Paul J. Sharek, et al. (2007), “Mortality and Code Rates Outside the ICU in a Children’s Hospital,” Journal of the American Medical Association 298: 2267–74. 9 Unexpected success.

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything
by Steven D. Levitt and Stephen J. Dubner
Published 11 Apr 2005

Levitt, “What the Bagel Man Saw,” The New York Times Magazine, June 6, 2004. Levitt has also written an academic paper about Feldman’s bagel operation: “An Economist Sells Bagels: A Case Study in Profit Maximization,” National Bureau of Economic Research working paper, 2006. / 43 The “Beer on the Beach” study is discussed in Richard H. Thaler, “Mental Accounting and Consumer Choice,” Marketing Science 4 (Summer 1985), pp. 119–214; also worth reading is Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life (New York: Free Press, 1992). 2. HOW IS THE KU KLUX KLAN LIKE A GROUP OF REAL-ESTATE AGENTS? SPILLING THE KLAN’S SECRETS: This section has been substantially revised since the original version of Freakonomics was published, owing to the authors’ discovery that Stetson Kennedy—in both his memoir, The Klan Unmasked, and in interviews with the authors—had misrepresented his role in personally infiltrating and attacking the Klan.

Time Paradox
by Philip G. Zimbardo and John Boyd
Published 1 Jan 2008

Zeckhauser, “Price Differences in Almost Competitive Markets,” Quarterly Journal of Economics 93: 189–211 (1979); A. Tversky and D. Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211: 453–58 (1981); R. H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1: 39–60 (1980). 20. R. H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12: 183–206 (1999). 21. R. B. Cialdini et al., “Reciprocal Concessions Procedure for Inducing Compliance: The Door-in-the-Face Technique,” Journal of Personality and Social Psychology 31: 206–15 (1975). There is some controversy about whether this effect is, in fact, due to the contrast between the large and small requests.

Loneliness: Human Nature and the Need for Social Connection
by John T. Cacioppo
Published 9 Aug 2009

Combined with ever more sophisticated mental capacities—the ability to maintain the image of a prey animal when it is no longer in sight, the ability to continue to focus persistently on a certain goal for days or even years—running allowed us to move from scavenging on the savannahs to becoming competent hunters.2 With the expansion of our brain and our field of vision came an even wider expansion—not just of our range of habitation, but of our range in terms of the global and temporal nature of our concerns. It is this expansion that lies at the heart of the Third Adaptation. We became creatures not just of the moment, but of the future and the past. We could internalize lessons from experience, learn from our mistakes, and also plan ahead. We could defer gratification and we could keep mental accounts of treachery and of kindness extending back for generations, even centuries. With highly sophisticated and fully functional executive control, we could much more precisely sort out what served our own interests, while also taking into consideration our membership in various wider communities of interest, extending all over the world and into the future our great-grandchildren will inhabit.

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets
by Nassim Nicholas Taleb
Published 1 Jan 2001

CHAPTER 12 Pigeons in a box: Skinner (1948). Illusion of knowledge: Barber and Odean (2001) presents a discussion of the literature on the tendency to make a stronger inference than warranted by the data, which they call “Illusion of Knowledge.” CHAPTER 13 Arabic skeptics: al-Ghazl (1989). Rozan’s book: Rozan (1999). Mental accounting: Thaler (1980) and Kahneman, Knetch and Thaler (1991). Portfolio theory (alas): Markowitz (1959). The conventional probability paradigm: Most of the conventional discussions on probabilistic thought, especially in the philosophical literature, present minor variants of the same paradigm with the succession of the following historical contributions: Chevalier de Méré, Pascal, Cardano, De Moivre, Gauss, Bernouilli, Laplace, Bayes, von Mises, Carnap, Kolmogorov, Borel, De Finetti, Ramsey, etc.

