5 Ways How You Value Money Affects Your Finances

Lee Huffman  Sun, September 4, 2022

Investors value money differently based on their experiences, goals and beliefs. This process is known as mental accounting, and it often affects how we budget and spend our money. Mental accounting can also affect our investment decisions, leading us to make choices that make it harder to meet our goals. Learn more about mental accounting, including how it applies to finance and whether or not you should use it to make decisions.

For more help with financial planning, consider working with a financial advisor.

Mental Accounting Definition

Mental accounting describes how two similar people choose to spend their income based on how each person values money differently. In many ways, these criteria are subjective, and investors weigh each of the categories differently, which complicates the topic even further.

Sometimes, mental accounting is detrimental and can make it harder for investors to reach their financial goals. This can happen when people view money decisions in relative terms instead of absolute terms.

Behavioral economists study the concept of mental accounting and how it affects our financial decisions ranging from daily spending to long-term investing. The concept was defined by famed economist Robert H. Thaler.

How to Use Mental Accounting in Financial Planning

In mental accounting, people treat money differently based on where it came from and how it is supposed to be used instead of treating every dollar the same. With investing and budgeting, people can treat their money differently in many ways. Here are a few examples:

Tax Refunds

Although a tax refund is getting a portion of the money withheld from your paycheck, many people view it as found money. They don’t always respect the time and effort it took to earn that money and, instead, feel that they can splurge when they get a refund. The money, which amounts to an interest-free loan to the government, may be used to fund a vacation, buy a big-screen TV or fund another purchase that they normally wouldn’t make.

If this happens to you, adjust your withholding rates to reduce your tax refund. This will give you extra money in every paycheck. Or consider using the money to build your emergency fund or contribute to this year’s Roth IRA.

Inheritance

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