Definition
Mental accounting leads people to treat money differently depending on its source or intended purpose, violating the economic principle of fungibility (a dollar is a dollar). Examples include treating tax refunds as "bonus money" to spend freely, maintaining a savings account earning 1% while carrying credit card debt at 20%, or risking "house money" (recent gains) more freely than original capital.
lightbulb Example
A trader who is up $5,000 for the month takes riskier bets because they're playing with "house money." But the $5,000 in gains is real money—the risk of losing it is identical whether it came from this month's gains or original capital.
verified_user Key Points
- Treats money differently based on source or purpose
- Violates economic principle of fungibility
- "House money effect" increases risk-taking with gains
- Leads to suboptimal financial decisions