Irresistible: The Rise of Addictive Technology and the Business of Keeping Us Hooked
by Adam L. Alter
Published 15 Feb 2017

Friedman, “Here’s Why People Work Like Crazy, Even When They Have Everything They Need,” Business Insider, July 10, 2014, www.businessinsider.com/why-people-work-too-much-2014-7; International Labour Organization, “Case Study: Karoshi: Death from Overwork,” International Labour Relations, April 23, 2013, www.ilo.org/safework/info/publications/WCMS_211571/lang—en/index.htm ; China Post News Staff, “Overwork Confirmed to Be Cause of Nanya Engineer’s Death,” China Post, October 15, 2011, www.chinapost.com.tw/taiwan/national/national-news/2011/03/15/294686/Overwork-confirmed.htm. In a classic paper: Dražen Prelec and Duncan Simester, “Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay, Marketing Letters 12, no. 1 (2001): 5–12; see also: Dražen Prelec and George Loewenstein, “The Red and the Black: Mental Accounting of Savings and Debt,” Marketing Science 17, no. 1 (1998): 4–28. CHAPTER 8: CLIFFHANGERS In their own: Responses to the ending of The Italian Job on the Internet Movie Database: www.imdb.com/title/tt0064505/reviews. Forty years earlier: Background material on Bluma Zeigarnik and her eponymous effect: A.

Beyond Diversification: What Every Investor Needs to Know About Asset Allocation
by Sebastien Page
Published 4 Nov 2020

Here I assume a US investor, but cash rates differ across countries. If they’re high, investors should expect high nominal returns on local assets. However, high cash returns usually coincide with high expected inflation. Some of my colleagues can effortlessly move between nominal and real returns, local and foreign returns, etc. They mentally account for spot and forward rates, interest rate differentials, and inflation differentials on the fly. I’ve been involved in global macro investing for many years, and I used to oversee a currency overlay business, but I’m embarrassed to say that I still struggle with these problems. I always need to pause and think through them.

Capital Ideas Evolving
by Peter L. Bernstein
Published 3 May 2007

Their whole way of life could be damaged. This imbalance in their family balance sheet does not concern many home owners, because they simply do not think about such matters as diversification and management of risk, at least where their houses are concerned. They tend to employ what has come to be known as “mental accounting,” which means they maintain a separate basket in their heads for their home and its mortgage, another basket for their 401(k) accounts, still another for their savings accounts, one for their consumer credit, and another to store their concerns about the cost of their children’s education. No basket has a relation to any of the other baskets.

Utopia Is Creepy: And Other Provocations
by Nicholas Carr
Published 5 Sep 2016

It is only when a sense that time may consist of something other than the immediate moment is allowed to impinge on the child’s consciousness that maladaptation becomes a real possibility. Hence, the most pressing job for the parent is to ensure that the virtual child is kept in a device-rich networked environment at all times. It is also essential that the virtual child never be allowed to run a cognitive surplus. His or her mental accounts must always be kept in perfect balance, with each synaptic firing being immediately deployed for a well-defined chore, preferably involving the manipulation of symbols on a computer screen in a collaborative social-production exercise. If cognitive cycles are allowed to go to waste, the child may drift into an introspective “dream state” outside the flow of the digital stream.

Invisible Women
by Caroline Criado Perez
Published 12 Mar 2019

Bovasso is one of the few female creative directors in US advertising. She is also a single mother. So when her firm announced that it was hosting a directors’ dinner, Bovasso had a decision to make: was this dinner worth the $200 it would cost her for a sitter and travel?130 Bovasso’s male colleagues on the whole had to do no such mental accounting: yes, men can be single parents, but they are a rare beast. In the UK, 90% of single parents are women.131 In the US the figure is over 80%.132 In Bovasso’s case, her male colleagues were able to just check their calendar and accept or decline. And most of them accepted. In fact not only did they accept, they also booked the hotel next to the restaurant, so they could drink.

