Mental accounting

Mental accounting is a psychological phenomenon in behavioral economics. In this process, people divide their money into different mental accounts rather than viewing it as a single, interchangeable resource. The term was coined by Nobel laureate Richard Thaler. This behavior leads to the origin or intended use of capital determining how riskily or rationally it is managed.

A classic example from the field of financial investment is the separation of dividends and capital gains. Investors tend to view dividends as additional income for consumption, while the invested principal remains untouched – even though, from an economic perspective, both positions constitute the same total value, aside from the different tax treatment of dividends and capital gains in the case of a Swiss private investor. The «play money account» for risky speculations is also a form of mental accounting: losses in this account often hurt less because they have already been mentally written off, while the retirement savings account is often managed conservatively.

This categorization violates the principle of fungibility (interchangeability) of money. The problem with this is that it distorts the perception of overall risk and often leads to suboptimal decisions, such as maintaining expensive overdrafts while simultaneously saving in a non-interest-bearing account. Those who understand mental accounting can evaluate their portfolio more objectively and avoid the trap of emotional earmarking.

Since every investor has a single overall financial situation with a specific risk tolerance, True Wealth implements the client-specific investment strategy as a single, holistic overall strategy. This is also more transparent and efficient in terms of administrative handling for tax returns. You can learn more about mental accounting in the video podcast with Felix Niederer.