Value of money changes depending upon the effort taken to acquire it

Sandeep just got married to Smita. Both of them had good jobs. Sandeep was very interested in the stock market and decided to quit his job and pursue a career in investing in stocks. Much against the wishes of his wife, he decided to put at stake their measly savings of Rs 1 lakh in the stock market. The first year, he tripled that money to Rs 3 lakh. Brimming with confidence, he became more aggressive. His portfolio stood at Rs 12 lakh in the second year. This led him to trade more and his portfolio was valued at Rs 22 lakh in the third year. With the renewed optimism, he became very confident of his abilities and he started trading more and took bigger bets. One day, as it always happens, the markets crashed. And Sandeep lost all the Rs 22 lakh he had made from the market. Soon after, he quit the market and again took up a job. When Smita asked about the quantum of his losses, he meekly replied that he had lost all their savings of Rs 1 lakh. How much did he lose really? Rs 1 lakh or Rs 22 lakh? Actually, he lost Rs 22 lakh, but he considered that the winnings were not his money. For him, Rs 1 lakh was his money and the rest was his winnings. This is what the Behavioural economists call the concept of “Mental Accounting’’, which is nothing but the tendency to value some rupees less than the others. Money is fungible, that is the notion that one rupee is capable of being used in place of another rupee. However, when individual behaviour is studied, money can become less than completely fungible. Mental accounting is the tendency to give different values to the same amount of money, depending upon how it is acquired, when it is acquired and the amount of effort taken to acquire it. This is very apparent in the stock markets. Those, who are on a winning spree become very aggressive and start trading more, as they consider it as free money. When a stock depreciates in value and investors start making a loss, they are reluctant to accept the loss. They will not sell their losing investments. They hold on to the losses thinking that if they sell, they will take a loss. In reality, the loss has already happened but they feel that they will incur the loss only if they sell. Whether they hold on to the stock or sell, there is no change in the quantum of loss. The other day I was surprised to find the senior director of a leading bank also falling prey to mental accounting. The bank had provided for some losses on their overseas investments. The stock price has started falling. To allay the fears of the investors, the director made an appearance on TV channels and told the investors not to worry about the loss. The bank had not sold the securities and the loss was not booked. Only if they sold the securities the loss could be thought of as real. Other common mistakes of mental accounting are investors maintaining fixed deposit accounts earning an interest of 9% and then having a margin trading account with their brokers paying an interest of over 20%. Faulty mental accounting makes them believe that their fixed deposit account is for safety and the margin trading is for business.