Mental accounting refers to how people separate and evaluate their money mentally based on subjective factors like the source of funds, intended use, and whether gains or losses are being realized. People do not always treat money as fungible or interchangeable due to mental accounting biases. For example, people are more willing to spend windfall gains like bonuses on unnecessary purchases rather than important expenses. They also take more risks with investment accounts than savings earmarked for emergencies. To avoid suboptimal financial decisions due to mental accounting biases, people should treat all funds interchangeably, have a coherent investment strategy, and avoid overspending leftover budgets.

1. MENTAL ACCOUNTING
Bimarsh Raj Giri
MBA III Semester
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BEHAVIOURAL FINANCE

2. MENTAL ACCOUNTING
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CONSIDER THIS
You bought a theatre ticket for Rs.
100. At the theatre entrance, you
discover that you lost the ticket.
On you way to the theatre to see a play
for which ticket costs Rs. 100, you discover
that you lost Rs. 100 on your way.
Would you buy another ticket
for Rs. 100?
OR Would you buy ticket for Rs. 100?
Loss = Rs.100
People are willing to pay Rs. 100 for the lost Rs. 100, than to pay Rs. 100 for Lost Ticket.

3. MENTAL ACCOUNTING
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Case 1 : You have Rs. 100,000 in your savings account in the bank.
Case 2: You get a Rs. 100,000 bonus.
If you need to spend Rs. 100,000 for a new phone, which Rs. 100,000 would you use?
Savings = Rs. 100,000 = Bonus
People think that Savings are Untouchable therefore one buys new phone using Bonus as Bonus is to Enjoy.

4. MENTAL ACCOUNTING
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We hesitate to add tip to ZOMATO delivery person but we usually easily give
tip away while we are in Restaurants.
People tend to view the same amount of money
differently based on factors like its source, use,
need, etc.
The rational behind this selection of choices is explained by the concept of
MENTAL ACCOUNTING

5. MENTAL ACCOUNTING
Mental Accounting is the set of cognitive operations used by individuals and households to
organize, evaluate, and keep track of financial activities. It is one of the Heuristics i.e. mental
shortcuts to make a judgement.
Mental Accounting was proposed by Richard Thaler. He has Nobel Prize for his contribution to
Economic Sciences.
Mental Accounting causes people to separate their money into separate “accounts”, often based on
specific criteria such as source of money and the intent for each amount.
For instance: We generally take the Bonus or Lottery money for granted while compared to hard
earned money.
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MENTAL ACCOUNTING

6. MENTAL ACCOUNTING
• Account Assignment:
Many People nominally place their money in different accounts broadly categorize into:
Expenditure, Wealth and Income
• Closure
It is natural to close the account when the item is consumed.
• Evaluation
If we are in winning position, we tend to close the account in gain territory.
If we are in losing position, we tend to avoid to close the account as feel losses more to gains.
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COMPONENTS OF MENTAL ACCOUNTING

7. MENTAL ACCOUNTING
• It is Mental Accounting bias, due to which we throw our unexpected gains i.e. tax refunds, bonuses,
birthday money, lottery winnings on less important purchases.
• We tend to keep too much money in cash emergency fund rather investing or paying debt
amount.
• We tend to avoid risk with our sudden or unexpected gains but overdo risk in our investment
accounts, leading suboptimal investment decision.
• We push away important purchase from one account but still spend on other less useful items in
different accounts.
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MENTAL ACCOUNTING BIAS : How it hurts?

8. MENTAL ACCOUNTING
• If Investors treat all the income, expenditure and wealth, irrespective of their source and purpose,
one can avoid adverse affect of Mental Accounting bias.
• Investors can avoid the affect of Mental Accounting bias if they design and have a proper asset
allocation and investment strategy.
• “Money is Fungible”, Get he fungibility concept in mine i.e. There is no difference between Rs 100
note, an another Rs.100 note or Two Rs. 50’s note.
• Be careful with the Budget. We tend to overspend the leftovers rather saving excess budget for
future investment or expenditure.
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OVERCOMING MENTAL ACCOUNTING

9. THANK YOU !!!
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