We all have quirky behaviours when it comes to managing money. One trick we fall victim to is called mental accounting. We separate our money into different types of mental accounts, with different rules, depending upon how we get it, how we spend it, and how it makes us feel.

An easy example is when you have a fund set aside for something like a vacation or house down payment while at the same time carrying high-interest credit card debt. Or how you decide to spend a $1,200 tax refund versus what you’d do with $100 per month if you had the right amount of tax coming off your paycheque in the first place.

I’m guilty of mental accounting every month when I budget $1,000 for groceries, $200 for dining out, $125 for clothing, and $75 for alcohol. I manipulate those mental accounts all the time, like when I overspend in one category and just take it out of another (shifting a meal from ‘dining’ to ‘entertainment’ for example).

The Mental Accounting Challenge

Mental Accounting and How We Spend Money

Why do we assign money to these mental categories? One answer is to control how we think about it. If we were perfectly rational and could figure out the opportunity costs and complex trade-offs of every single financial transaction then it wouldn’t matter how we label our money – it would just come from a big pool called ‘our money.’ It’s just money, after all; totally fungible and interchangeable.

But because we’re human with cognitive limitations and emotions we need help with our money decisions. That’s where mental accounting comes in and acts as a useful shortcut for what decisions to make.

Another interesting way we classify our financial decisions has to do with the length of time between when we bought an item and when we consumed it.

Nobel Prize winner Richard Thaler studied wine purchases and consumption and found that advance purchases of wine are often thought of as investments. Months or years later, when the bottle is opened and consumed, the consumption feels free, as if no money was spent on wine that evening.

Think of a couple that prepays an all-inclusive holiday to the Dominican versus a couple who books their flight and hotel, but opts for a-la-carte dining and entertainment options. The all-inclusive couple probably paid more for their trip, but since it was prepaid and all of their drinks, food, snorkelling and surfing is included, they likely had a more enjoyable experience than the couple who saved money on flight and hotel, but then had to pay as they go for everything else – feeling the pain of every purchase in the moment.

In the personal finance world, one common way to try and save money is with a ‘no-spend’ challenge for a day, week, or month. The idea is pretty straightforward – try not to spend any money. What we’re really doing is playing a mental trick on ourselves.

It’s damn near impossible to go a day without spending if you think about your money as one big pool of interchangeable dollars. Let’s say your rent is $1,200 and it comes out on the 1st of the month. Does that mean you don’t spend any money on rent from the 2nd to the 30th? Or is it that rent actually costs $40 per day and you simply prepay it at the beginning of every month?

The same can be said for insurance, groceries, gas, electricity, the list goes on. It’s easy to game a no-spend challenge the day after your fridge was filled and your bills were paid.

Indeed, when we talk about a no-spend day what we really mean is we’re not going to violate or manipulate our spending rules today.

Final thoughts

Behavioural economist Dan Ariely says mental accounting is perfectly normal. We’re real people after all, with emotions and stress and annoyance and deadlines and a lot of other things to do.

If we have to think about the pros and cons of our decisions every time we want to buy a specific item such as coffee, gas, an app, or a sandwich, it’s going to be a huge pain in the butt. The creation of complex budget categories often gets people to stop budgeting altogether.

Instead, if you have a hard time controlling your spending, Ariely suggests you decide how much you want to spend on a broad category of ‘discretionary items’ – things you can live without, like special brew coffee, fancy shoes, or a night of drinking.

Take that amount, on a weekly basis, and put it on a prepaid debit card. The opportunity cost of your decisions in this general category will be more apparent and more immediate. It still requires effort, but it’s not as annoying as separate accounts for coffee, beer, and Uber.

According to Ariely, this is one way we can use mental accounting in our favour while recognizing the complexity and pressures of our real lives.


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