Mental accounting leads to irrational investment decisions from "summary" of The Little Book of Behavioral Investing by James Montier
When individuals engage in mental accounting, they compartmentalize their money into different categories based on various criteria such as the source of the money or the purpose for which it is intended. This can lead to irrational investment decisions because people may treat money differently depending on which mental account it is in. For example, individuals may be more willing to take on higher risks with money that they consider to be "found money" or money that they see as gains from investments rather than their regular income. Mental accounting can also lead individuals to hold onto losing investments because they have segregated these investments into a mental account for "long-term investments" and are unwilling to admit that they have made a mistake. This can result in individuals holding onto losing investments for longer than they should in the hopes that the investments will eventually turn around, even when it would be more rational to cut their losses and invest in more promising opportunities. Additionally, mental accounting can lead individuals to ignore the overall risk of their investment portfolio because they are focused on the performance of individual investments within specific mental accounts. This can result in individuals taking on excessive risk in certain mental accounts without considering the overall impact on their financial well-being.- Mental accounting can cloud individuals' judgment when making investment decisions and lead them to make choices that are not in their best interest from a rational perspective. By understanding how mental accounting influences behavior, individuals can work towards making more informed and rational investment decisions that are based on a comprehensive assessment of their overall financial situation rather than arbitrary mental accounting categories.
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