You will be able to explain mental accounting and recognise your own mental accounts.
Darren will happily spend S$80 of his Chinese New Year ang bao money on a dinner he'd never pay for out of his salary. He guards a savings account he calls "untouchable" so closely that he once took a cash advance rather than move S$500 out of it. And he thinks of his CPF as something that belongs to a future version of himself, which in his mind barely counts as money. Every dollar he has is worth exactly the same in the shops. In his head, they sit in different jars with different rules.
Richard Thaler, whose work on the endowment effect came up in lesson 2.4, also described this pattern. He called it mental accounting: people sort money into separate accounts in their heads and treat each account by its own rules, depending on where the money came from, what it's labelled for, or where it sits.
The standard economic model says money is interchangeable. Economists call this fungibility. S$100 from a bonus and S$100 from your salary buy the same things and should be weighed the same way. In real life, people keep score account by account. A bonus is "extra", so it gets spent on treats. Salary is "real money", so it gets budgeted. Savings are "for emergencies", so they stay untouched even when an emergency arrives in the form of a costly debt.
An old experiment by Tversky and Kahneman shows the effect using nothing but imagined money. They asked people to imagine arriving at a theatre and finding they had lost a ticket they'd paid for. Far fewer said they'd buy a replacement than in a second version, where they imagined arriving and finding they'd lost the same amount in cash. The money lost was the same. But the lost ticket came out of the "theatre" account, which now felt overspent, while lost cash came from a general account and didn't touch the theatre budget.
Mental accounts are built from a few sources. Where the money came from is one: salary, bonus, ang bao, a tax refund, an investment gain. What it's for is another, such as rent, holidays, a wedding, or "fun". Where it physically sits is a third: a separate bank account, a CPF account, an e-wallet, cash in a drawer.
Time matters too. People often treat this month's budget as a closed account, so overspending in week three feels like a disaster even if the month before came in well under.
None of this is irrational in the sense of being silly. Money is easier to manage when it's grouped, and nobody can weigh every dollar against every possible use. Mental accounts are a shortcut, and like most shortcuts they work most of the time.
Mental accounts can be a useful tool for discipline. If you label S$200 a month as "holiday", you're less likely to spend it on something else, which is the whole idea behind the sinking funds in Money Foundations, lesson 3.2, Sinking funds: turn a yearly bill into a monthly line. A separate account for your emergency buffer is harder to raid on a whim. Labels can make good behaviour easier.
They become costly when a label stops you from seeing that a dollar could do more somewhere else. The most common examples in Singapore:
keeping a large sum in savings while paying high interest on a card or loan, which lesson 3.3 covers spending windfalls freely because they feel like free money, covered in lesson 3.2 taking big risks with investment gains because it's "the market's money" treating CPF savings as unreal and ignoring them when planning a home purchase or retirement
Darren's untouchable account is a good example of both sides. The rule has stopped him spending his savings on impulse for three years, which is worth a lot. It also stopped him using S$500 of it to avoid a cash advance that cost far more than the interest the savings were earning. The rule was helpful until it met a situation it wasn't built for.
You can't decide whether a label helps until you know it's there. Most mental accounts are never written down. They show up as phrases you use: "that's my bonus money", "I don't touch that", "it's only ang bao money", "the dividends are for fun".
Darren listed his. Salary pays the bills and is watched closely. Ang bao money is for treats. The untouchable account is never used. Investment gains are "house money" and can be gambled. CPF is not real.
Reading his list back, he could see which rules he'd chosen and which had just happened. The untouchable rule was deliberate, and he wanted to keep it with one exception for expensive debt. The house money rule had never been decided at all.
Make your own list of the jars you use and the rule that goes with each. Include the ones you'd be a little embarrassed to say out loud.
List the mental accounts you use, such as bonus money, savings or ang bao money, and the rule you follow for each.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).