What is Mental Accounting?

 

We often assign a different value to

different things but that can sometimes

lead to a negative

consequences.

 

Mental accounting refers to the way

different people tend to perceive

the value of money this is usually

due to individuals subjective criteria

which greatly varies from one person to

another due to many factors for an instance you

might value dollar differently when it's earned

through work compared to when it's

given to you these differences in the

way we classify funds tend to make us spend more and

make irrational decisions about the money a good example

of this is when the person saves up for a vacation

and uses his savings john while having a

considerable credit card debt

at the same time he would probably

categorize his savings money

differently from the money he uses to

pay his debt

and so be left with piling interest

while having some money

sitting in his jar in the end he could

have just

used the money to pay off his debt than

to pay a lot more

interest just to have his vocation fund

separately right the solution may seem

straightforward but people still don't

follow it

another example when a person makes a

rational decision is after receiving

his bonus in his mind this money is just

additional cash so he can waste it

without feeling

guilty about it as a result mental

accounting often leads to poor financial decisions

that will only make your financial situation

worse so be sure that you treat all your

money equally and if you have extra money then

you should use it wisely

 

Relationship between prospect theory and motivation of investor

There is a prospect theory in finance which means “a theory that describes decisions between alternatives that involve risk”. This was the meaning which some websites use to describe prospect theory. In simpler words however prospect theory is decision making under risk. The alternatives out of which we have to decide about, one of our best possible alternative to choose are uncertain, we only know about the probabilities of uncertainty for example this alternative security is 25 percent risky or this one is 60 percent risky etc. Prospect theory directly addresses how these alternatives, which present at the moment are framed and evaluated in the decision making process.

Now we’ll come to the second part that is motivation of investor. To see how prospect theory will affect the motivation of investor we shall first have to see the type of investor. There are two types of investors. One type is related to “risk takers” and other is related to “risk averse” investors. These two terms are self-explanatory so we shall now see how the motivation level of these two types of investors is related to prospect theory.
If the investor is a risk taker then in the presence of many risky securities for the investment purposes, he would go for the risky one alternative.

 For him, the principle would be

“Higher the risk, Higher will be the rate of return”

For him the motivation level will be high, his decision making would be stable. On the other hand a risk averse investor, who avoids risk, will have a low motivation level, because from the ample alternatives available to invest, he may not select any one of them or the chance is that he may select the least risky alternative. That leads to low motivation level to invest.

When we talk about risk, we did not specify it by saying political risk, exchange rate risk in case of international investor or default risk, or the risk inherent in the investment.  At the macro level, in our country or at the micro level, in our organizations, where we urge to motivate investors, so that they come and invest, offering them other benefits and lowering the interest rates in case of investment securities may not be the only attraction for the investors to invest. It depends on the type of investor which affects the decision making and motivation of the investor

 to invest.

So which type of investor are you?