We all like to think we make financial decisions rationally. Yet, why does spending with a credit card often feel less painful than paying in cash? Or why might an emergency fund be treated as untouchable, even when debt payments are due? These subtle behaviors reflect a concept in economics known as “mental accounting”, which, often without us realizing it, can hinder our overall financial well-being if left unaddressed.

What is mental accounting?

Mental accounting refers to how people mentally organize and allocate their money into different categories they create for themselves. The concept was introduced by American behavioral economist and 2017 Nobel Memorial Prize in Economic Sciences recipient Richard H. Thaler in his 1985 Marketing Science journal article, Mental Accounting and Consumer Choice.1

Through his extensive research in behavioral economics, Thaler observed that this behavior isn’t new. Individuals and households have long divided their wealth into distinct “buckets,” setting aside certain amounts of money for specific purposes.² Similar patterns can even appear within companies through budgeting practices. However, because human judgment is subjective, this tendency can lead people to make decisions that aren’t always rational or financially optimal.²

How does mental accounting affect spending, saving, and investing?

On spending

One of Richard Thaler’s key arguments is that the mental accounting bias is revealed in how people spend money differently depending on how they receive it.¹ For instance, when money comes unexpectedly, such as from a “windfall” like a tax refund or a bonus, people often feel more comfortable spending it freely than they would their regular income. Thaler himself illustrated this tendency in a 1990 article, Anomalies: Saving, Fungibility, and Mental Accounts, where he described winning $300 from a college football betting pool and immediately thinking about splurging on champagne, dinner, or a play.³

However, this mindset can become problematic when individuals have other financial obligations, such as credit card bills, student loans, or outstanding debts. By labeling windfall money as “fun” or “discretionary,” they may overlook more urgent financial priorities.⁴

On saving

In a similar light, mental accounting can affect financial decisions around one’s available savings. Traditional economists often argue that limited borrowing stems from a lack of access to credit. However, Richard Thaler offered a different perspective, suggesting that some individuals and households are not necessarily constrained by the market, but rather by self-imposed mental rules that shape their borrowing behavior.³

As Thaler explained, some people “simply do not like to be in debt.” Even when they have substantial assets or access to affordable borrowing, they often choose not to use it. He supported this view with several studies, including one revealing that many elderly homeowners avoid new mortgages or reverse mortgages, even when these could enhance their financial flexibility and improve cash flow. He observed that reverse mortgages have been “extremely unpopular, in part, because they are called mortgages."⁵

On investing

Mental accounting also influences investment decisions in several ways. Thaler observed that investors often separate their portfolios into "safe" and "risky" accounts, believing that this division protects their wealth from potential losses. In reality, overall returns remain the same; the difference lies in the psychological comfort such distinctions provide.⁶

Another related concept is "myopic loss aversion", which explains why investors who check their portfolios frequently tend to become overly cautious and risk-averse. The term was first introduced by Thaler and economist Shlomo Benartzi in 1995,⁷ and has since been explored in several subsequent studies. In a 1997 study, Thaler and fellow behavioral economists found that participants who received frequent portfolio updates allocated roughly 59% of their funds to bonds, while those who reviewed their portfolios annually or less often invested more heavily in stocks.⁸ This behavior highlights how short-term "mental accounts" can influence investment decisions, often leading investors to prioritize short-term comfort over long-term growth.

Final thoughts: the real way to overcome mental accounting biases

Throughout Thaler’s research, one clear takeaway stands out: the best way to overcome mental accounting bias is to treat money as fully interchangeable, no matter where it sits.1,6 Whether received through a regular income stream, as a bonus, or as a gift, a dollar holds the same value. Learning to see it that way helps us make decisions based on what’s truly right for our financial goals, not on the mental categories we’ve created.

Of course, we’re all human, and bias is part of how we think. The key is recognizing these biases and making conscious choices, so that our financial decisions serve our goals, rather than the mental rules we’ve unconsciously set.

For further perspectives on mental accounting and related ideas, explore UBS Nobel Perspectives & Economic Views to access insights informed by Richard Thaler and other Nobel laureates in behavioral economics.

References

  1. Thaler R.Mental accounting and consumer choice. Marketing Science, 1985.
  2. UBS.Richard H. Thaler: Perspectives on Nudge Theory & Behavioral Economics. UBS Nobel Perspectives, 2026.
  3. Thaler RH.Anomalies: Saving, fungibility, and mental accounts. Journal of Economic Perspectives, 1990.
  4. Cookson JA, Gilje EP, Heimer RZ.Shale shocked: cash windfalls and household debt repayment. National Bureau of Economic Research, 2020.
  5. Venti SF, Wise DA.Aging, moving, and housing wealth. In: Wise DA, editor. The Economics of Aging. University of Chicago Press, 1989.
  6. Thaler RH.Mental accounting matters. Journal of Behavioral Decision Making, 1999.
  7. Benartzi S, Thaler RH.Myopic loss aversion and the equity premium puzzle. Quarterly Journal of Economics, 1995.
  8. Thaler RH, Tversky A, Kahneman D, Schwartz A.The effect of myopia and loss aversion on risk taking: an experimental test. Quarterly Journal of Economics, 1997.