Role Of Money

. Except for the very poor where money coincides with survival, money is a proxy for points on a scale of self-regard and achievement. We keep a score of rewards, punishment, promises and threats in our heads. They shape our preferences and motivate our actions, ie

. we refuse to cut losses when doing so would admit defeat

. we are biased against actions that could lead to regret

. sharp distinction between omission and commission

. not doing and doing

NB the sense of responsibility is greater for one than the other and is linked with our emotions, ie a form of mental self-dealing or accounting that inevitably creates conflicts of interest. For example, we hold several bank accounts like for things like general savings, educational, medical emergencies, etc. There is a clear hierarchy in our willingness to draw on these accounts to cover current needs. We favour self-control, ie simultaneously putting money into a savings account and maintaining debit on credit cards.

. Mental accounting = a comprehensive view of outcomes that are driven by external incentives. It is a form of narrow framing that keeps things under control and manageable by a finite mind. Mental accounts are used extensively to keep score like golfers are keener to avoid a bogey than to achieve a birdie; another example: financial research has documented a strong preference for selling winners rather than losers in share trading (disposition effect) rather than the rational approach of selling the share that has the worst future prospect. If you care more about your wealth rather than your immediate emotions, you would sell the shares with the worst future prospects, rather than the winner. An additional issue is the taxation situation: realised losses reduces your taxes, while selling winners exposes you to more taxes. It is an instance of narrow framing

"...The emotions that people attached to the state of their mental accounts are not acknowledged in standard economic theory..."

Daniel Kahneman 2012

. Rational decision-making is only in the future consequences of current investments; justifying earlier mistakes is not included.

. Sunken cost fallacy = the decision to invest additional resources in a losing account when better investments are available. Many organisations "throw good money after bad"and keep investing in a poorly performing project rather than "cutting their losses and running". This is based on not accepting the humiliation of closing the account of a costly failure, ie where the choice is between a sure loss and an unfavourable gamble, the latter is often unwisely preferred. Sometimes a personal interest is involved as closing a poorly performing project will leave a permanent mark on an executive record or at least attempt to postpone the day of reckoning. This can result in the objectives of different stakeholders clashing (agency problem), eg top management wanted to keep the poorly performing activity going while the Board (looking after the shareholders' interests) wanted to stop the project.

. Sunken-cost fallacy keeps people for too long in poor jobs, working on underperforming projects, staying in unhappy marriages, working on promising research projects, etc

 

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