Mental Accounting
Mental Accounting , coined by Richard Thaler, is the human tendency to treat money differently based on its source, intended use, or label — instead of treating it as fungible . We mentally bucket money into "salary", "bonus", "tax refund", "dividend
Mental Accounting, coined by Richard Thaler, is the human tendency to treat money differently based on its source, intended use, or label — instead of treating it as fungible. We mentally bucket money into "salary", "bonus", "tax refund", "dividends", "lottery winnings" and spend each differently.
Plain-English example
An investor holds ₹5 lakh in a "bonus account" earning 3% in a savings account, while simultaneously paying 14% on a ₹3 lakh credit-card EMI. Economically he should pay off the card. But the bonus is mentally tagged "fun money / Goa trip fund" and stays untouched — a 11%-spread leak driven entirely by labelling.
Other examples
- Treating dividends as "income to spend" while reinvesting capital gains — but in total-return terms they are identical
- Holding cash for "emergency fund" while running a margin loan
- "Playing with house money" — taking outsized risk with paper profits
- Tax refund treated as a windfall, not as your own deferred salary
How to mitigate
Build a unified household balance sheet that nets everything. Force yourself to ask: "Would I borrow at 14% to put ₹5 lakh in savings at 3%?" — that's literally what you are doing.
SEBI caveat
Mental accounting can be useful when it enforces savings discipline (e.g., goal-specific SIPs). The bias is recognising when buckets hurt vs help. Education only.
Related
See also Loss Aversion, Disposition Effect, Anchoring.