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Using Clients’ Mental Accounting for Better Planning

March 12, 2018

People often use mental accounting to apportion their money into conceptual buckets. This can lead to poor financial choices, Cicily Maton tells the Wall Street Journal. But financial advisors can harness this tendency to separate streams of income to help steer clients right in difficult times, says Maton, a senior financial planner with the Planning Center in Chicago.

One example of mental accounting is how people treat $10 they find on the street. Typically, they view it as money they haven’t earned and therefore don’t feel the need to allocate it in the same way they would $10 from their regular income, according to Maton.

The same logic comes into play when people view a tax refund as a bonus. Advisors, however, can help clients recognize that the refund is in effect their own deferred earnings, Maton tells the Journal.

The key is getting clients to realize the negative effects of mental accounting and then using it to reinforce healthier ways to view their money, she tells the newspaper.

It helps, says Maton, if advisors can then get clients to consider their financial goals in terms of their values. So, instead of putting the goal as “paying off the mortgage,” for example, advisors can help clients view it as “gaining financial freedom.”

Similarly, advisors can use mental accounting to counter clients’ fight-or-flight impulses, according to Maton. During the 2008 crisis, her practice held meetings for clients in which they were asked to consider the amount of available funds they would need in the next two years and the money they would need in an emergency, she tells the Journal.

Advisors then showed clients how those funds could be easily accessed from the safer portions of their portfolios — namely, bonds and cash, according to Maton.

This helped clients understand that they were prepared to weather the downturn and wouldn’t have to exit their equity allocation, she tells the Journal.

By Alex Padalka
  • To read the Wall Street Journal article cited in this story, click here if you have a paid subscription.