We are all mental accountants, the Nobel Prize-winning psychologist Daniel Kahneman says. That is to say, "we keep our money in different mental accounts for which we have different rules." For instance, how much do you spend for a vacation? How much do you put into savings for your children's education?
Kahneman points out that mental accounting can be a sensible thing if it is used as a tool of self-control. However, in the video below, derived from Kahneman's lesson on Big Think Edge, the only forum on YouTube designed to help you get the skills you need to be successful in a rapidly changing world, we see how mental accounting can also make fools of us.
For instance, investors tend to view each stock that they buy as a mental account. They want to sell it when it is a winner. So they tend to sell their winners and to hang on to the losers in their portfolio. "That turns out to make them substantially poorer than if they had done things differently," Kahneman says.
And so the key to thinking our way out of this problem, Kahneman says, is "you’re better off if you frame things broadly, if you have very limited emotional responses to small gains and to small losses. That tends to induce better decision-making."
Watch the video here:
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