What is... | June 11, 2015

What is house money?

Imagine a scenario in which a woman enters a casino with EUR200, gambles and is lucky enough to win another EUR200. She then wagers the winnings in a much more aggressive manner – simply because she views it as “house” money from the casino.

This scene illustrates the wider term “house money”, referring to money people don’t feel completely entitled to and may treat differently as a result.
It’s as if the money belongs to the “house”, not us. It may feel like an unearned windfall that’s not really our own. Because of that, it can be easier to spend.

Funny money
One euro note is the same as any other euro note; they can be swapped to save or spend however we like – this is known as the fungibility of money.
Yet the way we account for income in our heads means we are inclined to treat money differently depending on the context in which we receive it.

What’s the difference?
The house money effect was explained in a classic 1990 behavioural economics paper by Richard Thaler and Eric Johnson.
They noted that investors are more likely to buy risky stocks after profiting from a previous trade.
Money received from one source or in one way may be treated as more valuable than another.
“After a gain, subsequent losses that are smaller than the original gain can be integrated with the prior gain, mitigating the effect of loss aversion and facilitating risk-seeking,” Thaler and Johnson wrote.
“The idea is that until the winnings are completely depleted, losses are coded as reductions in a gain, as if losing some of ‘their’ money doesn't hurt as much.”

A taxing question
Compare a tax rebate to regular monthly pay.
We might think about these two income groups differently – perhaps based on various thinking traps, how we perceive risk, loss or gain, and sometimes in ways we think will benefit us.
As a result, we tend to handle the two income groups differently – perhaps feeling freer to splurge with the rebate.

On the house?
In Western Australia, “free money” bonuses  were offered to first-home buyers in 2013 to choose new homes.
As a result, nearly half of properties bought by first-time buyers in 2014 were new, up from one in four.
But the availability of such additional funds or “house” money can encourage people to take riskier decisions – perhaps buying more expensive homes than they would have done.
The house money effect tempts us to take more risk, perhaps just at the point when we’re beginning to benefit from savings based on prudent financial decisions.

Taking control
On the positive side, the house money effect can also be thought of as a control mechanism.
Separating our main sources of income from any extra or “house” funds can help us set clear boundaries for our spending.
This means it is possible to have a good night out without breaking the bank.

BehaviourRiskMental accounting

eZonomics team
.(JavaScript must be enabled to view this email address)