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Mental accounting affects financial choices from "summary" of Your Money and Your Brain by Jason Zweig

Mental accounting affects financial choices. It's like a filing system in your mind, where money is divided into different mental accounts based on where it came from or what it's intended for. This can lead to irrational decisions when it comes to spending and investing. For example, imagine you have $100 in your wallet. You might think of $50 as "fun money" to spend on a night out, while the other $50 is "savings" for a rainy day. But in reality, money is fungible - it's all the same, regardless of where it came from or what you intend to use it for. This mental accounting can lead to what psychologists call "budget illusion," where people feel like they have more money to spend in one mental account than another. This can result in overspending in one area while neglecting another, leading to financial problems down the line. Furthermore, mental accounting can also affect how we perceive gains and losses. People tend to feel the pain of losses more acutely than the pleasure of gains, which can lead to risk aversion in certain mental accounts. This can prevent people from taking necessary risks to grow their wealth, ultimately hindering their financial success.
  1. Mental accounting can cloud our judgment when it comes to money. By understanding how our minds categorize and allocate funds, we can make more rational financial decisions and avoid falling prey to the biases and illusions that can harm our financial well-being.
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Your Money and Your Brain

Jason Zweig

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