Holidays: enjoy the great outdoors and think outside the box!

A daily life shaped by compartmentalisation…

Let us imagine Romain planning a week-long holiday within a set budget. He is likely to divide his spending into categories, allocating specific amounts for accommodation, meals, transport, and so forth. Strictly adhering to a nightly accommodation budget may unfortunately lead him to focus solely on the cost of the hotel room and to reject a more expensive option that could reduce transport expenses or include an attractive half-board offer… and ultimately provide better overall value in line with his financial constraints.

This tendency to make suboptimal decisions due to “mental compartments” has been widely documented. The original experiment on this subject was conducted by Daniel Kahneman and Daniel Tversky¹, who studied how two groups reacted to a loss of $10. The first group lost a banknote intended to purchase a theatre ticket. The second group lost the theatre ticket after having already bought it for $10. While 54% of participants in the second group refused to purchase another ticket, 88% of those in the first group were willing to spend an additional $10. This difference in behaviour cannot be explained without considering mental accounting: the first group feels they have already allocated their spending to the “cultural outings” budget and are unwilling to double it, whereas the second group is effectively replacing an unallocated sum.

This illustrates the mental accounting bias — the tendency to treat sums of money differently depending on their origin, intended purpose (in this case, the “culture” budget), or even their form.

Research on this topic has developed over time, notably through Richard Thaler’s work (“Mental Accounting and Consumer Choice”, 1985²), which provides further examples: spending unusually large amounts at a restaurant after receiving airline compensation, saving for a dream home at a lower return than the interest paid on a car loan taken out simultaneously, or taking pleasure in receiving from one’s partner (despite shared accounts) a gift one had previously declined to purchase due to its cost.

More recent research³ has examined mental accounting when consumption occurs long after purchase. For instance, for a bottle of wine bought for $20 several years ago and now worth $75, 30% of participants believe that drinking it or giving it away “costs nothing”, and only 30% assess the perceived cost of gifting it at $75. However, 55% value it at $75 if it is accidentally broken. Consumption of a previously purchased item is therefore often perceived as “free” until replacement becomes a consideration. At that point, the dormant mental account is reactivated, and a more realistic assessment of the cost emerges.

Finally, a 2015 study⁴ analysed the impact of gift cards on spending behaviour. Participants were given $100 either via a bank card or in the form of brand-specific vouchers (Levi’s or J.Crew). It showed that typical branded items (jeans or jumpers, depending on the retailer) were significantly more popular (56%) among those holding retailer-specific vouchers than among those with general-purpose cards (35%).

…to be avoided in order to broaden the scope of personal finances

In personal finance, the use of funds is often influenced by their origin: lottery winnings, one-off bonuses, or unexpected inflows. A common example is tax refunds, often perceived as good news by households… whereas they simply reflect an unnecessary, interest-free advance to the tax authorities. Conversely, proceeds from the sale of a business after many years of work are likely to be treated with far greater care.

Sound financial management, however, requires treating all money in the same way, regardless of its origin, form or intended use. It also calls for a holistic approach, avoiding compartmentalisation and ensuring consistency in asset allocation so that it aligns as closely as possible with one’s preferences and objectives.

Similarly, costs should not be considered in isolation. For instance, a solution such as life insurance may involve management fees, but these should be assessed alongside the benefits of tax efficiency within the wrapper and its advantages for estate planning. Likewise, it is important to understand the fees embedded within the performance of an investment product (such as funds) compared with explicit service charges, which may be more visible—but not necessarily more expensive.
 

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Only two sections in this article… almost a complete breaking down of barriers!

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