Question

Explain the concept of mental accounting and how it impacts financial decisions.

Explain the Availability Bias. Explain the example using CNBC I spoke of in the slides.

Explain the concept of mental accounting and how it impacts financial decisions.

Explain the Availability Bias.

Answer 1

Mental accounting : In this behavioral bias, an individual creates different categories for money and assigns different amounts of money to these categories. These categories are chosen arbitrarily and have no financial basis for these categories. Money in the savings accounts and money in the brokerage account is treated differently, when people are affected by this bias. Money obtained from salary and the money obtained from capital gains are also treated differently. So, this bias makes people take disastrous financial decisions. We should treat all money the same, if it is earned or obtained from any source.

For example, if we are holding a large sum of debt on our credit card and also holding significant cash balances on or savings accounts ,which is hardly earnings any interest for us, We delay paying out credit card bills and continue paying interest on it, even though we have idle cash kept in our savings account. This is not a wise decisions the person is suffering form mental accounting bias.

Availability bias:

When an individual is affected by this bias, then he readily agrees to the information which is easily available to him. Things that come readily to the mind, are accepted as a result it affects out ability to think and hence take valid decisions.

An investor recently came across anew article that a company has launched a new product and it has new growth opportunities open for itself. Just on the basis of this news, an investor purchases this stock and soon suffers huge losses as the product failed to be accepted by the market as a result the stock crashes. So, here the investor did not carry out research and readily accepted the information presented to him in the newspaper and hence he suffered due to this.