I was recently reading “A Mathematician Plays The Stock Market” by John Allen Paulos and found an interesting story that resonated with me. I am a firm believer that once revenue is obtained, received or booked it has become yours and may be added to net worth or at the very least acknowledged as temporarily YOURS. There is no such thing as the “houses money” in my books, a loss is taken at face value with no justification. When you justify mistakes you do not learn the all important lesson rooted within it. Now here is a story that may illustrate exactly how ridiculous the concept of the “houses money” really is.
A man and his wife travel to Las Vegas to sight see as well as conservatively gamble. After a long night out, (and losing $1000 dollars) the man wakes up to find a 5 dollar chip sitting on the hotel dresser. He thinks of it as some magical sign or omen, springs out of bed and runs down to the casino floor, in such a frantic pace, he doesn’t even change out of his green bath robe. He ran to the nearest roulette table and threw it on to the red seven, which hit and paid 35-1 on his $5, or $175. He then continued to gamble and put the winnings on another single number, which in turn hit, leaving him with $6125. He continued this feat for another two wins, leaving him with $7.5M. The casino disagreed and would not take one last wager saying that they could not afford that payout if he were to hit again. The man ran to the nearest casino that agreed to take the bet. He threw the money on number 8 hitting once again. Ecstatic the man decides to let the 262.5M ride, only to lose it all on the next spin.
The man left the casino and began to walk back to the hotel room where he met his wife who was waking up and had asked “Where have you been?” The man replied that “I have been playing roulette downstairs for the morning.” His wife then responded “How did you do?”
The man casually replies “Not bad, I lost 5 bucks.”
The story of The Man in the Green Bathrobe illustrates a concept known as “mental accounting”. Mental accounting is a tendency to value some dollars less than others and thus to waste them.
“More formally, mental accounting refers to the inclination to categorize and treat money differently depending on where it comes from, where it is kept, or how it is spent.” (Belsky and Gilovich 1999)
A person who has paid $10 for a ticket to a movie is less likely to pay for another ticket if he or she loses it than a person who loses $10 on the way to purchase the movie ticket is to cough up an additional $10 to buy the ticket in the first place. Why is this the case you might ask? It is because you assign a value of $20 to the movie in one scenario, where as your write off the first $10 and assign a $10 cost to the ticket in the second scenario. This is another example of mental accounting and the biases that can be attributed to it, depending on which accounts money is taken from or going to.
Think twice next time you use mental accounting, attempting to catch yourself and act a little more rational just by acknowledging your limitations/biases as a human.
Check out 5 Summer Readings for the Capital Market Enthusiast for some summer reading ideas.