How do we decide what to buy and how much to save, and how do we experience these financial transactions?
For his work in answering such questions, the US economist Richard Thaler won the Nobel Prize in economics in October.
Although investors diligently pay attention to the economy, jargon-laden papers and impenetrable economic theories can often seem irrelevant to their concerns – but that’s not the case as far as Thaler’s work is concerned. There are many lessons we can extrapolate from his academic work.
For instance, in his 1999 journal article, ‘Mental Accounting Matters’, Thaler argues that we divide our money into different ‘mental blocks’ even though money is ‘fungible’, which means it’s interchangeable for different purposes.
For example, we will spend more money on a credit or debit card when we shop than we do when we use cash, and we’re less likely to remember the amount we spent too. That’s because paying by card mentally decouples the purchase from the payment. So leave your cards at home when you go shopping if you are on a tight budget.
Similarly, the acclaimed Nobel Prize winning psychologists Daniel Kahneman and Amos Tversky found that people are less willing to buy a second ticket to a play after having lost their ticket, than they are to pay for a seat after losing an equivalent sum of money.
Buying a replacement ticket does not appeal to people because it is included in the ‘mental account’ for going to the theatre, unlike the loss of a random cash sum.
The committee lauded Thaler for making ‘economics more human’. When asked how he planned to spend the prize money, he answered: ‘Irrationally’.