Mental Accounting
We’re continuing our discussion on way to trick yourself into making smarter money moves. I think in particular the method we’re talking about today, mental accounting, can work really well for streamers.
What is mental accounting?
Mental accounting describes an interesting way that humans think. When we’re looking at some resource that we possess we tend to assign it to a specific category. Picture it like you’re saying that you only use the money in one particular account for one purpose and no other. Perhaps you have certain nicer things you keep to use only when you have company, like a nice bottle of wine.
Just remember: mental accounting is assigning a resource to a specific purpose that isn’t necessarily its only purpose.
When can it be bad?
Mental accounting can work against you. The most common example I can think of is when you have money saved into investments (especially something volatile like cryptocurrency) while at the same time carrying credit card debt. Odds are you’re not doing much better than a 10% return on investment (ROI) on that investment account. However, it’s also likely that the credit card is charging you something like 18%. You’re making a bad financial move if you’re borrowing at 18% and earning 10% on your money. Even if it’s sexier or more fun to be investing it’s more practical to paying down higher interest debt. I go through this debate all of the time with student loan planning clients. The math speaks for itself.
How can I use it to my advantage?
The good news is you can use your own tendency towards mental accounting to your favor!
First, it can help with building an emergency fund. If you’re setting aside money for use in the case of a true emergency and you don’t touch it because of that, you’re making good use of mental accounting.
Next, it can help you reduce spending. One of the most common budgeting methods for people who really struggle with money is called the envelope system. In this system you take physical envelopes and store cash in them for your different budget categories. You cover rent, food, fun, and any other payment you have to make. Once the money runs out you’re done with that spending category for the month. This works really well with covering things like entertainment spending. Even though you have cash in the other envelopes they’re marked for other purposes and you’re less likely to dip in to them for a night out or a new game.
Mental accounting can also help you increase spending, if it’s appropriate. I’ve had several clients struggle with feeling ok spending on things like vacations. They live below their means, they’re saving and investing appropriately, and they love to travel but still they feel guilty. One thing I’ve done is help them set aside a specific account to hold funds for travel. Even though that money could be used for other things the fact that they’re (as a part of a practical budget) earmarking it for travel makes them less guilty when they spend it.
Finally, this also works with business investing. If you keep money in the business that you plan to reinvest you’re less likely to take it out and spend it on other things.
Conclusion
You need to look at your money as a whole picture and make sure that you’re not making silly arbitrage mistakes because of mental accounting. However, it’s also a tool you can use to your advantage if it can help you do some good quality of life spending. The point is that you have to be mindful of it and benefit from it instead of being ruled by it.
You don’t have to figure this out alone. This is what we do- help streamers make great money decisions. If that’s something that sounds interesting to you reach out me or schedule some time for a free consult. You can check out what I do here.
