How to distract yourself from mental accounting?

In the olden days, many people used to keep the money for rent, furniture, groceries and so on, in separate jars. They are being continued even today. We have the same mental accounting approach towards our various pools of assets.

An investor tends to compartmentalise the assets they use for downside protection from the assets we use for upside potential. For example, many investors use small-cap funds to grow their capital or mentally set aside this investment for upside potential. Similarly, an investment in government securities is considered as a safe investment and is used for downward protection as well as for financial needs that we cannot defer. This phenomenon of investors to make decisions based purely on mental categories is known as ‘mental accounting’. Although many a time, they look rational but however, sometimes, it may be misleading and lead to sub-optimal utilisation.

For example, the tax refunds or any unexpected money such as the lottery is often used for impulsive buying because they are not being accounted for in your financial plans. Nevertheless, there is no colour of money and before spending it, you should consciously compare where the money could alternatively be spent on. If all your goals are well-funded and do not require extra funding, feel free to spend such unexpected inflows into your extravagances.

Getting rid of mental accounting

From the perspective of inflows, all-cash can be used for investments. As a matter of fact, you should not care whether this cash is coming from salary, incentive or lottery? However, most people do care about the source of these inflows. To get rid of this, you need to get financially organised. You should be aware of all your income, expenses and track them accordingly. This will help you to avoid the trap of mental accounting.

The second step is to keep track of all your financial goals. You can write it down and know which goals are on track and which one needs extra funding. This will help you to follow something tangible and avoid mental accounting. Finally, if you can get the help of a professional financial planner, it will not only help you to get rid of mental accounting but also, other behavioural biasedness as well.