Science in the Soul: Selected Writings of a Passionate Rationalist
by Richard Dawkins
Published 15 Mar 2017

Who then would rally against reason? The following statements will sound all too familiar. ‘I don’t trust educated intellectuals, elitists who know more than I do. I’d prefer to vote for somebody like me, rather than somebody who is actually qualified to be President.’ What other than this mentality accounts for the popularity of Donald Trump, Sarah Palin, George W. Bush – politicians who flaunt their ignorance as a vote-winning virtue?*3 You want your airline pilot to be educated in aeronautics and navigation. You want your surgeon to be learned in anatomy. Yet when you vote for a President to lead a great country, you prefer somebody who is ignorant and proud of it, someone you’d enjoy having a drink with, rather than somebody qualified for high office?

How Markets Fail: The Logic of Economic Calamities
by John Cassidy
Published 10 Nov 2009

In 1977–1978, Kahneman and Tversky spent the academic year at Stanford, where they became friends and collaborators with Richard Thaler, a young economist who had done his Ph.D. at Rochester, a bastion of mathematical orthodoxy. During his graduate training, Thaler had developed a list of anecdotes that seemed to contradict the theory he’d been taught, such as people’s reluctance to part with minor possessions—mugs, pens, those sorts of things—and their tendency to divide their expenditures into separate mental accounts (one for leisure, another for rent, and so on). Thaler thought these types of behaviors might be linked to the mental shortcuts and biases that Kahneman and Tversky had identified. In 1980, he published a paper outlining some of his ideas in a reputable but somewhat obscure publication, The Journal of Economic Behavior and Organization, and in 1987 he began writing a regular column entitled “Anomalies,” in the much more influential Journal of Economic Perspectives.

Kingdom of Olives and Ash: Writers Confront the Occupation
by Michael Chabon
Published 29 May 2017

A sinewy woman with jet-black hair and cobalt-blue eyes, she came to Israel in 1977 from Argentina when she was eight years old. Ten years later, she served in the army in Gaza during the first intifada, so she had no doubt that what she heard were gunshots. As she rushed down the stairs to see what had happened, she did a mental accounting of the whereabouts of her five children. Two were still at school, two had gone to play football, and one, Ofek, had just left to visit his grandmother. It was Ofek who came barreling back towards the apartment, screaming. “Mum! Mum! Orlev, Na’or . . . Terrorist!” “Go upstairs! Close the door!”

Economic Dignity
by Gene Sperling
Published 14 Sep 2020

Kathryn Schulz, “The Many Lives of Pauli Murray,” New Yorker, April 10, 2017, https://www.newyorker.com/magazine/2017/04/17/the-many-lives-of-pauli-murray. 2. Pauli Murray, “An American Credo,” Common Ground 5, no. 2 (December 1945): 22–24. CHAPTER ONE: ECONOMIC METRICS AND INVISIBILITY 1. See Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12, no. 3 (1999): 183–206, https://doi.org/10.1002/(sici)1099-0771(199909)12:3<183::aid-bdm318>3.0.co;2-f) [inactive]; and Richard H. Thaler, “Behavioral Economics: Past, Present and Future,” SSRN Electronic Journal, May 27, 2016, https://doi.org/10.2139/ssrn.2790606. 2.

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest
by Andrew W. Lo and Stephen R. Foerster
Published 16 Aug 2021

The behavioral critics of rationality also devised empirical studies in which investors seemed to deviate from the predictions of simple models of rational behavior. According to the behavioralists, these apparent deviations from rationality could be attributed to investor biases, such as excessive optimism, overconfidence, overreaction, loss aversion, herding, miscalibration of probabilities, and mental accounting. There will be more on the behavioralists in chapter 9. Trying to Beat the Market Eugene Fama’s grandparents emigrated from Sicily and came to the United States in the early 1900s, making him a proud third-generation Italian American.4 His parents, aunts, and uncles started their working lives around the beginning of the Great Depression.

Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals
by David Aronson
Published 1 Nov 2006

Either a single large price change or a sequence of similar changes can induce investors to alter their expectations too much. These price changes can feed on themselves, thus generating price momentum that may lead to a bubble or crash. A judgment error that sometimes contributes to positive feedback is mental accounting. This is the irrational tendency to think about money as if it belonged in separate accounts, which should be treated differently. Gains from prior speculative ventures may be assigned to the hot-action account, whereas money accumulating in the home-equity account is treated with greater conservatism.

Blueprint: The Evolutionary Origins of a Good Society
by Nicholas A. Christakis
Published 26 Mar 2019

If the object of one’s assistance becomes permanently disabled, emigrates, or dies, then one’s investment in that person would be lost. But if the problems are temporary—requiring, for example, that you extend a branch to a drowning person while safely standing on the shore—then that person would be a good investment and would make a good friend. A system that allowed a sort of fluid mental accounting for these sorts of exchanges would be very valuable. Evolving the capacity to help others when they need it and when it does not cost much, as well as the capacity to track such connections, would be useful, evolutionarily speaking, for all involved. Tooby and Cosmides argue that, in foraging societies, infection, injuries, food shortages, bad weather, bad luck, and attacks from other groups were constant threats with major evolutionary impact.

The WEIRDest People in the World: How the West Became Psychologically Peculiar and Particularly Prosperous
by Joseph Henrich
Published 7 Sep 2020

This suggests that not only do our mentalizing abilities allow us to think about supernatural beings, but that those with superior mentalizing abilities may be more inclined to believe in gods, ghosts, and spirits because they are better at conjuring the richness of their minds. One piece of evidence for this idea is that Americans, Czechs, and Slovaks with better mentalizing abilities and greater empathy are more likely than others to believe in God. The impact of mentalizing accounts for the common observation from global surveys that women are more likely to believe in God than men. Across societies, women are better than men at mentalizing and empathy. Once we adjust for men’s inferior abilities, women and men don’t differ in their belief in God or other supernatural agents.

Rationality: From AI to Zombies
by Eliezer Yudkowsky
Published 11 Mar 2015

“But,” you say, “dollars are fungible; a dollar you use for one thing indeed cannot be used for anything else!” To which I reply: But human beings really aren’t expected utility maximizers, as cognitive systems. Dollars come out of different mental accounts, cost different amounts of willpower (the true limiting resource) under different circumstances. People want to spread their donations around as an act of mental accounting to minimize the regret if a single cause fails, and telling someone about an additional cause may increase the total amount they’re willing to help. There are, of course, limits to this principle of benign tolerance.

Strategy: A History
by Lawrence Freedman
Published 31 Oct 2013

Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–458; “Rational Choice and the Framing of Decisions,” Journal of Business 59, no. 4, Part 2 (October 1986): S251–S278. 15. Richard H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1, no. 1 (March 1980): 36–90; “Mental Accounting and Consumer Choice,” Marketing Science 4, no. 3 (Summer 1985): 199–214. 16. Joseph Henrich, Steven J. Heine, and Ara Norenzayan, “The Weirdest People in the World?” Behavioral and Brain Sciences, 2010, 1–75. 17. Chris D. Frith and Tania Singer, “The Role of Social Cognition in Decision Making,” Philosophical Transactions of the Royal Society 363, no. 1511 (December 2008): 3875–3886; Colin Camerer and Richard H.

The Better Angels of Our Nature: Why Violence Has Declined
by Steven Pinker
Published 24 Sep 2012

In fact, most of the residents—ranchers, farmers, insurance adjustors, even lawyers and judges—held beliefs about the applicable laws that were flat wrong. But the residents got along by adhering to a few tacit norms. Cattle owners were always responsible for the damage their animals caused, whether a range was open or closed; but if the damage was minor and sporadic, property owners were expected to “lump it.” People kept rough long-term mental accounts of who owed what, and the debts were settled in kind rather than in cash. (For example, a cattleman whose cow damaged a rancher’s fence might at a later time board one of the rancher’s stray cattle at no charge.) Deadbeats and violators were punished with gossip and with occasional veiled threats or minor vandalism.