Mental Accounting: Take A Hard Look At Your Members

What is the difference between 50 Dollars and 50 Dollars? Right, there is no difference. Or maybe there is? In a recent study two groups of subjects were asked whether or not they would be willing to buy tickets for a play. One group was told that they had spent $50 earlier in the week to see a basketball game; the other group was told that earlier in the week they received a $50 parking ticket. The first group was significantly less likely to buy the ticket for the play. Clearly people think about money in ways that go well beyond currency value.

How people spend their money is driven by powerful but unconscious intuitive theories. In other words we are not conscious of many of the influences that are encouraging us to spend, save, or borrow money. As credit union professionals you see the “illogic” of many members’ money choices everyday. In order to really help your members, we need to peek into the inner workings of their minds to see how they make choices - and how we can develop products, market, and serve them better.

One core principal of intuitive decision making is illustrated by the following study: Subjects received a hypothetical choice task in which they were asked to imagine a situation in which they had just inherited a large amount of money from their great uncle and needed to decide whether to invest it in a low risk company, a high risk company, treasury bonds or mutual fund. Some people received variants of this “neutral” choice task in which they were told that a large portion of the money was already invested in either one of the alternatives (e.g. the low risk company). The results show what is called the “status quo bias”: People are far more likely to select an option when it is presented as the status quo – the current situation - rather than as one of the alternatives. In other words, choices were not determined by a true preference among the alternatives; rather each one of the alternatives became more popular when it was presented as the status quo.

This tendency to “not choose”, but rather stay with the status quo, is significant as it relates to financial services. First and foremost it implies that it is very difficult to get members to acquire new services since participating generally requires active choice to do so. A member’s decision may have less to do with the value of the product or service and more to do with a “built in” reluctance to change. Let’s say for example you want to encourage customers to participate in a savings plan that automatically transfers a certain amount of money from checking into a savings account. Opting for this plan requires departing from the status quo, which humans are reluctant to do. So what should you do to encourage savings? A better way to boost participation is to offer it as the default with each new checking or savings account. It is easy enough to have an opt out clause for members who don’t want the benefit. As a matter of fact, case studies (e.g. in the auto insurance sector, organ donor programs, retirement plans etc.) have proven that opting in vs. opting out of a program makes a tremendous difference (25% choose a program when opting in versus 75% choice of program when opting out).

An equally powerful basic tendency of financial decision making is driven by the fact that, psychologically speaking, losses loom larger than gains. In other words, the pleasure associated with gaining $100 is lower than the pain associated with losing $100. This powerful psychological dynamic can mean a lot to your credit union.

Let’s say your credit union is offering a great relationship pricing model. You are proposing a mortgage discount of .25% for your most reliable customers or you offer an additional 1% on a money market account. You are presenting what your customer will perceive as a potential gain. But that doesn’t necessarily make them join that program. Think about potential losses, however: Mentally, losses loom large and consequently, people are willing to make changes from their current situation in order to avoid them. So, the real story you need to tell your members is how much they will potentially lose by not acting. Chances are, they will listen AND act!

In order to understand and predict customers’ behavior we need to understand more than just the intuitive theories that drive decisions. We need to understand the mental accounting strategies that most individuals apply. Mental accounting differs from economic accounting models in one fundamental way: In mental accounting money is not fungible! Once allocated to one account it will stay there and be difficult to transfer. Thus, mentally, $50 is not $50! Mental accounts are labeled and they vary with respect to the propensity to consume out of that account. For example most people are more willing to spend an increase in income (raise) on consumer goods than an increase in assets (home equity). Or people are more willing to buy a vacation when they receive $2000 as a gift than as a work bonus. Violating fungibility is a dominant characteristic of consumer financial decision making which needs to be taken into account when offering financial services. When we talk about “getting to know the member better” we mean that we really need to listen and understand the way they think about their money. We need to listen for the “labels” that people put on their money. Then we can help them by creating products and services that are consistent with their real-life needs and goals - as well as their internal decision process.

Thus, peeking into your members’ minds and synchronizing financial services with their mental accounting will ultimately help you to * align services and clients more efficiently prove success of your marketing strategy and predict market behavior more precisely