Finding a Ben Franklin on the Sidewalk

Finding a Ben Franklin on the Sidewalk

Imagine you're walking down the street and stumble across a $100 bill...

You look around to see if anyone is searching for this money. No one is. So you decide to keep it.

But how do you use it?

Most of us would choose to spend it – almost right away. We'd take our spouse out for a nice dinner, buy some lottery tickets, or purchase a wish-list item that we've been eyeing for a while.

Now, let's say you get an extra $100 from your employer because you worked on a holiday. In that case... most people hold on to it. It will go straight into a savings account or into an investment account.

Why do we spend the $100 we found on the street differently than the extra $100 we earned at work?

The answer is because of a behavioral bias called "mental accounting": treating money differently based on its intended use or where it came from.

Economist Richard Thaler, who developed the concept of mental accounting, once ran an experiment where he asked a group of people two simple questions. Here's the first question...

Imagine that you have decided to see a movie and have paid the admission price of $10 per ticket. As you enter the theater, you discover that you have lost the ticket. The seat was not marked, and the ticket cannot be recovered. Would you pay $10 for another ticket?

Only 46% of the participants told Thaler they'd buy another movie ticket. Most said they'd skip the movie and go home.

He then asked this question...

Imagine that you have decided to see a movie where admission is $10 per ticket. As you enter the theater, you discover that you have lost a $10 bill. Would you still pay $10 for a ticket to the movie?

Thaler found that 88% of respondents – nearly twice as many – said that they'd still buy the movie ticket.

On a logical basis, these two answers are wildly inconsistent. In both scenarios, you're down $10. So the answers to both questions should be the same.

However, because of the mental-accounting bias, we tend to categorize our money into different buckets.

According to Thaler, we view going to the movies as a transaction in which we exchange the cost of a ticket for the experience of seeing a film. Buying a second ticket makes the movie seem too expensive, since a single ticket now "costs" $20. In contrast, since we don't post the loss of the cash to the mental account of the movie, we're still fine to spend $10 on a ticket. Fascinating, isn't it?

Most of us are guilty of mental accounting... especially with our investments.

We place a different value on money that we inherit versus money that we earn from our jobs. We place a different value on cash from tax refunds and end-of-year bonuses versus the cash in our 401(k). As a result, we invest money differently...

Many studies have shown that people tend to label additional income either as "regular income" or as a "windfall gain." Folks are more likely to spend or aggressively invest windfall gains compared with regular income.

You'll often see investors use their end-of-year bonuses to buy something speculative like cryptos. It's money that you were not expecting, so you might as well have some fun with it and gamble, right?

We also mentally label money based on its intended use. For instance, you've probably said this once or twice in your life: "It's only my play money."

When investors put "play money" into the markets, they often throw out all their normal investment rules – no protective stop losses, no sensible position sizing, etc...

Your money is your money. While it's fine to set aside part of your wealth for speculations, that doesn't mean you benefit from throwing it carelessly away.

We're several weeks into the new year. It's time to make some changes to how you perceive your money.

Always remember that every dollar in your possession has the same value regardless of its origin or how you intend to spend it. Losing $1,000 in the stock market is the same as spending $1,000 to fix your car's transmission or losing a $1,000 wad of cash on the street.

To overcome the mental-accounting bias, a great strategy is to follow proper asset allocation and diversification... something we'd recommend to help you keep your investment goals on track (for more reasons than this bias). It's a framework for how to invest the money you have – however you got it.

But figuring out what to invest and how much money to put in each of your investments takes a lot of time and work.

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Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
January 27, 2025