In his book “A Mathematician Plays the Stock Market” John Allen Paulos tells a story of a man and his wife, who travel all the way to Las Vegas to do some regular touristy sightseeing, and maybe do a little conservative gambling.

Anyway, after a long night out, and losing $1,000 dollars, the hero of the story wakes up to find a $5 chip sitting on the hotel dresser in the room he was staying at. Naturally he thinks of it as some sort of magical sign or omen, jumps out of his bed and runs back down to the casino floor, in such a hurry that, he doesn’t even change out of his green bath robe. He ran to the nearest roulette table and threw the chip onto the red seven, which hit and paid 35-1 on his $5, or $175. 

He then continued to gamble and put the winnings on another single number, which in turn hit, leaving him with $6125. He continued like this for another two wins, leaving him with $7.5M. The casino would not take another wager, saying that they could not afford that payout if he were to hit again. The man ran to the nearest casino that agreed to take the bet. He threw the money on number 8 hitting once again. Ecstatic the man decides to let the £262M ride, only to lose it all on the next spin.

He left the casino and began to walk back to the hotel room where he met with his wife as she was waking up and asked him “Where have you been?” The man replied that he had “Been playing roulette downstairs for the morning.” His wife then responded “Well how did you do?” The man casually replies “Not bad I suppose, I only lost 5 bucks.”

Now in case you didn’t know, this is an example of what is called mental accounting, which was defined by Belsky and Gilovich in 1999 as “The inclination to categorise and treat money differently depending on where it comes from, where it is kept, or how it is spent.” 

The bloke in the green dressing gown had just lost a huge sum of money. But in this somewhat exaggerated example, he never really saw the money as his, and so he was extremely reckless and cavalier with it and the loss didn’t really hurt him. But there’s a lot more to this entry than that of just an academic interest or even an amusing story.

For example, it’s well documented, that people gambling while using a credit card, often place bigger bets than they would if they were using cash. Obviously, the money is the same, but the source for some reason, makes a complete difference. And even if you’re not a gambler, you can probably recognise the truth of this – it’s a lot less painful to pay for something using a card than it is paying with cash that you can see instantly disappear when you spend it. It’s totally irrational I know, but none-the-less it’s still a harsh reality for a great many of us.

Let me now give you another manifestation of this:

Let’s say you set out one Saturday evening to buy a well earned takeaway meal. It’s a very windy day this day, and as you take your phone out of your pocket, you pull a $10 note out along with it, and it blows away and down a gutter. It is gone. You still however continue to walk into the take away and buy your meal for $10. How much has the meal cost you? Most people would say it’s cost $10, and perhaps you’d agree. Assuming you still had enough money on you, you’d certainly continue with your plans to buy your much deserved takeaway.

Let’s imagine now that you get to the same take-away unscathed, you buy your meal for $10, but on the way out, you trip up and tip everything out on to the pavement before even taking a bite. Leaving a perfect pavement pizza for the whole world to see. You now have to go back into the shop again and buy the same meal if you still want to eat. So how much will this meal cost you? Most people would now say it will cost them $20, and may well decide to not proceed to buy it as a result. And yet the financial consequences of both visits to the takeaway are exactly the same. Logic would suggest that both situations are viewed, and reacted to, in exactly the same way. But in reality, that won’t happen for most people.

I’m sure you will agree (I can wait...), this is a huge and fascinating area which straddles the wide and varied fields of psychology and economics, but I still had to bring it to your attention for all of its practical applications to you, both as an individual and or a business person.

As an individual, it’s worth giving some thought as to what extent you use ‘mental accounting’ like this in your day to day life, and whether a more rational and consistent approach to money would have a positive effect on your finances. Because by all rational measures, money is just money. Its source, place of keeping and intended purpose should not really be relevant to its value or how easily you can part with it.

And moving swiftly now from gamekeeper to poacher, as a business person, it’s useful to know that your potential customers usually have a variety of sources for their money, and they are unlikely to treat each of them in the same way. They are attached to some money (cash, earnings and funds with a pre-determined purpose for example) much more strongly than other money, such as winnings, Paypal balances and credit card balances.

When businesses look at ways to increase sales, they usually look at the offer they’re making, their product and their pricing. But they rarely consider how they might exploit the ‘mental accounting’ of their customers, and tap into sources of funds which are valued less highly, and are more easily accessed as a result.

So in order to hopefully open a few of you up now, particularly if you have any kind of money making enterprise, I would suggest it could be worth giving some real thought to this little anomaly of the financial world, because while I’m sitting here all on my little lonesome, doing my best to entertain and educate you all without so much as a buy your leave, a pardon me or even a stray fart from you in your passing by, it would still be nice to occasionally hear from a few of you reader types. I’d be particularly interested as to how you guys think you might be able to use this information to your own advantage (Still waiting...).