By Eric Reich
One of the areas that I often see clients get hung up on is that they associate certain funds with a particular use or value. In reality, all of the money you have is your money to be used for anything you need to use it for. This association is known as mental accounting. Basically, what this means is that people place different values on the same amount of money. While not always a dangerous habit, there are certainly instances where it can be dangerous to your financial wellbeing.
Inheritance is the most common situation where mental accounting can lead to problems down the line. I very often hear from clients that “my dad left me that stock and he was really good at investing so I never want to sell it.” While I can certainly understand the emotional attachment to something a loved one left behind for you, it isn’t hard to imagine situations where this mentality can result in disastrous consequences. I can think of dozens of stocks that were a great buy 30-40 years ago that people would never want to own today, or worse, they aren’t even still an existing company anymore. The world of investing is not only constantly changing, but it is doing it at an even faster pace. To assume what was good a long time ago will forever be that way, is simply bad investing. Instead of focusing on the individual stocks themselves, look more towards the use of the funds that your loved one would have wanted you to use that money for. This slight change in focus can help you be more open-minded about the investment options themselves and still honor the gift you were given. While associating a use for the money is still a form of mental accounting, it is one that poses little to no danger to investors.
Examples of bad mental accounting can be the “House Money Effect”, a term common to gamblers. This is where investors associate the money they are investing differently because it came from the results of profits somewhere else and not “their own money”. Once any money is received, it is all your money. There is no such thing as “house money” regardless of whether you won it, earned it, inherited it, etc. The danger here is that people tend to take much greater risks with money that they don’t associate with as “theirs”. For obvious reasons, this is not a great strategy. All investments should be made with the same thought process and risk assumptions. Don’t view a gambling win, a tax refund, a bonus, etc. as being any different than any of your other money, because it is all your money regardless of where it came from. Other examples include the tendency of people to spend more money when using a credit card than when they use cash. I think we all understand the risks in that line of thinking.
Just be mindful of what mental accounting is, and if you find yourself doing it, just ask yourself is this the harmless kind, or the dangerous kind? By stopping to at least recognize that you are doing it, you may be able to protect yourself from a potentially bad financial decision.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Reich Asset Management, LLC is not affiliated with Kestra IS or Kestra AS. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. To view form CRS visit https://bit.ly/KF-Disclosures.
Eric is President and founder of Reich Asset Management, LLC. He relies on his 25 years of experience to help clients have an enjoyable retirement. He is a
Certified Financial Planner™ and Certified Investment Management AnalystSM (CIMA®) and has earned his Chartered Life Underwriter® (CLU®) and Chartered Financial Consultant® (ChFC®) designations. A lifelong resident of Cape May County, Eric resides in Seaville, NJ with his wife Chrissy and their sons ,CJ and Cooper, and daughter Riley.
