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.