We tend to compartmentalize the various parts of our lives Friends, family, work, money,
hobbies, and faith are each parts of our lives we put into separate compartments. Of course, this
often occurs subconsciously.

Compartmentalizing money is also known as “mental accounting.” It reflects how often we
mentally separate the various money components in our minds. There are, however, a few pitfalls
with mental accounting.

One is that trying to track our finances mentally makes it too easy to miss important details or
overlook problem areas. A mental budget, for example, often does not account for everything in
the budget. We tend to perceive things to be better or easier than they really are. A mountain hike
in our minds is easily doable, or a quick stop at the store will not take more than 5 minutes on the
way to an important appointment. In reality, these things take more than the resources we allocate
in our minds.

An easy example of metal budgeting is the impulsive purchase that we excuse as only being $10
or $20. If it’s just $10, we perceive to have the money to cover it. While it may be true for one or
two purchases in a month, the reality is that we give ourselves such permission far more often.
One of my often told cases is about a client who excused frequent dining out, but then did not
have enough money to cover other bills. Those frequent excuses added up to $1,000 per month!
Most of the time, it is not that bad, but the idea is that money is spent without actually accounting
for it.

I see this over and over with clients who engage in mental accounting. To get past it, we must
have a written plan of action for money. Another problem with mental accounting is that it is not
coordinated with other areas of our lives. The goals we want to achieve in life, relationships,
faith, recreation, and work all have an impact on the money compartment. However, by
compartmentalizing each one, nothing is unified or working together.

Common goals are to purchase a home or get out of debt. The success rate with mental
accounting is low, simply because goals take deliberate planning and effort to achieve. This is
where we sometimes have to make hard decisions with our money and learn discipline.
The first step to overcome the problems with mental accounting is to put the budget in writing
and then begin to monitor progress.

R. Joseph Ritter, Jr. CFP® EA is the Executive Director of Zacchaeus Financial Counseling,
Inc., a 501(c)(3) non-profit organization based in Lake Junaluska, NC which specializes in tax
services and financial counseling and planning for low and middle income households.