A renowned psychologist and a Nobel Prize winner in economics have explained mental accounting. He added further detail in his book “Thinking Fast and Slow”.
He stated that “We grab our money in different accounts, which can sometimes be physical and sometimes only mental. We have spending money, general savings, and trademark savings for our descendants’ education or for medical emergencies.
There is a clear hierarchy in our willingness to draw on these accounts to cover current needs”. He further adds and points on that we use mental accounts for mastering our desires and impulses as well.
Money or wealth is also divided into mental accounts. A proverb saying, ‘Wealth, too, is often separated into various mental accounts.”
This can lead to the weird responses and reactions of simultaneously borrowing at a high rate of interest and saving at a low rate or in other words by keeping money in a savings account. While maintaining an outstanding balance on a credit card that charges interest at more than 20% per year.
How is all this linked to insurance and mutual funds?
Insurance policies as they are sold are more accustomed to the concept of mental accounting.
If someone buys a child-plan ULIP (Unit-Linked Insurance Plan), they are essentially saving money for the education needs of their child. If a person buys a pension plan, they are saving money for retirement.
These days there are even women who have only insurance plans, which are apparently structured to meet the investment needs of women rather than men.
As mentioned earlier cash is something that I freely interchangeable with another in satisfying an obligation. We can run a systematic investment plan (SIP) in a mutual fund and still save money for our retirement or our child’s education.
But it does not sound the same. In our mind, we are not doing anything adequate for our child or neither are we planning for a retirement conducive to our mental ease.
Sometimes when we look back we remember seeing an insurance advertisement which shows a young woman planning to study abroad and her father being worried about it until he comes to know that she has already saved money for her education by investing in an insurance policy. I know the phrase ‘investing in an insurance policy’ sounds weird, but that’s how things have evolved in India.
The point is that the woman in the advertisement did not have to buy an insurance policy to save money for education, she could have bought a mutual fund as well but she did not.
Let’s introduce a logical conclusion, it is important that mutual funds play the mental accounting game as well if we just talking about fantastic annual returns over a period of five or ten years.
Their approach towards marketing mutual funds is very repetitive and they also need to tell the potential consumer what mutual funds can be used to save money for making it as a simple yet very powerful insight.
Are you confused about what to buy between Insurance and Mutual Funds? Contact MoneyMindz free financial advisory service and get more options.
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